ADTRAN Holdings Inc (ADTN) 2006 Q3 法說會逐字稿

Good morning. My name is Heather, and I will be your conference operator today. At this time I would like to welcome everyone to the ADTRAN third quarter 2006 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 session. (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 market for such products, product and channel mix, component costs, manufacturing efficiencies and other risks detailed in our annual report on form 10-K for the year ended December 31, 2005 and form 10-Q for the quarter ended June 30, 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 its website at www.ADTRAN.com reconciliations of these non-GAAP measures most comparable GAAP measures including the reconciliations presented in ADTRAN's first quarter earnings release. I would now like to send the conference over to Mr. Tom Stanton, Chief Executive Officer. Please go ahead, sir.

Thank you Heather; good morning, everyone. Thank you for joining us for our third quarter 2006 conference call. With me this morning are Danny Windham, President and Chief Operating Officer and Jim Matthews, Senior Vice President and Chief Financial Officer. In the third quarter all our primary growth areas comprising of Broadband Access, Optical Access and NetVanta saw sequential growth. We also continued to see a rebound in HDSL revenues. During the quarter we achieved significant milestones in our selling efforts with our Optical Access products by receiving product approvals from one RBOC and a limited application approval from another. We anticipate initial deliveries to both of these customers to commence in the fourth quarter. I would like to remind our listeners, however, that awards of these types take some time to translate into meaningful revenue.

In Broadband Access our outside plant remote terminal DSLAMs achieved a record revenue quarter with substantial sales into a growing and diverse customer base. Combined, our primary growth areas comprising of Broadband Access, Optical Access and NetVanta contributed about 31% of total revenue in the third quarter of 2006. Our outlook remains extremely positive for these product areas.

In our enterprise business we experienced another record revenue quarter with NetVanta and revenues for the nine months ended September 30 continue to be very strong over the same period last year. This category experienced accelerating order flows as efforts to improve enterprise channel focus and leverage carrier distribution continues. Integrated access devices grew sequentially with positive contributions from both traditional IEDs as well as our new IP business gateways. We continue to be enthusiastic about the increasing customer adoption of our IP business gateways.

Although still early in the sales cycle, our Total Access 5000 platform continues to generate significant interest. Specifically we currently have in process more than two dozen active FOAs and lab trials spanning a broad spectrum of service providers. The Total Access 5000 platform significantly broadens our range of Broadband Access products as it is targeted to address the growing requirements for applications including IP TV, Metro Ethernet and the movement towards IP centric networks.

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 lead like Jim Matthews to review our results and our guidance for the fourth quarter of 2006. We will then open the conference up for questions. Jim.

Thank you, Tom, and good morning. Revenue for the third quarter was $132.7 million, up from $122.3 million in Q2 of '06 and down from $149.2 million in Q3 of '05. For the total company systems revenue was $73.6 million in Q3 of '06, up from $66.9 million in Q2 of '06 and down from $80.3 million in Q3 of '05. Comparing Q3 of '06 to Q2 of '06 the increase in systems revenue was primarily due to increases in the primary growth areas comprising Broadband Access, Optical Access and NetVanta products accompanied by revenue increases in integrated access device and TA 1500 products. Comparing Q3 '06 to the same period the prior year the decrease in systems revenue was primarily due to a decrease in international Broadband Access product revenue to a single international carrier and decreases in integrated access device in M13 Multiplexer revenues. Partially offset by increases in North American Broadband Access product revenues and NetVanta product revenues. HDSL/T1 product category revenue was $56.4 million in Q3 of '06, up from $52.7 million in Q2 of '06 and down from $65.5 million in Q3 of '05. Comparing Q3 of '06 to Q2 of '06 the increase in HDSL product category revenues is attributable to increased sales of HDSL products to carriers. Comparing Q3 '06 the same period the prior year, the decrease in HDSL T1 is primarily attributable to a decline in T1 revenues and to a decline in HDSL revenues to a carrier. Digital Business Transport Total Reach was $2.6 million in Q3 of '06, down from $2.7 million in Q2 of '06 and down from $3.3 million in Q3 of '05.

Carrier networks division revenues were $101.5 million in Q3 of '06, up from $94.6 million in Q2 of '06 and down from $113.5 million in Q3 of '05. Comparing Q3 '06 to Q2 '06 the increase in carrier network division revenues was primarily due to increases in Broadband Access, Optical Access and TA 1500 product revenues. Comparing Q3 '06 to the same period the prior year the decrease in carrier networks division revenues was primarily due to a decrease in international Broadband Access product revenues to a single international carrier, a decrease in HDSL revenues and a decrease in M13 Multiplexer revenues, partially offset by an increase in North American Broadband Access revenues.

Enterprise network division revenues were $31.2 million in Q3, up from $27.7 million in Q2 of '06 and down from $35.7 million in Q3 of '05. Comparing Q3 of '06 to Q2 of '06 the increase in revenues was primarily due to increases in traditional integrated access device, IP business gateway and NetVanta product revenues. Comparing Q3 '06 to the same period the prior year the decrease in enterprise network division revenues was primarily due to decreases in T1 and integrated access revenues. Partially offset by an increase in NetVanta product revenues and IP business gateway product revenues.

International revenue as a percent of total revenue was 6% for the third quarter compared to 6% in Q2 of '06 and 13% in Q3 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 59.3% of revenue during the third quarter of '06 compared to 59.9% for Q2 of '05. The decrease in gross margin percentage is primarily the result of lower volumes compared to the third quarter of '05.

Research and development expenses were $18.3 million in Q3 of '06 compared to $15.1 million in Q3 of '05, comparing Q3 '06 to the same period the prior year the increase was primarily due to stock-based compensation expense recognized in Q3 of '06 of $1 million and an increase in new product development activities.

Selling, general and administrative expenses were $26 million for Q3 of '06 compared to $25 million for Q3 of '05. The increase was primarily due to stock-based compensation recognized in Q3 of '06, up $1 million. Other income net of interest expense was $3 million in Q3 of '06 compared to $2.4 million in Q3 of '05 and this increase was primarily related to higher interest rates related to fixed-income securities. The Company's income tax provision rate continued to be unusually high in the third quarter and year to date due to the continuing delay of the passage of legislation extending the federal R&D tax credit. The result of this delay was an increase in the tax rate of about 90 basis points for the nine months ending September 2006.

Non-GAAP earnings per share assuming dilution for Q3 of '06 were $0.35 compared to GAAP earnings per share of $0.42 for Q3 of '05. GAAP earnings per share assuming dilution were $0.33 for Q3 of '06. Non-GAAP earnings per share excluding the effect of stock compensation expense for employee stock options associated with the application of FAS 123(R) which ADTRAN adopted effective January 1, 2006. As ADTRAN applies FAS 123(R) it believes that it is useful to investors to understand how the expenses associated with the application of FAS 123(R) are reflected in this results of operations. 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 were flat with the prior quarter at $47 million. Net trade accounts receivable increased approximately $9 million from the prior quarter to $73 million primarily due to increased revenues. WINDSTREAM's came in at 50 days for the third quarter, up from 48 days from the second quarter of '06; net cash provided by operating activities came in at approximately $23 million for the three months ended September 30, 2006. Under certain cash and marketable securities totaled $288 million at quarter end after paying $6.7 million in dividends during the quarter, and after repurchasing 2,758,000 shares of common stock for $58.9 million during the quarter.

Now we would like to discuss guidance for the fourth quarter of '06. Revenue for the fourth quarter of 2006 is expected to range from $125 million to $130 million. GAAP earnings per share for the fourth quarter of 2006 assuming dilution are expected to range from $0.29 to $0.31. Non-GAAP pro forma earnings per share for the fourth quarter 2006 assumed dilution are expected to range from $0.31 to $0.33. Non GAAP pro forma earnings per share for the fourth quarter 2006 exclude the effect of stock compensation expense resulting from the application of 123(R). Tom, back to you.

Thank you, Jim. All right, Heather, at this time we would like to open it up for questions.

(OPERATOR INSTRUCTIONS) Vivek Arya.

Thank you. My question is regarding your fourth quarter outlook. I think this is the third time that the outlook has been lowered with respect to the prior guidance and I'm just trying to see if there has been any change and how you have expected the market conditions. And I'm just trying to get a better sense for why the outlook has been consistently lowered with respect to what you are just expected two to three months ago.

Vivek, we have had a hard time this year trying to project past a quarter out, and a lot of that has to do with the very limited visibility that we have because of the nature of our business. If we take a look at the fourth quarter outlook versus what our previous outlook was in the fourth quarter two main things come to mind. One is, although HDSL had a strong sequential quarter, we did pick up market share in the third quarter. And if you were to net that market share gain out it still wasn't as strong as we would have hoped to have seen it. So we have moderated our outlook in the fourth quarter based off of that.

Secondly, although we did have some very strong custom momentum in our Optical Access area we still have to turn those projects into meaningful revenue. And as we have seen through this year, our ability to gauge the timing of that has been very difficult. So those are the two main factors that affected the change.

And one quick follow-up on that, Tom, I know its probably a little early to look at 2007, but when we look at results so far your new product sales even though you've had record quarters and some of those to new products, they are essentially flat year-on-year. But as your traditional product sales, if my math is right, are down 15% year-on-year. So based on those two, how should we start thinking about 2007 for ADTRAN?

Well, I'm not sure about the actual numbers on flat versus not flat but let me just give you kind of a flavor on the new product revenues. Probably the biggest -- well definitely the biggest impact of course was our single international carrier. And if we were to net that international carrier out of the new product revenues I think we would have seen good growth. Having said that, that did happen and we have to deal with it. So we're still expecting good growth in 2007 on these new product areas and are somewhat optimistic based off of some of the recent events we've had with approvals. I do think by the way, if you do the math the new product revenues, Jim, correct me if I'm wrong, were up 22% or so.

Roughly about 22% nine months this year verses nine months last year.

And so that (indiscernible) is better than flat.

I meant for the third quarter of --

Yes, yes, and that is true for the third quarter. If you look at the third quarter which we talked about extensively, we had that Q2 kind of backlog situation that exacerbated that problem.

And the traditional products, those were down 15% year-on-year. And the question really is do you really see growth in the traditional products as you look out in 2007?

Traditional products this is not the time for us to give guidance for next year, but traditional products we have been targeting low single digit type growth. We did have a tough comparable to third quarter of last year, here again because of some of the inventory situation that we ran into and potentially double ordering by one of our large customers which affected the Q3 numbers also. If you look at the baseline demand I would say that I would call it flattish probably for this year, and as to how that grows, those traditional products grow in the future, there will be some met adds to that because of the market share gains that we expect in products like our IP gateways. HDSL which is a big segment of that is going to be driven by wireless capacity upgrades and enterprise spending. We don't see any new technologies having a significant impact in that area today, and that doesn't mean that there won't be some of that impact in the future. We don't see it today. We see that really being driven by end-user demand, and it is going to be the growth or the decline in that business will be driven periodically and probably more cyclically by those two customer bases.

Thank you.

John Anthony, Cowen & Co.

A couple questions. Looking at the guidance could you just quantify for us how much contribution you're going to get from these optical contracts? Is it meaningful, is it just a little bit, or is it something that is really moving the needle here?

We are relatively gun shy on our Optical Access projections because of the timing associated with large carriers. So I wouldn't call the incremental piece on Optical Access in Q4 to be that meaningful.

Is your reduced guidance of function also of -- I guess what is the best way to put this -- do you see any carriers just come to you effectively, any of your customers and say look, we're not spending anymore in the fourth quarter? Or is this really just the HDSL spillover and the uncertainty surrounding optical?

I would say that those two pieces are the majority. We have a broad customer base, and I think some of the smaller carriers are taking a look at where they are with their CapEx levels for the year, but in general I would say those two pieces are driving our outlook right now.

Okay, and one last question on the guidance. Would you be willing to tell us whether you expect Broadband Access and NetVanta to increase again sequentially in the December quarter?

That is a tough one. Broadband Access is probably, is the more difficult of the two because we did see seasonality in Q4. We have continued to be pleasantly surprised by the growth in our remote terminal [outside] plant business, but that is difficult to say. It is difficult to nail down.

Thanks, guys.

Ehud Gelblum, JPMorgan.

Let me drill down a couple other things. First of all a housekeeping question if you can go over the 10% customers and compare them to last quarter. Your HDSL business still up $3.7 million sequentially and has gone up steadily in each of the last two quarters. You had said earlier in the year that Q4 was starting to look like a tossup could go either way, and you didn't necessarily know what your Q4 seasonality was going to be. This now is your third straight year where Q4 is down. Putting that together with the fact that you've often said in the said the visibility isn't more than two, maybe three weeks, it would mean to me that you don't necessarily have any visibility that your Q4 is going to be a down quarter now. And therefore you're working on the assumption that visibility -- I'm sorry -- that seasonality is no longer a tossup but Q4 is a down seasonal quarter for you and that is just how it is. Is that what is going on, and why? I mean given that HDSL was up and that you shouldn't have necessarily have any more visibility out beyond the end of October, what gives you the confidence that it is down now? Is it really just you're seasonally down from now on in the fourth quarter and we should always be putting our models exactly down 10% or so?

First of all let me let Jim cover the 10% customers and I will cover the second half.

For the third quarter the 10% customers are as follows. AT&T at 18%, Verizon at 13%, [embark] at 11%, Windstream at 13%.

Okay, on the seasonality and Q4 and whether or not we should just be going forward guiding down, I would say the feeling is generally that our traditional business does decline in the fourth quarter. We saw some seasonality also in our outside plant remote terminal business last year. To the extent that we are -- that we got higher in fourth quarter typically its because of market share gains, and because of the new product opportunities or market share gains with our new products, and those are the things that would tend us to offset that normal seasonality.

We were expecting some of that coming into Q3. We did see the normal -- you are right -- we did pick up an HDSL. You're also right that we have very little visibility into Q4 at this point in time because we are early into the quarter. I would say what we're doing is taking a look at the HDSL number, seeing the rebound that we saw and we did expect a rebound, seeing the rebound we saw netting out the market share gains and saying okay, if we were to lay this out what would that mean for Q4. And that is what we're guiding to. We are also because of our inability to forecast turn on times for some of our new product revenue we are also being cautious on that.

So we are to read into this the decline in revenue from this quarter into Q4 assuming the midpoint of your range is based on a decline both in HDSL, which you don't necessarily know about but you are kind of relying from past historical as well as decline in outside plant DSLAMs because A, it was so strong this quarter and B, seasonally you're just figuring bad weather does that to you?

I would say yes, that is a fair assessment, but we multiple pieces are affected, HDSL being the biggest piece that is affected by Q4 seasonality, but I think you're right.

You said NetVanta was up again this quarter. It was down last quarter. Is it back to the same level it was in Q1 or is it higher?

It was a record quarter, I believe. It was a record for the history of the productline.

And your anticipation going to the fourth quarter which is normally a seasonally strong quarter for enterprise, is that it would be up again is what I would assume (multiple speakers) in your mix.

Enterprise sees the same type of seasonality. Our enterprise business sees the same type of seasonality as the rest of the Company. So I think if you look back, you will see it being affected to some degree. Danny, any color on that?

Yes, we haven't attempted to break down the guidance within the different new product families to the level that you're asking. The NetVanta revenues that we have in Q3 carry good momentum into Q4, and then there is this question of just the productivity in Q4, given the amount of time that is normally consumed by holidays in Q4 and its impact on our ordering cycles.

Thanks very much.

Ken Muth, Robert Baird.

Can you guys talk a little bit about the revenue opportunities in the TA 5000 product and how you look at the future for that?

Sure, Ken. First of all, the interest in the 5,000, I mentioned it in my prepared notes. The interest in the 5000 has been kind of a pleasant surprise in that, at this point in time, we are kind of turning away FOAs and lab trial requests and just trying to do with the number of customers and make the customers that are working with us today happy. And we will get through these phases and move on to kind of a more general selling approach.

As far as outlook, that would be more of a 2007 type conversation than in 2006, although I think that there is the potential for it to be incrementally positive to the entire company. In the relatively short term, I think that trying to do it within one quarter is still very difficult. I will say, though, that it seems like we've got a really good product line here in that it's going to have a lot of legs and it's going to take us where we want to go, but I would say it is still early in the sell cycle.

Anything you could think of that would be 10% of revenues in '07?

Yes, it would and this is going to come back to haunt me probably, it wouldn't surprise me to see it in a quarter. I think it would be difficult on a yearly basis.

Okay, great. And then any thoughts, Jim on the share buyback in Q4, any expectations there?

We basically leave it up to current market conditions and make decision really on a daily basis whether or not we engage.

Thank you very much.

Marcus Kupferschmidt, Lehman Brothers.

Good morning, everyone. Quick housekeeping question. Jim, your 4Q EPS guidance assumes what share count relative to what you saw here in 3Q?

Slightly lower in that as we go through the fourth quarter we have the full average in or the full effect of what we actually repurchased in the third quarter, so it should be just a bit lower.

No incremental buybacks, got it. I guess a bigger picture here is to understand more of kind of the guidance in the ins and the outs, if you think about your reduction in the guidance for fourth quarter versus what you thought a quarter ago, with what you implied in the full-year guidance. How much of the reduction is just timing versus the HDSL market, demand isn't as good as what you wanted today versus what you thought it was a quarter ago, and some of the other legacy products. Can we differentiate the two factors?

Probably not in the granularity that you're hoping for. I would say both of those weight in on our thought of Q4. I can't say one was 60 and one was 40. I would say that we are not expecting a significant kind of inflection point on Optical Access in Q4. HDSL will be kind of what HDSL is, and the best gauge that we have with HDSL is history, unfortunately.

Well, I guess to be clear, then do you start to see just a sprinkling of the market share benefits on HDSL in 3Q or was 3Q a full quarter of that?

I would characterize 3Q of being nearly a full quarter of the market share gains.

All right, and then does that make you then feel at all like HDSL, before when you were talking about flattish but there's something going on that the demand isn't as good as what you thought, given that, I mean do you feel like there is a lot of inventory that is still being absorbed in the channel right now?

I would say that was probably true in the first half. I would think at this point we would have to be true to that inventory situation that occurred in the second half of last year. If you look at HDSL on a customer by customer basis to be honest with you, the customer by customer looks good. I think Jim mentioned in his notes that we had one carrier that was by far the majority of the HDSL decline year-over-year and that one carrier by the way turned out to be the one that had the inventory situation last year. I would characterize HDSL today as flattish and as to whether or not it grows next year is going to be dependent on things that are to some extent out of our control. Which is going to be whether or not enterprise spending increases for bandwidth upgrades and what the wireless network infrastructure people do.

And if you wouldn't mind one more quick clarification, a quarter or two ago I believe the idea was that DSLAMs would grow sequentially through the year and now we're kind of tempering that back a little bit due to some seasonality. But I guess you always knew about seasonality, so my guess is something else changed behind the scenes, too, like maybe timing of a new win or something like that. Is there anything you can do to elaborate for us what you're thinking about?

I do think we thought we would have a stronger second half than first half and we still believe we're going to have a stronger second half than first half. As to Q4 specifically on DSLAMs, I don't recall saying that although I won't say that I didn't, I do not recall saying that. But outside plant remote terminals had a very good quarter, and that momentum continues. But we do know that we saw that affect last year come December. So we are just kind of gearing up for that.

Thank you very much.

Andrew Schopick, Nutmeg Securities.

I am going to ask a couple here and hopefully you can clarify a couple of things. Telstra, as a customer, can you provide us with the year-to-date revenues derived from Telstra versus the comparable nine months of a year ago?

Andy, I don't have those numbers before me, but Telstra is significantly down.

I clearly recognize that it is down.

And it was -- I think if you take a look -- the numbers that we do give are international breakouts quarter to quarter, and I think if you take a look at the international decline first of all I would say that we have picked up outside of Telstra and Danny, correct me if I'm wrong on this, outside of Telstra we have actually grown the international business. So that would lead you to believe that at least 100% of that decline on a dollar basis was Telstra's (multiple speakers).

It is true that more than 100% of the decline between Q3 of '05 and Q3 of '06 was Telstra, (multiple speakers) I think going year-to-date.

Yes, nine months year-to-date --

Yes, I think you could do that same math, and we don't have it in front of us but I think you could do that same math and you would get the same accuracy or type of accuracy.

All right, on the share buyback program I think Marcus may have put some words in your mouth that the company doesn't necessarily agree with in terms of additional incremental buybacks. I want to be sure I have these numbers right. It looks like you're completed on the set 2005 program. If I look at what you have done here in the quarter, it appears to me that you have about 2.1 million shares remaining in the July '06 program. Is that about right?

Actually, Andy, we have remaining $3.6 million for repurchase.

3.6 million remaining for repurchase?

Right.

Okay, and in general I think a lot of us are somewhat surprised at the degree of the reduction in guidance as this year has progressed and that we are now looking at a down year revenue wise. What are you really seeing in the carrier and enterprise environments here as we exit this calendar year? Are you seeing a clear signs of some slowdown in just budgetary spending or outlook? Obviously you're not prepared to really talk about 2007 until early next year, but I really wonder what you are seeing on more of a macro basis.

On the macro basis to be honest with you there is not a -- it is hard to generalize as an overall feeling. I think that they are kind of customer by customer feeling. We have some customers of course that are going through mergers which make it a little murkier as to what their plans are, and we have some customers that are going through divestitures, which make it a little murky in those. I general I would say the outlook hasn't significantly changed. I think they are still very focused on the growth areas that they want to concentrate on. I think that there is opportunity because of some of these changes in ownership for market share gains that probably wouldn't exist or would take longer to capitalize on if these movements weren't happening. I think the IOC customer base has been very robust this year for us. A large percentage of that has been just pure market share gains, but that has been just a very strong market for us, and we continue to see great enthusiasm in that marketplace. On the enterprise side, Dan, do you got any?

Yes, I think its hard for us to characterize ADTRAN's business versus the total enterprise spend because over the last two years our product set has really transitioned to the spot where we're addressing a small to medium-sized business customer. And we are probably seeing more pressure on our traditional T1 business within the enterprise space than we would have predicted. So the spot where the growth and the new products have not been able to overcome the decline in those traditional products. We are approaching the spot where those traditional products are less significant, and will become easier for us to overcome those declines. We don't expect those declines to stop. We do expect to continue to grow the new product set and over time have that being the basis of the enterprise (indiscernible) spread.

Thank you.

Ari Bensinger, Standard & Poor's.

Thank you. Since Optical Access was sort of one of the primary reasons on the Q4 lower expectations, can you give us a timeframe as to when you see that turning into meaningful revenue? Is it at the latest a Q1 event, or what is the typical time where some of these new products gain acceptance and are turned into actual revenue?

There are multiple customers that we're talking about. We specifically -- I specifically brought up two without names, two RBOCs, and so we do have other ones that we are in towards the tail end of the sale cycle. There are two ways to characterize these customers. One would be where you have broadbase approvals, and then you're going through the normal rollout phase and typically for us that has been a six to nine-month period before you hit the run rate of where you want to be. The second is one where you have limited approvals and your job then is to go in and continue with the lab trials and continue to bring new products in and broaden that approval. Those type of wins take longer. But the win will be there but meaningful revenue takes longer.

Thank you.

Jason Ader, Thomas Weisel.

Thank you. I guess I'm trying to reconcile Tom and Jim, the outlook for the traditional products, which I guess you said earlier you kind of viewed as flattish with just the results for the first nine months of '06. My math is right the legacy systems business. So within in the systems everything but the new products would have been down about 10% year-over-year. And on the HDSL line would have been down about 10% year-over-year as well for the first nine months of 2006. So and based on your guidance for Q4, it doesn't seem like you think the market conditions are changing for the better for the traditional products. In fact, it sounds like HDSL is underperforming your expectations somewhat based on the commentary on market share gains.

So what I guess I'm struggling a little bit to figure out what to model for the traditional products just based upon your specific commentary on flattish versus the results for 2006 so far.

My commentary on flattish probably reflects a few things. One is that we did see double ordering in the second half of last year because of the backlog situation that we ran into in Q2. And that did have an impact through. So that affected the second half of last year's revenue, and showing it to do, so it was higher than probably demand would have called for. And then of course it also affected the first half of this year as some of that inventory was worked off. And so if you were to net that and that's a difficult thing to net because our customers don't -- first of all they don't tell us when they are double ordering because I think they get the sense that if they do tell us that they may be at the end of that Q at a tight supply chain. And so it is difficult to figure out exactly how much was [what]. But if you were to net that out I think you would get closer to the flattish that I was talking about.

All right, so when are we going to have kind of a clean comp, do you think?

To be honest with you I think a clean comp would be difficult because the year-over-year comp will be difficult through the second half.

What about Q4, would that be a little cleaner just because --

Q4 we were still, if you look at the Q4 number there was still some of that going on, and then you're going to have the problem with Q1 probably being actually a little understated because of the impact of them working that inventory off. So my hope would be maybe Q2 of next year we would start seeing realistic numbers comparison wise to be able to understand the underlying demand.

Let me ask it a different way. If I look at your, just looking at your traditional products for 2005, looks like it grew about 1% year-over-year. And you are saying in there there was a bunch of double ordering. And then 2006 it is going to be somewhere around down 10% based upon your guidance for Q4. And so I just kind of look at those two years, maybe 2005 was sort of inflated and 2006 is deflated, but over that time period it doesn't seem like there is much growth. So you're saying that that two-year period would be kind of flattish. Is that --

The other thing that you have to factor in which is becoming less of a factor on our major revenue contributors in that product area is ASP declines. So we did see ASP declines over the last two years, and some products are affected more than other products. HDSL was definitely affected to some extent, although I do believe that price declines in that area have moderated and will continue to moderate going forward.

So if we are thinking about, if we're looking at the 2006 numbers for legacy products being down somewhere in the 10% range, what you're saying to me is that that is not necessarily an accurate view of the markets that you plan based upon the strong results in 2005?

I think that is a fair assessment. I think yes, I think we had a situation the middle of last year and if you look at the -- if you're trying to look at revenue numbers which I know that is a big piece of this, then you can come to a conclusion. But I think if you go one layer deep and you look at ASP declines and it just shifts in inventory situations, I think that it gives you more clarity, anyway.

Okay. Thank you.

Simon Leopold, Morgan Keegan.

I wonder if you could go into a little bit more detail in terms of the opportunities for the optical products that you alluded to, to RBOC activities. If you can give us a bit more detail as to what is driving it, what specific applications are using these products for, what the competitive landscape looks like in these particular initiatives, the two you alluded to. A bit more color there. And also if you could just give us an update on the IP PBX products that you've highlighted in the past you didn't talk about those today. If you can give us a status and the outlook for those specifically, thank you.

It is difficult for me to give much more color on the Optical Access wins because we have customers that are very touchy about us kind of preannouncing and talking about their network plans as well as the impact that may have on potential competitors that they deal with. So it is very difficult for us to give much more color than we've given other than to talk about that we have signed agreements and that we are moving forward and one of those deals is a broadbased application type deal. The other one is lesser broadbased and we are hopeful that both of them will be meaningful to the Company. And the timeframe of six to nine months for the larger of the two to ramp up seems to be a realistic timeframe. And that is dependent on us going out and executing which I think we've shown we can do in the past. The 7100 is alive and well and doing well, had a good quarter early on in the introduction of that still. Danny do you have color on that?

Yes, one thing I would like to do is just make sure that we classify the NetVanta 7100 as a small or medium-size business product which is really an office in a box. Its not an attempt on ADTRAN's part to go compete in the IP PBX space. We did see growth in that segment in Q3, but we really are early on and in a channel development mode where we are recruiting resellers to lead with that product. And those numbers were reflected in the fact that NetVanta had a record quarter in Q3.

Thank you very much.

George Notter, Jefferies.

Question on the HDSL -- I guess I was trying to figure out why those market share gains in the HDSL business wouldn't stay in the revenue stream looking into Q4. It seems to me that naturally or intuitively you would think that would continue going forward. Is there something else then in the HDSL business that would be down in Q4 relative to your expectations?

No, George, there is no reason why -- we have secured that market share, we are comfortable that market share is there to stay for a meaningful period of time. The only thought on HDSL is when we exit the quarter we look at the level of the HDSL business. And we say okay now that we had secured this market share with normal seasonality trends, affecting, potentially affecting HDSL in the fourth quarter, where will we be? And that is not a matter of that market share disappearing in Q4.

Got it, and then just as one quick follow on, I wanted to know about the Windstream business. It seems like those folks haven't been big in your revenue stream for some time. Maybe you could talk about what popped up there. Thanks.

Windstream which formerly was Alltel has been a 10% customer in the past. Having said that they were a very strong customer this quarter. They buy an awful broad base of our products, including DSLAMs. And they I think that is just indicative of the strength that we saw in the IOC market. They do actually resell some of those products too to the IOC markets. I think the strength you see there is just our continued push into the IOC's.

Thank you.

Reg King, Nollenberger Capital.

First, Jim, can you help us with the tax rate and go back to your comments that the tax rate still is higher than you would have expected because you still don't have the tax credit through? For guidance for our next quarter should we expect that we are still going to see this high to normal tax rate?

I think it would be prudent to expect the higher rate, yes, in the fourth quarter.

And then Tom, on the international business we know that Telstra has been off for several quarters here. Recently I think I saw some comments from the (indiscernible) Telstra saying most of the cost-cutting is done and that is nearly over. He seemed to have more optimistic comments in regarding spending patterns in '07. Have you seen any increased activity from the customer that might lead you to believe you're going to have some pickup in business from Telstra next year?

I would expect a pickup in business next year. I don't know if I would call that pick up meaningful, that we would plan on it being a meaningful pickup to the overall revenue of the Company. The situation that we ran into that showed that decline actually was the builtout of the network and once the network was builtout we are pretty much held to net subscriber adds onto that network. We have seen that business pick up through the year as that rollout and marketing of those services have seen more success, and I don't have any reason to believe that we wouldn't see continued positive momentum as that service gets more widely deployed. But I don't expect, I wouldn't expect in 2007 to see the same type of impact that we saw last year, although I am very hopeful that our international effort in general will show continued success.

Thank you very much.

Joe Chiasson, Susquehanna Financial.

Two questions. Tom, could you characterize what is out there still in terms of available opportunities with respect to the optical product? And what I mean by that is with last quarter's results you've got at least two RBOCs now in the bag as far as the OPTI product is concerned. What else is out there as potential opportunities as it pertains to the RBOCs and to the top tier independents at this stage?

Let me try to break it down a little finer. There is an awful lot of opportunity, not just from a customer segment but in some areas also from an application perspective. First of all, right now there are four RBOCs, potentially going to three. We have talked about two of those potentials as the mergers go forward, you know you would expect us to try to do whatever we can do to show our value to the merged entities and grow our market share that way. There's no guarantee of success there, but you can imagine that's what we're trying to do. We also have yet another RBOC stand-alone entity that has not adopted all of our Optical Access products todate. As you can imagine, we are working hard and we are actually past the initial phases of trying to make some headway there. So those are just flat out customers that we can capitalize. If you kind of go to the tier 2's we've actually covered that base pretty well, and we're just expanding applications within the tier 2's. And then you also have the wireless carriers where we've had made some inroads and actually have generated some sales, and it's a matter of us continuing our sales push to grab more market share there.

And in terms of the TA 5000 you mentioned several dozen customers that you were in the works with there. Can you characterize what the majority of them are using the TA 8000 platform for; is it a BB-DLC application, is it a DSLAM application or what is the majority of those look like?

I would say the majority are BB-DLC applications, where they are looking at both POT and DSL in the same platform.

Okay, thanks.

Scott Coleman, Morgan Stanley.

Just a housekeeping question first. I am wondering if you could give us some insight into the linearity of this quarter both in terms of revenue and bookings, if there was anything different that you saw as you went through the quarter.

Linearity in the third quarter was a little backend loaded, so to speak as compared to the second quarter, which would explain the DSL increase and also the receivable increase.

Okay, and similarly for orders as well?

I would not agree with that, no.

I would say that was shipments versus orders, I would say that is just different.

Thanks, guys. And maybe sort of a bigger picture question. Tom, you have been the CEO for I think four or five quarters now at ADTRAN, and certainly hasn't been the easiest period in the Company's history. A lot of transitions going on whether from a customer base or a technology perspective. How are you trying to position the Company going forward to reduce dependence on HDSL? It has to be more than around just the growth products would be my suspicion, but what do you want the Company to look like two to three years down the line from now?

A pretty broad question. Let me cover pieces that I can cover. First of all you are right, we're heavily dependent on HDSL or have been heavily dependent on HDSL and we are heavily dependent upon a relatively small customer base, which is North American centric. We have been on an effort for a period of time now to number one, diversify the product set and number two, diversify the customer base. And we are making headways there. If you take a look at the new product revenues or the growth product areas, that is a very, very broad set of products which grows quarterly. So the 5000 is just the latest example of that where you are seeing less and less dependent on that HDSL revenues as being what drives the overall number, and I think we made good headway in diversifying that base. We will continue to make good headway in diversifying that base.

From a customer perspective we are RBOC centric. While there are multiple customers out there that have needs for the type of products that we develop and can benefit from the way that we actually develop those product, one of those is the wireless product segment which we launched some products later last year and are continuing to make headway there. The other is our international channel development, and we have spent quite a bit of time this year in trying to build the initial base, set up the high-level distributors and are right now working on VAR recruitment in multiple areas of the world with the biggest focus being Western Europe. All of those things are underway. We are doing those, I think in a prudent way where we are not betting the farm on the success of those. We are doing those in kind of a normal ADTRAN way of paying for them as you go. But those are efforts that are brand-new, and we've been able to manage those within the operating budget that we set forth.

So I think we are making good headway if you look at the company three years from now we will still be an access Company; we will be an access Company that you may not necessarily just think of copper, you'll think of fiber and copper and it will be an access company that will have a much more global presence than it does today.

Thanks. That is a I think a thoughtful and fairly detailed answer to what you accurately described as a broad question. I know in the past ADTRAN had talked about percentage of sales, targets or goals for some of the new products. Maybe this isn't the right forum for it, but I believe it would help investors understand where the company is going if ADTRAN was willing to talk about sort of sales mix or domestic versus international customer mix. Not in the next quarter but some targets as you guys work to sort of remake the company into the access equipment company of the future. Maybe that's just my perspective but I know I find it helpful.

I think that is a fair comment; we will take that into consideration.

Thanks guys.

Erik Zamkoff, Morgan Joseph.

Good morning, gentlemen. Quick question. I will go bigger picture. What percentage of your total business including optical and HDSL is would be characterized as serving the wireless backhaul market? And then from there, given the clear bottleneck that is developing as 3G applications continue to proliferate, what is your viewpoint on how your customer base, that being the RBOCs, will go after that market? And do you see that as a potential HDSL/optical opportunity, or do you see that bottleneck as allowing other technologies to come in and possibly take share from what right now is primarily fiber and copper delivery of backhaul track?

Good question. Let me tackle the first piece of the question, and that is the percentage of our optical business an HDSL business that is wireless backhaul. Unfortunately we don't have that number. We ship to a fixed warehouse which is an RBOC warehouse and then they ship it out for deployment, and we have no means of tracking who the end-user was. We have in the past said that we think it is a meaningful piece. People have speculated is it in the '20s; we haven't argued with that. But the reality of the situation is nobody knows. So we do think it is a meaningful piece to the business. We do think that to the extent that wireless capacity is added or wireless cell sites are added, that does have a meaningful impact on our HDSL business as well as our optical business.

As far as the opportunities or potential competitors as 3G upgrades rollout and as people digest the cell sites that they have purchased and then start moving forward with more infrastructure buildout, I think the positives outweigh the negatives. I think what we have tried to do in the last year or so is position our products with the right approvals within the right carriers and make sure that we are the commonsense logical choice for those upgrades. And I think we've done a pretty good job at this point in trying to do and a large piece of the Optical Access potentially is buried within that. So I think it is a positive. There are technologies that are batted around from time to time. We participate in those technologies, things like Ethernet over copper, where we are making sure that we are positioned well if that type of transition were to happen. But we don't see that as a near-term threat. We think at this point in time that the way they are going to deploy will be with fiber and copper, using HDSL and normal (indiscernible) fiber products, although I would say that Ethernet is always high on our minds.

Thanks.

Cobb Sadler, Deutsche Bank.

Thanks a lot, guys. Just have a couple more questions on the optical products since it looks like they will be driving a lot of your growth next year. Have you started shipping an OC 48 product yet?

Started shipping our OC 48 product at the tail end of last quarter.

Great. And could you run through so the IOCs have been buying for over a year now. Could you talk about what the purchase patterns are from those guys? Are they still growing? Do they buy a bunch and then kind of consolidate? What is the growth trend within that installed base?

I would characterize it as continuing to grow through the year, and the answer to the second piece which is do they buy kind of sit, I think if you look on a microlevel at an individual carrier that is sometimes the case, the larger ones don't do that so much, the smaller ones do. But I think that there are enough customers there to where when we ship one we have the potential of finding another one and shipping another one right after that. So that has led us to just nice, strong growth through the year this year.

Okay thanks a lot, and one last question on the outside plant DSLAM POT, can you tell us a little bit -- you probably don't want to tell customers but could you tell us a little bit about what the applications are? Are you shipping into a 5 Mb DSL deployment, or is it just new footprint on a Mb, 2 Mb product?

It is across the board. It is -- we have some that are just flat-out DSL 1.5 Mb service. We have some that are specifically chosen 1100 series of products because they want to deliver 7 to 11 Mb. So it is a broad range of customers.

Did you have two major carriers for the outside plant DSLAM during the quarter or can you say? I'd be speaking RBOCs there.

We are selling our outside plant DSLAMs to a broad range of customers, and at this point in time all of the RBOCs except for (inaudible) we actually sell to that one, too, but just not a meaningful number.

Thanks. Great. Thanks a lot.

At this point in time I think we are out of time. I would like to thank everybody for joining us on the conference call, and we look forward to hearing you, to talking to you next quarter. Thanks very much.

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