ADTRAN Holdings Inc (ADTN) 2005 Q4 法說會逐字稿

At this time I would like to welcome everyone to the ADTRAN fourth quarter earnings release conference call. (OPERATOR INSTRUCTIONS). During the course of the conference call ADTRAN representatives expect to make forward-looking statements which reflect management's best judgment based on the factors currently known. However, these statements involve risks and uncertainties, including the successful development of market acceptance of new products, the degree of competition in the market for such products, the products and general mix, component costs, manufacturing efficiency, and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2004 and Form 10-Q for the quarter ended September 30, 2005. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which may be made during the call.

In addition, ADTRAN will use certain non-GAAP measures in the conference call this morning. And ADTRAN will post on the Investor Relations section of our website at www.ADTRAN.com a reconciliation of these non-GAAP measures to the most comparable GAAP measures.

Speaking on the call today from ADTRAN are Mr. Tom Stanton, Chief Executive Officer, Mr. Danny Windham, President and Chief Operating Officer, and Mr. Jim Matthews, Senior Vice President and Chief Financial Officer. Mr. Stanton, you may begin your conference.

Good morning everyone. Thank you for joining us on our fourth quarter 2005 conference call. As Jamie mentioned, with me this morning are Danny Windham, President and Chief Operating Officer, and Jim Matthews Senior Vice President and Chief Financial Officer. I am very proud to report that 2005 was a great year for ADTRAN. We closed the year with record revenues and record operating earnings. During the second half of 2005 we built significant momentum in Optical Access and remote terminal outside plant DSLAM product revenues, and have established an excellent base to expand our positions in 2006. In general, our markets witnessed improvements from both wireline and wireless spending during the year, and we anticipate the momentum to continue through 2006.

During 2005 we saw tremendous growth in revenues related to wireless carrier applications. We anticipate significant growth in this area through 2006 with our new wireless focused products, including the MX 410 MX 3200 series products and new additions to the Opti 6100 product family.

During 2006 you'll also continue to see the introduction of new features and new products to broaden our potential. These introductions will include, among others, significant additions to our business networking product line, including new NetVanta products specifically focused to address the growing voice over IP market, a broading of our new family of IP business gateways, and enhancements to our Opti product line to include higher speeds and enhanced ethernet capabilities.

Also, we will begin broadening our range of Broadband Access products with the addition of new platforms and new DSL technologies. These platforms will be targeted to specifically address the growing requirements for applications, including IPTV, metro ethernet, and the movement towards IP centric networks. With the introduction of these products and others, we anticipate momentum to continue in our primary growth areas, comprising of broadband access products, Optical Access products, and our business networking products. Combined these areas contributed at record levels in the fourth quarter at about 31% of total revenue.

As most people know, the size of each of these markets is measured in billions of dollars and represent significant growth opportunities for our Company. In 2005 we made significant strides in these areas, and we anticipate that over time these categories will represent the majority of our revenue streams.

Additionally, we have continued to take advantage of leadership positions in our traditional product areas. In 2006 we are hopeful that past and current efforts will translate into additional market share gains in our HDSL business, as we continue to dominate this market with best value and features. We believe HDSL will continue to be the primary solution for enterprise connectivity. And we are well-positioned to maintain the vast majority of this market for the foreseeable future.

Going forward we believe our primary growth areas will continue to see strength based on market share gains related to both current and future product introductions, and customer spending trends. Our traditional product areas will continue to track on a macrolevel with enterprise demand, wireless network expansions, and wireline capacity upgrades.

I would like Jim Matthews to review our results and our guidance for first quarter and year 2006. We will then open the conference up for questions.

Revenue for the fourth quarter was $140.6 million, up 34% from $104.6 million in Q4 of '04, and down 6% from $149.2 million in Q3 of '05. For the total Company systems revenue was $76.6 million in Q4 of '05, up 56% from $49 million in Q4 of '04, and down 5% from $80.3 million in Q3 of '05. Comparing Q4 of '05 to the same period the prior year, the increase in systems revenue was primarily due to an increase in Broadband Access, Optical Access, NetVanta and M13 Multiplexer product revenues.

The sequential decrease in systems revenue for Q4 of '05 was primarily related to decreases in Integrated Access Device and central office DSLAM product revenues, partially offset by increases in Optical Access and remote terminal outside plant DSLAM product revenues. ACSL TI product category revenue was $61.1 million for Q4 of '05, up 19% from $51.4 million in Q4 of '04, and down 7% from $65.5 million in Q3 of '05. We attribute the sequential decrease in systems and HDSL T1 revenues to typical seasonality and the backlog reductions that occurred in Q3 of '05.

Physical Business Transport Total Reach was $2.9 million in Q4 of '05, down from $4.3 million in Q4 of '04, and down from $3.3 million in Q3 of '05. Delving one step deeper, Carrier Network Division revenues were $106.9 million for Q4, up 40% from $76.1 million in Q4 of '04, and down from $113.5 million in Q3 of '05. Comparing Q4 of '05 to the same period the prior year, the increase in Carrier Networks division revenues was due to an increase in systems, and HDSL revenue, partially offset by a decrease in DBT Total Reach revenue. The sequential decrease in Carrier Networks division revenues was due to a decrease in systems, HDSL and DBT Total Reach revenues.

Enterprise Networks division revenue were $33.7 million in Q4, up 18% from $28.5 million in Q4 of '04, and down 6% from $35.7 million in Q3 of '05. Comparing Q4 of '05 to the same period the prior year, the increase in Enterprise Network division revenues was primarily due to an increase in T1 revenue. The sequential decrease in Enterprise Networks division revenues was primarily due to a decrease in systems revenue. Revenue from the international sector was $15.1 million for Q4, up 63% from 9.3 million in Q4 of '04, and down from $19.4 million in Q3 of '05.

Gross margin was 59.9% of revenue during the fourth quarter of '05, compared to 56% for Q4 of '04. The increase in gross margin percentage is primarily the result of favorable product mix, continuing improvements in manufacturing efficiencies, and product cost reductions. Research and development expenses were $14.9 million in Q4 '05 compared to $17.8 million in Q4 of '04. The decrease was primarily due to higher to higher Telcordia expenses incurred in 2004 relating to Optical Access products and accelerated approvals for DSLAM products. Selling, general and administrative expenses were $24.2 million in Q4 of '05, compared to $23 million for Q4 of '04. This increase is primarily due to increased selling costs relating to increase revenues.

Other income, net of interest expense, was 2.1 million in Q4 of '05 compared to 2.4 million in Q3 of '05. Earnings per share, assuming dilution, for Q4 '05 were $0.41 compared to $0.19 for Q4 of '04. From a balance sheet perspective, inventories decreased $3 million from the prior quarter to approximately $50 million. Net trade accounts receivable decreased approximately $5 million to $66 million due to decreased revenues. DSOs came in at 43 days for the fourth quarter, down from 44 days for the third quarter of '05. Net cash provided by operating activities came in at approximately $40 million for the three months ended December 31 '05. Unrestricted cash and marketable securities totaled $383 million at quarter end, after paying $6.8 million in dividends during the quarter.

Now we would like to discuss guidance for the year and first quarter of 2006. Revenue for the year is expected to range from $565 million to $590 million. GAAP earnings per share for the year, assuming dilution, are expected to range from $1.35 to $1.45. Pro forma earnings per share for the year, assuming dilution, are expected to range from $1.43 to $.153.

Revenue for the first quarter of 2006 is suspected to range from $127 million to $131 million. GAAP earnings per share for the first quarter of 2006, assuming dilution, are expected to range from $0.28 to $0.30. Pro forma earnings per share for the first quarter of 2006, assuming dilution, is expected to range from $0.30 to $0.32. Pro forma earnings per share for the year and first quarter 2006 exclude the effect of stock compensation expense resulting from the application of SFAS 123R. Tom, back to you.

At this point I think we're ready to open it up for questions.

(OPERATOR INSTRUCTIONS). Vivek Arya of Merrill Lynch.

Two questions. Two questions. If I look at your conventional segment, which is everything except the DSLAMs off DMS LAN [tops]. If my math is right the revenues there grew only 2% year-on-year for 2005 versus 2004. My question is what do you foresee the trend for that segment in 2006? Can you get that segment back to a growth level?

And then my second question is for Jim. Which is, Jim, the operating margins at 32% are the highest in all of telecom equipment. And my question is what do you foresee as the operating margin level next year? And do you expect that to trend back to your mid-20s level that has been historically, or do you expect it to be at a high level as we have seen in the last one or two quarters? Thanks.

In terms of your latter question, if we look at our guidance that we gave, I think you'll see that it pretty much implies that we anticipate still operating above the 25% model during 2006.

Let me take the first part of your question as far as growth on our traditional product line. First of all, the first half of the year was a little more challenging to us definitely than the second half. And if you recall in the first quarter it was definitely a challenge. We are under the belief that the second quarter is probably more reflective of what our product ines will do going forward. And we really haven't deviated from that kind of high, single digit growth potential. Especially in 2006 one additive plus may be a potential to actually grab some additional marketshare which we're hopeful of being able to do.

Gina Sockolow of Buckingham Research.

Just could you go through the tax rate -- why it dropped in the fourth quarter, and what your outlook is for that? And also, any 10% customers that you had in the quarter? And if you can comment on the status of the SEC arrangement, and looking forward what the ongoing consolidation among service providers mean for your carrier business?

Jim Matthews. I can take the first two. Yes, our tax rate dropped to 32% in the fourth quarter, a year-to-date rate of right at 34%. And as we closed out the end of the year, we obviously trued up our actuals in terms of the R&D credits and certain other components of the tax rate to bring it into pretty much the actual for the year. As far as our outlook for '06 tax rate, we are anticipating a rate slightly above the 34% that we experienced in '05.

Let me cover the SBC merger. We believe, and have believed for some period of time, that SBC -- that the marriage of SBC and AT&T will net be a positive for us. SBC has been a long-standing strong customer for us. AT&T has been a customer, but a fairly dormant customer. I think as time has gone by, we are actually a little more optimistic today than we probably were six months ago about the ability not only for it to affect the carrier side of our business, but the enterprise side of our business. I would say at this point in time we're pretty bullish.

Jim, I think you need to cover the 10%.

As far as the 10% customers go in the fourth quarter, SBC now AT&T came in at 20%, Verizon came in at 10%, and Sprint came in at 17%.

John Anthony of SG Cowen.

A couple of questions. I apologize if you already discussed this. Can you give us a little more detail on the new product breakdown? You have given it to us as a percent of revenue in prior quarters. If you would be willing to do that again, and just as any clarity or more detail on the split between DSLAM, Optical, etc.

Jim Matthews here. Yes, we did state that the quarter came in at about 31% of total revenue for the three primary growth areas. And the split was pretty much the same order that we have talked about recently, with DSLAM's leading, followed by Optical Access, followed by NetVanta.

If you could also talk about the timing of some of the new products when they might be contributing meaningfully to the new products revenue stream. Is this kind of a back half phenomenon? Do you think it is going to be evenly weighted?

Let me take that. First of all, we have products coming out throughout the year. Let me add a little bit of color to Optical too in the second half. Optical had a very strong second half for the year. So we are very bullish on that, and quite optimistic about what it is going to do in 2006.

As far as some of the new products, we have products really starting to be -- we have products that are in lab trial now, fairly new products that are targeted towards the ethernet DSLAM and IPTV space. We have enterprise products that started shipping in the fourth quarter. And we will continue with future rollouts through the first half. And then we have some larger platform products which we expect to be rolling out in the first half, which means you won't see meaningful revenue on those probably until the end of the year or maybe early the following year.

Lastly, any thoughts about the cash balance and what you might use that towards?

That of course it is up to our Board. What we have traditionally used it for has been for dividend payouts and for our share repurchases. At this point in time we don't see a deviation.

Ari Bensinger of Standard & Poor's.

Looking forward in the DSLAM as a growth driver, can you talk about where maybe the carrier footprints are and what you expect them to be, and also how you expect the mix between central office and outside DSLAM remote?

Sure. The carrier footprint coverage question is a difficult question, because everybody calculates the number slightly different. My best guess would be that we're probably somewhere on average in the '80s. My hope would be that we would see that get into the mid-90s or so. As far as our mix is concerned, we have been saying for some period of time that we thought the remote terminal outside plant space was going to be the space that grew the fastest, and it has done that in the second half. And we would expect that to continue through 2006 as people continue to rollout their footprint coverage, but also as they kind of position themselves for higher bit rate services, which kind of belies the definition of that, it means they need to be closer to the customer.

And then an operating model question. R&D expenses was down sequentially. I am just wondering if that has to do with Telcordia expenses trending down, and what to look forward?

I think it was only down slightly sequentially on Q4. But going forward as we look into '06, I think we can anticipate R&D to be in the low double-digit range or the low teens in terms of percent to revenue.

That is historically has been what we have been operating at.

George Notter of Jefferies & Co.

Just looking at your guidance range for the full year -- certainly you have a lot of new product flow coming here. It sounds like you're hopeful that you can gain incremental market share in the HDSL space. I look at the guidance for the full year, it seems to imply about 3% growth off of basically an annualized run rate that you printed here in Q4. I guess I'm trying to understand the dichotomy between all the new product flow and your enthusiasm for any of the growth areas in your business, and yet you're looking for overall growth at the midpoint around 3%.

I think the 3% that you are speaking of is based off of a fourth quarter run rate. Is that correct?

Exactly.

I think it is important to say that typically we see seasonality in the first quarter. We don't expect anything different in the first quarter of 2006, and our guidance reflects that. And through the year we anticipate for our revenues quarter to quarter to ramp through the year as the new products come on, and as we see success in other areas.

The other thing to try to keep in mind is, as I'm sure you're aware, it is tough for us, as I think it is for anybody in this space, to try to factor in exactly what impact a particular product will have in any short period of time. Yes, if we look at the product portfolio today, we are very optimistic about its long-term potential, and even its kind of nearer near-term potential. But trying to factor in exactly when those potentials will come into play has just always been difficult.

Anything you can say just qualitatively about which of the new products you have really factored into the guidance for 2006? Certainly you mentioned the new Access platform. It sounds like that is not in the guidance, but how about some of the other areas like some of the new products and new product features on the enterprise side? The new TA 900 product -- you think about some of the new activities you have got in the Optical Access portfolio and potential growth in outside plant DSLAM, how much of that have you really baked into the guidance?

This is Danny. I will take TA 900 and the NetVanta questions. The TA 900s were introduced in late 2005. And we have modeled growth for the TA 900s throughout the year, even though it would be more back-end loaded than it is front-end loaded on a start up basis. Also, the NetVanta products that Tom mentioned, which will be focused on the voice over IP market opportunity, will be introduced in the late Q1 quarter, and it will probably really be a second half event before we begin to see revenues for that. So we haven't modeled a significant amount of revenue from those products for the first half, and beginning that in the second half.

As far as Optical Access products, we have potentially wireless carriers and wireline carriers. Some of those potentials are large enough to where they would post significant upside in that product line. Where we were a little more moderate in the way that we were forecasting those just not being able to really judge the exact timing of those.

Nikos Theodosopoulos of UBS.

I just had some quick questions. Can you give the list in the quarter between -- within DSLAM what percentage of the business was remote versus central office?

Let me just say that the remote terminal outside plant were -- and I think maybe for the first time actually -- was larger of the two. So we actually saw that shift which we have been talking about have occur in fourth quarter reduction was larger than central office DSLAM.

Within the new product category in the quarter, clearly it sounded like the the OPTI family was was up sequentially. Was that the case for DSLAMs and NetVanta as well? Can you give us a sense of the sequential trend of the three businesses, whether they were up or down?

Yes, let me did a little bit more color to that. The DSLAM business was slightly down sequentially, with the remote terminal outside plant being up. And if you will recall, we have several central office DSLAM customers. And I would say in general we did have that shift coming from Q3 -- Q2 to Q3 with inventory which probably impacted the central office DSLAM business as that was an ongoing business at that point in time, more than the remote terminal and outside plant. Danny, do you want to cover NetVanta?

NetVanta revenues were down slightly Q4 versus Q3. If you compare that with the decline that we have seen for the Enterprise division and for ADTRAN, we believe that is mostly explained just through the seasonality of Q4.

I believe that is the second consecutive quarter that NetVanta has not shown a sequential increase. Given that it is still a very low revenue base in a big market, what do you attribute that to?

We did see the growth moderate in the second half of the year, but all in all NetVanta still had a great year. Revenues for NetVanta almost doubled year-over-year, and we expect that momentum to continue into 2006.

The last question I had was, do you have a sense overall for the full Company what percentage of the business flows into the Wireless segment?

We have been -- that is a difficult thing for us to judge because of the nature of the products and equipment that we're shipping. It would be tough for me to say. I would say that it has an impact. I think going into 2006 where we have products that are targeted to specifically for wireline -- or excuse me, wireless customers -- we will be able to give you a better sense of that. But there is no doubt that a portion of our HDSL business flows to wireless activity when there really is no way for us to judge that.

Marcus Kupferschmidt at Lehman Brothers.

A couple of clarifications for you. Could you give us a sense of the IAD business, you said that the revenues declined at least sequentially. You just launched some new IP IAD revenues, so I expect that to be growing. Do you expect that just to do offset declines in legacy IADS, or how should we think about the total IAD business?

It is Danny. I will take that one. I think we believe the market for traditional IADs probably contracted in 2005. We saw a decline in our traditional IADs year-over-year. And the traditional IADS, the TDM and ATM-based models, are consumed primarily by the competitive service provider base. And that base has been under increasing pressure in 2005.

What we saw in the decline between Q3 and Q4 I believe is mostly explain through seasonality. But we do believe the outlook for IADs is still positive. The IP IADS that we have introduced really are probably going to go into a new category, a new market opportunity that we're calling IP Business Gateways. And the emergence of that IP Business Gateway market, the Total Access 900, is well positioned into that segment. And there are other products that we anticipate to go into that segment throughout the year.

And a couple of the things that would help drive adoption of the IP Business Gateway model is that some of the traditional carriers and the incumbent carriers are currently evaluating that model for delivering service, as well as an international incumbent carrier. So that might be the growth driver for the IP Business Gateway. And we would expect the market for traditional IADs to be commiserated with our legacy product family growth.

Let me add just a little bit to that. I think what the level of activity that we are seeing through traditional RBOCs and IC business gateways have gone up significantly in the last six months are so. We're hopeful that they are serious about actually rolling out significant numbers in the future.

It is probably also worth mentioning that in the traditional IAD space the unit volumes are actually up year-over-year. And what has been driving the revenue decline has been changes in product mix and ASP reductions in the marketplace.

A couple of other things. In terms of your full year '06 revenue guidance, maybe you could give us a little insight into the growth areas of the business? And could you give us a rough sense of do you, within your guidance, expect $1 growth of DSLAMs to be similar to the be $1 growth of OPTI, or do you expect one to be bigger than another in '06?

That is pretty fine granularity. On a percentage basis, I would still say that in 2006 we would see OPTI probably at a higher growth percentage than DSLAMs. On a dollar basis I think that that is going to be a nice little fight to watch. I think it is going to be tough to call.

Just two other quick things. In terms of your first quarter guidance, should we think that these new products would be a little more resilient than the total declines you're seeing in the overall business?

What do you mean by first quarter -- in relation to first quarter guidance?

Yes. In terms of do you have some more momentum there, so that they should hold up a little better than the overall seasonality?

In most of the serious that we're talking about we're picking up market share. So to the extent we augment our market share in Optical Access, for instance, or in our IP Gateway products, which are fairly new products that we haven't had products in that space before, then, yes, they would be incremental. As to -- I mean our guidance for Q1 we stated that. I would say that those would be incremental to what we typically see in seasonality.

And then one quick one for Jim. The expenses came a little bit less than what I was certainly looking for in the fourth quarter. Is there anything there in terms of just timing that benefited you, or is this a good level to think about for the business going forward in terms of just kind of giving a run rate for the revenue?

Yes, nothing unusual there. And again going forward we are targeting the low teens for R&D expenses and the high teens for SG&A. That is our typical model, and we expect that we will track to that.

Ehud Gelblum with JP Morgan.

A couple of questions if I could. First of all, it sounds like there are a lot of products in the pipeline, and a lot of new products coming out this year. Should we be thinking that all that R&D -- I know you gave guidance was where it should be as a percent of revenue, but why wouldn't R&D move up as you plan to push a lot of these products out to market?

R&D as a dollar expense will move up, but it will move up coincident with our revenue increases. We will spend more in R&D in 2006 than we did in 2005, but we are extending growth also in 2006.

And a significant percentage of the R&D work required for the launch of these new products is done at this point.

Maybe that is how that correlates. If we look at the tax rate, you said that the low tax rate this quarter had to do with true ups, I guess, from the prior quarter when you accrued a 36% tax rate. Should we read into that that in Q3 you had expected the net income to be a little higher in Q4, and that is why you have taken the 36% tax rate in Q3 to make up for it? And therefore how should we look at the pretax operating income this quarter vis-a-vis what you expected it to be, given that it sounds like or looks as though you had accrued more taxes than you actually ended up needing? It just looks as though you perhaps were expecting it to be a little higher. I'm just trying to gauge how the operating income this quarter (multiple speakers) your expectations. Am I looking at it the wrong way?

I think it really has more to do with some unexpected benefits that we saw as we closed out the year that drove the tax rate. As we look at '06, again we are anticipating a tax rate just slightly above the 34.1% that we closed out the year in '05.

That is helpful. There were actually some extra R&D benefits?

That's correct.

That came through that you weren't expecting?

That's correct.

That's very helpful. When you look at the -- can you give us a sense of the linearity of last quarter? And did you see any budget flush? That seems to be a big thing that no one else is seeing out there. I am just wondering if you --?

We can say we didn't see it either. As it is our typical method of operation, we don't typically go out and look for budget flushes, because we think they tend to impact the following quarter to the extent that you actually see a positive in the quarter that you are in. We don't typically participate or actively participate in budget flushes. But we -- as far as linearity, linearity in the quarter, if you look at the booking rate of the quarter, it is typical to what we would see in the fourth quarter, which means it was more front-end loaded. And then as the December rolls around you see a decline in the order rate.

On the gross margin, it stayed resiliently strong even though revenue on a sequential basis was down. Should we expect therefore that the 59.9% or basically 60% is the run rate going forward? And if your growth areas continue to grow, it should probably go up.

We have been historically a little -- forecasting gross margins has been historically tough for us. Every time we say the gross margins are going to go back down to what our previous corporate average was, we have been proven wrong and they have continued to climb. And we're happy about that. Do we expect them to fall back to our older 55% range in 2006? Absolutely not. Do we expect that 59% will be -- or 60% will be the top? Some of that is out of control -- out of our control. Some of that is due to market dynamics. But we're not expecting a significant gross margin decrease in a short period of time.

Your product mix would sort of hint that it should go up.

It does. But the thing that is tough to gauge is what the market dynamics of those new products will be six months from now. I would say that as of right now, being as the products that are really driving a large percentage, if not all of the growth right now, are our newer products that have higher gross margins. You expect that in the near-term, but over the longer term you would expect market factors, including competitors, to actually factor into that.

Finally, do you have any visibility into where inventories sit with your customers for the DSLAMs or HDSL?

What was the question again?

Do you have any visibility into where inventories -- what inventories look like at your customers for DSLAMs or HDSL?

We don't have good visibility into that. We wish we always had more. And our typical visibility is a matter of a couple of weeks. But I would say that there's nothing out there that we are aware of as far as being any type of inventory situation.

Tim Daubenspeck of Pacific Crest Securities.

The first question is on international. You had a very strong Q3 in international. Can you talk about down sequentially it looks like is that primarily Telstra or is there a lot of other customers that contributed to that?

Telstra is our largest international customer, so Telstra went down actually Q3 to Q4, and they did have a fantastic Q3. Some of that decline was due to the fact that they were in -- at least the first half and actually through the third quarter -- in a network buildout that commenced sometime around third quarter. And so now what we're doing -- what we are seeing from Telstra is something that is more in line with net subscriber adds as they put new customers on to this (indiscernible) network that they have built out. Danny, do you have any more color on that?

Yes. I guess international for ADTRAN is still very tightly coupled with Telstra. But if you look at Telstra's performance Q3 to Q4, we actually made progress in some other regions in Q4. And if you remember, we brought on a new Vice President of International Sales in Q3, and he is today diligently trying to position us to grow beyond Telstra in the international marketplace.

Thanks. And I know visibility is tough, but can you talk about any change in the relationship with Telstra? There's a lot of moving parts there with Alcatel and privatization and all that. Can you kind of give us an update what is going on now with the relationship?

You're right, there a lot of moving parts. But I would say at this point in time we are as closely coupled as we have been in the past. We're still working with them on some new products that need to get into their labs. We're still talking about expansions of the applications and of the feature sets that we're delivering them. And we're very hopeful that that will continue to being a growth account for us.

And then a final question I will ask kind of the Alcatel outside plant DSLAM question. Have you see the product in the -- kind of in the field? And here in North America are you seeing any competition? Is this part of what is factored into -- what could be conservative guidance?

I've heard of the product. I physically haven't seen the product. I don't know if they're actually shipping the product at this point in time. I would say that in the near-term that the outside plant business that we have is something that we're comfortable with. We have longer-term contracts with most of the larger carriers. We also believe we have some competitive advantages through what Alcatel is talking about shipping. So we don't see any near-term disruption there.

That is fair. And then just one final question, Jim, any buybacks in the quarter?

No.

Joe Chiasson of Susquehanna Financial.

Two questions. Jim, the first one is for you. Could you explain just real briefly what is going on with respect to the pro forma EPS number that you're now issuing? I assume, or I understand it does not include the impact of 123R, but I am assuming it must include some options expense. Could you just clarify that?

That is exactly what it is. FAS 123R is the -- what equates to the $0.08 difference between GAAP and pro forma. It is all relating to share expensing.

But the pro forma number does include some options expense I guess presumably under just the pre-existing 123 rules, or it includes no options expense whatsoever?

I'm not sure I understand the question. FAS 123R does reflect the option expensing that we (multiple speakers).

Why don't we take that one off-line then. The other question I had was for Tom. Tom, could you I guess maybe talk a little bit about what your strategy is at this point in time with respect to broadband access? In particular I'm thinking about the IPTV and the FTTP applications. Certainly we're in the midst of a large RFP right now from the RBOCs for FTTP, and I'm wondering whether you guys envision yourselves being players in that market at this stage? And if in fact you did respond to the RFP? And also on the FTTN side as well, where you see yourself currently in relation to Alcatel here in North America?

Let me cover the FTTP first. We have been fairly specific that GPON was the right technology for us to enter in the FTTP market in. And that we were not going to be driven by market forces that may force us to enter that market earlier than you could actually sustain a profitable product line in a longer-term growth potential, and be able to make money in it. We have not entered that market. GPON is the right technology for us to enter that market with. And we have some platforms coming off this year that I think once we introduce those platforms it will all make sense as to where our longer-term product strategy is in that space.

We're not in a big hurry to enter that market, but it is a market that we will be entering in. And we do believe over the long-term that you have to have GPON technology in order to be in the access space. It is something that we will be addressing. As far as FTTN, I think we're positioned very well. We have been shipping our FTTN product, which is 1100 Series product, for over a year. We have thousands of prepositioned nodes that can be upgraded for FTTN deployment. We started trialing our 1100F, which is our video enabler, in the fourth quarter of this year with some major customers.

So we think we're positioned well. I think the real question on FTTN is going to be really timing as to when do the carriers actually start rolling out significant quantities. And I mean all the carriers. And I do believe we will be positioned well when that happens.

Ken Muth of Robert W. Baird.

On the Q1 kind of midpoint guidance there, it looks like it is roughly down about 8% sequentially. The last three years you have been pretty flat sequentially. It this just a factor of numbers where you are coming off such a high revenue base now and that kind of gets you to a more seasonal type number, or are there any other shifts going on?

Q1 is always -- is just a difficult quarter for us to forecast, and you're right that it has been traditionally down. I think that one other piece that is kind of a new animal for us in Q1 is really not being able to understand at this point in time the seasonality of outside plant DSLAMs. We had surmised I think on the last conference call that we may see seasonality in outside plant DSLAMs. And it is kind of a common sense thing. You would expect things that have to go outdoors and installed outdoors in the middle of winter are difficult. We did factor in some seasonality in outside plant, without really having a good feel at this point in time. So this is really the first year for king of mass rollout as to really how that is going to impact us. We gave it the best shot we could.

On that same thinking, do you expect the mix shift to kind of change, or it will remain stable here in the kind of remote terminal versus central office DSLAM?

I would expect that we would see stronger momentum in remote terminal in outside plant over the long-term. I think that there are still potentials in the near-term for kind of spot central office footprint adds. And we know that there are literally hundreds of central offices that are being talked about. To the extent that they do that then we will be able to participate in those. And those may drive that mix one way or another for a short period of time, but over the long period of time it is remote terminal and outside plant.

And then one last question on the Optical side, there's on is a lot of excitement around the wireless opportunities. How many wireline opportunities to you think you have, or trials that you have ongoing right now in the Optical side?

We have talked about several customers that have been in different states of discussion with us. We have -- some of those being Sprint, MCI, and there have been a couple of RBOCs that we have been working with for some period of time. We're still very, very optimistic on that.

We did start shipping to Sprint's wireline side of the business in the second half of last year. We're optimistic we will be shipping to the wireless side of the business in the first half of this year. The other opportunity, MCI, we don't typically announce customer wins, but I think in that mix of opportunities I just told you, I will tell you we have received orders this quarter for a rollout with our OPTI 6100 product families in one of those opportunities. I would say we're right on track and would expect the wireline growth to be substantial this year.

Simon Leopold with Morgan Keegan.

I wanted to talk a little bit about what you see going on at some of your independent customers. I think in the September quarter you had highlighted independents as contributing some of the strength that wasn't expected. And maybe in this discussion if you could address what you see going on at Altel and Sprint with consideration of the spin outs of the wireline business?

So far I think it has all been positive. I think the general feeling there -- at least might my perception of it -- is that they're picking up momentum on what they want to do on the wireline side. I think they are probably going to be less CapEx strapped. And I hate to speak for them, but I think a large percentage of their CapEx is spent on the wireless side. And I think at this point in time they are kind of taking another look at what they want to do long term on the wireline side of the business. And we view both of those situations as being positive for us. Both of those were strong customers for us in the past, and we think that it has rejuvenated their view on the wireline side of the business.

Overall, what percentage of your business is coming from independent -- U.S. independents at this point?

We really don't break that out. I would hate to start a trend here. I will say it is meaningful, and it absolutely grew significantly in 2005. And we expect, especially with some of the targeted product that we have coming out in 2006, for it to grow in 2006.

And then just a last question on the new products you alluded to in the GPON space. You talked about voice over IP. What do you see as catalyst for more detailed analysis? Would it be contract wins, trade shows? What are you looking for it to give us more information?

Some of these products are just too early to introduce, even though they may be actually in labs. To the extent we introduce products we basically introduce our competitors to those products. We have typically been conservative on the way that we talk about products. But the larger GPON capable platforms will be something that you should be seeing. And you will see it at trade shows. And you will probably see some product introductions come out after we get a little bit of history behind us.

Scott Coleman of Morgan Stanley.

Jim, I'm wondering if there any material differences in the gross margin across outside plant remote terminal or central office say DSLAMs?

No.

Tom, just a quick question for you. You indicated the 1,100 [F] trials with some significant customers in Q4. Does that include some of your RBOC customers for outside plant DSLAMs?

I think that would kind of be preannouncing my customer base there, so I -- it includes significant customers. I would like to leave it at that.

Joanna Makris of Canaccord Adams.

You did talk earlier in the call about the fact that some of the down tick in the HDSL and NetVanta businesses are due to seasonality. But I'm wondering if you can talk more about your general broader outlook on the enterprise market? You did signal that you would expect some increases in NetVanta, but what is your general take on any changes in the general enterprise spending environment and your ability to gain share in NetVanta specifically?

This is Danny. I will take that one. The spending outlook for IT spend, which is probably the best thing we can get to correlate to networking equipment in the space that we are in, is projected to grow in mid single digits next year. I believe that environment for ADTRAN to continue to grow the NetVanta product and take share in that market is very good.

Andy Schopick of Nutmeg Securities.

I would really like to follow-up on that because we are several years into kind of a recovery here, with that enterprise representing about one-quarter of your current business, 25%. Let me just read some numbers to you. 2002 enterprise just under 127 million; 2003, 129 million; 2004, 131 million; 2005 just ended about 127 million. Why aren't we seeing more growth in that sector of your business? What is really happening on the enterprise side of things?

This is Danny. I will take that one. The numbers that you just read don't really paint the underlying picture of what is going on inside the Enterprise division, because the Enterprise division has essentially been reinventing its product sets over the last five years. Five years ago the Enterprise division was almost exclusively a wide area networking supplier. And the market for wide area networking products has been in the decline now for five years. So over that timeframe you have seen ADTRAN be able to introduce products that would essentially allow us to offset the decline in the wide area networking space. The wide area networking space has now decreased to a small enough percentage of the Enterprise business that some of the new product categories do have an opportunity to actually give the Enterprise division a chance to grow in 2006.

Between 2000 and 2003 or 4 we saw strong growth from our gaining market share and position in the integrated access device marketplace. And in 2004 and beginning in 2005 we have begun to see growth from NetVanta. With the decline of IADs in 2005, there hasn't been as apparent. 2006 we expect to see growth in NetVanta. We hope that the IP business gateway market will give us growth for the IAD class of products, and believe that there's an opportunity for the Enterprise division to go in 2006.

Then in your assumptions or guidance for the current year, what type of growth rate overall within a range are you anticipating on the Enterprise side in 2006? Over or under 10%?

First of all, we don't break down growth by product segment. But I would expect -- 2005 was absolutely a kind of fresh start year as far as NetVanta. We absolutely started shipping -- and we started shipping before that, but we saw some significant momentum in 2005 as far getting name recognition. Danny had mentioned that revenues increased almost 100%. We are at the early stage of a product family, with us introducing, by the way, new products on a regular basis of a market segment that is substantially larger than anything else that we have touched within the enterprise business, and we're gaining momentum.

That is not a business that we have to worry about CLEC spending declining for one year. That is not a business that we have to worry about it going away the same way that the wide area network business went through. I think we have the right momentum. I think that we are much, much closer to having a complete product set. And I think we're moving in the right direction.

Thanks for the explanation.

Michael Perica of Brean Murray.

Tom, I have a question regarding -- and want to get more specific -- when you're talking about new platforms, specifically DSL technologies, for this year, what you're going to unveil? Are you developing a CPE type line video DSL product that some of your customers are talking about and looking at to put on the outside of the home? Number one, are you doing that? And number two, if not, do you think this could potentially cause issues for your position with your remote terminal and your OSP DSLAMs?

I don't think it will cause issues with the remote terminal OSP DSLAM product. I do think that there are areas in that termination business. And if you think about -- let's say DDSL [TMs] or DDSL2-IVs for that matter. I think if you take a look of the set of where DDSL2 will touch copper on the CPE side of it, that there are absolutely places that make sense for us to play in. And we will play in those places. Now I don't think that that is a significant contributor in 2006, because I think the number of the DDSL2 lines are going to be deployed in North America is relatively trivial. But I do think longer-term that that will absolutely make sense for us to be in.

Moving over to OPTI, do you expect to be shipping to seven of the seven carriers using our previous metric that we gauged you on with the DSLAM market share gains by the end of 2006?

If I look at the entire OPTI set -- I don't know. I will have to get back to you on that. I think there is potential, but I wouldn't go out on a limb and say yes.

Bill Choi of Kaufman Brothers.

Just a question on looking at SBC and Verizon, you're two very loyal customers there. They have consolidated at this point both MCI and AT&. So when we look at sequential numbers here you have both of those customers declining double-digit sequentially roughly. And at the same time you're adding on MCI and AT&T. I'm just trying to figure out, given the relatively strong performance in DSLAMs and a couple of your new products, what exactly is going on with these customers as they consolidated you're smaller customers, MCI and AT&T -- if you could give a little more color?

I would say that the sequential decrease that you saw had nothing to do with the consolidation. The sequential decrease you saw was driven largely by two factors. One is both of those customers are large customer as of ours. And both of those we did have a -- we did ship second quarter backlog and third quarter backlog too. The second thing that we saw, which is typical, is we did see seasonally at the end of the year on both of those two customers. I think that you can contribute to exactly that and nothing more than that.

Can you give an apples-to-apples numbers at least as to what SBC would have been? They were 21%, now they actually include AT&T in their 20%.

This is Jim. The old AT&T and MCI has been very, very, very small contributors in terms of revenue. It is really -- it really doesn't apply so to speak as far as we're concerned.

I think an accurate way to look at it will be from 21 to 20, and that is it.

Yes.

I thought AT&T was like a 3% customer at least.

No.

No.

And neither was MCI?

No.

Okay. Well, that helps. Finally, you talked about backlog a little bit. Can you give any kind of backlog information? You were at three weeks, and ending June you brought it down to something like two weeks. Where do we stand at the end of December?

I would say that the end of December we stand exactly in the sweet spot of where we typically run our business. We got past that anomaly in the third quarter, and we hope not to have it back.

One final question for Danny. Just your discussion on the whole enterprise part, I can agree on this relative weak performance over the three years of economic recovery here. You mentioned that prior to this you were a lot more exposed to WAN enterprise. The way I understand it is that you have last year's sweet spot of selling NetVanta. That as CMD02s get kind of sucked into the routers, you are essentially blocking and tackling and trying to grow off it.

In fact, you should be benefiting from all of these WAN enterprise relationships with telcos, etc. And I guess generally I would have anticipated still a stronger growth rate sometime into '05 and into '06. Could you just elaborate exactly where you have an advantage over a guy like Cisco when, in fact, it is not your WAN enterprise historical background and your relationships?

I do believe that the relationships we created while selling WAN access here have benefited our growth in NetVanta. So in NetVanta hoping up almost 100% year-over-year is evidence to that fact. Now many of the resellers who are out there who sold ADTRAN LAN access gear also sold Cisco gear. And so in the process of ADTRAN becoming a player in the internetworking space, we have been out, not only trying to convince our traditional library networking resellers to lead with ADTRAN, but to also grew grow a new reseller base. So that is -- essentially we have to establish ADTRAN as a credible supplier with a broad product family and redefine the channels that we use to reach those customers. And that is a multiyear investment that is so far going really well.

Just one other question here. Sprint, they were up nicely. Is that largely due to Sprint proper or is that the distribution arm of Sprint, North Supply?

We don't have that level of detail. But I can tell you that Sprint North Supply does distribute to many of the independents across the U.S. And we have certainly seen growth there this year. And also, we are selling into Sprint wireline and wireless as well. We saw some activity in those areas too in the fourth quarter.

I think we've got time for one more question.

Todd Koffman of Raymond James.

Just a quick clarification. Did you say your overall December quarter DSLAM revenues were up or down sequentially?

Overall DSLAM revenues for December quarter were slightly down.

Tom, I thought that you said that your remote terminal revenues were now comfortably more than half. Did I misunderstand that and that was that piece was up?

That piece was up, and you did misunderstand.

Thank you.

Okay. Well, thank you very much for joining us on our conference call. And we look forward to talking to you again in three months.

Thank you. This concludes today's conference. You may now disconnect.