ADTRAN Holdings Inc (ADTN) 2007 Q2 法說會逐字稿

Good morning. My name is Theresa and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2007 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 reflects management's best judgment based on factors currently known. However, these statements involve risks and uncertainties, including: the successful development and market acceptance of new products, the degree of competition in the market for such products, the product and channel mix, component costs, manufacturing, efficiencies and other risks detailed in our annual report on Form 10K for the year ended December 31st, 2006, and Form 10Q for the quarter ended March 31st, 2007. 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.

I would now like to turn the call over to Mr. Tom Stanton, CEO of ADTRAN. Please go ahead, sir.

Thank you, Theresa. Good morning, everyone. Thank you for joining us on our second quarter 2007 conference call. With me this morning is Jim Matthews, Senior Vice President and Chief Financial Officer.

During the quarter we saw healthy sequential revenue gains in both our growth and traditional businesses. Notably we saw a 23% sequential and a 79% year-over-year increase in revenues for internet working products during the quarter. Broadband access revenues saw sequential solid growth of 10%, despite continued softness at one of our larger carrier customers. During the quarter in Optical Access we continue to progress in our selling efforts across all of our accounts, both in currently approved applications, as well as an expanding our application base. We continue to expect sequential growth in this product area as we capitalize on current awards and future application approvals. Following a strong first quarter, HDSL revenues continued to show sequential and year-over-year quarterly increases as demand in that market remained steady.

In our networking products comprising of NetVanta and IP business Gateways had its fourth consecutive record revenue quarter with a very healthy sequential and year-over-year revenue increase, contributing 11% to the company's overall revenue. This category continues to experience accelerating order flow as a result of persistent efforts to improve traditional enterprise channel focus and leverage carrier distribution channels. Also during the quarter, we were awarded new business for IP Business Gateways to be deployed by second regional bell operating company. We continue to believe RBOCs will adopt to the IP -- Gateway -- business Gateway model for delivery of converged IP services for SMBs. We remain optimistic about the potential of our NetVanta and IP Business Gateway products and the long-term positive impact on the growth of our company. During the quarter, the Total Access 5000 platform continued to progress well across all customer sets, namely, tier 1, tier 2, and tier 3 carrier customers. During the quarter, shipments to tier 3 customers continued to expand and we see this expansion progressing for the foreseeable future. We anticipate initial shipments to tier 2 customers will commence in the third quarter, followed by growing revenues among this customer set in subsequent quarters. Our progress with tier 1 carriers remains on track, with all of our targeted applications. We continue to expect revenues to commence with tier 1 carriers in 2008.

Our new Total Access 5006 platform was introduced in the second quarter targeting remote terminal upgrade opportunities and has been extremely well received by numerous IOCs. We anticipate shipments of this new platform to commence by the end of this year. Although we are very pleased with the number of awards to date in our Total Access product family, we should remind that carriers require significant time to operationalize complex products, like the Total Access 5000 platform, and the timing of these opportunities can vary significantly from anticipated dates. The Total Access 5000 platform significantly broadens our range for broadband access products, as it is targeted to address the growing requirements for applications, including IPTV, metro ethernet and the movement towards IP centric networks. Our activity around remote terminal and outside plant DSLAMs continues as we role out new features and enable higher speed applications and seamless fiber and ethernet migration in our Total Access 1100 series of products. During the second quarter we commenced meaningful shipments of our Total Access 1100F. This product substantially increases the bandwidth capabilities of our 1100 series product line. This product will find applications across all size carriers, including tier 1s.

Also during the second quarter we introduced a Total Access 1124P, broadband multimedia gateway, the world's first easily deployable high-speed fiber outside plant platform with integrated voice capabilities. With these additions, we believe our Total Access 1100 series products will continue to gain momentum in conjunction with our Total Access 5000 and 5006 platform, as carriers deploy next generation services. We believe the amalgamation of these products provides the industry's best solution for next generation [FGTX] architectures. Going forward, we believe our growth businesses will continue to see strength based on market share gains related to both current and future product introductions, and customer spending trends. Our traditional businesses will track on a macro level with enterprise demand, wireless network expansions and wireline capacity upgrades. I would like Jim Matthews to review our results for the second quarter 2007 and comments on the third quarter. We will then open the conference call for questions. Jim?

Thank you, Tom, and good morning, everyone. Revenue for the second quarter was $123.7 million, up from $110.3 million in Q1 of '07 and up from $122.3 million in Q2 of '06. For the total company, loop access revenues were $55 million for the second quarter of '07, up from $51.3 million from Q1 of '07 and slightly down from $55.4 million in Q2 of '06. Comparing Q2 of '07 to Q1 of '07, the increase in loop access product revenues was primarily attributable to an increase in HDSL revenues and an increase in enterprise T1 revenues. The slight year-over-year decrease was attributable to a decrease at enterprise T1 revenues, partially offset by an increase in HDSL revenues. Carrier systems revenues were $46.5 million for Q2 of '07, up from $39.6 million in Q1 of '07 and flat from Q2 of '06. Comparing Q2 of '07 to Q1 of '07, the increase in carrier systems revenues was primarily attributable to revenue increases in broadband access and in M-13 multiplexer products.

Business networking products for Q2 of '07 were $22.2 million, up from $19.5 million of Q1 of '07 and up from $20.5 million in Q2 of '06. Comparing Q2 of '07 to Q1 of '07, the increase in business networking revenues was attributable to record revenues levels for NetVanta and IP Business Gateway products and an increase in traditional integrated access device revenues. Comparing Q2 '07 to the same period the prior year, the increase in business networking revenues was attributable to record revenue levels of NetVanta and IP Business Gateway products, partially offset by a decline in traditional integrated access device revenues. HDSL product revenues were $46.3 million in Q2 of '07, up from $43.8 million in Q1 of '07 and up from $46 million in Q2 of '06. Broadband access product revenues for Q2 of '07 were $20.2 million, up from $18.3 million in Q1 of '07 and slightly down from $21.5 million in Q2 of '06. The year-over-year decline in broadband access product revenues is primarily attributable to lower spending at one of our larger carrier customers, partially offset by the effect of market share gains and bandwidth upgrades at other carrier customers. Optical Access revenues were $9.8 million for the second quarter of 2007, up from $8.6 million in the first quarter of '07 and up from $9.1 million in Q2 of '06.

Internet working product revenues were a record $13.6 million in the second quarter of '07, up 23% compared to $11.1 million in Q1 of '07 and up 79% compared to $7.6 million in Q2 of '06. The increase in internet working products continue to be the result of accelerating order flow from persistent efforts to improve traditional enterprise channel focus and leverage carrier distribution. As a result of the above, carrier networks division revenues were $93.3 million for Q2 of '07, up from $84.4 million in Q1 of '07 and down from $94.6 million in Q2 of '06. Enterprise networks division revenues were $30.4 million in Q2 of '07, up from $25.9 million in Q1 of '07 and up from $27.7 million in Q2 of '06. International revenue was $8.3 million for the second quarter of '07, up from $7.8 million in Q1 of '07 and up from $7.6 million in Q2 of 06. To provide the reporting of each of these categories, we have published them on our Investor Relations web page at www.adtran.com.

Gross margins were 59.5% of revenue for the second quarter of '07 compared to 59.6% for the first quarter of '07, and 59.2% for the second quarter of '06. Research and development expenses were $19.5 million in Q2 of '07, up from $18.4 million in Q1 of '07 and up from $17.5 million in Q2 of '06. And the increases in research and development expenses were primarily attributable to an increase in customer-specific product development activities in our broadband access product category. Selling, general and administrative expenses were $26.2 million for Q2 of '07, down from $26.5 million in Q1 of '07 and down from $26.3 million in Q4 of '06. Other income net of interest expense was $2.8 million in Q2 of '07, down from $3.7 million in Q1 of '07 and down from $3.8 million in Q2 of '06. Other income net of interest expense for Q1 of '07 included a pretax life insurance benefit of $1 million, other income net of interest expense for Q2 of '06 was higher than Q2 of '07, primarily as a result of higher investment balances and gains from the sale of securities. The company's income tax provision rate was 35.2% for the second quarter of '07, up from 31.3% for the first quarter of '07, and slightly down from 35.5% for the second quarter of '06. The lower tax rate in the first quarter of '07 was primarily attributable to a benefit recorded in the first quarter, relating primarily to clow closure of tax audits from prior years. Earnings per share assuming dilution for Q2 of '07 were $0.28 compared to $0.24 for Q1 of '07 and $0.27 for Q4 of '06.

From a balance sheet perspective, inventories decreased to $43 million at quarter end. Net trade accounts receivable were $66 million at quarter end, resulting in DSOs of 49 days for the second quarter, compared to 48 days for the second quarter of '06. Net cash provided by operating activities came in at approximately $29 million for the three months ended June 30, '07. Unrestricted cash and marketable securities totaled $276 million at quarter end after paying $6.2 million in dividends during the quarter and after repurchasing 1.437 million shares of common stock for $37.1 million during the quarter. As you are aware, ADTRAN has traditionally seen sequential revenue increases from the second quarter to the third quarter and our expectations are that the third quarter revenues this year will follow that trend. Things that may potentially impact revenue for the third quarter this year will be the following: continued stability of our traditional product revenues, spending levels at AT&T, the adoption rate of the OPTI 6100 with tier 1 carriers, deployment of our Total Access 5000 platform at tier 3 carriers, and continued growth in internet working revenues.

For the year 2007, we continue to anticipate year-over-year revenue growth. However, this growth will continue to be dependent on the health of wireless spending, the micro IT spending environment, the timing of deployments at 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. We believe that our strong operating model will continue to generate significant profits and cash flow as history is proven with our 2007 pretax earnings target exceeding 25% of revenues. Tom, back to you.

Okay. Thank you, Jim. Alright, Theresa, at this point, we're -- we'd like to open it up to the questions.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of John Anthony with Cowen.

Good morning, guys. Couple quick questions. Would you be willing to give us a sense of magnitude on the tier 2 adoption on some of the TA 5000 projects? And then also, I know you're kind of moving away from giving specific guidance, but can you give us kind of a magnitude for the September quarter increase in revs? And right now there's a fairly broad expectation that you will see an increase in the December quarter. Can you kind of give us a sense for what you're seeing and what would impact or prevent you guys from growing in the December quarter on a sequential basis?

Sure, John. First, we'll look at the magnitude of the tier 2s. We've had a focus for quite some period of time with the Total Access 5000 product on the tier 2s and tier 3s, and as is typically the case in our business, tier 3s kind of move quicker. Tier 2s move maybe not quite so quick and then Tier 1s move the slower of the three. We have been working with these tier 2s for some period of time. We have belief that we are at a point of success with a couple of these tier 2s and we're very hopeful that we start seeing shipments this quarter. I would tell you that will take sometime to ramp up. So as to how meaningful that will be in the third quarter, I think it's left to be seen, but we're not expecting a lot in the third quarter, where it's kind of like any of these other larger customers, they get started and then they expand from that first quarter. So that's kind of what we're expecting here. As far as third quarter expectations, I think -- I think people can do the math and kind of see what we've done historically, in the second quarter to third quarter rampup. I would say that that's probably not -- that's not an unreasonable number. I think that the things that will change that either up or down will be those points that Jim noted, which is really the expansion of the 3000 into those tier 3 carriers, excuse me, the 5000 into those tier 3 carriers and the OPTI 6100 takeup and then the general health of the traditional product line area. And I would say fourth quarter is exactly the same thing.

Your next question --

Go ahead.

I'm sorry. Your next question comes from the line of Brian Coyne with Friedman, Billings.

Good morning. Thanks for taking my call. Couple quick ones. With regard to the NetVanta product line and your comments about sort of being -- showing some progress in terms of channel development, where would you say you stand in that process right now? Do you think we're -- [hackney] baseball analogy, are we sort of in the third inning or maybe the seventh inning in terms of that? And then, secondly, in terms of the better order flow on the traditional side, I mean if -- I'm assuming you're talking more about HDSL. Would you say that the bigger driver on that is I guess wireless capacity upgrades or would you say enterprise spending?

Well, first of all, on the channel development that's a tough analogy, because my belief is that channel development is an ongoing thing. I don't think -- I don't think you ever get to the end of it. I would say that we're relatively early on a -- our new approach towards the enterprise channel, which is really leveraging our carrier distribution capabilities, or the carrier's distribution capabilities, as well as a big focus on increasing the number of bars that we have out selling the product. That's really been a push that we started sometime last year. I think we're starting to see some benefits of that push, but I would say we're early into it. And that will be one of those things that will evolve over the next several years and we'll continue to fine tune it from that point in time. The second piece of your question was?

On HDSL.

HDSL. Well, wireless, of course, is the piece that we believe to be the most variable piece of the business, but, in general, I would call wireless stable. I don't think that the numbers that we have seen, and the problem you have is we have these quarterly periods of time that we report these numbers in, but if you look at it on a larger timeframe, I think -- I think stable is the right way to look at it and I don't think that we have seen a big shift in that demand over quite some period of time.

Got it. Makes sense. And then just one final one, you talked a little bit about some specific customer development work on the optical products that influenced your R&D a little bit. Can you talk a little bit about the application there and is around [sonnet] or (inaudible) ethernet and can that be something that you can leverage into other customers? Thanks.

Well, yes. The actual R&D expenditures we talked about was in the broadband access piece and that was really centered around the 5000. And so the Total Access 5000, which is being deployed, and will be deployed by some of the larger carriers for multiple applications, and, yes, the R&D that we're doing there can be leveraged between the carriers for those different applications. What one tier 1 carrier will buy is different initially than what another one and we fully intend to try to get all of them buying it for everything. But, but it was really around the 5000.

Great. Thanks very much.

Okay.

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

Hi, good morning, guys.

Good morning.

I guess, first question, the optical business for the quarter had some nice sequential growth, but my guess is it might not have been as strong as what you might have hoped for. I mean are you seeing -- can you maybe give us a little more insight into -- are you talking to all the customers and having the right conversation and it's just a function of how much will they take, are they still doing something to really get it operationalized and up and running?

Yes, it's -- it's -- I tried to touch on that on my comments and what I was really trying to maybe point out is that every single application that we have won or that we have been approved, or that we have been talking about is still moving forward. It's been a frustrating thing for us and I'm sure frustrating thing for a lot of people on this call in trying to judge where the different intervals of revenue will actually start to contribute. In some customers, we're well through all of the testing and other very large customers we have started deployments with let's say a phase I application and the phase II application is in the lab trial or getting out of lab or we may be doing OS integration. So it's different phases for different customers, but everything is on track. It's just that the train is moving a little slow.

Okay. And then in terms of the broadband business, there was -- looks like about a 10% sequential increase or so -- in the numbers in the broadband product. Do you think that that shows some seasonality with those customers, or were you hoping to see more sequential improvement, more seasonality in what normally is a strong period in the June quarter here?

I -- I would say on whole, it wasn't -- it was a pretty good quarter. We have one major customer that went through a slow down last year. We saw a little pick up in that customer in the first quarter and we think some of that may have been inventory corrections due to just too low of buying in the second half. I would say that that customer really hasn't returned to the same level that we would predict them to be able to return to. So I would say there's probably still a little bit of slowness, but I would think it's pretty -- it's pretty targeted slowness. I mean it's not the entire market. I would say we have really one customer that we're still hoping to see some acceleration out of.

And finally, anything you can clarify in terms of what we should look for to see the snap back in that customer, what that customer needs to do?

I wish I knew. I -- I really don't. I mean I think -- I think we saw a bottom that was too low in the second half of last year, definitely in the fourth quarter of last year. And we saw the results of that in Q1, but I don't know what the trigger is.

Okay. We'll watch for that. Thanks.

Alright.

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

Hi. Tom, Jim, can we get the 10% customer numbers, who they were and how much?

Sure, Paul. This quarter, Q2 actually, we had four 10% customers and AT&T came in at 24% and that does include BellSouth. Verizon came in at 13%. Embark came in at 11%, and Qwest came in at 11%.

Okay. And -- but clearly you think AT&T is not yet come back to full order patterns?

Well, that's correct. Particularly considering that in the first quarter it was 29%, although that was probably inflated a bit from a very low fourth quarter. But they are not back to prior levels.

Alright. Is -- is any particular section of AT&T, or is it across the board?

I would say in general it's across the board. There's nothing that really -- there's a little bit more slowness in one area than another, but I would say in general, it's across the board.

Alright. And in terms of gross margin, with TA 5000, I know it's still very early days, but as you look forward at the ramp also further off, the penetration, does gross margin profile change at all? I know it's been pretty stable in the 59% plus range, but should we expect any shift there over time?

You may see a quarter-to-quarter variation, but I think once these things get rolling out in large volumes, I think that you'll see everything gravitate towards that kind of 59% number.

Tom, it sounds me like that's a change from previous commentary in the sense that you sound comfortable that you'll be able to maintain. I don't want to put words in your mouth, but that you'll be able to maintain 59% to 60% -- 59% to 60%.

Well, I think what we officially say is high 50%, and which tries to give us a little bit of latitude because things do change on a quarter-by-quarter basis. But the reality of the situation is we've been at 59% for quite some period of time and we don't see a change in the pricing environment or in the margin profile of our products. So, it's tough not to say that it will be right around that range.

Okay. One last quick question, if I might. Ethernet, can you give some additional color in terms of -- I know you've had some recent ethernet offerings and where you're at in terms of ethernet service delivery capabilities on the various platforms and what's coming down the road.

Well, ethernet pretty much is touching every one of our platforms at this point. Of course, on the enterprise side, that's kind of a given with our router and switch products. On the carrier side, some of the things that we introduce over the last six months or, so 5000, of course, is ethernet in, ethernet out, and is at its core in ethernet product. The 1100 series, we have migrated to ethernet. The 1100F that I mentioned in my notes is, allows ethernet in, fiber ethernet in and then feeds the 1100 series with ethernet. So it's -- the 3000 series, even our older platform, has now -- has ethernet capabilities and we're shipping ethernet DSLAMs and that product area. So I think it's pretty much touching. I don't think of a product it's not touching.

Okay. Thank you.

That includes the 6100, too, by the way.

Okay.

Your next question comes from the line of Vivek Arya with Merrill Lynch.

Hi. Good morning. A couple of questions. Tom, my basic question really is how much of the growth in the new products is merely helping to offset declines in your more traditional products, and I just want to take two or three examples there. For example, broadband access, which is a growth area, sales went from $21.5 million in June '06 to $20.2 million in June '07. Even though your 5000 is growing, so how much of the TA 5000 growth is actually just helping to offset the declines in TA 3000. Another example is even though your internet working NetVanta products are doing very well. They went from $7.6 million to $13.6 million. You also see declines in the other IP products from $12.9 million to $8.6 million. So that's my first question. How much of the growth in new products is just helping to offset declines in your traditional products?

Well, I mean I think the -- we put enough numbers out there to where you can actually draw conclusions on what that is and I would say from quarter to quarter, that is -- that's variable. The decline in broadband access, for example, is really, really in one customer, and we expect that that customer will come back. I can't tell you exactly when that customer will come back, but we believe that customer will come back. The Total Access 5000, by the way, did contribute revenue, but I wouldn't call it substantial, even to the broadband base yet. I think that's something that's still coming online in future quarters. IEDs and the growth in -- first of all, we're very positive about the growth in internet working, we're also hopeful that we're actually building momentum so we would see continued increases in growth over time. IEDs is absolutely a market that is variable from time to time. We saw a decrease towards the tail end of last year, it kind of started coming back up this quarter, but it's -- that's just a business that fluctuates. So I, I think the math -- I think you can do the math and I can't tell you that this dollar replaces this dollar. I think you can see in general where the buckets are and how much of it actually just decreases. I would say that the, our full expectations are that the growth products will grow at a higher rate and with more momentum than the decrease in our traditional products.

I see. And the R&D that ticked up this quarter because of some product (inaudible) activities, is that a one-quarter phenomena, or should we see R&D expenses to be generally high for the next one or two quarters also?

I think you'll see them in relative terms higher than what we have historically done, and what we have is some very specific developments going on in order to win some of these opportunities. Now, what you'll also notice is we are trying to work on the SG&A line in order to offset as much as we can those increases. If you look at the total OpEx line, Q2, for instance, is typically a higher SG&A quarter for us because we have major trade shows in that quarter, and you typically see it actually decrease after that. My sense is that you would see the same thing the rest of this year, with potentially an uptick in R&D that would offset that. We're trying to keep that as much in line as we can, but it may actually increase a little bit more than where we are.

I see, and just the last question, Tom, the business -- the underlying business in growth fibers, I think you'll see residential broadband you have business services and then you have wireless backhaul can you give us a sense of how your total sales today, what part is learning to what of these growth drivers. For example, if you look at your sales, roughly how much of that is really leveraged to wireless backhaul how much is really leveraged to business or residential DSLAMs?

Well, I think residential is a fairly easy number to come to, because I think if you look at our broadband access breakout, you could assume by far the majority of that is for residential services. It may be a little bit more difficult next year, as broadband ethernet over copper starts contributing to that number and then we'll have to deal with how we can give you a sense of that. But I think broadband is really our residential piece. The more difficult one, though, is, of course, is the wireless versus business lines because HDSL and Optical Access are used in both and we really don't have the breakout of that.

I see, but does it -- in just rough terms, is it fair to think wireless backhaul is maybe 10% to 15% in terms of end demand drivers, or is it substantially more than that?

In total end demand, I've heard numbers anywhere from 10 -- well, from 10% to 25%, and I don't have a data point. I think that's -- first of all, that's a broad range, of course, and you would like to narrow it down, but I wouldn't have anything specifically to tell you that that range would be wrong.

Okay. Thank you.

Okay.

Your next question comes from the line of Ehud Gelblum with JPMorgan.

Hi. Thank you very much. I want to follow up on the operating margin issue and wrap that a little bit into the R&D question that you were just talking about. Last year you had in the second quarter slightly lower revenue and slightly higher operating margin. Next, ,in the third quarter of last year you had revenue roughly about where your revenue in third quarter this year will be, maybe a little bit lower, and your operating margin was as high as 26%. I understand your R&D is higher now. How should we be looking at the operating margin? Should -- sounds like the 26% is probably not possible at these revenue levels. Will it stay either 22.5% now? Can we get the 25% now, is that sort of where we can be and as you move into the fourth quarter, etc., with these higher R&D levels, do you think you can get above 25% and into the 26%, 27% range, or do you think we kind of stay in the 22%, 23%, sort of as you look at the give and take between raising your R&D and the operating margin? And then I have a followup.

Ehud, this is Jim. I'll take that one. As far as our pretax margins go, we still anticipate being over -- at or over 25% or slightly over 25% for the total year.

That's including your interest income, correct?

That would include interest income.

Can we peel that off, just for the time being, because that's a separate issue that sort of depends on your cash balances and how much you buy back and stuff like that?

Well, yes, it is. Typically that will vary between -- anywhere between interest income net of interest expense will vary, say, between 1.5% to 2% of revenue roughly. Okay? So, you can use that as a range. But I would anticipate on the pretax basis for the third quarter that given those revenue ranges, that we should be at or above 26% on a pretax basis.

And I should subtract 1.5% to 2% to get to an operating margin, that therefore is around 24.5%? Is that the right math?

That's, that's -- I think that would be a close estimate, yes.

As you get into Q4, does it move up again with revenue? Assuming your revenue continues to go up, which let's take that as a separate issue.

Yes, if revenue continues to go up, we would think that the operating profit would increase as well.

It would not be absorbed into additional R&D? Okay.

Well, assuming revenue goes up, we wouldn't see that. I mean the uptick that we see in R&D, and like I say, we do have focus on expenses in other levels. If we saw an uptick, we would not be expecting to spend all that in R&D.

Okay.

We're at a pretty good rate you right now. If you take a look at the engineering sources we have today in play, we're at the level now to where it's within striking distance of being able to get everything we need to get done, done.

On the R&D side?

On the R&D side.

Okay.

We couldn't expect at all that our revenue increases for the second half of the year should outpace increases -- any increases in OpEx.

Okay. I would hope so as well. Okay. Two more questions. One is, as you look to the fourth quarter, it sounds like, Tom, you said of the several things that we should be looking at, one is the adoption of the OPTI 6100 at your T1 carriers. Can you give us quickly what we need to be looking for? I know that's been delayed six or nine months from your original plan. What is causing the slowdown and how do we get our arms around the timing? Do you think some of those start following you in Q4, are they going to be pushed out into Q1, Q2 of next year, and what does it really depend on?

Well, if you look at the plans today, yes, they actually should start coming online before the end of this year, but the caveat to that -- and literally these are what the current plans are. The caveat to that though is that they, those plans have been in place before and they have been delayed for one reason or another. So, our expectations are that we would actually see continued sequential growth and that we would see more contribution from those awards throughout the rest of this year, but we have the unknown as to whether or not plans change. The good thing for us is none of the plans changing have derailed the opportunities themselves, but they have been delayed.

What has actually caused the plans to change? Is it more the --

There's a litany of reasons that things change and sometimes it's the customer themselves not knowing exactly what they needed to get done and having to revamp resources in order to get them done.

As far as you can tell, it's not competition coming in?

No, it's not competition. And I'm pausing here just to make sure I'm covering the entire space of opportunities, but in none of the -- in none of the spaces I can think of, it's really a competitive problem. It's more of an execution problem.

Okay. Two other questions, if I could. One is, when you look at, Jim, your guidance of this year, growth over last year, so far your first two quarters have been, call them flat with last year, up 1% or so, 1.5%. Your guidance for Q3 seems to again be flat, up a tad a bit from Q3 of last year. Your Q4 number was so low at $109 million, to be anywhere near your guidance of just up year-over-year, you would have to have a serious decline in Q4 and it sounds like that's not going to happen, so therefore it sounds as though aside from your original guidance of up year-over-year, it sounds like you're sort of pushing us up much more significantly in the 4%, 5%, 6% range just by virtue of the fact that you don't expect to be anywhere near that in Q4. I just want to make sure that we're covering all the bases and making sure that --

I don't think at this point we're anticipating a Q4 as low as $109 million.

Okay. Understandable. And the last thing is, as you look at Q1 of '08, seasonally you've been down and that's taking your margin down as well. Assuming that you are seasonally down, regardless of how much or how little that would be, do you expect your margin to compress to the sort of the same levels as it has in the past Q1s, or do you think we could kind of keep it up maybe closer to what you were talking about, the 25%?

That's hard to say. I mean I hate to start talking about '08.

Okay. I'll leave it at that. I appreciate it. Thanks.

Okay.

The next question comes from the line of Cobb Sadler with Deutsche Bank.

Thanks a lot. Had a question on your 10% customers. Qwest popped up as a 10% customer. Can you talk about what products are being sold on that account? I know it's HDSL, but what about the TA 5000?

The biggest increase in Qwest, and Jim, correct me if I'm wrong, I don't have the number right in front of me, is in broadband access.

Correct.

Okay.

And we are not at this point shipping any Total Access 5000s to Qwest.

Okay, great. And you talked about second half of the year, wireless backhaul being kind of a swing factor. What, if you had to characterize what products benefit the most, I mean is it the M-13, looked like they were pretty strong in the quarter, Optical Access or just the general T1 business? Is it all three that benefit by uptick in wireless backhaul, or is it just a few, or how does if shake out?

I would say traditionally all three would benefit. I mean there are -- we have quite a few traditional products that can be utilized in one area or another in that area, but I think you pointed out the biggest ones.

Okay, and then within internet working, can you just give us some guidance on the enterprise router versus the IPPBX, were they both strong? I may have missed it. You may have talked about it already. But which one was the strongest, which one drove the upside in the quarter?

Enterprise routing.

Great. Thanks a lot.

Your next question comes from the line of Jason Ader with Thomas Weisel.

Thank you. Jim, or Tom, could you just give us a little bit of color commentary by segment for the third quarter, just in terms of which segments do you expect to grow the most, if you had to kind of rank order, I don't know, HDSL, broadband access, Optical Access and internet working? Which would -- which do you think on a sequential basis might grow the fastest in Q3? Where is your greatest degree of confidence at this point?

Well, Jason, this is Jim. That's a difficult question. It's hard to say. Typically -- typically in Q3, we see growth in all of the categories, but as far as which one will show the greatest growth is hard to say at this point.

Can I -- can I ask you to just maybe make a guess based on the available information and order flow and just where are you most confident at this point?

The problem with guess is people forget the guess part. But, really if you look historically, what we have seen, what Jim said, we have seen an increase in all of them. The HDSL is typically up. Almost all of our traditional products are typically up. The newer products, we see a typical increase in the installed base. The swing factors, I think for Q3 on which one will actually drive to a higher number will be Optical Access, the 6100 uptick in new markets, exceeding what the seasonality may be in our traditional market. The Total Access 5000, with tier 2 -- tier 3 carriers, I think that's a swing factor that may drive broadband access to even a higher level. So I think those are probably the biggest ones. Now, internet working had a great quarter, but I would still characterize our internet working and our, specifically our NetVanta growth as one of those that we would see steady increases.

Okay.

That will see these kind of stair step increases. It would be nice if that happens, but what we're planning for is continued steady growth.

So kind of broad-based growth across all product categories in Q3. So you must be feeling pretty good about that overall.

Well, yes, but we don't have a lot of backlog. So the positive feelings that we get are based off of historical trends and what we typically see. Here again, though, with the two swing factors probably being the 6100 and the 5000.

Okay, and then on the 5000 for the tier 2s that you talked about, I guess potentially getting some revenue in -- by Q4, is that -- is that one customer that you're kind of thinking about, or a couple of customers -- or a few customers?

It's a couple of customers, and really what we're looking at is kind of shipments into the -- the initial shipments into the quarter and then them wrapping up, and I will tell you that there's not a tier 2, and there aren't, I think, by last count was four tier 2s. There aren't any that we aren't doing something with.

So shipment this quarter sort of operationalize it and then recognize revenue?

Right, but each one is at a different stage, so there are couple that were very far along the pathway and a couple that were not quite right.

Does that make you a little bit more confident on Q4 than maybe historical periods where Q4 tended to be kind of a wild card type of quarter, but since you have TA 5000 potentially contributing significantly in Q4 based on tier 2 customers, does that help your overall--

Yes. There's no doubt that that makes you feel better. You'll have more time with tier 3s. You're starting to ship some tier 2 revenue. The 6100 will have been farther down its path. All of those are positive things for the end of the year, but the negatives being is that seasonality -- that seasonal variability can swing. So, but, yes, all of those are positive things.

Okay, and then last question is just on AT&T. I guess without committing it to any kind of forecast there, but are you at least getting signals from the customer that spending could come back to more normal levels? You have conversations with them -- you have conversations with them all the time, I'm sure.

Right. Yes. Well, we're not getting signals that anything -- I mean, we haven't lost market share. The products that we're selling into and the applications that we're selling into haven't gone away. So, we're positive that as they get to more normal spending levels that we'll benefit from that, but, I'm not getting any specific timeline.

Okay. Alright. Thanks, guys.

Your next question comes from the line of Nikos Theodosopoulos with UPS -- UBS.

Thanks. I just had some quick clarification questions. I don't think I heard it or saw it in the press release. Do you have the option expense for the quarter?

Nikos, yes, I have it right here before me. And also on a total basis, you'll see it on the cash flow statement for the six months and you can back in for the three months, but I can break it down by line item on the P&L for you.

Yes. That's what I was looking for.

Okay, so cost of sales for Q2 was $88,000, for SA -- FAS 123 expense. R&D line was $1.084 million. SG&A line was $1.124 million, for a total of $2.296 million.

Okay, thank you. And within the broadband access segment, is the TA 5000 still very small contributor, less than 10% of that segment at this point? I know it's been fairly insignificant in the past. I wondered if there has been any change --

Yes, it's still less than 10%.

Okay, and just one last question, when -- when -- in the internet working segment now that it's becoming a bigger, bigger piece, and I know you have some tier 1s as distributors there, when you report like a Verizon as a percentage of sales, do you include in there what they sell as -- to enterprise customers, or do you not include it in there?

Yes it is included in there.

Okay. So right now if you look at your internet working business, are the biggest distributors traditional nontelco distributors, or would you say your biggest channels are telco customers, like Verizon or whoever?

I don't know that specifically, but let me just add a little bit of color to that. When somebody like Verizon sells our product, a typical distributor is somebody that has our product and has other products and then moves that product to an SMB through selling efforts. Verizon has, I believe some of that, but what's happening more often than not is they are selling this as part of a bundled service. So they go to the customers who wants internet access or something and say, here's the service. It's this much a month. It comes with this platform. So it's not a -- a traditional bar in that sense.

Okay, great. Alright. Thank you.

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

One is if you could talk a little bit about the seasonality trends for the December quarter. If we ignore last year, which was kind of a weird year, you've typically shown slight declines going into the December quarter, and it sounds like you've got a number of opportunities that may allow you to defy that normal seasonal trend. If you could comment on that, and then I've got a followup. Thanks.

Well, Simon, this is Jim. I'll take a swing at that question. I mean you're right. Typically it's been flatter or down overall. We've had one or two fourth quarters that have been up, but we do have, obviously, a number of incremental things this year that we didn't have the benefit of last year in terms of the OPTI 6100 and Total Access 5000. Okay. Now, whether or not that bucks the typical trend in the fourth quarter, we don't know, but I guess there's a potential for it.

Okay, and then also wanted to talk a little bit about the competitive landscape. You talked about AT&T, specifically, where you felt like you were maintaining your share. Maybe if you could drill down on those tier 2 and tier 3 carriers, what the competitive landscape looks like, because particularly with products like the TA 5000 that are new, I imagine that suggests you're taking share from somebody. So if you could speak to where you are in terms of share trends, who you're taking share from, if you are, or if it's just general market. Thanks.

I would say that, I mean, I would say that there's two types of customers out there. Those that haven't started an upgrade cycle and really have older equipment out there that they are looking at replacing, and in those cases to a -- a large number of those opportunities the equipment that may be out there may be the old AFC equipment, which is now Telabs equipment, and we're competing with several different vendors, Telabs is one of those vendors, Calex is one of those vendors, Alcon is one of those vendors, and we're just going out and competing with them. There are cases where there's existing next generation product out there and we're doing well in penetrating those accounts, and in some cases actually replacing some of that newer generation equipment. So I think it's kind of -- it falls into those two camps. In general, I would say that that market is eager at this point in time to go out and upgrade their infrastructure, so I think it's a good market for us to be targeting, and I think we happen to have some a very good products at a very good price point at the right time. So that's why we're so optimistic about it.

So if we look at it, it sounds like it's the general industry trends are more favorable, but you're going to grow a little bit faster in that tier 2, tier 3 market because of some share gains. Is that a fair paraphrasing of what you said?

Yes, but understanding that we had zero market share, the weird thing about that question just answered is if they are upgrading an AFC cabinet is at a market share gain because you would not have been in that market. So -- but I think in general the answer to your question is yes.

Okay. Well, thank you very much.

Okay.

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

Thank you. On the Total Access 5000, the way you're tiering it now by customer segment, it seemed in the last six months from the tier 1s there was some talk that you would have some deployments before the end of 2007. Now you're -- is it incrementally new that you're pushing that out into 2008, is that an early 2008, or it's unclear?

No. I don't think it's new. I think that we've been, for some period of time now trying to -- to explain to people that we believe it's 2008 and we have not defined the period of time in 2008. We will say that we're undergoing different levels of trials or lab evaluations right now, but our stance on the 5000 has been that it would contribute this year, that we were hopeful that it would meaningfully contribute by the end of the year, but that would be -- that contribution would be more with the tier 3 customers and then the tier 2 customers and then in 2008, the tier 1.

Okay. Just unrelated, just a quick bookkeeping, I don't know if you report this anymore with your new reporting, you used to do around, I want to say $7 million or $8 million a quarter in T1 revenues. Do you report that number, and if you do, what is that number for the June quarter?

Todd, this is Jim. We don't actually write that out. I don't think we ever actually broke it out specifically.

Okay. Thank you.

It would be included in the loop access category along with HDSL in the breakout that we give.

Yes. We do break out HDSL now.

And we do break out HDSL separately as well. And there are some other smaller items within loop access in addition to T1 revenues as well.

Okay. Very good. Thank you.

Your next question comes from the line of Ari Bensinger with Standard & Poor's.

Hello?

Yes.

Yes, hi. Just in terms of international, any sense of maybe trying to increase your exposure there? It's been under -- basically, under 10% for a long time now and do you see any opportunities?

There are absolutely opportunities. The product set that we built and is coming to fruition this year with the 5000, as well as the 1100 series is a product that makes sense to an awful lot of carriers worldwide and we are working on those. We have had starts and stops in our international growth, so we're a little leary on trying to project these. Some of these are very new customers to us that we're trying to understand what their buying habits will be and what their contract negotiations will be like. So I think we're pretty early on. But we are actively pursuing that, as well as in targeted markets, trying to grow our enterprise business.

Great, and lastly for modeling purposes, tax rate, a little above where it has been. Anything -- any guidance going forward?

We anticipate that it will be around a 35% range in the third quarter.

Thank you.

Your next question comes from the line of Andrew Schopick with Nutmeg Securities.

Jim, I just need for you to repeat a couple of numbers for me that I missed. Access in the second quarter, was that $77 million?

Access in the -- you mean broadband access?

Yes. Or I should -- I think it's loop access.

Okay. Loop access. Loop access revenues for the second quarter were $55 million.

$55 million.

Right.

And also the carrier network division versus the enterprise?

Sure, the carrier networks division for Q2 of '07 were $93.3 million in revenue.

$93.3 million.

And enterprise networks division was $30.4 million.

$30.4 million. And would it be safe to conclude that your FAS 123(R) expenses are going to run just around the $9 million level this year versus about the $8.1 million last year?

For the quarter --

I see what they are for the quarter.

Yes, but we -- Andrew, we expect that they will be around $2.3 million on a quarterly basis.

For the remainder of the year?

We think so.

Thank you. That answers my questions.

Okay, Theresa, one more question, please.

Your last question comes from the line of George Notter with Jefferies.

Hi, guys, just a quick housekeeping item. Big drop in inventory days sequentially. I guess I was just trying to figure out what drove that on the higher revenue and cost of goods line this quarter.

Yes. I'm glad you brought that question up. We actually, if you remember, as we rolled into the second half of last year, we saw a decrease from a couple of our major customers. We actually built up some inventory and have been working that down on kind of a steady basis, and I think what you're just seeing at this point in time is us getting to a comfortable inventory level. From a turns basis, I think that we're comfortable with the level we are. I wouldn't see it on a turns basis actually going -- our turns going substantially higher from here. I think we're right in the spot that we like to be at from a delivery availability standpoint.

Got it. Thanks.

Okay. Well, thank you, everybody, for joining us on our call, and we look forward to our third quarter conference call.

This concludes today's second quarter 2007 earnings release conference call. You may now disconnect.