ADTRAN Holdings Inc (ADTN) 2003 Q3 法說會逐字稿

Good morning. My name is Monica and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the ADTRAN third quarter earnings release 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 one on your phone key pad. Questions will be taken in the order they are received. 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 judgment based on factors currently known. However, these statements involve risks and uncertainties including the successful development and market acceptance of the new products. The degree of competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies and other risks detailed in our annual report on form 10-k for the year ended December 31st, 2002. Such risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which may be made during this 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. I also would like to welcome everyone to our third quarter conference call.

As you have seen this morning, ADTRAN's third quarter results generated a 20% revenue growth with GAAP earnings increase of 411% from our prior year results. While the company over the past year has held expenses flat, we have grown our revenue during the year. This has provided the earnings leverage that the company has enjoyed in 2003.

Jim Matthews, our Chief Financial Officer will give you a more detailed look at the company's financial performance, and after his remarks, then we will give you some more thoughts and get on into the question and answer session.

Jim?

Thank you, Mark.

Good morning, everyone.

As disclosed in the press release, revenue for the second quarter -- for the third quarter, I'm sorry, was $106.2 million sequentially up from $90.4 million in Q2 of '03 and up from $88.2 million in Q3 of '02.

Systems were $53.3 million in Q3 sequentially up 37% from $38.8 million in Q2 of '03 and up 97% from $27.9 million in Q3 of '02. The systems catagory includes revenue from new products comprising NetVanta router and VPN products, Total Access DSLAM products, Optical Access products and additional new products as they are introduced. The systems category also includes revenue from Total Access and Atlas, multiplexers, M13 MXs and integrated Access devices.

HDSL T-1 was $45.9 million, sequentially up from $43.3 million in Q2 of '03 and down from $49.2 million in Q2 of '02. Digital business transport total reach was $7.1 million in Q3 down from $8.3 million in Q2 of '03 and down from $11.0 million in Q3 of '02.

By market, the revenue breakdown for the quarter was 69% for carrier and 31% for enterprise. Carrier network's division revenue were $73.6 million for Q3 sequentially up from $62.1 million in Q2. Revenue increases in this division occurred across multiple customers with the larger increases coming from DSLAM, HDSL and M13 multiplexor products as we continue to gain market share in these and other areas. Enterprise networks division revenues were $32.6 million in Q3 sequentially up from $28.3 million in Q2 of '03.

For the quarter, we continued to experience a sequential revenue increase for NetVanta products accompanied by a significant sequential revenue increase in traditional enterprise network products. Revenue increases occurred across multiple customers and included a significant increase in IAD revenue from an incumbent carrier as we see an increasing interest among incumbent carriers in using AIDs to reduce the cost of delivering services to their customers. Overall, these trends in the enterprise networks division reflect what we believe to be an improving business climate accompanied by market share gains in end user markets.

Revenue from the international sector, approximated 4% of total revenue. Gross margin was 55.5% of revenue during the third quarter of 2003 compared to 54.9% for Q2 of '03 and 51.6% for Q3 of '02. The increasing gross margin is primarily due to continued improvements in manufacturing efficiencies and product cost reductions.

Research and development expenses were $15 million in Q3 of '03 compared to $13.6 million in Q2 of '03.

Billing, general and administrative expenses were $20.6 million for Q3 of '03 compared to $20.3 million of Q2 of '03. Other income, net of interest expense, was $2.4 million in Q3 of '03 compared to $2.2 million in Q2 of '03.

Other income, net of interest expense for Q3, included receipt of a $650,000 cash settlement from a former customer from a prior year. Other income net of interest expense for Q2 included a net gain of $225,000 from the sale of investments. Due to increasing pretax income, our income tax rate for the quarter increased to 33.2%. This puts our year-to-date tax rate for the nine months at 31.5%.

Earnings per share assuming dilution for Q3 of '03 were 42 cents compared to 9 cents for Q3 of '02 and compared to pro-forma earnings per share of 27 cents for Q3 of '02.

The pro-forma presentation last year segregated the financial effect of impairment charges of marketable equity securities and writedowns of private securities. Management believes a pro-forma reporting presentation provides investors with additional insight into a companies operating results.

Additionally, as we announced late yesterday, the company's Board of Directors declared a two for one stock split effective in the form a stock dividend for shareholders of record on December 1, 2003. Split effective earnings per share data are included in the condensed statements of income attached to the press release issued late yesterday.

From a balance sheet perspective, inventories decreased $1 million from the prior quarter to $38.3 million on increased revenue. Trade accounts receivable increased $3 million from the prior quarter to $53.9 million. However, even though inventories -- I'm sorry. Even though revenues increased 17% sequentially, DSOs came in at 46 days for the quarter, down from 51 days in Q2.

Net cash provided by operating activities came in a at a strong $28 million for the three months ended September 30, 2003 and $49 million for the nine months ended September 30, 2003. Cash and marketable securities, net of debt, totaled $278 million at September 30, 2003 after paying special and quarterly cash dividends on August 29, 2003 totaling $83 million.

As you will recall, we discussed guidance for the fourth quarter in our press release issued October 2nd. We anticipate revenue for the fourth quarter to be in a range of $104 million to $107 million with fully diluted earnings per share in a range of 40 cents to 42 cents or 20 cents to 21 cents split effective.

We are guiding gross margins for the third quarter in a range between 54.7% and 55% and operating expenses should be around $35.3 million to $35.7 million. Also, we are guiding interest income net of interest expense to be in the range of $1.5 million to $1.6 million. We are also anticipating a tax rate of approximately 31.5% to 32% for the quarter.

For the year, all of this translates into revenue guidance of $387 million to $390 million with gross margins very close to 55% and earnings per share of $1.40 to $1.42 or 70 cents to 71 cents split effective.

Mark, back to you.

Thank you, Jim.

As everyone is aware, the strength of our third quarter was a continuing surprise to us, causing us to revise up our guidance twice during the quarter. As primarily a book and ship company, our visibility is inherently limited. However, our order rate today remains strong.

In addition to continuing market share gains, our new product offerings, especially our DSLAM product line, has provided the revenue growth we have enjoyed today. Our confidence in both our present position as well as our future prospects, have allowed us to announce a 2 for 1 stock split. We also have had the pleasure of declaring our regularly, quarterly dividend of 15 cents per current share.

At this point in time, Monica, I would appreciate it if you would start the question and answer session. Of course, if anyone has any question for us this morning, which I'm sure they do.

At this time, I -would like to remind everyone, in order to ask a question, please press star one on your telephone key pad. If you are using a speaker phone, please pick up your hand set before asking your question. Please hold for your first question.

Your first question comes from the line of Ryan Molloy with Soundview Technology Group.

Thanks. I just have two questions.

One, can you maybe allude to what percentage of revenue the new product contributed this quarter and with the gross margin guidance for the fourth quarter, is there any possibility with a greater ramp up in your product that gross margin guidance may be a little conservative? Thanks.

Ryan, let me take the gross margin question and then turn the other over to Jim.

50 to 55% as we've said for a long time is our range of budget for gross margin, and we are a little over that now. We do not really think that it's going to continue to ramp up because what we're going to do is- they use that as a significant strategic advantage to allow us to generate market share and revenue. And so no, I would not look for that to ramp up except for maybe a very short period of time because we will be bringing that down to the 55% range that is our budget.

Jim here will take the first part of that.

Sure, Ryan. We're looking at 13% of our revenue year-to-date is attributable to new products.

And where do you think that might be exiting the year, Jim, if you have a target internally?

Mark, would you like to take that?

I would think that it would continue to grow as it has continued to grow significantly during the year, so I would think it would be over 15% by the time we exit the year.

Thanks, guys.

Your next question comes from the line of Sanjiv Wadhwani with Piper Jaffray.

Thanks.

In terms of guidance, clearly, you guys had a tremendous third quarter and looks like visibility is getting better, and the general market conditions are getting better. So I'm curious to see why the flat guidance versus what's going on in your end markets.

Secondly, as far as the new products are concerned, just to clarify, you said 15% exiting the year. Is that the contribution in the fourth quarter just the full year contribution from the new products as a target? Thanks.

Okay. Well, the flat guidance, all we're doing is we're looking at history. And the history shows that the fourth quarter in relation to the third sometimes is up, sometimes is down. It's very difficult to predict. And so since we are a book and ship, and we look at the fourth quarter, we had such a, as we, I don't know, such a strong third quarter, we are loathe on top of that to predict at this very early point in time that kind of a continuing trend.

Now, as we said earlier in the third quarter as it went along, surprised us. The fourth quarter may do the same. We just don't know, but it is very difficult when you are a book and ship company to be able to predict when you see a very strong trend start to develop where they are going to continue or whether it's a short-term thing. The 15%, I think that what we will be seeing is a 15% for the total of the year, which of course would mean that in the fourth quarter you will see a much higher than 15% run rate.

Thank you.

Your next question comes from the line of Nikos Theosodopoulos.

Niko? Nikos, are you there?

Sir, please press star one on your telephone key pad.

Hello? Nikos? Yes, can you hear me?

Yeah, we can hear you now.

Just two quick questions. First on the new products.

Is it fair to say that the DSLAM products representing over half of the new product revenue? It seems like, you know, that's where the biggest deployment's occurring. And on HDSL, this was a decent sequential increase. And I know that you've been gaining additional market share. Is all of this sequential increase this quarter, you think, due to market share gain or is there a slight improvement in just the traditional HDSL business in the quarter?

Thank you.

Nikos, let's take the one first. The HDSL, I think that it's finally both, market share gain as well as a very, very small improvement. And the good thing about saying a very small improvement is it's one of the first times that you can be pretty well sure that it's not a small decline. So yes, I think it's both a combination of market share but also underline maybe the start, let's hope so, of an improvement in T-1 line growth. The DSLAM numbers, I think Jim, you have the more specific details than I do on that one.

Nikos, only in general terms. Your question was in regards to how much DSLAMs make up of the total new product revenues?

Yeah. I mean, it sounds to me based on the press releases that you put out, just the size of the market and so forth it would seem like that product line is contributing over half of the new product revenue. And I just wanted to see if that's a reasonable assumption.

I think that's pretty much a fair statement, yes.

Okay. All right. Thank you.

And Niko, one last point on that. Also the DSLAM was sort of out there first from a time standpoint, so, yes, the market size for DSLAMs is quite large but also for the other new products are also large. They just haven't really been on the market as long as the DSLAM has, so we look forward to their coming on very strongly in the future.

Thanks, Mark.

Your next question comes from the line of Todd Koffman with Raymond James.

Just a follow-up to that.

On the enterprise side, can you give some indication now as to how much success you've had with your branch office router?

Todd, this is Mark.

Yes. The success is following just about the type of time line that we anticipated where we got an initial surge then a flattening. And then a start of a longer term growth curb to come under that. So once again, we are very, very early in the introduction phase. It takes us a while with new products to get the attraction that we like to see. But it has come along quite well and pretty much on target.

We have, as you know, released a number of new models, and new feature sets for the router. And we also have released the IP switch that is going right along with the router ,as we have said before, this is going to be the start of a significant product line for us. It is not going to be just a few products. It is going to be a significant number of products added to that line over the years.

Thank you.

Your next question comes from the line of Steve Levy with Lehman Brothers.

Hi. It's Marcus Cooperschmidt (phonetic) for Steve Levy.

Could you guys break out CLEC (phonetic) sales as a percentage of revenues during the third quarter? And then I had one other follow-up.

Sure, Marcus, in terms of CLEC revenues, we are looking at between 13% and 14% of total for the third quarter.

And in terms of a bigger picture question. The past you guys have talked about trying to get the business back to a 24%, 25% pretax kind of level. And if I look at the 3Q results, it looks like you reached the about 24%. Can you talk about what you think this business, the model could look like a year from now or can you -- do you guys think that you can drive additional leverage given the productivity you guys have been seeing lately in the business?

This is Mark. I think our model of 24 to 25 is a very good long-term model that we're going to stay with. And the reason is pretty basic, that if you attempt to try to drive that model any higher than that, you just build an umbrella for a competitive attack.

We prefer when we're in that luxury position that every now and then you find yourself in, I think we are right now, that being on the high side or potentially on the high side that you are better off to lower your selling prices in those competitive areas, that the ability to low are pricing will generate market share capture for you. That, to me, is the better long-term approach to run the business. So, no, we don't intend to revise up that pretax profit range.

Sure. I guess along those lines as a follow-up, do you guys expect to continue to drive good management of the operating expenses as you guys have been doing in the last few quarters?

Lord, I hope we continue to drive good management. We'll try our best.

Okay, great. Thank you.

Okay.

Your next question comes from the line of Andrew Schopick of Nutmeg Securities.

Thank you and good morning. Couple of questions.

First on the financial side. Foreign exchange gain or loss in the quarter, Jim. Was there a transaction gain or loss in other income there?

About $150,000, Andrew.

Of a gain?

Yes.

Okay. And also, you know, with the business still being a book and ship type business and with the overall environment still lumpy and less than predictable, to what extent do you think there are factors specific to ADTRAN in terms of new products that might mitigate any anticipated seasonality early next year. Are you comfortable commenting at all at this stage about the conditions you expect to see on the carrier side, especially as you exit 2003, going into 2004?

Okay.

We're not, for the reasons that you gave, really comfortable, but we can tell you a few things that we do know. Especially in the new product area. It appears to us that the opportunities in our -- with our new products should continue strong into next year. We have a number of brand new potential opportunities in the DSLAM area that conceivably we could get going into the early part of next year. And so what we're looking at right now is a potential that we might be able to overcome as you say the inherentcies that occur in the first quarter.

I don't think, however, that the opportunities that we're looking at, whether or not we can get those all materialized by the first quarter, is really as important as the fact that they are there and that during the year and earlier part of the year that we think we have a number of opportunities that are going to materialize and that are going to give us some significant revenue enhancements going forward.

One last thing, Jim.

Just in terms of the policy, of course, coming back from the Labor Day holiday in front of your Kaufmann Brothers presentation preannounced then we preannounced again an upward revision. Can you give us some sense of what the metric would be for any subsequent preannouncements? You've given us guidance of $104 to $107 million in revenue. If you were to come up 5% short or be 5% above that in late December, would you preannounce on something that, you know, is 5% or less of anticipated guidance here?

5% or less? Mark, would you like to respond to that one?

Not particularly, but I will. Because 5% of outside the range, 5% away from the center of the range? If we -- if it looks to us like things are going to be -- 5% is sort of that marginal thing that I don't know whether we would or not.

Mm-hmm.

Much past that, the answer would be probably yes, definitely.

Okay, thanks.

Your next question comes from the line of Reg King with the W.R. Hambrick.

Yes, thank you. Mark, I was wondering if you could comment on two areas. One, it sounds to me that you are sounding a little more optimistic on enterprise spending and sounds like you talked about it a little bit. Could you give us some of the, you know, data points of feedback that you have seen in the market, which leads you to that little more optimistic outlook?

And then secondly, can you talk what you may be hearing in the market about this fiber to the home initiative? And do you think that might have any cannibalization on DSL growth next year?

Okay. First, revenue situation in the enterprise space.

As you saw, our enterprise revenue is up, you know, a significant amount quarter to quarter. And we saw that this a number of areas, as Jim said earlier, in the IADs, which is the router that has a built-in telephone exchange as well as high-speed data capability all into a single chassis. That was very, very strong.

Across the board, however, we also saw a firming that allowed us to put that revenue increase together for the enterprise. Previously, we've seen sort of a flat to down type of soft environment, but in addition, I think that what is making us feel good is that there's an awful lot of activity going on and a lot of opportunities out there that are being worked on by our customers that we just didn't see that activity level in the last year or two. And that is what we are really looking at to say that we think that maybe this time around that we don't have a head fake that what we really do have is the start of a stronger growth environment of the enterprise side.

Fiber to the home is a significant distance out there from a cannibalization factor. It is not any time soon going to put a damper, in my opinion, in any of the price lines that we have going. Certainly not in the DSL activity and the DSLAM activity. By the time that we get fiber to the home or be it fiber to the curb or to the neighborhood, that it is starting to be deployed in significant quantities, by the way, ADTRAN, at that point in time plans to be a participant in it, so we would be cannibalizing ourselves as we have done so many times in the past when that time comes.

Right. Thanks, Mark.

Your next question comes from Simon Leopold with Merrill Lynch.

Thank you. Couple of hopefully easy questions.

One, if you could comment on 10% customers during the quarter? And also I'm trying to get my hands around the trends in your DSL business. On one hand, we hear carriers talk about homes past approaching 80%. On the other hand, we look at port shipments and actual penetration being far below that.

If you could talk about your thoughts in terms of where the market's going for your products in DSL and perhaps quantify in terms of ports shipped this quarter versus last quarter? Thanks.

Okay, Simon. Jim, you have the 10% customers, I believe.

Sure, sure. SBC, Verizon and Sprint remain to be our 10% customers. All three of those are increasing from the percentage points that we've published in the 2002 10-k. SBC is now running for the quarter at about 27%. Verizon at about 16% and Sprint at about 12%.

Great.

Just in general, Simon, I don't have specifics but just in general, I think I might be able to shed a little bit of light on the difference between ports shipped and the percentage coverage. If I put a DSLAM into a CO and it has a lot of copper coming into that CO, then I basically have coverage for everybody that's hooked up to all of the copper that comes into that CO.

Now, the DSLAM I put in there may have a 200-port maximum capability and may have 50 ports installed. However, I may have coming into that CO in that port, I mean, in that bay, I may have 2,000 customers coming in. And so I just picked up coverage for 2,000 customers, but I only installed 50 ports. Obviously, as time goes on, I'm going to have to install more ports to be able to cover those customers.

So the fair way to interpret that is we should be paying attention to penetration rates and not homes past?

That is my personal opinion as it relates to the hardware involved. Now, as it relates to the service provider,no. Because he stands ready with his homes past to be able to hook them up. So if you want service and you are looking at service providers, you then want to look at percentage coverage. If you are looking at an equipment supplier like ADTRAN, then you probably want to look at the number of ports that are out there.

Okay, thank you very much.

Okay, Simon.

Your next question comes from the line of Josh Baylon with Legg Mason.

Hey, guys. Josh Baylon (phonetic) here for Timm Bechter. Wondering if the aggregate sales from some of the new opportunities you mentioned for DSLAMs could bring in as much revenue as sales to SBC's for DSLAMs event?

Josh, to start with, I'd lake to comment on your comment on SBC.

We have never confirmed any of our RBOC customers, exactly who they are from a individual standpoint. There, of course, is a lot of speculation out there as to this, that and the other as far as customers, but in general, our RBOC customers do not want us to comment specifically on any of the contracts that we may or may not have. And so let me caution you in regards to the SBC comment.

As far as additional business with the incumbents, yes, we are being evaluated in one form or the other in all of them. I would think that over the next year that we should be shipping and have a successful penetration into at least half if not the majority of the RBOCs. And it appears to me that we are really on the very front end a -- of a significant growth curve as it relates to DSL.

Okay, thanks.

Your next question comes from the line of Eric Buck with Janco Partners.

Thank you, good morning. Two questions again on the DSLAM area.

I was wondering if you could talk about the customer concentration within that segment if not quantitatively, at least qualitatively.

And second, Mark, in your discussion of ports versus coverage count, your description seems to be applicable to the large central office DSLAMs but can you really say the same for the pizza box versions that you've been deploying which aren't expandable from what gets put into the field?

Eric, yes. My discussion was in relationship to the large CO simply because I think that that's where you get the greatest disconnect between percentage coverage and ports installed.

In regards to the DSLAM, I've lost a train of thought if you would tell me what that question was again, please?

Just the concentration. Is there one or two customers that are the bulk of that business or is it more broadly spread?

It's getting pretty broadly spread. We started out with a large number of independents and also IXC's and the incumbent carriers are by definition a longer sales cycle. We have completed that sales cycle, as we have said before, with one as we just finished going into with the other three we're in the process and so I don't really have, Jim, maybe you do, the percentage that we would have with one, but I don't --

Well, in the interest of not naming the particular RBOC, which we discussed before, we are seeing larger volumes from one of the two larger ones.

What I'm saying is that there is concentration, of course, at this point it's not completely overwhelming.

Right.

We do anticipate that concentration, however, over the next six months to be reduced significantly in the proper way. And that is not through it being reduced but through the other. There's other parties increasing much, much faster.

Thank you.

Your next question comes from the line of Tavis McCourt, Morgan Keegan.

Good morning, most of my questions have been answered, but I think you mentioned in the prepared remarks that the IAD business was stronger than you expected and something about incumbent carriers pushing that. My understanding was historically, that was more of a C lack (phonetic) sale. Is that something that you guys have been pushing on to incumbents or something that's really a new strategy amongst the incumbents?

Both of those are true. We've been pushing from day one with the incumbents that the IAD's are a significant approach for them to embrace and we're now starting to see some of the incumbents go along with that position and take it as their own and start to embrace the use of IAD's.

So it's fair to say it is becoming a broad base adoption or one that's being particularly aggressive?

It's broad based but very, very early in the adoption phase.

All right. Thanks.

Your next question comes from the line of Gina Sockolow of Buckingham.

Thank you. What's your depreciation for the quarter?

Gina, it's about $3.8 million.

Thank you.

And the interest income line has me a little bit confused because it's been flatish above $2 million a quarter. Does that include this $650,000 settlement?

Yes, it does.

Okay. So why would it drop - in the third quarter, you already paid out the one-time dividend so the cash declined, so why would - that should have been in the third quarter already. Why would it decline in the fourth quarter?

Well, the $1.5 to $1.6 million number that I mentioned was other income net of interest expense, okay?

Mm-hmm.

So $632,000 roughly of interest expense has been deducted. And also, we do not anticipate an additional $650,000 payment in the fourth quarter. So that's a one-timer so to speak.

Okay. Thank you.

And then my broader question is, can you comment on the demands from the service providers sector? Particularly the RBOC? Are you seeing their spending going? Are they increasingly spending on - of second forces? Are you a second force in those new RBOCs and whether or not they are a second source, are they spending for new builds or replacements in the DSL space?

Thank you.

I'll take that one, Jim.

We are a second source except that not as you might look and think of second sources where for the same product or the same function, you have two suppliers and you give one 80 and the other 20. What we are a source for is for different sized CO's where our hardware would go into the medium and smaller CO's at this point in time where our competition would be primarily in the larger only. And also, ours would go in the remote terminals.

And so yes, there's two sources in general for the DSLAMs. But it's divided upon the different functions and the different types of places that the units would be installed more than just the same functionality being divided between two suppliers.

The second part of your question is that what we're seeing is, in our opinion, a renewed significant interest in access spending. We collate that, at least I do, without any firm confirmation from anybody that an awful lot of that is from a willingness now after the FCC's ruling that gives the RBOCs at least some comfort that if they put in DSL in packetized form that they are not going to have to then turn around and lease that to their competitors at low rates. And I think that the reduction in that concern has spurred a significant amount of access spending. And I think that that is much more of a reason than anything to do with the second source type environment.

Okay. And one other question.

When you said it's also a function depending on functionality. Is that a technology capability or a scalability issue?

Gina, as far as scalability, you don't want, you know, a smaller CO and you certainly don't in a remote terminal, want to install a very, very large system that can only be really efficient when it has a large number of active ports. You want something that is more scalable that scales down more effectively to a smaller size. That is the advantage at this point in time or at least that is one of the advantages that we have with our equipment is that it can scale down to smaller sizes more efficiently.

Thank you.

Your next question comes from the line of George Notter of Deutsche Banc.

Hi, guys. Thanks very much.

A couple of questions on the enterprise business. I wanted to ask about the Ethernet switching initiative. I know you will introduce new products on that end of the business sometime soon. Also, I understand that you guys have gotten into the Dell catalogue for selling routers through that Internet working catalog. I just want to get a sense for what kind of traction you might be seeing there, thanks.

George, it's a little too soon on the Dell situation for us to comment. And I'm not really sure that we can anyway.

Prior to our next conference call, we're going to have to certainly check and see, you know, if we are allowed to comment on that. But anyway, in any regards, that's a little new as far as the particular catalog. We are very happy with the traction we're getting on an across the board basis both routers and also very happy with the interest that we're getting in the initial discussions on our IP switch.

Got it.

And then as a follow up, I think this question was asked differently earlier, but you have a lot of new product addition to the portfolio here. Obviously a handful of products on the enterprise side a handful of additional products on the carrier side. Yet, your expenses, you know, maintained, you know, fairly flat on a sequential basis and continue to. Can you give us a sense for, you know, why we shouldn't see some upward pressure on absolute levels of operating expenses going forward given all of the new product activity? Thanks.

Okay.

The reason in general that we have the leverage with operating expense that we have is that as our revenue fell over the last three years, we did not lower our operating expense at an equal percentage of our revenue decline because we simply didn't - number one didn't have to from a financial standpoint and number two, that was our investment in the future. We're now taking advantage of that effort over the last three years with the new products that we have. And because we didn't lower that expense.

Going forward, we are getting close to the point where, as we talked earlier that we now have an opportunity to raise expense in an equal or less percentage than our revenue. We're not really at that point yet but we're getting close to being able to do that. And as we do, we then can take a look at our expenses such as our sales and marketing and our engineering and put those dollars to work in the most productive manner that we can, be it our decision that the most productive be in engineering on a particular project or in sales and marketing for new market opportunities.

Great, thanks.

Your next question comes from the line of Joanna Makris with Adams, Harkness, & Hill.

Just a quick question with respect to your DSLAM - How much of that would you say in a term tal -- terminal space is new market build o. [ no audio ]

Joanna, about halfway through that, your volume dropped off to where I couldn't hear it. Jim, could you hear that?

Not very well. Joanna, could you repeat?

I apologize. All of your existing DSLAM business, how much of that would you say is driven by new product replacement and new build outs in remote terminals as opposed to existing remote terminal builds?

I would say that the majority at this point in time is still not in the remote terminals, that it's in COs and the build out in the remote terminal area is in the process of being scheduled in the future more so than current. So I would say the vast majority of the DSLAM activity we're seeing is in the CO's with the remote terminals still to come.

And when you look at that remote terminal business to come, do you see it as your product being deployed as the RBOCs move into new market or do you see it as potentially a replacement of existing say digital loop carrier infrastructure that might be in place in existing markets?

I don't think you see much replacement of anything that is there. You're talking about new installations and there may be existing products that would be already there in a remote terminal. We would look at our products as being the products of choice to add to that terminal for expansion of the capability regardless of what happened to be there to begin with.

Thank you.

Your next question comes from the line of Mark Sue with C.E. Unterberg.

Thank you. Because of the mix of products and also the mix of segments, should this December be more linear and less lumpy compared to the September quarter you just finished and also compared to last December?

Mark, I would I -- I would think so, but boy, I tell you, I'm no good at predicting the future. I always break the end with a broken glass. One would think that the December quarter should not be lumpy, should be strong.

Got it. And separately, if I were to ask on the NetVanta product line, are you looking at this stage to partner with some of the other security companies as you look to improve some of the feature sets or is that something you would do internally?

That's something we'll do internally.

Got it. Thank you and good luck.

Thank you.

Your next question comes from the line of Kerry Snyder with Pacific Growth Equity.

Good morning, thank you. This is Kerry Snyder calling on behalf of of Joe Noel from Pacific Growth Equities. One question, gentlemen.

We see the company's gotten a lot of revenues vise-a-vis market share gains and we hoped you could talk about T-1 line growth, which we hear is coming back, but we'd like to get your thoughts on this.

Thank you.

Okay, Kerry. As we said earlier, T-1 lines are - no longer do we look at them as flat to down. We now can look at them as flat to up.

It's just simply too early and it is too difficult for us to be able to be able to pick out between our market share gains and the raw line growth itself to be able to try to give you a number as to how much they're up. But I think that I feel safe at this point in saying that T-1 line growth is turned in and is now up not down.

Thank you very much.

Your next question comes from the line of Michael Perica with Brean Murray.

A couple quick questions. First, Jim. Of the CLIK (phonetic) number you cited of 13 - 14% of revenue, is AT&T still classified as a CLIK?

Yes, they are.

Secondly, Mark, one of the new products I don't believe got any attention is the Opti-3 and MX. Last I checked, you had one major IXC and one ILIK as customers. Is that still the case?

The one major RBOC, yes that is true. The IXC, I think there is more than one.

Okay.

We are in the evaluation - in a just a significant number of opportunities with the both the Opti-3 and the MX. And we would hope that over the next 12 months that we would see some very, very significant upside potential in that product line.

And if I could follow up, please, on the application, are you seeing it evenly split with the wireless base station interconnect and then CPE type applications or is it skewed towards one or the other?

We had one significant application as it related to the wireless infrastructure. The majority of applications, however, are wireline going into office buildings.

Excellent. Thank you.

Your next question comes from the line of Andrew Schopick of Nutmeg Securities.

Thank you. I'd like to follow up on the fiber to the curb and home question.

I wonder to what extent, Mark, you could share with us your own particular thoughts about the various technologies with respect to broadband upon whether ATM or gigabit, Ethernet pods are really the way to go. With both SBC and Verizon being involved in that initiative, does ADTRAN have any internal development work under way that would allow it to participate in this emerging market or are you investing in any private companies that may be playing in this field?

Okay, Andrew, what a question.

The last part of it, we are investing internally. We are looking at the different technologies. We're especially looking at pond(phonetic) and we have every intention of participating in these new technologies as the economics involved and the potentials involved come closer to fruition.

As far as our opinion internally, as to the advantages, disadvantages, both technically and economically in the different technologies that are out there, that is a question that will take more than about the three or four minutes that we have left in this conference call. I would recommend to you that you give our Kevin Snyder, who's our Chief Technical Officer a call, and he will be able to discuss that in a heck of a lot more detail than I can and would be able to do so at length with you. And I think you can get a much better feel from him in an offline environment.

Thank you, Mark.

Your next question comes from the line of Steve Levy with Lehman Brothers.

Hi, just a quick clarification. When you guys refer to the guidance in the fourth quarter for other income, does that include any kind of one-time payments or collection of a payment?

No, it doesn't Marcus.

Okay, great, thanks.

At this time, there are no further questions. Do you have any closing remarks?

Yes. Thank you.

It has been a pleasure to be able to talk to you this morning, answer the questions and provide you the information on the third quarter. I look forward to being able to present to you our fourth quarter and year end results this coming January. And thank you very much for your interest in ADTRAN.

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