ADTRAN Holdings Inc (ADTN) 2006 Q2 法說會逐字稿

Good morning. My name is Lisa and I will be your conference operator 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. (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 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 markets for such product; the product and channel mix; component costs; manufacturing efficiencies; and other risks detailed in our annual report on Form 10-K for the year ended December 31st, 2005, and Form 10-Q for the quarter ended March 31st, 2006.

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.

ADTRAN will post on the Investor Relations section of the website at www.ADTRAN.com reconciliations of this non GAAP measure to the most comparable GAAP measures, including the reconciliation presented in ADTRAN's first quarter earnings release.

Speaking on today's call 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.

Thank you, Lisa, and good morning, everyone. As Lisa mentioned, joining me today are Danny Windham, President and Chief Operating Officer and Jim Matthews, Senior Vice President and Chief Financial Officer.

In the second quarter we witnessed a rebound in HDSL revenues and saw sequential and year-over-year growth in Broadband Access and Optical Access product revenues. Our marketshare wins in the U.S. for Broadband Access products are particularly notable as revenue growth from these gains more than offset lower year-over-year Broadband Access revenues from a single large international customer.

Additionally during the quarter, we made significant progress in positioning our Optical Access products for continued revenue growth as we proceed through this year. Combined, our primary growth areas comprising Broadband Access, Optical Access and NetVanta contributed about 31% of total revenue in the second quarter of 2006. We continue to see robust order acceleration in these areas and our outlook remains extremely positive for these three product initiatives.

In our enterprise business, integrated access devices grew sequentially as we began shipping more meaningful volumes of IP business gateways. Although NetVanta was slightly down from a record revenue first quarter, NetVanta revenues for the six months ended June 30th were very strong over this same period last year as this category continued to experience accelerating order flow as efforts to improve the price channel awareness and leverage carrier distribution continued. We continue to anticipate very meaningful success in IP business gateways and NetVanta product areas.

Many will recall that the first quarter marked the announcement of two significant product lines for ADTRAN. Our Total Access 5000 platform began shipping in small quantities during the second quarter and we anticipate volume shipments will commence this quarter. This platform significantly broadens our range of Broadband Access products as it is targeted specifically to address the growing requirements for applications including IPTV, Metro Ethernet and the movement towards IP-centric networks and new DSL technologies.

Additionally, feedback on the introduction on the NetVanta 7100 series of IP PBX products continues to be overwhelmingly positive; and we are encouraged that this new family of products will significantly add to our value proposition for our primary target of small- to medium-sized businesses. We anticipate the 7100 will begin volume shipments this quarter also.

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 macro level with enterprise demand, wireless network expansions and wireline capacity upgrades.

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

Thank you, Tom. Good morning, everyone.

Revenue for the second quarter was $122.3 million up from $118.9 million in Q2 of '05, and up from $108.6 million in Q1 of 2006. For the total Company, systems revenue was $66.9 million in Q2 of '06, up from $62.8 million from Q2 of '05. Comparing Q2 of '06 to the same period the prior year, the increase in systems revenue was primarily due to an increase in the primary growth areas comprising Broadband Access, Optical Access, and NetVanta product revenues, partially offset by a decline in 303 concentrator and narrowband systems revenue.

HDSL T1 product category revenue was $52.7 million in Q2 of '06, slightly down from $53.6 million in Q2 of '05. Comparing Q2 of '06 to the same period the prior year, the decrease in HDSL T1 is attributable to a decline in DSU/CSU revenues, partially offset by growth in HDSL. Visual business transport total reach was $2.7 million in Q2 of '06, up from $2.4 million in Q2 of '05.

Carrier networks division revenues were $94.6 million in Q2, up from $89.3 million in Q2 of '05. Comparing Q2 of '06 to the same period the prior year, the increase in carrier networks division revenues was primarily due to an increase in systems revenue.

Enterprise networks division revenues were $27.7 million in Q2, down from $29.6 million in Q2 of '05. Comparing Q2 of '06 to this same period the prior year, the decrease in enterprise network division revenues was primarily due to a decrease in T1 product revenues partially offset by an increase in NetVanta product revenues.

Total revenues increased sequentially in the second quarter by 13%. DBT total reach revenues increased to $2.7 million in Q2 of '06, from $2.2 million in Q1 of '06. HDSL T1 revenues increased 28% to $52.7 million in Q2 of '06, from $41.1 million in Q1 of '06.

Systems revenues increased to $66.9 million in Q2 of '06, from $65.4 million in Q1 of '06. Also on a sequential basis, carrier network division revenues increased to $94.6 million in Q2 of '06 from $81.2 million from Q1 of '06; and enterprise network division revenues increased to $27.7 million in Q2 of '06, from $27.4 million in Q1 of '06.

International revenue as a percentage of total revenue was 6% for the quarter, up from 5% in Q1 of '06 and down from 13% in Q2 of '05. The decrease in international revenue from the same period the prior year was due to a decline in Broadband Access product revenues from a single international customer.

Gross margin was 59.2% of revenue during the second quarter of 2006 compared to 58.5% for Q2 of '05. 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 $17.5 million in Q2 of '06 compared to $16.4 million in Q2 of '05. Comparing Q2 of '06 to the same period the prior year, the increase was primarily due to stock-based compensation expense recognized in Q2 of '06 of $972,000.

Selling, General and Administrative expenses were $26.4 million in Q2 of '06, compared to $24.3 million for Q2 of '05. The increase was primarily due to stock-based compensation expense recognized in Q2 of '06 of $1 million, and increased costs primarily related to expansion of international sales and marketing efforts.

Other income, net of interest expense was $3.8 million in Q2 of '06 compared to $2.4 million in Q2 of '05. This increase is primarily related to higher investment balances and higher interest rates related to fixed income securities.

The Company's income tax provision rate continued to be unusually high in the second quarter due to the continuing delay in the passage of legislation extending the federal R&D tax credit. The results of this delay was an increase in the tax rate of about 90 basis points in the first half.

Non GAAP earnings per share assuming dilution for Q2 of '06 were $0.29 compared to GAAP earnings per share of $0.27 for Q2 of '05. GAAP earnings per share assuming dilution were $0.27 for Q2 of '06. Non GAAP earnings per share exclude the effect of stock compensation expense for employee stock options, associated with the application of FAS 123R which ADTRAN adopted effective January 1,2006. As ADTRAN begins to apply FAS 123R, it believes that it is useful to investors to understand how the expenses associated with the application of FAS 123R are reflected in its results of operation.

The presentation of these non GAAP measures permits both investors and management to more readily compare past results with future results, and to better understand ADTRAN's performance over the periods presented.

From a balance sheet perspective, inventories decreased $1 million from the prior quarter to approximately $47 million. Trade accounts receivable increased approximately $2 million from the prior quarter to $65 million due to increased revenues. DSOs came in at 48 days for the second quarter down from 52 days for the first quarter of '06 and down from 49 days for the second quarter of '05.

Net cash provided by operating activities came in at approximately $24 million for the three months ended June 30. Unrestricted cash and marketable securities totaled $329 million at quarter end after paying $6.9 million in dividends during the quarter, and after repurchasing 3,355,000 shares of common stock for $82.7 million during the quarter.

Now we would like to discuss guidance for the year and third quarter of 2006.

Revenue for the year is expected to range from $500 million to $515 million. GAAP earnings per share for the year assuming dilutions are expected to range from $1.13 to $1.20. Non GAAP pro forma earnings per share for the year assuming dilution are expected to range from $1.22 to $1.29. Revenue for the third quarter of 2006 is expected to range from $130 million to $137 million. GAAP earnings per share for the third quarter of 2006 assuming dilution are expected to range from $0.31 to $0.33. Non GAAP pro forma earnings per share for the third quarter of 2006 assuming dilution are expected to range from $0.33 to $0.35. Non GAAP pro forma earnings per share for the year and third quarter 2006 exclude the effect of stock compensation expense results and from the application of FAS 123R.

Tom, back to you.

Thanks, Jim. Okay, Lisa, at this point we would like to open it up to questions.

(OPERATOR INSTRUCTIONS) Vivek Arya with Merrill Lynch. There is no response from that line.

Gina Sockolow with (indiscernible) Partners.

Thank you. Could you just go through on the carrier side center any significant 10% customers and what changed with the international customer and how we stand with the RBOCs ordering pattern in the U.S.? Thank you.

Sure, let me start -- Jim, if you would go with the 10% and then let me cover the international (inaudible).

For the second quarter, the 10% customers comprised AT&T at 23% of revenue; Verizon at 13% of revenue; and [Enbark] at 16% of revenue.

On the international customer, we had a large customer located in Australia that actually did a network build-out last year that was completed towards the tail end or maybe early fourth quarter where they actually bought DSLMs for a business DSL service and at this point in time the infrastructure build-out is complete.

So what we expect going forward would be normal linecard and NTU sales which are remote sales as they bring customers on to that network.

From a order flow perspective, I mean that's we have several large customers that have -- are different positions within that but I would say the order flow was typical for a second quarter.

John Anthony with Cowen.

Good morning. I'm hoping you can help me reconcile the kind of disconnect that we -- you started at the beginning of this year when you gave guidance in January of 565 to 590 million for the full year. This is the second time you have lowered guidance yet it seems you're almost becoming more constructive on your outlook moving forward.

So can you help us reconcile what is changed from a numbers standpoint, given the guidance you gave in January to the guidance you've given now? Is it customer-specific? Is it product-specific?

I would say it's probably more product-specific than anything. Coming into this year we have had - and for all practical purposes still have - a lot of opportunities laid out in front of us. And as we go through the year, of course, we get smarter and smarter and smarter. But those opportunities are still in front of us but those opportunities haven't delivered at this point in time.

So I think it's a matter of us taking a look at where we are, giving our best snapshot at the year at any point in time and trying to relay that information as accurately as we can. The opportunities are still in place though and I think a lot of people are cognizant of what they are. A large part of that being around the 6100 product family.

And given these opportunities when you say they are still in front of you, are the customers in a decision-making process? Have the decisions been made and it's a timing issue? Is it a valuation issues? Are they looking for additional functions? Can you help us out there a little bit?

Sure. First of all, there are several customers and I will give you the general tenure of the larger ones.

The larger customers have made their decisions. We are moving forward with - the larger customers by the way have gone through the lab testing - and we are moving forward with implementation and as many may know, implementation within a large carrier is variable from a time perspective.

So it's in judging that, I think we made great hurdles in getting you into the lab, out of the lab, field trials and all the necessary steps. We are into getting everything finalized, getting practices written and getting things rolling. That would be in general. There are a couple of customers where we are less far along. But I think the ones that we have spent the most time talking about that's the state we are in.

Okay. Two other quick questions. TA 5000. Did you recognize any revenue or did you just ship?

No, we typically recognize revenue for most of the products we ship but I would say it was not meaningful. It was very, very early into that cycle. And I will say there is strong demand and we have over a dozen trials that we will be participating in this quarter.

So there's very good demand out there. But having said that we are talking about carrier so, and you expect us to be kind of cautious on our outlook there.

Lastly if we look at your systems business, 60 - call it 67 million in round numbers - and we extract the new systems, that implies your core systems declined 7% annually. Was there a one-product category within core systems or was it just kind of a hodgepodge, a mixed mixture of things that just didn't work in that business line?

Let me let Jim answer that.

Yes where we saw declines, John, we're in 303 concentrators. Also in narrowband shells that they are reflected in the systems category. Those were the larger negatives.

Was there a reason why those declined that you can pinpoint?

Let me add to that. The 303 concentrators are (indiscernible) mainly by CLECs. That has been a product that has been on our portfolio for quite some time and as you would expect those concentrator sales will probably - they have surprised us for their longevity - but will probably declined over time as people move to more IP-centric networks.

As far as the narrowband access shelf that's the 1500 product I would surmise, Jim. Mainly the 1500 product. That is a product that is, you can call it a small channel bank or a large channel bank or a small [BOC] used mainly -- there's a very specific project-oriented sales associated with that. So that is one that you'll see kind of up-and-down and we have seen up-and-down over the last few years.

Thanks.

George Notter with Jefferies.

Two quick questions. On the new revenue guidance, I was trying to figure out if there is anything motivating that guidance in coming down, that is beyond the 6100? Are there any other products that you are thinking about beyond the 6100 that is causing the change in guidance?

Secondly, your commentary on taking share in the Broadband Access space was interesting. Any more flavor for where you might be taking share? What the opportunities are there?

We believe we have taken share in some of the existing customers that we have been selling to. In that share of course we have done a good job in the remote terminal (indiscernible) [plant] space but we also believe we have picked up some shares in the central office space, in some of the customers that we have been selling to.

And as far as the guidance is concerned, there we have legacy products which we had a HDSL T1, actually did a pretty good job this quarter. There is a strong year-over-year comparison if you look at the second half.

We have no reason to believe at this point in time that that won't occur but I think we are trying to be prudent and we are taking a look at that kind of ramp up and saying, "Okay, what should we kind of running the business by and what should we be guiding by?" That is what we have done.

With the 6100, I think it's the same thing. I think if you would have asked us this time last year we would have expected - even factoring in normal RBOC delays, we would have expected to see some revenue coming from some of these major accounts at this point in time. But we haven't seen it.

Now we are kind of at the corner here where it should be coming online. But I think us planning on all that business coming online in the second half wouldn't be prudent at this point in time. So I think it's just several factors.

Got it. Just as a quick follow-up on the Broadband Access piece, you said you're taking share in the CO side. Is that more independent telco revenue? Is it RBOC revenue? What do you think?

I think it's both.

Thanks.

Scott Coleman with Morgan Stanley.

I'm wondering if you can just give us some updated thoughts on growth expectations for each DSL, the legacy products, and the new growth products, given the reduction in full year topline guidance?

I just kind of commented a little bit out on George. I mean I think that we're, you know, HDSL and legacy products, we have -- we were -- they were basically where we would hope they would be in the second quarter. And what we are looking at right now is strong comparisons year-over-year. And with our inability to forecast long-term on HDSL or any of these legacy products due to the lack of forecast by the customers and variability in the order rate, I think that we are just trying to factor that in and not --

That helps Tom. And I think in the past what you've said is, when you look at Optical Access versus Broadband Access, your expectations were that the growth rate in Optical percentage growth rate would surpass Broadband but that the dollar growth rate would be relatively equivalent.

It sounds like from your Optical comments that you're not quite so optimistic on Optical although you are still expecting strong growth in the second half of the year.

I would say that our guidance would kind of reflect as you are saying, I would say there is absolutely still opportunity for the Optical growth rate to meet our expectations this year. But I think it is a matter of us necessarily kind of structuring the expense levels and the guidance around all that having to happen.

Maybe I'm misunderstanding but if it could hit those growth rates then wouldn't that imply some level of upside to the guidance you are issuing today? And are you just being conservative or am I missing something?

I don't know if I want those -- I don't necessarily want to say we are been conservative. I think we're trying to be prudent based off of the period in time that we have left in the quarter; the significant second half growth rate that has been expected; and us trying to just judge where the timing of these things are and when they would actually come in. So -- which is a very difficult thing to do. And you know that and we definitely know that.

Right. I understand and I guess just one last question. In the past, you have talked about bringing on Tier 1 customers for the Optical product in the second half of the year. And I realize that is tough to forecast but does that still seem to be a high likelihood based on what you're seeing today?

I think it is a very high likelihood.

Great. Thanks a lot.

Marcus Kupferschmidt. Lehman Brothers.

Good morning, everyone. Just want to comment and make sure I understand in terms of the change in the guidance here. Trying to be a little more prudent about some of the opportunities in Optical versus where we were a quarter ago. And then we are saying we are trying to be a little more prudent about some of the legacy products.

I'm just a little confused and just want to understand the key message before I ask a follow-on.

I think the key message is, I think you pretty much hit on it. We have two things in there that drive our business as you are aware. New products, primary growth drivers, which are comprised of the three product areas, and then our traditional business.

And what we have done, what we are doing is if traditional business comes in as strong as it did last year which, I will have to reiterate, we have no reason to believe it won't - we are not necessarily going to plan for that - then we will do well. If the 6100s and the DSLMs come in as strong as they have the capability of doing in the second half, we will do well.

We are not necessarily planning on both of those things happening at this point in time, due to the kind of sporadic ordering pattern and product introduction at these larger customers.

Just in terms of -- sounds like we have a lot of confidence for what you should grow sequentially from 3Q based on the full year guidance. I guess the point there is, new customers coming on versus more from existing customers?

I would say it means that there is enough new marketshare opportunities out there for us in our product space, that we believe that that's a likelihood at this (inaudible) .

When do you think we can generate revenues for Optical for the OC-48 and SDH products?

OC-48, I am - if I look at our product introduction and where we are with customers it could be in the third quarter. We are not planning on that at this point. We are planning more for fourth quarter which kind of [gets to] your previous question.

And for SDH?

SDH, we have a product set available now. We have actually started generating some revenue from that product set. That will continue to grow as we continue to enhance the number of different line cards and technologies that put into the 6100.

Ehud Gelblum with J.P. Morgan.

Thank you very much. Let me try and attack this from a different perspective. Let's take just your HDSL business.

You just mentioned in the press release and on the conference call that it is all sort of back to run rate level. Can you compare the level of your HDSL business this year right now sort of to what it was last year at this time and your visibility?

I believe your visibility in the past has been on the order of two to three weeks. Is it the same now, less or more? And the run rate this year versus last year at this time?

Let me try to dissect that. I think we've mentioned that Q2 and HDSL was above Q2 of last year. I would say the order run rate -- I mean there were several things that kind of drove that inventory situation that we were in last year at this time.

And for instance, some of that was Optical. A large piece of that was Optical. I would say that our inventory situation is at kind of normal levels.

How about your visibility going forward?

Visibility is backlog-wise normal and visibility-wise, it is not significantly different than it has ever been, you know, a couple of weeks.

But from last year it sounds like you had a large backlog in Q2 of last year. You don't have it this year.

Last year we had an inordinately large backlog versus what our normal backlog, which we had characterized it as basically a week's worth of additional backlog. I just kind of reiterate it. Our backlog situation at this point in time is where we would normally like to see it.

So maybe the difference between last year and this year, relatively, the same run rate, backlog is one week less and that feeds into the going forward thoughts and what HDSL does for the rest of the year. Is that the right way to -- ? And therefore your guidance -- ? (MULTIPLE SPEAKERS)

I don't know if I would necessarily peg HDSL for this. We've mentioned that HDSL has come back in line and it rebounded from where we were. But I would say, in general, I mean we are in a normal inventory situation this year; and last year, we were -- we had more backlog than we had typically had previously.

If you were to look at Q3 and Q4 and the pieces of your guidance for the rest of year compare that for HDSL and compare HDSL in Q3 and Q4 this year -- and then Q3, the actual Q3 and Q4 of HDSL last year? (MULTIPLE SPEAKERS)

That gets into -- do I have any reason to believe that it will be substantially different than last year? I don't.

But what we have done is, we have taken the new product introductions, the new product growth rates, the traditional business, kind of blended them together and done a lot of what ifs, and come up with what we believe to be the prudent numbers under which to guide by and to run the business by.

So talking about -- there's no reason that would be that different. If we look at the OPTI 6100 the difference in your guidance is about $40, $45 million. Your prior guidance and your current guidance. Is it the right message and the right assumption to assume that that $40 million is essentially from these customers? Whereas the timing, like you said, the implementation takes a little bit longer than you anticipated and so that $40 million is not necessarily a loss because you have those customers. It's just a matter of perhaps being pushed out into 2007?

We haven't pegged a new particular number around the 6100 or around particular customers. I would say that part of your question is actually accurate, which is all of the major deals are intact and that we are absolutely not planning on all of those deals or at least not planning the business on all of those deals coming online this year.

I'm less concerned in the timing when they come on. It's sort of irrelevant whether they come on in November or they come on in March if those customers are there, especially given your business model but the only thing (MULTIPLE SPEAKERS)

I love that comment by the way.

Your business model has grabbed market share and in time you'll hopefully get 60, 70% of these markets that you are trying to get into anyway.

I am just trying to echo the last five questions and what we are basically hearing is that HDSL is right where was last year, albeit there is a week difference but we can calculate what a week is. Yes there are some pluses and minuses but your visibility is only three weeks anyway. So the HDSL is not that much different now versus what it was last year and there's a $40 million change in your guidance - most of which is from pushouts from Optical Access, maybe some other things here and there, if you have [3] concentrators.

So maybe some of that got pushed into next year but, essentially, your outlook hasn't changed very much. It's just being cautious on the timing of what falls into the calendar at 2006.

That is what we are all hearing. I just want to make sure that we are not hearing the wrong thing.

I would say that's not a bad summary. I think the only - what we have because we have a fairly broad product mix, definitely, for a company of our size. I think we have the - I guess you could call it a luxury, of being able to have growth in one area and maybe see flatness in another area and or see growth in traditional products and see products move out. And we would like to be able to utilize that.

Fundamentally, you're right. Has the world changed in the last year? No it hasn't. Has the kind of underlying things that drive both our legacy business on a macrolevel, both our legacy business and the attractiveness of our new product, has that changed? The answer to that is no.

Thank you. If I could get a couple of different questions in there. Book to bill. If you have book to bill, it would be very helpful and you mentioned 303 concentrators in the 1500 product. Can you help us size those to get a sense of (inaudible) percentage wise? How large they are?

Gosh, Ehud. We don't break out any of those numbers in terms of book to build. I mean, we are essentially book and ship business as you know and breaking out those revenues for those products, they are smaller. They are part of the legacy business but, again, we don't break them out.

And they are getting smaller it sounds. Thanks so much.

Vivek Arya. Merrill Lynch.

My question, Tom, is that when I look at your total year guidance and then I look at the implied fourth-quarter guidance it seems you are guiding to a sequentially up fourth quarter, which is very different from your usual seasonality of the sequentially down fourth quarter.

First I just want to make sure that my math is right. And, second, if it is, what is causing you to have a sequentially up fourth quarter this year?

I think your math is correct and we do still have an awful lot of opportunities that are in front of us. And we do plan on being able to grab market share and being able to capitalize on that market share. On that market share is by the way not only an existing products but it's in -- excuse me, not only in our new product areas but we also have some existing products that we are very hopeful that we will be able to grab market share in.

I see. And as a follow up -- .

We have done that -- I'm sorry but we have done that in the past. I think historically you have seen times where we have actually seen it up fourth quarter mainly due to market share. And we are hopeful that we will see the same thing play out this year.

So the market share is related to Optical and HDSL or is it some other area? I'm just trying to understand how much visibility you actually have in these market share gain versus just optimism around that?

Its always optimism until you see the purchase order. So I would caveat everything we say kind of with that line. We expect to see market share in existing products, including IP gateway and HDSL. We have -- we expect to see or hopeful that we would see continued market share gains in Broadband Access and of course Optical. We fully expect to see market share gains.

And one other sort of macro-related question is, over, I would say 94, 95% of your sales are now coming from the U.S. [theater]. And the commentary we have seen from other vendors like Lucent has been very weak, probably (indiscernible) consolidation and slowdown in U.S. wireless spending, etc.

Tom, what is your view on the second half carrier CapEx? Do you expect second half U.S. carrier CapEx to be more than the first half this year or more than the second half of last year? How do you see that?

I can tell you, I have no better of a crystal ball and it almost takes a crystal ball to be able to look at the CapEx numbers at this point. But we are expecting our business to grow in the second half. The comment about wireless CapEx is one that we pay attention to, because there is some portion of our business that is driven by that.

I think that the good thing that we have going for us, though, is that we have combination of both wireless and wireline customers and wireless and wireline applications. And so far that mix has been a positive thing for us.

But a lot of our business growth is premised around market share gains, which can happen regardless of the CapEx environment.

One last question. Jim, what is your tax rate guidance for the second half of this year and, perhaps, an early look at those (indiscernible)? How should we model tax rates?

Our year-to-date tax rate is 35.8%. So that's, again, that's through the second quarter. Obviously we are anticipating that rate for the third quarter, as well. Now for the year as I mentioned before the R&D tax credit legislation has not yet been signed. But at this point, we anticipate that to be done towards the end of this year, in the fourth quarter, at which point we should pick up a meaningful credit.

We continue to anticipate that that legislation will be retroactive to the first of this year. So we are anticipating about an 80 basis points pickup, so to speak, on the year tax rate in Q4.

So 35.8% for Q3? And close to 31% for Q4?

No. 80 basis points. So that would put it fairly close to 34%.

So 34% for Q4?

I'm sorry, 30 -- it should be pretty close to 35% I should say.

35% for Q4?

For the year.

For the year.

For the year.

And that's implied in your total year EPS guidance also?

That is correct. So 35% for the year would be the anticipated rate, based on the data points that I gave you and that should give you something in the back end of the quarter.

Thank you.

Jason Ader with Thomas Weisel Partners.

Good morning. If I look at the systems, the legacy systems revenue, and I look at the HDSL, is it fair to say, Tom, that for the six months - if I kind of do the math - for the six months of '06 versus the first six months of '05, we are down somewhere in the kind of 5 to 10% range. Is that about right?

I don't have that (inaudible).

That's not irrational (MULTIPLE SPEAKERS).

Okay. So is that something that has surprised you guys? I am just trying to figure out because, historically, we have talked about the traditional products growing -- let's say on a six or nine months ago I think, when we have discussions about on these calls about traditional products, we talked about growth of maybe mid-single digits, maybe high single digits. In that kind of range.

Now we are kind of in more of an erosion. Has that been a surprise to you?

There is a [piece], you know, that we talked about on the first conference call that absolutely was a surprise and that was probably the biggest impact at least in our T1 and HDSL, which is the -- we had a large customer that did a realignment of their warehousing and ordering.

We as I think the numbers reflect this quarter, that activity is over. But those are lost dollars. Once they do kind of realign and are able to operate at a lower basis, the dollars that they shipped out of those warehouses are gone.

And I think that that does kind of reflect in some of the math that you're doing.

I guess what I'm getting at is, I'm not -- I don't think anybody here, it seems on the call, that we are concerned about the new products. It seems like you guys have a lot of momentum there productwise. You have good traction with the customers.

It just seems like on the traditional products - especially as you talked about the comps are very tough for you on the HDSL side in the second half of '06 versus '05, and then the traditional stuff, some of the 303 concentrators and things like that - it seems like, is there something that could surprise -- could be just the traditional products continuing to be somewhat weak?

I'm trying to get comfortable with whether your opinion or your overall view on the traditional products has changed. Or are you still feel like we are just going through a temporary dip and things will come back?

Here again, I just have to go back to what it is, that is happening in the marketplaces. There is absolute work for us to do going forward in our traditional products. I think that HDSL is one of those where we have gained market share and we will continue to gain market share; and the usage of HDSL is one of those that is driven by market dynamics that are no larger than ADTRAN.

We don't believe at this point that they are really a competing technology that have gained any serious foothold that will, in the near term, really affect those.

[IED]s is kind of a different story. I mean IEDs are one of those where we have leading market share. There is still market share for us to give. But at the same time that marketplace is undergoing a conversion to IP gateways. We entered that market for all practical purposes in the fourth quarter of last year; and we have seen good traction but we have work to go and we have market share to gain.

So some of it -- I mean, none of this is kind of on autopilot. We have to continue to earn our keep here.

Just some quick housekeeping questions. Jim, maybe you can respond to these. On the Broadband Access side, just from my math, it looks like it was both Broadband Access and Optical were up slightly sequentially. Is that right?

They were both up sequentially. Yes.

Okay. Was one up more than the other?

I don't have that level of detail before me.

And then the telstra ATM-based DSLAMs. That went in the Broadband Access line, correct? Last year? That would've been in Broadband Access. Correct?

Right.

So year-over-year, what you're saying is if you pull out that particular customer, your overall growth would've been extremely strong?

That is a fair assumption.

Okay. Thank you.

Ken Muth with Robert W. Baird.

Good morning. On the NetVanta side of it is down a little bit sequentially. Kind of any reason for that? I would've thought that sequentially it would've been up, given the seasonal patterns. And then the outlook for that in the second half of this year, how do you view that product category and anything you are doing in the VAR channel to maybe try to accelerate it?

That (indiscernible) revenue in Q2 I would characterize as having been strong. And probably the biggest explanation of why that didn't set a record is because we had a really really strong record, Q1.

The revenue analysis in Q2 is still encouraging because like Q1 there are really no single big deals dropping their revenue. So the base of revenue is getting broader. And there are things happening in the NetVanta product family that I think are really worth mentioning from a positioning perspective because Q2 included no revenue from a NetVanta 7100, which we are close to releasing and shipping.

We also spent quite a bit of energy in Q2 positioning ourselves to be able to sell into some markets that traditionally we have not been in a position to sell into. Specifically, some selected countries in Europe.

So if you look at the progress in Q2, while it was a reasonable revenue month or revenue quarter, I think the bigger story is that we have been working to expand our coverage of the marketplace and expand the product base and that you'll see some those benefits in Q3.

Then on the margin side are you seeing any margin deterioration or erosion in that product line?

We are in the market segment in which we complete which primarily is small- to medium-sized businesses we really have been one of the price aggressors there. And we have not seen margin erosion or competitors who are attempting to take on the price-leading position to compete with us there.

Tom and Jim, if you look at the kind of systems side and kind of extrapolate the guidance that you gave, in trying to be conservative so close to the lower end of that guidance of the 500 million, that would kind of imply a 6% year-over-year growth rate in that systems category.

At what point do we kind of see a pickup in that business? Is it further router or it seems like we have got to have a couple of things going on the legacy side as well as get some things going on the OPTI side. Where would you kind of categorize the outlook for that segment?

Without commenting on the breakout of systems and legacy - because I don't think we gave that granularity in the guidance - but could the systems business grow substantially more than the base off of new products and legacy systems products thing where they are, the answer is absolutely yes.

The opportunities that we have out there which, Ken, I believe you are aware of some of these, are fairly large or definitely large and incredibly large for a company our size. So the opportunity is absolutely there.

Does that mean that we are not going to continue to drive for market share in legacy systems? The answer to that is no, of course. There are some products that by their very nature will decline over time. 303 concentrators is an example of that.

But I think we have as many new products coming in. IP gateways being an example and for that matter even for some period of time, traditional IEDs, where we can potentially grab market share, that will continue to grow.

So I think I answered your question but in general, no. We don't have to have that growth but that doesn't mean we wouldn't try to get that growth.

And last question. Do you have any U.S. economic or global economic concerns looking out for the second half '06 and even early '07, or just how things are shaping in the economy as well as in the carrier market landscape?

We have the exact same concerns as probably everybody on this conference call. So, yes, there are things that are within our power to control. And there are things that are not. We have to keep moving forward. Did we factor in any significant downturn in the change in the economic environment in the second half. The answer to that is no.

Thank you very much.

Andy Schopick. Nutmeg Security.

Jim, I'm going to ask you a couple of very specific questions because we covered a lot of ground here today. Given the weakening stock price and the aggressive buybacks that have been underway, what weighted average fully diluted share count are you using for 3Q and 4Q?

Well, Andy, what I've got to be careful very careful of is not to assume any additional buyback in the guidance we give for the year. So basically, taking what we ended up with in Q2 and going forward and also assuming the full weighting so to speak, all of the buyback that we did in Q2. Obviously Q2 had partial waiting for the 3.3 million shares that we purchased. (MULTIPLE SPEAKERS) that that would come in in Q3. And obviously would be there for Q4 as well. But I have assumed no additional buyback.

In the estimate that you provided us.

Right.

Cash flow from operations. Can you just provide that number? I know there is some adjustment now for FAS 123R in terms of calculation cash flow but wonder if you could give us -- ?

Cash flow from operations, $24 million. We had 2.1 million and CapEx expenditures for the quarter.

Are your customers really starting to signal or tell you anything different, regardless of the Middle East situation, because I think there are some signs here that the outlook in general seems to be weakening for the second half. I'm just really wondering what your customers are really communicating to you and why you are seeing some of the shifts and pushouts that you are seeing.

The communication we get from our customers has been fairly consistent for quite some time. The shifts that we see and I would not characterize them as pushouts because I think it's a matter of getting through - more specifically talking at this point for instance on the 6100 product - the shifts that we are seeing are not driven by singular events.

They are driven by schedules and people meeting schedules from what the customer plans and what the customer wants and how quickly they can actually implement. There has been no single shifts in our customer in regards to the attractiveness of the products or their willingness and desire to actually deploy the product. I think it's more of a tactical of getting things done on time.

I just want to clarify. The $82.7 million that you expect to repurchase shares were done over what timeframe?

It was done under the timeframe of -- beginning just a few days after the last conference call leading up to the last day of the prior month.

So it was all in the, basically, the quarter.

It was all in the quarter, yes.

Simon Leopold with Morgan Keegan.

I've got a couple of hopefully trivial ones. In the past I think you've talked about your gross margins from new products as being better than average. Just wondering if that is still the case.

I think that is still the case. I will tell you that as we continue to march through time and cost reduce our traditional products, and continue to grab market share, I would say that the differential there has become less and less. We seem to be kind of legacy products continue to improve as we continue to get more efficient. But yes, I would say in general our new products are still at a higher gross margin.

I apologize if this is beating a dead horse but getting back to the HDSL market, it sounds like on the lower guidance, you are still expecting some sequential improvement off of this quarter. Certainly a more modest space and playing with my model it looks like you'd be expecting quarterly contributions to average somewhere in the, maybe, mid-50 million range. Am I doing the math right or missing something in that?

Here again that would be kind of guiding to the segment, which is something that we haven't done. But would we expect our traditionally and for quite some time third quarter is stronger than second quarter not only in legacy products but typically any product but definitely in legacy products. We would expect third quarter to keep constant with that kind of a historical low.

You guys have a dominant market share, obviously, in HDSL. What are you seeing in terms of the unit pricing? How's that changing?

It's a stable market. We have price decline as we have, one, longer term contracts that will kick in periodically but I would say it's a very stable market.

So when you say stable, should I interpret that as normal year-over-year declines within what's traditional? Or are you saying there are no price declines?

I am saying that it is normal year-over-year declines that would probably be less than what we have traditionally seen. HDSL is from the technology perspective, it's a very good value for the customers; and I think that they have factored those into their thought processes as we signed these longer term contracts.

Just one last one. The legacy systems products, if I'm doing the math correct, I think you gave us 31% of revenue for new products, suggests that the legacy group was up slightly sequentially. Is that correct?

It would be up sequentially, yes.

Thank you very much.

Nikos Theodosopoulos with UBS.

Thank you. I had a couple of questions. The first one was on operating expenses. I think you made in the early comments, comments about SG&A being higher due to some international efforts. And I'm just looking at your OpEx this quarter, and it was about 41.9 million and that excludes the option expensing.

If I compare that to let's say your peak quarter last year when you were doing about 149 million in revenue, your OpEx was actually lower at about 40 million. So can you elaborate a little bit on the increased level of OpEx? Is there some (indiscernible) mine-related expenditures there or is this an effort by the Company to increase international sales and more of a sustainable level going forward?

Thank you.

I would think (indiscernible) is one of those kind of taxes that you pay and the more successful you get in system products, the more you pay and what we have set our goals on are trying to manage the overall R&D expenses in line with the revenue growth which, of course, is difficult to do in the near term. But it's not that difficult to do in the long term.

The SG&A expense increased Danny had mentioned that in the previous answer about our expansion in international and we are serious about growing our international presence. We are serious about growing the percentage of international revenue that contributes to the Company. And we have together some concrete plans in order to grow our distribution channels internationally and secure our systems business.

Having said that, we are doing all of that with the goal of being able to manage within the model that we have set up and have been able to live by it for quite some time. So you will see an increase and the increase this last quarter was specifically in the SG&A side was largely driven by that. But that is not one of those things that -- it's one of those things that we plan on being successful in. And it's one of those things that we will manage that expense coincident with the revenue growth.

Just two other quick ones. Given that NetVanta was down sequentially and revenues were up is it fair to say to that product fell below 5% of sales this quarter?

No. It was above 5%.

Above 5%. Okay.

It was -- the decrease sequentially was small.

The last questions I guess with the -- I think BellSouth and AT&T have made public comments that they expect this merger to close before Thanksgiving. So do you anticipate any change in the spending patterns by AT&T, your largest customer, either prior to or simultaneous to the merger as they look at the two companies? Or do you think it is just going to be business as usual for you as that merger closes in the second half?

I can tell you specifically about our product on a larger scale. They may do things that we wouldn't be aware of. On our products, we don't expect a serious change. We do talk to them about where our products sit in their portfolio and what they plan as far as subscriber adds and where they want to be. And right now we don't see any change.

Thanks a lot.

Lisa, I think that was probably the last call. Let's just do one more and then we will finish up.

Joe Chiasson with Susquehanna Financial.

Good morning. Two questions. Tom, is there any possibility that you are seeing any type of negative impact with respect to the consolidation activity that is going on in the CLECs space? And what I'm thinking of specifically is, that Level 3 has acquired five companies here in the last nine months; talking about acquiring more.

Also you've had Sprint and Alltel spin off their wireless divisions. Is that in any way negatively impacting what is going on thus far this year and do you expect that to change? If so, in the balance of the year?

Let me let Danny answer that.

I do believe that the merger activity we have seen in CLECs has caused some disruption within their businesses. And as such, I think, has created some disruption in what they are doing to build out their networks.

One of the biggest effects that we have seen with CLECs consolidation is the effect that it has. Once several smaller companies consolidate themselves, they use their leverage to be able to for price negotiation purposes; and we have seen some ASP reductions in our IED family - specifically because of those mergers.

Is there any way of characterizing, Danny, just how big of an influence this is? I mean, is this -- you've obviously alluded to the fact that you are losing a little bit of price leverage and that whole thing. But I mean, is it a matter of potentially you are seeing sales orders pulled as a result of it?

I don't think pulled. Possibly delayed. In the case of the ASP reductions, those normally happen pretty quickly so upon a merger the companies get together, use their leverage to try to go back and renegotiate with all of their vendors.

I don't see the same level queued up within the customers where we are. We have been successful in the second half of what we saw in the first half. Of course that can change.

Just one other question if I might, with respect to the HDSL and the mature segment, the mature products in the systems group in particular. I am just wondering, you've mentioned one the call here about the CSUs and the 303 concentrator and the 1500 shelf being a drag on things.

Is there any way to sort of characterize just how big of an impact that is going to continue to be going forward. It's a little bit difficult because you guys obviously don't realize the specifics as to how big those particular revenue segments are. But any way to put a little bit of color around just -- again how big of a drag that's going to be?

It is difficult and the reason is is 303 concentrators are, for instance as an example would be a product that has been long in the tooth for some time. And we have actually seen growth over the last couple of years, depending on the quarter. The CSU business which is really in the T1 HDSL in the systems business would be one I think that, if you can extrapolate our numbers and kind of correlate that back from what we said the HDSL numbers have been, you can kind of extrapolate what the decline has been.

And I would characterize in any of the areas where we see a market decline that you would see gradual decline that would be consistent with what you have seen over the last few years. None of these tend to dive with a very steep slope. They tend to just kind of trickle down from quarter to quarter.

Thank you.

Thanks, everyone, for joining us on the phone call this morning. We look forward to our call a quarter from now and be able to share some more information with you. Thank you very much, Lisa.

You are welcome, Sir. This concludes today's conference. You may now disconnect.