ADTRAN Holdings Inc (ADTN) 2006 Q4 法說會逐字稿

Good morning. My name is Lynn, and I will be your conference operator today. At this time, ill like to welcome everyone to the ADTRAN Fourth Quarter 2006 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer 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 and market in such products, a product in general 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 September 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. Thank you. I would now like to turn the conference over to Mr. Tom Stanton, CEO of ADTRAN. You may begin your conference.

Thank you, Lynn. Good morning, everyone. Thank you for joining us for our fourth 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.

During the quarter, customer consolidation and spending reductions led to overall softness beyond typical seasonality. Although these factors led to less than anticipated revenues at some of our major customers, we believe our market share initiatives continue to gain momentum during the quarter. Highlights of the quarter included initial shipments of Optical Access products to AT&T, Quest, and Verizon business. We continue to anticipate our Optical Access revenues to Tier 1 carriers will ramp through 2007.

In Broadband Access, our Total Access 5000 platform continues to gain traction. During the quarter, we successfully completed about one-third of the two dozen first office applications and lab trials that were in process during the prior quarter, and continued our introduction of new features to expand service applications. We also commenced several new trials as customer reception remains very strong for this platform. We anticipate revenues for Total Access 5000 will continue to ramp as we progress through the year. 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 IPTV, Metro Ethernet, and the movement toward IP centric networks. Although our DSLAMs were affected by seasonality and the slowdown previously mentioned, we anticipate growth in this product area will be driven primarily by our outside plant remote terminal DSLAMs. We believe in 2007, carriers will continue to pursue footprint expansion and bandwidth upgrade projects. Our outlook for Broadband Access and Optical Access products remain positive.

In our networking products comprising of NetVanta and IP business gateways had another record revenue quarter. For 2006, interworking revenues grew in excess of 50% year-over-year. This category continues to experience accelerating order flow as a result of very persistent efforts to improve enterprise channel focus and leverage carrier distribution. We continue to be enthusiastic about the increasing customer adoption of our NetVanta and IP business gateway products.

Going forward, we believe our primary growth areas will continue to see strength based on market share gains related to both current and future product introductions and customer spending trends. Our traditional product areas will continue to track on a macrolevel, with enterprise demand, wireless network expansion, and wireline capacity upgrades. I would like Jim Matthews to review our results for the fourth quarter and our guidance for the first quarter of 2007. We will then open the conference call for questions. Jim?

Thank you, Tom, and good morning. Revenue for the fourth quarter was $109.9 million, down from $132.6 million in Q3 of '06, and down from $140.6 million in Q4 of '05. Carrier network division revenues were $80 million for Q4 of '06, down from $101.5 million in Q3 of '06, and down from $106.9 million in Q4 of '05. Comparing Q4 of '06 to Q3 of '06, the decrease in carrier network division revenues was primarily due to seasonality, accompanied by delays in carrier spending in the fourth quarter of 2006, resulting in decreases in HDSL, M13 Multiplexer, Broadband Access, and Optical Access product revenues. Comparing Q4 '06 to the same period the prior year, the decrease in carrier network division revenues was primarily due to a delay in domestic carrier spending in the fourth quarter of '06, resulting in decreases in HDSL, M13 Multiplexer, Broadband Access, and Optical Access product revenues.

Enterprise networks division revenues were $29.8 million in Q4, down from $31.2 million in Q3 of '06, and down from $33.7 million in Q4 of '05. Comparing Q4 of '06 to Q3 of '06, the decrease in revenues was primarily due to a decrease in traditional integrated access device revenues, reflecting normal seasonality, partially offset by increases in IP business gateway and NetVanta product revenues. Comparing Q4 '06 to the same period the prior year, the decrease in enterprise network division revenues was primarily due to decreases in T1 and traditional integrated access device revenues, partially offset by increases in NetVanta product revenues, and IP business gateway product revenues.

For the total Company, systems revenue was $58 million in Q4 of '06, down from $73.6 million in Q3 of '06, and down from $76.6 million in Q4 of '05. Comparing Q4 of '06 to Q3 of '06, the decrease in systems revenue was primarily due to a revenue decrease in traditional integrated access devices due to normal seasonality, and delays in carrier spending in the fourth quarter, resulting in revenue decreases in M13 Multiplexers, Broadband Access and Optical Access products, partially offset by increases in NetVanta products and IP business gateways. Comparing Q4 '06 to the same period the prior year, the decrease in systems revenue was primarily due to decreases in traditional integrated access devices and delays in carrier spending in the fourth quarter, resulting in decreases in Broadband Access product revenues,Optical Access revenues, and M13 Multiplexer revenues, partially offset by increases in IP business gateway and NetVanta product revenues.

HDSL/T1 product category revenue was $49.3 million in Q4 of '06, down from $56.4 million in Q3 of '06, and down from $61.1 million in Q4 of '05. Comparing Q4 of '06 to Q3 of '06, the decrease in HDSL/T1 product category revenues is attributable to decreased sales of HDSL products to carriers. Comparing Q4 '06 to the same period the prior year, the decrease in HDSL/T1 was primarily attributable to a decline in T1 revenues, and to a decline in HDSL revenues to carriers. Digital Business Transport Total Reach was $2.6 million in Q4 of '06, flat with $2.6 million in Q3 of '06, and down from $2.9 million in Q4 of '05.

International revenue was $10.6 million for the fourth quarter, compared to $8.1 million in Q3 of '06, and $15.1 million in Q4 of '05. The increase in international revenue for the fourth quarter compared to Q3 of '06 was primarily due to an increase in Broadband Access product revenues. The decrease in international revenues in Q4 of '06 compared to Q4 of '05 was due to a decline in Broadband Access revenues from a single international customer.

Gross margin was 58.3% of revenue during the fourth quarter of '06. Research and development expenses were $17.1 million in Q4 of '06. And selling, general and administrative expenses were $26.2 million in Q4 of '06. Research and development and selling, general and administrative expenses for the fourth quarter include stock-based compensation expense of $900,000 and $1.1 million, respectively. Other income net of interest expense was $3 million in Q4 of '06.

The Company's income tax provision rate decreased to 28.5% in the fourth quarter due to the passage of legislation retroactively extending the federal R&D tax credit and as a result of closure of tax audits from prior years. Non-GAAP earnings per share assuming dilution for Q4 of '06 were $0.26. GAAP earnings per share assuming dilution were $0.24 for Q4 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 applies FAS 123R, it believes that it is useful for investors to understand how the expenses associated with the application of FAS 123R are reflected in its 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 increased to $53 million during the fourth quarter due to delays in carrier spending. Net trade accounts receivable decreased $13 million to $60 million due to lower revenues. DSOs came in at 49 days for the fourth quarter, down from 50 days for the third quarter of 2006. Net cash provided by operating activities came in at approximately $22 million for the three months ended December 31, 2006. Unrestricted cash and marketable securities totalled $274 million at quarter end, after paying $6.4 million in dividends during the quarter, and after repurchasing 1.312 million shares of common stock for $28.9 million during the quarter. For the total year, we repurchased 7.425 million shares of common stock for $170.5 million.

Now we would like to discuss guidance for the first quarter of 2007. Revenue for the first quarter of 2007 is expected to range from $102 million to $108 million. This guidance takes into consideration normal seasonality, and does not factor in a significant change in the carrier spending environment as compared to the fourth quarter of 2006. Earnings per share for the first quarter of 2007, assuming dilution, are expected to range from $0.18 to $0.21.

As all of you are aware, ADTRAN normally carries approximately two weeks of backlog at any given times and sells to large customers with varying order patterns. These factors lead to significant difficulty in forecasting near-term revenues. Therefore, in lieu of performing guidance in the future, we have decided to attempt to increase transparency in major product areas that drive our business, in addition to providing our views regarding future long-term revenue trends.

Going forward, our new product categories to be reported will be loop access, carrier systems, and business networking. Loop access will comprise DDS and ISDN Total Reach product, HDSL products, including TA 3000-based HDSL and TDM HDSL products, T1 and T3 TSUs, CSU/DSUs, and tracer fixed wireless products. Carrier systems will comprise Broadband Access products, including DSLAM products and TA 5000 products. This category will also include Optical Access products, TA 1500 systems, 303 concentrator products, M13 Multiplexer products, and Wireless Backhaul products.

Business networking will comprise Atlas Integrated Access devices, Total Access Integrated Access devices, and Internetworking products. Internetworking products will comprise our NetVanta product line and IP business gateways. Additionally, we will provide subcategories of product revenues for Broadband Access, Optical Access, and Internetworking products to provide greater transparency of our primary growth areas. Also we will provide HDSL revenue as a subcategory. To provide the reporting of each of these categories, we have published them on form 8-K just issued, and on our Investor Relations web site at www.ADTRAN.com.

Management believes the Company's long-term growth achievements will be the result of our continuing success in our primary growth areas. Today, these areas are Broadband Access, Optical Access, and Internetworking products. Each of these three product areas address markets measured in excess of $1 billion in size individually, providing us the realistic prospect of doubling our revenues over time. We believe that our strong operating model will continue to generate significant profits and cash flow as history has proven, with our pretax earnings target in the high 20s in terms of percent to revenue. For 2007, we do anticipate year-over-year revenue growth. However, our ability to meet double digit revenue growth in 2007 will be dependent on the health of the wireless spending, the MacroIT spending environment, the timing of developments, or the timing of deployments, rather, of our Optical Access product awards at Tier 1 carriers, as well as continued success with our NetVanta, IP business gateway, and Total Access 5000 product categories. Tom, back to you.

Okay. Thank you, Jim. Lynn, I think we're ready to open it up to questions now.

[OPERATOR INSTRUCTIONS]. Your first question comes from Vivek Arya of Merrill Lynch.

Thank you. My question is about 2007 overall guidance. You have always provided annual guidance, when I look at it, at least the last two to three years. So Tom, I'm curious as to why you're not providing annual guidance this year? That's my first question.

We have gone back and forth on trying to understand the right thing to do with our guidance policy. I think as indicative of what happened in 2006, I think the problem with yearly guidance with us has been trying to time major wins and trying to put a time frame around specifically RBOC and actually when they will actually get through the lab evaluations and actually start producing revenue. It's just a difficult animal. I think what we decided to do instead of that makes an awful lot of sense, which is try to provide you, the investment community, with the most up-to-date information we can on where we are along the curve, but realizing that these things, which can have a major impact on our revenue, are things that are nearly impossible to time.

My other question is regarding gross margins. They actually dipped down this quarter. Can you give us a sense for why that was? And what's really the outlook for 2007? Should we be modeling close to 58%, or closer to the 59% plus that you have been historically?

Jim, do you want to take that?

Sure. Vivek, in terms of the fourth quarter gross margins, the margins did decline just a little, and it was really related more to product mix, an unfavorable product mix issue. In terms of '07, we are anticipating, continuing to anticipate gross margins in the high 50s. Whether or not they vary between 58% to 59% really is going to depend on product mix from a larger part. So, again, it could potentially vary from quarter to quarter, but remain in the high 50s, is what we anticipate.

All right. And the last question is, Tom, when I look at 2006, and I look at the way you define your product segments before, which was the traditional products and then the new products, your traditional products declined 13% year-on-year, the way I calculated, and your new producted grew only 7%. So as you look at 2007, I understand that the new products should do well with all the trials, but I don't understand why you think the traditional products can also grow. Do you see any technology substitution impacts there? Main question is, do you expect your traditional products to grow in 2007?

That's a difficult question to answer, but I'll try to give you just the things that would move that. For traditional products, the biggest impact on whether or not those grow are going to be what happens in the IT environment and what happens in the wireless environment. You're right that traditional products did decline year-over-year, 2005 to 2006. The majority, the largest portion of that decline was in the Enterprise T1 segment. And we have to be, just from the law of number, we have to be close to reaching the bottom there. So I think that that pressure will ease up in 2007. HDSL declined not nearly, I think we actually break that number out now if you look on the web site, it declined about 6% or so, and that was a nonrobust cellular and WAN connectivity environment. So I think that's probably the biggest swing factor as to whether or not traditional products are going to grow or not. I think we've put the numbers out there. And as to whether or not the wireless or the WAN connectivity market improves in 2007, I think that's just a difficult thing to forecast.

As far as new products and how the new product segment did, you're right, the new product segment did see growth. We would like to see more growth. There are some things that we've talked about in the past that were factors in specifically our Broadband Access growth. If you were to look at Broadband Access year-over-year in North America, our Broadband Access revenues actually grew right around 50%. The big downfall that we saw in Broadband Access, still our growth here, but the biggest impact we had negatively was in the Telstra network buildout that we've talked about a lot. So I think historically, our new product areas still look very favorable, and I think we have every right to expect them to grow in some significant way in 2007. The traditional products, we're at a fairly high market share position, and those things will be more dependent on what happens in the other environments that we don't have control over.

Okay, thank you.

Okay.

Your next question comes from the Paul Silverstein of Credit Suisse.

Hey. If I missed it, my apologies, but with respect to Optical Access in particular, can you give us an update on what your view is? You've been fairly open in terms of the development of this product and the progress you've had with the various RBOCs. Can you give us some insight, your best guess, how it pans out during the course of '07 in terms of where we're at and how far you think we'll come in penetrating?

I hope far, but let me just give you a snapshot of where we are. I mentioned in my notes that we had started shipping initial shipments to AT&T, to Qwest, and to Verizon business, which is predominantly the old MCI. Those were initial shipments, not in and of themselves meaningful, but at least we've got the things approved and we've got them to start rolling now. Fourth quarter was not the best quarter to introduce new products into the network, because I think the spending environment in general was just slow. But we still expect those to ramp up.

With AT&T, with the approvals that we have today, which covers, which really isn't application, it covers both sell sides and customer print applications, we expect that to grow, although we do expect to get additional approvals on different plugin modules throughout the life of that product. So over the next few years, so we would expect to grow from where it was in fourth quarter. Qwest, I would say the same thing, although I think the potential we have at Qwest is somewhat less than what we have at AT&T, because that is a limited application, and our job is to go in there and make that a broader application than what it is today.

Verizon business I think has the potential to be meaningful today. You can bet you we're trying to go in and broaden that to the Verizon Telco network. But the biggest opportunity we have today is AT&T, followed by Verizon business, and then followed by Qwest. I'd kind of caution, saying that's the newest opportunities, we still have ongoing, strong business with the second-tier carriers, and we expect to expand that as we get more products out there.

Okay. On the HDSL side, how much of what's going on in your HDSL revenue is related to slow cellular spending by Cingular and others, and how much of it is Ethernet substitution? I know you don't have great visibility, but can you give us any insight there?

I would think it's predominantly wireless spending, and that's just because I think it's a much larger number. The area where you would see substitution with Ethernet impact us -- first of all, a large percentage, and I don't know the number, but just intuitively, you would think a large percentage of what's transported over HDSL is Ethernet. So it is probably still the predominant way business would be connected. ADTRAN is connected with multiple T1s, and we transport Ethernet over it predominantly. That's where you would see that actual cannibalization today would be, number one, in Merto Ethernet where they have fiber run to the premises, or number two, Ethernet over copper. I would say we haven't seen anything, any impact of any meaningful size of Ethernet over copper, although we have introduced a lot of products in that area and are hopeful on those. On Merto Ethernet, I still think that the reach is relatively limited, and I just can't believe that's a big driver today.

Okay, thank you.

Okay.

Your next question comes from Marcus Kupferschmidt of Lehman Brothers.

Hi. Just wanted to clarify the guidance for EPS, I believe that assumes 123R stock option comps. Can you tell us how much that will be for the quarter for the full year?

Marcus, for the quarter, we're estimating a consistent cost to the fourth quarter, which is about $2 million including in OpEx, okay? As far as going forward for '07 on a quarterly basis, I wouldn't expect it to vary much from that.

Great. Sounds like we're saying we made some nice forward strides on the optical opportunities here. Could you give us a sense of what else is changing? Are you getting better visibility into what the opportunities for the products for the full year, kind of where you are in doing what you need to do to kind of be able to hunt for that business or turn in the revenues?

I'll take a stab at that, Marcus. You're right in that we did make some forward progress, and probably the biggest reason I believe that is that I don't believe in purchase orders until we have them in hand, and we actually got some purchase orders in hand in the fourth quarter, so that was good to see.

Moving forward, there is a significant amount of business that we believe we can have on the approvals we have today, and we've traditionally seen six to nine months for those to hit the run rate level, and we're still believing that's the right time frame. Additional applications, and there are applications that we are -- additional products in some carriers and then additional applications in other carriers, in some areas we're in the lab, and in some areas we're out of the lab and we're in first office applications. Trying to time those has been the most difficult thing that we've tried to do here as a management team, and I would like to not try to time those here on the call. I have no doubt that some of those will happen this year, and you'll just see expanded coverage and expanded revenues this year out of Optical Access, but I wouldn't want to put anymore granularity on that.

All right. And one other quick one. How do you get a sense of HDSL if customers are reusing it? It sounds like there was some additional reuse that started at one of your larger customers in the fourth quarter?

Yeah, I've heard speculation on that. I think specifically people are talking about AT&T. I truly haven't gotten a letter from AT&T saying they've started reuse, and I don't expect to ever get a letter like that from a carrier. The level of spending that they were at, and especially in buying them and the BellSouth combined entity was low enough, long enough that I would think that some reuse had to have occurred. I don't know if that was a corporate-wide thing, or you just saw different central offices or different regions see a budget crunch to a large enough extent that they went out and started grabbing different plugs or whatever. I could believe it happened, although I really haven't been notified of that.

Great. And that's in specific reference to the fourth quarter only, correct?

Well, fourth quarter, we saw a downtick start in the third quarter with AT&T, less so with BellSouth, but AT&T, we saw a steeper downtick, and definitely more so in BellSouth. I would say it's predominantly in the fourth quarter.

Thank you very much for the clarification.

Okay.

Your next question comes from George Notter of Jefferies.

Hi, thanks very much. I wanted to ask about the TA 5000. If I go back and memory serves me last conference call, you guys mentioned that you thought the product had hit 5% of sales in a quarter in 2007. Is that still the bogey here? Do you feel better or worse about the TA 5000 based on another three months of feedback from customers? What can you tell us there that's new or different? Thanks.

Sure. I think the question that we were asked last quarter was could you see it happening, and I said, I probably shouldn't say this, but it's possible for it to happen later on in the year, and I still believe that. To get to the root of your question is, do we feel better today than we did a quarter ago? The answer to that is yes. The reason is, first of all, we've gotten through several applications, these first office trials and lab trials, and have actually been deployed in the field for revenue with some of these customers, and the list of customers that are still waiting in line for us to move forward with them continues to grow, both in the total quantity, and really the size of those customers. We've got some very large customers very interested. So the larger the customer, the longer it takes. I think some of the largest customers we wouldn't see contribute in 2007 and probably 2008. But I think we feel better, literally, every week or every month as this product moves forward. And we did get some pretty important features delivered in Q4, which was good to see. And that kind of helped ignite some of these customers turning over into revenue-producing customers.

Great, thanks.

Okay.

Your next question comes from the Nikos Theodosopoulos of UBS Investment Bank.

Yes, thanks. Just some quick questions. You mentioned that the gross margin was down sequentially due to mix. I'm trying to see what that would be, and I don't quite see a big mix shift. If anything, your enterprise sales were higher. So was it mix or was it volume? And if there was mix, can you elaborate a little bit?

Well, mix and volume, a bit of both, Nikos. So from a mix standpoint, we did see, obviously, a sequential decline in two of our primary growth areas, which carry a higher gross margin.

What was the percentage of sales, I may have missed it, of the new products this quarter?

Actually, I didn't call that out, but I can tell you what that is, and it's on our web site as well. For the fourth quarter, Broadband Access was $14.4 million; Optical Access was $8.9 million; and Internetworking was $10.9 million.

Okay. All right. So I'll go check that out. Do you have the 10% customers for the quarter?

Yes, Nikos. AT&T at 19%, and Verizon at 14%.

Okay. I don't know if you have this handy, but do you have -- if you were to look at BellSouth, Cingular, and AT&T for the full year of '06, do you know how big they would be as a percentage of your sales?

Okay. Looking at BellSouth, to give you some color on that, Nikos, looking at BellSouth for the quarter, they were at 4% of revenue, and for the year is not going to be much different than that. Cingular would be very, very small for the year.

Okay, all right. Thank you very much.

Your next question comes from the Ken Muth of Robert Baird.

Hi. On the optical side, it sounds like the progress is finally kind of starting to come to fruition. Could you look out a little bit beyond just the first quarter and see more customers coming on, or would you kind of be more cautious and just say what we have right now is the customer base that we'll end the year with?

I do think we'll bring -- this is Tom. I do think we'll bring customers on. I guess the reason we've kind of focused more on that is if you take a look at AT&T, which now includes BellSouth, Qwest, and Verizon, they control a large percentage of the fiber rings in North America. So I think we focus more on that. But we've actually added customers through the second half of the year, and I don't see that stopping. I think we'll continue to add customers. I think the product is broad enough now to where it plays well in smaller carriers as well as large carriers.

Okay. And what is the potential opportunity you have at AT&T? You talked at them rolling out DSL coverage to 100% of their subscribers. That at 19% of revenue today, that is, obviously, a lot of things you're selling to them, but if you look specifically at the DSLAM product, would you see that to have a sharp acceleration at some point in the year?

I'd never believe in sharp accelerations from carriers, although periodically from time to time and all the stars line up, you see that. We're not planning on a significant spike. I would fully expect us to be able to grow revenues within that account, and we have other initiatives going on with some of our newer products that hopefully will bare fruit over a longer period of time, but we're not expecting a spike. If it happens, we'll be very happy.

Lastly, on the NetVanta side, the revenues obviously increased nicely there sequentially. Is it because you're adding new bars or you've got some new products out there? Can you point to any few reasons that you're seeing better opportunities right now?

I pointed out on the notes that I think the success that we're seeing right now, we've seen success for a few quarters in a row now, it's got more to do with the bar strategy than probably anything else, the bars coming online in our carrier distribution partners, where we're getting some of the larger carriers to move some of our products. I think it's more to do with that than any particular product driving forward.

Okay. Great. Thank you.

Your next question comes from Andrew Schopick of Nutmeg Securities.

Thank you. Let me run through these pretty quick. Jim, AT&T and Verizon, I think you gave us for the fourth quarter. Could you give us the percentages for the year?

Andy, I do not have that before me.

Okay. Could I ask you if you can confirm the tax rate expectation for '07?

Our anticipation, Andy, is somewhere in the range between 34.5% and 35%.

So you do expect it to tick up a little bit?

Yes.

And also I wondered on the stock buybacks, what remains in the authorization?

What remains today is 2.288 million shares.

2.288 million?

Right.

I wondered, Tom, if I can ask you a quick question as well. Are there any new emerging standards that ADTRAN in particular thinks could be opportunistic for new product development, or whether you can discuss at all general R&D development efforts to hopefully pick up the pace of growth in the years ahead?

As far as standards, there are all kinds of standards that we're involved in. Many of them today are Ethernet-based standards, and we're taking a leadership role in several of them.

Would that include PBT, for example?

I'm not specifically aware of that.

All right, go ahead.

And there are some loop standards that are coming close to fruition on that we're leading the charge. So I think the standards environment today is no different than it has been in the last ten years, and as they emerge and get more mature, then you'll start seeing revenues from them, and we would like to stay up to speed with those. As far as any R&D shifts, the answer to that is not a significant shift. I think that the products that we have introduced over the last -- really over the last five years, if you start with the 6100 product line, which takes time to get implanted in carrier's networks, but from there, you can grow through applications and through new product development, that's one case in point. I think the 1100 series of products with our 1100F fiber deployment and our 1148s, and ADSL, and we'll be introducing DDSL this year, we'll be introducing POT variants of it this year, I think was a very good product line that was to some extent ahead of its time, and it's just now getting to a point where carriers are looking at it for what it's total application can be. And I think the 5000 is another case in point. I think that the range in which we're reaching out and how much we're ahead of the deployment curve for ADTRAN is just about right.

Okay, thank you, Tom.

Okay.

Your next question comes from Simon Leopold of Morgan Keegan.

Thanks. I wanted to see if you could discuss what the biggest obstacles would be for recovery of sales? And my presumption is that to a high degree, it's the spending patterns coming out of AT&T post merger? And if that is in fact the case, if you could give a little bit of color on how you think that trends, and maybe as we look out, how you see your opportunities of expanding your Broadband into BellSouth, a topic you've discussed before, but if you could give us an update. Thanks.

I don't know if we've ever specifically said that we would expand at BellSouth, but that we were hopeful, and our track record with AT&T has been that we can provide value to their merged entities and be successful. We're hopeful there, both on the the Broadband front and the optical front, but we haven't had direct conversations about adding them to their particular contracts. What's the other piece of the question?

How do we think about the timing, and is it correct to assume that that's the biggest factor in sale improvement?

Well, we had slowdown, we saw slowdown in more than one carrier. We had talked before about Embark having a slowdown also in the fourth quarter, and you can probably -- the other carrier we saw some slowdown from was Windstream. It was really several carriers we saw slowdown. We understand those slowdowns a little bit better than probably AT&T in that we understand the budget problems associated with those. We are confident we didn't lose any market share. I think we have better insight as to them turning their purchasing buckets back on, or their purchasing spigots back on and feeling better about where that environment will be in 2007. AT&T is one that we don't understand as well because I'm not sure what the goal is. If I understood what the goal was, I could probably feel better about commenting when that recovery would occur. We're not expecting it to occur in Q1, and if it does, we'll be pleasantly surprised. But right now, we're assuming the environment is the environment until it changes.

Okay. No, I certainly understand that and can appreciate it.

Okay.

Thank you.

Your next question comes from Jason Ader of Thomas Weisel.

Thanks. Jim, do you have the revenue percentage from Embark in the quarter?

They were under 10%, Jason.

Okay. So it's safe to say that was down pretty sharply?

Embark was down for the quarter.

Okay. So just looking at your guidance, it seems to me kind of conservative, just given that somebody like Embark call turn back on. I know you don't want to necessarily assume that, but is it fair to say that if things would be sort of normal spending, then you'd probably do better than what you guided to?

Well, what we did -- this has to do with not counting purchase orders until you have it in your hand. We assume that the environment in Q1 was basically the same spending environment as we saw in Q4. And that could change, but at this point in time, that seems like the best way to take a look at the quarter until you actually see something change.

But in the case of a customer like Embark or other customers where they may have run into budget issues, just running out of budget, and now that we have a reset, wouldn't that argue for somewhat of a rebound?

You can make an argument for that, and I won't dispute the argument, and hopefully that's what we'll see. We also have the other factor, though, which is typically Q1 is seasonally down from Q4. Now the environment in Q4 was such that it kind of wasn't as natural of occurrence as you typically see in Q4. But trying to factor that, whether or not you'll see seasonal downness off of Q1 was also something that we just had to take into account.

Okay, great. A couple more quick questions. On the IADs together with the IP business gateways, just as a full category, just trying to get a sense of cannibalization, Jim. Can you help us understand what that area is growing at or not growing at, if we included both of those products?

Okay, so the Internetworking products includes both NetVanta and IP business Gateways, okay? To kind of give you a feel of the relative importance of the IP business gateways, in the fourth quarter, revenues there were about $2.2 million, and in the third quarter, about $1.6 million.

Okay.

They've grown to -- they've grown from zero -- we started revenueing in the second quarter of '05, and they've grown consistently since then. Albeit, a relatively small base.

Okay. I haven't done the math, but it sounds like the IADs, if I would include IP business gateways and IADs, overall were still not growing very much.

I would agree with that.

Okay. Is there any chance that that can change? Because you're still going to have this cannibalization factor, right?

I think there'll still be a cannibalization, but a lot of the business that we're seeing, at least in the near term is customers that we're not currently active in IP gateways with, and they have made a change. So a lot of that is just market share gains. We're actually picking up market share. The health of the IAD business, in general, is going to be more dependent over the near term on the [inaudible] environment. We saw an awful lot of merger activity in 2006. There was some ASP impact because of that merger activity; but in general, I think it was a more -- I hate to say confused, but let's say difficult environment in which to do business with that it had been previously. And we're hoping a lot of that clears up this year.

Okay. Last question for you. How big a threat do you see from cable operator competition from the standpoint of small- and medium-sized businesses starting to move to cable lines instead of T1 lines over the next couple of years?

Over the next couple of years, probably too short of a time frame. Over the long-term, they're absolutely a threat. I think that they pronounced their mission in life is to go and win that customer base. I think the Telcos are taking that serious and are doing things to mitigate that, and as we've seen in the past that when the RBOCs and the other carriers decide they actually want to put together an offensive front and move forward that they can be successful. We're hoping we're successful here. Only because today we're in the cable business.

Could that have a negative impact on your ASPs only because the RBOCs may want to get more aggressive on T1 pricing, and therefore, pressure their suppliers a little bit?

Not on -- on most of the products we have, at least most of the loop products we have, like HDSL and ADSL and things like that, the equipment cost is negligible compared to the overall deployment cost. HDSL today is typically less than $100. I don't think that that's not where they would go to try to save money.

All right. Thanks, guys.

Your next question comes from Joe Chiasson of Susquehanna Financial.

Jim, if I heard you correctly, it sounded like the international number was over $10 million this quarter, is that correct?

That's correct, Joe. It was $10.6 million.

Okay. That looked like a pretty good sequential uptick there. Any color you can provide on what the background is behind that?

We saw a broadening base of our international this year, and then we had an additional positive event which happened in the fourth quarter, which is we had Telstra come on, back to life again in Q4. As we said before, they built up their network in 2006 -- excuse me, 2005, and in 2006, we saw an impact of that. They basically disappeared, and we believe that that point in time that we would kind of be held to market demand on the service that they build out, which is called BBSL. That market demand has started to pick up, and we saw a nice pick up in Telstra revenues in Q4.

Okay. Can you give any color, Tom, as to how much of the delta there, quarter-over-quarter was related specifically to Telstra, or alternatively, how sustainable do you perceive that to be going into '07 here?

I believe without '07, a lot of backlog, I believe that the rate that we're at right now is from a Telstra perspective is sustainable. We saw a pickup, though. It's probably even in the pickup that you saw in Telstra versus non-Telstra, quarter-to-quarter. And I think that's very sustainable. I think that you'll see -- hopefully, you'll see acceleration in those rates. Here again, it's still a relatively small base we're dealing with.

Okay. Tom, just one follow-up. With respect to the recent Verizon spinoff of the rural properties in Maine, New Hampshire, and Vermont, any thoughts on that, and what type of opportunity that might potentially represent for you guys?

It's definitely an opportunity. It sounds like the acquirer is kind of stepping out a little bit more proactively and talking about a more vested buildout of DSL. We are ventured to that customer, and we're hopeful we'll be able to participate in that. My belief is that Verizon would build that network out over times anyway, but I think any acceleration is not necessarily a bad thing.

Can you say whether you've had any equipment deployments in those prior Verizon territories there in those states?

I don't know specifically. I would be very surprised if we haven't.

Okay. Great, thank you.

Okay.

Your next question comes from Scott Coleman of Morgan Stanley.

Thanks. I'm wondering if you could elaborate on your comment, Jim, about providing more transparency in giving slightly different guidance. What exactly do you mean by that?

Well, the increased guidance or transparency, Scott, is in relation to the revenue breakouts that we're now providing.

Okay.

The old breakouts or the old categories were a bit dated, absolutely. So we've realigned the categories that we're reporting, and we're also reporting subcategories to specifically identify our primary growth areas, which are obviously very important to --

Okay, I appreciate it -- I guess I misunderstood and thought from a guidance perspective, you were going to change your methodology and talk about -- give a little more view into what products were going to grow at what rates in the near term. But I guess a misunderstood that.

Yes. If you were to list the questions that we were most typically asked; how is Broadband Access doing, how is Optical Access doing, how is Internetworking doing, and by the way, what is the HDSL number. What we've done, in revising the way that we're actually reporting these things, we're trying to give you better access to those numbers.

Okay. Appreciate that. If I could just follow-up on one of the earlier questions about your guidance assumes no change to the carrier spending environment in the first quarter. I just want to confirm that that means you haven't seen anything particularly different over the first three plus weeks of the quarter so far. Is that a fair assumption at this point?

I would rather not talk about what's happening this quarter. We'll do that on the next conference call. So any other questions?

No, I guess that covers it.

Okay. Thank you.

Your next question comes from Todd Koffman of Raymond James.

My question was answered. Thank you.

Your next question comes from the Ehud Gelblum of JP Morgan.

Thank you very much. Two questions, if I could. First of all, Tom, as you look at this pause in spending that seems to have happened at the back end of last year and your assuming continues in the carrier space in the beginning of '07, when it comes back, assuming that it does come back, and as we see BellSouth properly integrate themselves, do you expect there to be catch-up spending, so that you for a quarter or two will be above whatever run rate you would normally be having? In a sense, kind of recognizing several quarters worth of retro-spending, or do you think it will just, from the run rate you're having right now, it will just continue sort of, and we sort of maybe lost a little bit a couple quarter's worth of revenue.

Historically, we've been through situations like this before, and we've seen both things happen. We have seen, I think the last slowdown in HDSL we saw was probably Verizon when they went through a reuse program. And they did come back, and they came back a little stronger for two to three quarters, and then kind of settled back down to their old rate. We've had seen people, especially budget situations, where there's kind of a pent-up demand and you see that spike. As to where this one will land, it's difficult to forecast. Like I said, we're not really expecting a spike, though.

Okay. But it's possible that you could see one for a quarter or two?

It's absolutely possible.

Okay. As you look out of the two categories you have, essentially when you step back and basically look at carrier versus enterprise, do you have a feeling that -- which of these do you think will outgrow the other this year, I know obviously carrier is much larger for you than enterprise, but your assessment as you look out in 2007, do you think enterprise, is a better year for enterprise than carrier, or vice versa, just overall?

My guess today, just because of where we are on approval, is that carrier would probably, at least on a dollar basis, outgrow enterprise. 2008 may be different than that, because a lot of the sequential growth we're seeing. NetVanta now, as you look at the Internetworking number, you can see those starting to become a substantial number to us. And if we can keep growing at the rate we've historically grown at, it's going to have an impact. I'm not sure if 2007 is the year where all those things line up.

That's on a dollar basis. How about on a percent basis?

The biggest unknown on whether or not it would be on a percent basis is probably the [inaudible] market and whether or not we see that market sees growth this year. The market sees growth, I think it could actually be up on a percent basis.

Thank you. Last thing, in your new three categories that you'll be reporting on, can you give us a sense as to what the margin structure of each one looks like? At least, the line up as to which one has the highest margin? I think I have a sense, but just wanted to get a better drilldown. Which one has the best margin, the next, and the last?

I think, being that Broadband Access and Optical Access are in the carrier systems, those are certainly carrying higher gross margin. Internetworking seems to be the highest gross margin product line that we're selling today, and that is in the business networking category.

I think it's easier to say which one is the lowest, more than likely the loop access would be the lowest.

Right.

So carrier and business networking you think are roughly equivalent?

I really don't have that number in front, but I would say they probably are.

Okay, thank you very much.

Your next question comes from [Michael Restler].

Thank you, my question has been answered.

Your next question comes from Cobb Sadler of Deutsche Bank.

Thanks. I just have two quick questions left. On, first of all, on inventory, it looks like it was up about $6 million quarter-over-quarter, and that looks like the biggest number ever in the history of the Company. I was just wondering what is actually in that number? Is it a broad spectrum of overall products that you're selling, or is it more Optical Access or more HDSL?

It's a mix of products. Let me first start by saying, it is by no mean it is largest inventory number, which is nothing to be proud of, but by no means the largest inventory number in the history of the Company. Inventories did pick up. Inventories picked up for the most part because we had lower than expected revenues. We will work those inventories down over time. One of the thing we do have to be cognizant of, which is why I wouldn't say that we would try to fix it in Q1, is there is that potential that customers will come in and try to restock to a level that they're more normally used to, and we don't want to get ourselves in the situation that we found ourselves almost a year ago, which is we entered Q2 in a very good backlog situation, but with low revenue. Then all of Q2 and most of the rest of the year, we found ourselves trying to catch up, and we ran into a double ordering situation with some of our customers. We don't want to play that out again. Inventory levels will probably be a little higher as we try to work ourselves through this area with consolidation and other things having an impact. And they'll be just a little higher until we get through that. Then you'll see us go back to normal levels.

Okay, the question is it -- have you built inventory for some revenue that you see out there, or is it just the product that you've built that you hope to ship.

There's -- I would say a little bit of both. There's some of the things that we have out there because of the lead times we procured, but that would be no different than any other quarter. I would say other than that, it's just trying to take a look at historically what carriers have done, trying to map that into what it is that we actually have on our shelves, and with Q4 being down from what we initially thought, there's just kind of an additional buildup. I would say it's a situation I think we're comfortable with where we are right now, and it will work itself out over the next two to three quarters in and of itself. If we saw an uptick in business, I think we're well positioned for that, though.

Okay. And my mistake in inventory, I was only looking back to '02. On the carrier and enterprise, can you talk briefly or at least give us directional information about which way the margins moved within each segment. I know you probably won't give us -- we'll probably have to wait for the Q for the exact numbers, but were enterprise margins up because the NetVanta was strong or not?

I don't have those numbers before me, Cobb, at this point.

Great, I'll just wait for the Q, then. Thanks a lot.

Okay.

Our next question comes from Rich Church of Hunterburg.

Thanks. Has your business at Embark, WINDSTREAM, or others been impacted by changes in your sales team focused on those accounts at all?

No. I'm not aware of any major changes in our sales teams at those accounts anyway, so no. In fact, we've actually probably beefed up most of those areas in the last year and a half or so, as our revenues have grown substantially in those areas.

Right, okay. Given their very strong 3Q, do you have any visibility into inventory levels in those accounts, that would be driving that?

Not direct inventory levels, but I would say empirically, you have to assume those inventory levels are fairly low.

Right. Okay. Tom, in the past, you've talked about optical versus DSLAM in terms of when one would pass the other. Can you update us on what you think the timing would be of that?

That's dependent on the uptick of these optical awards, and I hope it happens in -- well, I guess, I'm not sure if I want it to happen or not happen in 2007. You want both of the areas to grow significantly. I just think they both have real strong opportunities, and we should be able to see good growth over the future on these two products.

Okay, great. Thanks a lot.

Okay. Lynn, I think we have time for one more question if there's another one out there.

Thank you. Your last question comes from Rob Bovo of XI Asset Management.

Thanks, guys. My question has actually been answered.

Okay. Okay. Well, thank you, everybody, for joining us on our conference call. We look forward to seeing you and talking to you next quarter. Thank you very much.

Thank you. This includes the ADTRAN fourth quarter 2006 earnings release conference call. You may now disconnect.