ADTRAN Holdings Inc (ADTN) 2004 Q2 法說會逐字稿

Good morning. My name is Amanda and I will be your conference facilitator today. At this time, I would like to welcome everyone to the ADTRAN second quarter earnings release conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. Questions will be taken in the order they are received. If you 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 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 31, 2003. 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, and Mr. Jim Matthews, Senior Vice President and Chief Financial Officer. Mr. Smith, you may begin your conference.

Thank you, Amanda. Good morning to everybody. It's a pleasure to welcome you, also to ADTRAN's second quarter conference call.

Amanda tells me there is 180 people that have signed in this morning. And it's a pleasure to have that many people involved and interested in our company.

Both our revenue and earnings this quarter continued to grow. Our revenue was up 5.8% sequentially, and 33% year-over-year. Earnings were up 5.3% sequentially, and 73% year-over-year.

All of our growth was internal, being driven primarily by the continued acceptance of new product introductions. Our sales of DSLAMs, Optical Access and network switches and routers continued to grow.

Our market share in each of these new product areas is currently less than 10%. This will allow room for enormous market share growth and revenue growth as we move to market share percentages more consistent with our history.

Of special note this quarter was also an increase in our international sales. They increased to 7.23%, up from 5.68 in the prior year.

At this time, I will ask Jim Matthews, our Chief Financial Officer to provide us more details on our quarter's results and guidance for the balance of the year. Jim?

Thank you, Mark. And good morning, everyone.

As disclosed in the press release, revenue for the second quarter was $120.6 million, up 33% from $90.4 million in Q2 of '03.

Carrier Network's Division revenues were $86.6 million for Q2, up 39% from $62.1 million in Q2 of '03. Comparing Q2 of '04 to the same period last year, revenue increases in this division occurred across multiple product categories with the larger increases coming from DSLAM, HDSL and M13 multiplexer products.

Enterprise Networks Division revenues were $34 million in Q2, up 20% from $28.3 million in Q2 of '03. Revenue increases in the Enterprise Networks Division occurred across both traditional and new products.

For the total company, systems were $59.6 million in Q2 of '04, up 54% from $38.8 million in Q2 of '03. The growth in systems revenue was a result of increasing new product revenues.

New product revenues comprised total access DSLAM products and Optical Access products and NetVanta router, ethernet switch, and VPN products. Revenue growth in systems was also the result of increasing sales of M13 multiplexer products and integrated access devices.

The HDSL/T1 product category revenue was $54.7 million for Q2 of '04, up 26% from $43.3 million in Q2 of '03. Digital business transport total reach was $6.4 million in Q2 of '04, down from $8.3 million in Q2 of '03.

Revenue from the international sector for Q2 of '04 was approximately 7.2% of total revenue.

Gross margin was 57.8% of revenue during the second quarter of '04, compared to 54.9% for Q2 of '03. The increase in gross margin is a result of continuing improvements in manufacturing efficiencies and product cost reductions.

Research and development expenses were $15.9 million in Q2 of '04, compared to $13.6 million in Q2 of '03. This increase primarily relates to an increase in product development activities compared to the same period last year.

Selling, general and administrative expenses were $24 million for Q2 of '04, compared to $20.3 million in Q2 of '03. The $3.7 million increase in SG&A expenses relate to expenses associated with the increase in revenue for the quarter.

Other income, net of interest expense, was $1.9 million in Q2 of '04, compared to $2.2 million in Q2 of '03. Our income tax provision rate for the quarter was 32.5%.

Earnings per share assuming dilution for Q2 of '04 was 26 cents, compared to 15 cents for Q2 of '03. This reflects a 73% increase in net income for the second quarter of '04, compared to the same period last year.

From a balance sheet perspective, inventories held steady from the prior quarter at about $44 million. Trade accounts receivable increased to $69.7 million, DSOs came in at 53 days, flat from March of '04, and up from 51 days at June 30 of '03.

Net cash provided by operating activities came in at approximately $12 million for the three months ended June 30 of '04. Cash and marketable securities net of debt totaled $338 million at quarter end, after repurchasing 496,900 shares of common stock for $12.4 million and paying $6.4 million in dividends.

Now, we would like to discuss guidance for the third quarter and for the year of '04. As most of us know, we are booking [ship] business, therefore we typically carry very little backlog from quarter to quarter.

Considering this factor alone makes the process of providing meaningful guidance extremely difficult. However, we continue to see indications of continuing revenue momentum across our new product categories.

Given this trend in new product revenues and our continuing revenue stream from traditional products, we are guiding revenue for the third quarter of '04 to a range between 120 million and $123 million. This reflects an increase in revenue for the third quarter of 13% to 16% compared to the same period last year.

We are guiding gross margins for the third quarter to a range around 57% to 57.5%. We are guiding operating expenses for the third quarter to a range around 31.5% to 32% of revenue.

Also, we are guiding other income net of interest expense to be around 1.4 to $1.5 million. With an anticipated tax rate of approximately 32.5% for the third quarter, this should result in earnings per share between 26 cents and 27 cents for the quarter. This reflects an increase in net income of approximately 24% to 28%, compared to the third quarter of '03.

For the year, 2004, we are guiding revenue to be in the range of 475 million to $485 million. This reflects a year-over-year increase in revenue of 20 to 22%. During the year, we are anticipating continuing increases in revenue reflecting the positive effect of increasing traction of new products and continuing market share gains in traditional products.

For the first six months of 2004, revenues for new products were 20% of total revenues. We continue to make good progress towards achieving our guidance for new product revenues of 21% to 23% of total revenues for the year.

New products comprise outside plant and central office DSLAMs, Optical Access products, and our NetVanta range of products comprising access routers, ethernet switches, and VPN products. We anticipate DSLAMS will continue to lead new product revenues in '04 as we continue to anticipate carriers will deploy significant quantities of total access DSLAMs to meet the demand from an increasing DSL subscriber base.

For the first six months of 2004, revenue for traditional products grew 19%, compared to the same six-month period last year. The growth in traditional products was led by our HDSL range of products in the Carrier Networks Division and integrated access devices in the Enterprise Networks Division.

We are guiding gross margins for the total year to be in the area of 57% to 57.5%. We are guiding operating expenses for the total year to be in the area of about 32% to 32.5% of revenue, with other income net of interest expense to be around the range of 1.3% to 1.4% of revenue.

We are guiding pre-tax income to be in the area of about 26.5% of revenue for the year. We are guiding a net tax provision rate of 32.5% for the year. This results in an increase in our guidance for earnings per share from a range of 97 cents to $1.00, to a range of $1.04 to $1.06 for the year. This reflects an increase in net income of approximately 38% to 42% compared to the year 2003.

Mark, back to you.

Thank you. I think we're now ready for the question-and-answer portion of our call. Amanda, if you will provide instructions and go ahead and proceed with the first question.

At this time I would like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. If you are using a speaker-phone, please pick up your handset before asking a question. Please hold for your first question. Your first question comes from the line of Andrew Schopick with Nutmeg Securities.

Thank you very much. I just wonder if you could comment a little bit more on the mix of business, direct versus indirect, in the quarter as I guess much of the new product line is being shipped through distributors, and if you could just comment at all about how you are managing or what views you have, insights into the channel inventory in the field.

Okay, Andrew, I think there may be some confusion as far as the new products and the indirect nature. What we have in general is our sales from the Carrier division are primarily all direct sales being sold into the different carriers on a very high percentage basis. In the Enterprise area, then the reverse is true.

So when we talk about new products, if we're looking at the new products that we're selling into the Carrier division, those are primarily direct sales. The sales in the Enterprise area, those are, of new products, those are indirect. And we have the ability to monitor very carefully the inventories of our distributors, and the world of distribution today, if you're going to be in it and survive, that you just simply cannot carry a large inventories. And so over the years, that we have found that the inventories at our distributors are very much in line with the outgoing sales level from those inventories. And we just really recently have not seen much variation in those levels, either up or down.

I want to ask Jim to comment, also, or clarify for me, because I'm not sure if I heard it correctly. Traditional product sales were up what percent in the first six months of the year?

19%, Andrew.

Thank you. I will pass it along.

Your next question comes from the line of Timm Bechter with Legg Mason.

Thank you. Mark, obviously you've had some success over the last year with the Total Access platform, you know, early on, 3,000 more recently the 1100. Where do you see the RBOCs heading collectively and maybe individually with their DSL expansion plans, a little bit longer term, beyond this year? It looks like ADSL 2+ and IP television appear to be fairly attractive to a number of the RBOCs out there. So I guess in essence what I'm asking is whether or not you see the DSLAM sales that you've had a lot of success with over the last year as sustainable over the next, you know, beyond a year, maybe two or three years out even?

Okay. And the answer to that is heavens yes. From a whole bunch of different perspectives.

Number one, the sales from a revenue shipping standpoint do not as of yet include many of our successful bidding exercises that have not yet really gone into production, but are in the process. And so let's start with the short-term and then work out.

And so as we look into the short to medium-term, then we have a number of contracts that we are in the middle of final negotiations that the volume associated with them has not started, and quite frankly won't start for some period of time. So as we look at the short to medium-term future, that looks very good for us.

The real heart of your question is, how do you think that the technology is going to evolve and where will that leave or place ADTRAN as the different technologies evolve? What we believe very strongly is that we'll be right in the middle of the technology sweet spot.

As all of the service providers look to be able to provide higher speed services, be they IP, be they video, in all cases, looking out into the future, they are going to have to increase the current available bandwidth. They are going to have to add optics into some portion of the equation. In all of those ways ADTRAN is working on products today.

You mentioned HDSL 2. Of course, we are, ADSL 2. We of course are very much involved in, you know, in that technology. And we plan to be right in the middle of the movement with DSL as it carries on into the future, and combines in different ways, and I don't think there is going to be a single way that you are going to see optics used. I think you're going to see multiple architectures and multiple approaches and we plan to be right in the middle of that with our DSLAM activities.

Mark, could you comment maybe at all on SBC in particular with what they announced at SUPERCOMM with the IPTV and the Microsoft Lucent offering?

Really, from a conference call standpoint I would like to avoid commenting specifically on any of our customers by name. They like to do their own press releases. And they just jump all over my neck and shoulders whenever I do forget and open my mouth to say something specifically about one of our customers. So I would prefer not to talk in specifics about individual customers of ours.

Fair enough, Mark. Thank you.

All right.

Your next question comes from the line of George Notter with Jefferies and Company.

Hi, thanks very much, guys. My question has to do with the guidance for the September quarter. You know, at face value, it seems like it's a little bit conservative on a handful of fronts. I mean I look at your DSLAM business, you seem to have a ton of momentum there. You know, questions like Qwest, Alltel, Frontier, you've signed recent contract arrangements there. It seems like that business ought to be ramping in September vis-a-vis where it is in June.

You know, similar situations in your routing and switching business, Optical Access, IADs, I mean, my assumptions are that those businesses continue to grow, you know, September versus June, and so I guess I'm trying to figure out if the guidance is more about conservatism or is there something that's fundamentally changed in some of these businesses that we haven't really been thinking about? Thanks.

Okay, George, number one, there's nothing that is fundamentally changed. Fortunately, or unfortunately, depending how you look at it, it is the same. The fortunate part of it is that of course, the momentum that we see, as you described it quite well for us, is very positive. The unfortunate part of it is, as Jim mentioned, that we have very little visibility, and that we book and ship in the same month. And the backlog that we carry from quarter to quarter or month to month is very close to zero. And so we're really not in a situation to be able to have really accurate guesses when we look at trying to predict the future.

So yes, we attempt to be conservative because we can't attempt, we can't predict accurately the future with the information and the kind of business that we're in. About the only thing that we can be sure of is that we think the direction of our business is positive and we know very well that the competitive status of the company is extremely positive.

So I'm sorry that we can't maybe be more accurate and definitive in looking at it, at the guidance. That just happens to be the nature of the business we're in.

And just as a quick follow-up, you know, you mentioned you don't want to mention customers by name, but there was one customer during the quarter that, you know, was headed towards a strike, and I was wondering if there was any kind of impact in your business that, you know, maybe you saw in the June quarter as a result of that, and you know, can we expect that business would maybe snap back in September versus June? Thanks.

We were talking about that yesterday, and Jim and I were this morning, and the answer is at this point in time we honestly, we really don't know. We had a very uneven second quarter, that the third month of June was quite strong in relationship to the first two months which quite frankly were weaker than what we originally anticipated.

Now, whether or not that had anything to do with the potential of a strike, it's just very, very difficult for us to say. Overall, I would say no, not much. But the one thing to try to answer your question is that the first quarter for our company is always a hockey stick, where March is always a strong month because January and February, people are getting back from vacation, and the weather is bad, and there is just not much done.

The other three quarters of the year, then the linearity is a random type of thing. Now, it so turned out that this particular year, the second quarter also was a quarter where the third month was very, very strong, recovering from the first two months that were much weaker. The reason for that, I honestly don't know, but I can report that's what it was.

Thanks very much.

All right.

Your next question comes from the line of Simon Leopold with Morgan Keegan.

Thank you. I wanted to drill down a little bit on the newish data networking products, the NetVanta line. If you could talk a little bit about the competitive landscape, particularly since our last conference call with you, Juniper has announced its entry, which I believe was anticipated into the enterprise market. If you could give an update as to how perhaps Cisco's response to Juniper might affect you, and a little bit more color on an update on where you stand on these products and where you think, or the timing of when you think this group of products crosses 5% of revenue? Thank you.

All right, Simon and I would be happy to. We have not seen much of a difference at all in the market in relationship to Juniper. The big competitive nature of course of Juniper and Cisco has been at the very high end. And announcements at Juniper has made, really hasn't, as we see it, affected much in the market that we play in.

Our competition, as we've said before, is 99.9% Cisco. It's just as simple as that. And that's where we are competing on a day to day basis and that's where our revenue is coming from.

And the revenue increase is continued in that area this quarter, we were very, very pleased with it. We have not reached that 5% goal that you have, and I have for that business, but we are headed there in a hurry and I think that it won't be too long before we would be able to tell you that we are there and have reached, you know, that milestone for us.

The thing that we, the thing that I think at least is, from a new product area, most encouraging during this quarter, was we introduced a switching router. This basically is where we take a 24-port, high-end programmable switch, and we couple it in the same chassis with a high-end router, and when you do this, you end up in the single box for a remote installation that if you have 24 terminals or less, all have you is a single box that will take care of your entire interface to your local LAN. If you have more than that, all you then do is come and add an additional switch that just goes right into one of the ports on the switching router.

That product has, as we've anticipated, had a tremendous excitement in the field. And during the quarter, the shipments in June on that particular product were just outstanding. So we feel very good in relationship to how that market is coming. It is an evolving situation, but I look forward to be able to tell you that yes, we have passed that 5% milestone.

And just a quick follow-up, as the mixed shift moves more towards this group of products, is it safe to assume that this is favorable to your gross margin?

Yes, that is correct.

Thank you.

Your next question comes from the line of Bill Choi with Kaufman Brothers. Mr. Choi, your line is open. Your next question comes from the line of Aaron Duda with Thomas Weisel Partners.

Hi, it's Jason Ader, hope you guys can hear me, Mark?

Yes.

Can you hear me? Okay. Great, thanks. I just wanted to touch on the visibility comments that you made and you know, ask about the timing of some of these DSLAM contracts that you've won recently. You've announced Alltel, you've announced Frontier, you've announced Qwest. There is speculation that you might have some other wins. Could you give us some sense of the timing of when the volumes hit? You said volumes haven't started in a lot of these contracts and won't start for a bit. What's, how can you help us think about the future of the DSLAM business and how these contracts will contribute?

All right. Most of the ones that you mentioned with the possible exception of Qwest, are, they're not small, but they are not as large as a very large incumbent, local exchange carrier. Let's put it that way.

Okay.

And so what we are seeing, and what we have seen to go back and look at the history of our DSLAM sales is that we've been consistently ramping with the independents, with the competitive carriers, with the ILECs. We've been consistently ramping these sales over time.

We then picked up a major win, which at this point in time I guess we can use SBC's name, as it is certainly public knowledge, and that provided then a significant, incremental increase in our revenue, significant opportunities to work with those folks, and to provide them with the DSLAMs.

We announced early this year the Qwest which also was significant. However, in both the SBC and certainly now in the Qwest environment, that, which is so typical of the way that we sell our products, originally at SBC, we were awarded a DSLAM contract for small line DSLAMs in very small volume COs. Since then, we've expanded that out to significantly in both size, location, application, and so significantly past that.

In the Qwest environment, we were awarded, in this case, outside plan, which we are shipping. We anticipate and working hard that we will be able to expand that to many other applications and larger DSLAMs. The balance of the incumbent local carriers, as you recently know, we've done very well there.

The timing that I spoke of, as to generate the next significant uptick in volume is going to come, come one of two, or the combination of two areas, adding another very large incumbent to our list of customers in the area, plus expanding in our current customer base, the use of our DSLAMs, there are different DSLAMs in our product line, for more applications. So the opportunities are there.

The anticipation of being the winning bidder for these, many of these applications, that part we think that we have passed a number of environments, and we're now into the implementation phase that, as you would imagine, the larger the opportunity, the longer it takes and the longer it should take to implement the program and to get the thing off the ground, and the volume going. And so the overall situation is very, very positive, where we can point to individual situations and circumstances with individual customers that we think are going to significantly grow the current revenue base that we have in the DSLAM area.

So should we think about it as a sort of consistent, steady growth for the next few quarters, and then some type of inflection point in '05? Is that sort of the timing that you're leading us towards?

I would think an inflection point towards the end of this year, the first of next year would be as good an inflection point timing guess as, that you can come up with.

Okay. And then just a last question on some of the other product areas, like Optical Access and NetVanta. Do you see, you haven't commented specifically on those product lines except to say that you felt pretty good about them. Are we seeing any meaningful uptick in those product areas, and if not yet, when might we see some significant uptick in those product areas and if not yet, when might we see some significant uptick in those areas? Because I know you're, you know, gaining traction in terms of your product portfolio, you're expanding your product portfolio, and you're raising awareness and so forth, but it doesn't seem like we've seen that big a contribution to revenue yet.

The percentage increases are tremendous. The contribution, I think Simon Leopold commented when were we going to be able to tell him that our router sales had passed 5% of overall corporate sales. And we said well, we're getting there but we're not there yet.

That is sort of the answer to your question. We're seeing tremendous increases percentage-wise, but we still haven't gotten in the optical and in the router up to that 5% to where you start at that point in time to see a measurable, significant contribution to the overall revenue base.

If you look at the numbers that Jim was attributing to our new product areas, then you see these very high growth rates with the sum of all the different new product areas. As these continue to grow, and especially the optical, which had a very, very fine quarter, and the NetVanta, once we get these up to where their growth is a significant percentage of the overall company's growth, then we're going to see a much more of a measurable contribution.

So it's just a matter of time is what you're saying until you can --

Absolutely, that's what I'm saying.

Okay. Thanks.

Your next question comes from the line of Reg King with WR Hambrecht.

Great. Thank you. Jim, I was wondering if you could help us a little bit with the gross margin for the quarter as well as your guidance for gross margin? I understand a lot of it came from cost savings. Can you give us a little bit of granularity? Is that cost savings spread out evenly throughout the products? Or is it more skewed toward what we know was recently, there was some cost improvements on the IED product line, but you can help us a little bit on that as well as the guidance?

Well, continuing cost improvement do have a, obviously a factor on us maintaining gross margins throughout the year. Through the remaining part of the year. But Reg, I also think what we're looking at is that a lot of the pricing is now behind us for the year.

Okay.

I think those two things again, are input so to speak to the guidance that we're giving for the remaining part of the year.

Great. Thanks, Jim. And then on the tax rate guidance, should we think about the tax rate being the same as we, I know you guys aren't giving guidance for next year, but should we assume that that would, there would be no change to the tax rate as we go into next year?

Well, I, Reg, you're right, we haven't given guidance on next year, but I think it would be safer to assume that the rate's going to uptick a little bit as we have certain fixed components that will remain the same, so to speak, as we anticipate hopefully that pre-tax income will increase next year.

Okay. Then finally, Jim, within international business, you know, continuing to increase here, it's not really sizable yet, but it's getting up there, so how should we think about the international business, whether the, are the key products the enterprise products, which I know you've marketed well in Europe, or is it across all your product lines? And then secondly, how do we think about the margin? Is that in line with the corporate gross margin that we're seeing domestically?

The gross margins are pretty much in line with corporate gross margins on the international side. The larger part of the revenues on international are continuing to come from carrier-based products although we are seeing revenues now from enterprise-based products as well. But again, not nearly to the magnitude of carrier-based.

Great. Thanks, Jim.

Your next question comes from the line of Marcus Coopersmith with Lehman Brothers.

Hi, thanks, guys. Can you hear me?

Yes.

Great. A couple of questions. I was hoping you could give us a break down of the, if you had any customers over 10% of revenues and what those contributed for the quarter?

Marcus, yes we did. SBC, Verizon and Sprint continue to be our 10% customers. Estimates for Q2 of '04, SBC at 20%, Verizon at 14%, Sprint at 15%.

Great. And then, if we wanted to just talk about the operating expenses for the quarter, and my read is that they came in slightly ahead of the original guidance outlined during, for the June quarter, and I guess my question is, you know, traditionally that trend has shown very good discipline on this. Is there something changing the philosophy? Do you look at expenses? Maybe you could talk to us about where you spent a little of that extra money versus what you had planned on spending going into the quarter? Thanks.

Mark, would you like me to take that?

Jim, go ahead.

Okay. Nothing in particular has really changed, Marcus. We did have upticks in SG&A primarily relating to the increase in revenue. We had a sequential increase of about a million dollars in research and development from Q1 to Q2. Again, primarily driven by continuing new product development initiatives. So nothing really that stands out significantly.

Reg, we have not changed our approach or thought process as far as being cost conscious, I can assure you. And the operating expense is getting close to the point where we would like to see it, but quite frankly, it's not there yet. And it's an area, when I say not there yet, I mean on a percentage basis. So we would like it to see the operating expense going forward increase at a rate slower than the rate of revenue increase to bring the percentage of operating expense down slightly from where it is now.

Just my quick math, based on the guidance for 3Q is you're thinking op ex in absolute dollars is about flattish? To midpoint of guidance?

Sorry, Marcus for Q3?

Yes. On a sequential basis, looks like it is about flattish then?

Well, perhaps so. Maybe a little bit lower. But again, it depends on the revenue level.

We're halfway in the guidance and I think that's about right.

Okay. Great. Thank you.

The next question comes from the line of Vic Carro with Piper Jaffray.

Thanks, my questions have been answered.

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

Thank you. Could you talk about the new products and break it out by the type of product in order of their contribution to total revenue, their quarterly growth rate, and their gross margin? And then I have a follow-up question.

Mark, would you like for me to take that?

Yeah, basically, we don't give details down to that level, but go ahead, Jim.

Right. We do not, but I believe on the last quarter, the conference call for the last quarter, we talked about a ranking of contribution of DSLAMs first, Optical Access second, and NetVanta third. In Q2, that ranking has not changed.

Okay.

Also, in terms of gross margin, we've also talked about the new product areas being higher in gross margin relative to our corporate goal.

And is that initial shipment or for a volume number?

No, the initial shipments. Where we are now in each of the programs.

Okay.

It's not some projection into the future, no.

Okay. Thanks. And the other question is, could you talk about the typical time span between when a major contract, you announce a major contract, when you begin shipping and when shipments reach their peak?

It depends entirely on the customer. The smaller carriers, and I assume you're talking of the carriers, because in the enterprise network, it's almost immediate.

Right.

But in the carrier, it's a matter of time frame in relationship to size of the account, quite frankly. And with the independents, CLECs and smaller carrier, it's almost like enterprise, to where within 30 or 45 day, you're shipping hardware.

When you get however to a large incumbent local exchange carrier, then you just simply cannot do things that fast, and that there's a lot of administrative functions that are necessary when you get to that size of volume and complexity of a system. And complexity of the network.

And so there once a competitive situation has been successfully completed, you are six months, I would say, from seeing in normal cases, from seeing the volume. Now when you see volume, it ramps very quickly to a level consistent with the contract that you've won. But it on average is a six months delay.

So when you look at your contracts in hand and under negotiation, it sounds like you need a stream of new contracts to keep the, to sustain the DSLAM revenue growth revenues.

Well if you're going to grow, you always need a stream going out, yes, you're absolutely correct, ma'am.

So looking forward, what are the new horizons for contracts that, for DSLAM contracts, or are you looking at other fields?

Well no, looking forward, I think what we've been saying is that we have a number of these in place that gives us a very good assurance of growth over the next six, nine months. That the situation is there. The negotiations and the administrative work has started. That what we don't see, however, on these very large ones is that the second that the competitive environment has been completed, then in two weeks later, you start shipping hardware, it just takes longer than that.

Okay. And so into '05, what will give you the growth, where will these large contracts come from?

The large contracts that we're looking at in late '04, early '05, if we're talking about two areas, one is a number of contracts with smaller carriers, the second is an expansion, as we've been talking about, the contracts that we have, and I say expansion and applications, and the larger customers that we currently have. And the third in that time frame would be very large, incumbent carriers that we have been successful in the competitive environment and are now working through the administrative portions of the work to allow the volume to start as we've said towards the very end of this year, first of next year.

Okay. Thank you.

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

Thank you. Just a follow-on to an earlier remark Jim made. Jim, you said that many of the pricing actions are now behind you. And I want to know, is that a subtlety and a change versus where I've heard you in the last say six to nine months talk about using pricing strategically?

No, there's no change there, Todd. What Jim, I guess, was pointing out, we all, everybody tends to think in terms of annual agreements and they sort of gravitate towards calendar year, and so we have a lot of pricing changes across the board in all kind was different areas that occur in the January time frame. Which is one of the reasons that we tend to get a little squeezed in the first quarter. And I guess what Jim and I have been saying is that, that time now is behind us to where we have the seasonal adjustments in price that just occur sort of every year.

Our using our advantageous gross margin environment to selectively strategically allow us to enter into markets that we want to is still there, and that has not changed. We are not raising our long-term guidance at all as far as our gross margin position.

Thank you.

Your next question comes from the line of John Anthony with Fulcrum Global Partners.

Good morning. A couple of questions. On the DSLAM opportunity, could you give a little more characterization if you're seeing an opportunity, the opportunities you're seeing in front of you, are they from initial DSLAM deployments, whether it be outside plant, remote terminal, or central office, or are you also seeing an opportunity from replacement of other vendors prior generations of equipment?

John, primarily it's new installations or in new locations or in older locations, where the subscriptions to the service just simply outrun the capacities fill up with the hardware they already have installed.

Okay.

But it's not a replacement of existing DSLAM hardware.

With the introduction of ADSL 22+ later this year, do you think there may be opportunities in 2005 that would expand the replacement opportunity?

Not significantly, John.

Okay.

Usually, there is very little replacement. When have you something that is basically working, it may be disconnected and reused with a different customer, but normally not replaced.

Okay. And then Jim, a question on the operating expenses. You said a lot of it was just kind of a normal increase with increased business. Was any of that increase associated with you guys trying to establish a bigger presence in Europe?

Not significantly, John.

So there was really no one specific bucket that you can point to and say this went up due to XYZ? It's just something we should expect to see trend for a little while, along with the increase in revenues?

In the range of the guidance that I gave for the remainder of the year.

Okay.

That answers your question.

Okay. And then lastly, can you also give us an update on some of the other products that we should expect to see you guys address? It seems like we've been focusing on DSLAMs, optical and some of the enterprise stuff we've been talking about now for six or nine months. Are you guys planning any other, you know, new growth initiatives, that are, you know, that's worth mentioning at these stages? Are you going to continue to focus on these three?

We've got a number of different things we're working on except as far as introducing hardware, and starting the process of revenue generation, no. The three areas we're looking at now, each one of them has an overall market well in excess of a billion, just domestically.

That's a large enough thing for us to bite off that would we could be successful in any one of these, you could obviously see the impact that it would have on the company, and yes, we are looking at new product areas outside of these. But our first and foremost job right now is to make these three successful because of the tremendous impact they have on the overall company.

And lastly on T1, do you guys see, what do you see happening in the HDSL market for the remainder of the year? Is there, are there any forces out there that are giving you better visibility on that market? And what is the pricing like?

The pricing is reasonably stable. We're not going to be able to get too much market share. We have so much now that there's not that much left.

We think that the line growth is a positive number in single digits. And that we may be able to add a little market share to that, but primarily the growth is going to be in the line growth, and we see that increasing rather than being flat like it was here six months ago.

Okay. Great. Thanks, guys.

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

Good morning, guys. Just a couple of things. I would like you to kind of confirm my math on the new products. It looks like, if I did my math right, the new products would have been about 25.5 million or so. If you could confirm that. And then secondly, --

In that area, Eric.

Okay. And then in each of the new product categories were up sequentially?

I'd like to comment, get back here to the new products. Jim, new product area would be a lot more than 25 million, wouldn't it?

This is just for Q2, I think, Eric?

Correct.

Excuse me, excuse me. Okay.

Yeah. You were backing into the quarter, I believe?

Right. And then all three of the new product categories were up sequentially?

Yes.

Okay. And then it looks like SBC downticked a lit little bit and Verizon was down a couple million sequentially. Was there something going on in the HDSL business, were those carriers, or in the RBOC space that was made up for outside of the RBOCs?

Well Eric, we sell virtually every carrier-based product to those two customers, around I just don't have the product breakout before me. But, you know, from quarter to quarter, you're going to see gives and takes between our larger customers. That's a natural thing that's going to happen.

Yeah, I was just surprised that sequentially have you HDSL/T1 and the DBT up and yet what would be the two largest customers for those products were down sequentially.

Well, I think also that what indicates is that we're increasing our business with non-10% customers.

Okay. Thank you.

Amanda, I think that looking at the clock, we have time for one more question.

Thank you. Your last question will be from Bill Choi with Kaufman Brothers.

Great. Can you guys hear me?

Yes.

Excellent. Can you just give a little more color on the enterprise business? It seems like it was down sequentially, and maybe provide a little more color between the mix of business between IAD, and CSU/DSUs?

Okay, the CSU/DSUs, as we all know have been in overall decline for, you know, quite some period of time. And the main reason for that is if a CSU/DSU function has been built into the router hardware, which is something that the router main for Cisco has done, it's something that we do. We build the DSU/CSU function into our routers, and so our stand-alone basis, that particular business has been in decline for quite some period of time.

Our integrated access device business has grown extremely well over the years. That was down slightly in the second quarter. I really don't have a reason for that, other than a tree does not grow to the sky in a straight line. The NetVanta portion of the business continued to grow and continued to grow very smartly on a, especially on a percentage basis.

Okay. Maybe one final question then. Just looking at your guidance, I think George took care of it from the new product angle. Perhaps just going back to, you know, looking at it either on an enterprise basis, you'd expect that the September quarter is typically stronger on your enterprise business, and you would think the same thing on the traditional HDSL/T1 business. Can you just give a little more color on that business, whether the linearity comments you made earlier apply to those products as well?

Mark, would you like me to try to --

Well --

I think it goes back to --

Which one of us is going to talk about that which we do not know?

Yeah. Exactly. I mean it comes down to visibility. Or lack there of.

Okay. In terms of typical seasonality on the September quarter for enterprise and HDSL, you know, we've seen that, what is included in your guidance? For those two businesses?

The seasonality that we have seen in a number of years where the third quarter is very, very strong, and we don't really, you know, you really can't say why, is not there, we have not included that because we don't see the exact reason as to why that should be so. If you look at this year, where normally our first quarter is very, very weak, and we have a significant quarter to quarter decline in revenue, from the fourth quarter to the first quarter, this year, that did not occur. It was flat. In fact it was just up just very, very slightly.

So for us to give guidance based upon a seasonality is almost as dangerous as us trying to buy stock based on the seasonality of the stock market. It may work three out of four times, but heaven help you on the fourth. And so what we are really doing is trying to look at what we can see visibly out there and try to give our guidance based on that, even though, you know, we just don't have the visibility we'd love to have.

A quick one final follow-up if I may. On the IAD business, when that was down, have you noticed any more increased competition in that segment of the business?

No sir, we have not.

Okay. Thanks.

All right. I think we have, we've gone through pretty much an hour of questions and I certainly appreciate everybody taking the time out of your busy day to be with us in our conference call. It's a pleasure to talk to everyone today, as it always is. We look forward to our conference call three months from now and be able to talk about my favorite subject, ADTRAN, at that point in time. So thank you very much for being on the call today.

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