ADTRAN Holdings Inc (ADTN) 2008 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the third quarter 2008 earnings release conference call.

During the course of the conference call, Adtran representatives expect to make forward-looking statements which reflect management's best judgment based on factors currently known. However, these statements involve risks and uncertainties, including the successful development and market acceptance of new products. The degree of competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2007 and Form 10-Q for the quarter ended June 30, 2008.

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. After today's presentation, we will conduct a question and answer session. (OPERATOR INSTRUCTIONS) Thank you.

I would now like to turn the conference over to Mr. Tom Stanton, CEO. Sir, you may begin your conference.

Thank you, Vanessa. Good morning, everyone. Thank you for joining us for our third quarter 2008 conference call. With me this morning is Jim Matthews, Senior Vice President and Chief Financial Officer.

As noted in our press release, we performed very well in the quarter, achieving an 11% year-over-year increase in revenue, a 13% increase in earnings per share and we set record revenue levels in some of our key product areas. The revenue growth in the third quarter was driven primarily by increases in our growth categories. Broadband Access, Optical Access, and Internetworking, which combined, grew 26% year-over-year.

During the quarter, Broadband Access revenues grew 26% year-over-year. Optical Access achieved a record revenue level, growing 21% year-over-year, and Internetworking also set a new record, growing 33% year-over-year. Also, HDSL, our largest legacy product area, came in very strong, with 50.8 million in revenue, growing 8% year-over-year.

This year-over-year increase in Broadband Access revenue was due mainly to our Total Access 5000 product family. This series of products continued to progress and remains on track with all our multiple major awards. During the quarter, we continue to receive new carrier approvals and shipped initial products to our second North American Tier One carrier. We continue to expect approval at the third Tier One North American carrier, to occur in the fourth quarter of 2008.

On a sequential basis, Total Access 5000 revenues partially offset a decrease in our 1100 series Fiber to the Node products and our 3000 Series ATMD sign ups. The activity around our 1100 series both from a bidding and lab activity perspective continued to grow in the US and abroad. We did, however, see a decline in Fiber to the Node revenues at a large Tier One domestic carrier. We believe this decrease is temporary and part of a longer-term, phased rollout deployment. We anticipate reacceleration of shipments to this carrier beginning in early 2009.

Optical Access again had a strong quarter with 21% year-over-year growth. Again, this growth was driven primarily by Tier One carriers, as we continue to gain traction with relatively new awards in that market segment. We continue to believe, despite our gains to date, that we are in the early phases of Optical Access conversion and that the increasing demand for bandwidth, both wire line and wireless, holds great promise for this product area.

Moving on to our enterprise segment, our Internetworking business saw it's eighth record revenue quarter within the last nine. This growth, although muted by economic conditions, continued to reflect the broad-base support we are seeing as we continue to utilize our carrier distribution channels and aggressively grow our VAR dealer base. This growth area now represents approximately 60% of our total enterprise revenue.

We continue to innovate and redefine this product segment, as evidenced by our recent introduction of a new, higher capacity switch product line and feature-leading 7100 series IPPX telephony product. The economic environment experienced during the first part of the quarter was similar to what we experienced during the previous nine months. However, the latter part of the quarter experienced additional weakness across most customer segments and across most product segments.

Optical Access, Total Access 5000, and NetVanta product areas did not see these decreases, as these categories continued to gain enough share to overcome the underlying slowness. Although it is still early in the fourth quarter, order rates have since stabilized. We believe the result of continuing share gains in our product categories will enable us to mute the effect of the environment we are experiencing. Although the escalating economic uncertainty and the resulting volatility in order rates forces us to enter the fourth quarter with some caution.

It is our belief that the underlying benefits of our products, coupled with the inevitable transition to higher speed IP-centric networks will over the long-term, overcome short-term macroeconomic weakness. And these facts, when coupled with our company's profession ability to increase market share in difficult environments, have fortified our optimism in our ability to prevail as a leading global provider of IP-centric solutions for both copper and fiber.

I would now like Jim Matthews to review our results for the third quarter 2008 and our comments on the fourth quarter of 2008. We will then open the conference call up for questions. Jim?

Thank you, Tom. Good morning, everyone. Revenue for the third quarter increased 11% to $137.2 million, compared to $123.8 million in Q3 of '07.

Broadband Access product revenues for Q3 of '08 increased 26% to $23 million, compared to $18.2 million in Q3 of '07. Comparing Q3 of '08 to Q3 of '07 the increase -- the significant increase in Broadband Access product revenues is primarily attributable to 1100 series Fiber to the Node upgrades and 5000 series rollout of the [Ethernode] copper services broadband digital loop carrier and other applications.

Optical Access revenues increased 21% to a record $16.7 million for the third quarter of 2008, compared to $13.9 million in Q3 of '07. Comparing Q3 of '08 to Q3 of '07, the increase in Optical Access [Inaudible - technical difficulties] is the result of continuing market share gains across numerous customers, including Tier One carriers.

Internetworking product revenues increased 33% to a record $19.2 million in the third quarter of '08, compared to $14.5 million in Q3 of '07. Internetworking products continued to experience increasing momentum as a result of continuing efforts to improve traditional enterprise channel focus and leverage carrier distribution. In total, our growth products grew 26% in the third quarter of '08, compared to the same period the prior year.

Carrier systems revenues were $53.9 million for Q3 of '08, compared to $44.6 million in Q3 of '07. Comparing Q3 of '08 to Q3 of '07, the increase in carrier systems revenues was primarily attributable to revenue increases in Broadband Access and Optical Access product categories. Business networking revenues for Q3 of '08 were $25.4 million, compared to $23 million in Q3 of '07. Comparing Q3 of '08 to Q3 of '07, the increase in business networking revenues was primarily attributable to record revenue levels of our Internetworking products, partially offset by decrease in traditional integrated access device revenues.

Loop Access revenues were $57.9 million for the third quarter of '08, compared to $56.3 million for Q3 of '07. Comparing Q3 of '08 to Q3 of '07, the increase in Loop Access revenues was attributable to an increase in HDSL revenues, partially offset by enterprise T1 revenues.

HDSL product revenues were $50.8 million in Q3 of '08 and this was the highest revenue level for HDSL in 12 quarters. As a result of the above, carrier networks division revenues were $106.4 million and enterprise networks division revenues were $30.8 million in Q3 of '08. International revenue was 7.8 million for the third quarter of '08, compared to $7.8 million in the third quarter of '07. To provide the reporting of each of these categories, we have published them in our Investor Relations page at Adtran.com.

Gross margin was 59.6% of revenue for the third quarter of '08, compared to 59.9% for the third quarter of '07. Research and development expenses were $21.7 million in Q3 of '08, compared to 18.7 million in Q3 of '07. The increase in research and development expenses was primarily attributable to an increase in activities related to customer-specific development efforts and to [telecordia] costs related to Tier One carrier product approvals.

Selling, general and administrative expenses were $26.3 million for Q3 of '08, compared to $25.3 million in Q3 of '07. Stock-based compensation expense net of tax was $1.8 million in the third quarter of '08, compared to $1.9 million for the third quarter of '07. Other income net of interest expense was $1.8 million in Q3 of '08, compared to $2.7 million in Q3 of '07. The decrease in other income net of interest expense for Q3 of '08 is primarily attributable to lower investment balances as a result of our share repurchase program and lower interest rates.

The company's income tax provision rate was 36.8% for the third quarter of '08, compared to 34.4% for the third quarter of '07. The tax provision rate for the third quarter of '08 was unusually high, primarily as a result of delays in federal legislation required to extend research tax credits for the 2008 year. Legislation was finally enacted in the fourth quarter of 2008 and therefore the research tax credit for all of 2008 will be reported fourth quarter.

Earnings per share assuming dilution for Q3 of '08 were $0.35, compared to $0.31 for Q3 of '07. Inventories were $48.3 million at quarter end. Net trade accounts receivable were $59.2 million at quarter end, resulting in DSOs of 40 days for the third quarter of '08, compared to 51 days for the third quarter of '07. Net cash provided by operating activities for the third quarter of '08 was a strong $27.5 million, compared to $17.5 million for the same period the prior year. Unrestricted cash and marketable securities totaled 220 million at quarter end, after paying $5.8 million in dividends during the third quarter and after repurchasing 1.9 million shares of common stock for $43.1 million.

In regards to our fourth quarter review, we want to remind you that we are a book and ship business and timing of near-term revenues associated with large projects we are engaged in, combined with the possible impact of a slowing macro environment make it difficult to predict revenue levels. With that said, Adtran has typically seen revenues decrease sequentially in the fourth quarter, primarily as a result of seasonality. On average, since the year 2004, this sequential decrease has averaged around 9% and we expect to see seasonality this quarter.

Additionally, a potential offset to the strong HDSL demand we saw in the third quarter and the softness in spending we saw in the third quarter, lead us to believe that we may see a mid-single-digit range percent negative sequential impact over and above average seasonality in the fourth quarter.

We believe the larger factors impacting the revenue we've realized in the fourth quarter will be the following. Spending levels at our large Tier One and Tier Two carrier customers, general economic conditions, stability of our traditional product revenues, order trends and traction at fewer international customers. The adoption rate of our Total Access 5000 and 1100 series platforms, the adoption rate of the Opti 6100 for Tier One carriers and continued growth in Internetworking revenues.

We believe we will execute in a range consistent to our historic operating model at the achieved revenue level in the fourth quarter. Tom, back to you.

Okay. Thanks, Jim. Vanessa, we're now ready to open it up to questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Vivic Arya from Merrill Lynch.

Hello, Tom, Jim. Couple of questions. In the last few years, along with the some sequential decline in sales in the fourth quarter, there has also been a corresponding decline in gross margins. I think in the last two years, it was 150 basis points or so. Jim, is it possible that we see more gross margin declines in the fourth quarter than that seasonal trend?

Well, we do expect gross margins to remain somewhere in the high 50s. Whether or not they decline that much, I, I don't know, but, again, we think the high 50s would be a good range.

Got it. And then Tom, a question for you. If you look at the demand drivers for the company, it's essentially residential DSL, it's enterprise services at the small-medium size businesses and wireless back haul. Can you give us a sense of what the proportional exposure is and which of these areas are under more pressure versus others?

It's tough to give -- depending on the product area, it is tough to give you that specific mix because we, of course, shift these products to the carriers and then the carriers disperse them for those different applications. My, my sense would be where we saw some pressure at the end of the third quarter in kind of order activities would be more in the traditional DSLAM area, where we saw a decrease in our 3000 ATM DSLAM. Now some of that is due to the -- may be due to, to pressure in the environment with that residential base. I think some of that is also that we are seeing more shipments towards IP-centric type DSLAMs, so I think there's a little bit of a combination there.

Got it. And one last question, there's a lot of concern that some of your larger carrier customers, AT&T, Verizon, Qwest, are not spending, or at least have curtailed spending in the fourth quarter. Tom, can you give us a sense as to what is the nature of the spending cutbacks? Is it across the board, or is it more in one type of project versus another? If you could just give us some color as to how widespread this is and what the nature of these cutbacks are?

Sure. We -- first of all, it's hard to say when something is doing well, I think I pointed out on my notes, that some of our product lines, Optical Access, the 5000 series, and the Internetworking products didn't see really any slowdown as far as a decrease in order activity. But what you don't know is what they could have been if there wasn't some sluggishness in the environment. So it's hard to speak to that.

But in general, I would say we saw pretty much an across the board kind of slowdown. Now, that happened kind of towards mid to -- as we got into the second half of the quarter, right around the turn point in the quarter and we saw a decrease in order activity. Now we did see it at the end of the quarter, basically last couple of weeks or so and then coming into the first couple of weeks of this quarter, a rebound in that. I mean we actually saw an order pickup. Things seemed to stabilize some, but the environment is still somewhat uncertain, which is why we're being a little cautious about the fourth quarter.

I see, great. Thank you.

Your next question comes from the line of Ken Muse from Robert Baird.

Hi, it's James Falkoff on for Ken. I guess just want to make sure I understood the comments on -- I think you said the order rates had kind of stabilized in October, but then you had also continued to express some caution. So I guess can you kind of resolve that for me? And I guess how does the environment look to you right today?

Actually the order rate stabilized really at the tail end of September and into October as we -- as far along as we are into October.

Okay.

And I would say that we actually saw kind of a pickup there in that period of time versus where we were previous in that quarter. The cautiousness is just that. It's just that, the general feedback we're getting is kind of constrained in spending, more constrained than they were in the first part of this year and that's really what's driving kind of our outlook. I think we're -- we can't tell you -- we're very much a book and ship business, so we can't tell you what the order activity will be or the revenue will be through the rest of this quarter with the specificity you would like to have. But in general, I would say the environment is cautious, very cautious.

Okay, and I apologize. What were the kind of -- I think you mentioned specific factors that were contributing to the, I think you said an impact in kind of the mid-single-digits above and beyond normal seasonality.

Yes, that's really -- and that's really just taking a look at kind of what our order flow has been and looking at -- and trying to project with a crystal ball what we may think the environment and what the attitudes of the different carriers will be. And we felt it was kind of our duty to at least give you some sense of what we think the activity levels are liable to be and that's where we came with that. Jim, do you have anything else to add?

That's right. That pretty much sums it up. And again, looking at the order trends coming out of the third quarter and what we're seeing towards beginning of this quarter, again, a bit of a rebound. But again, we, we still feel the need to be cautious in what we tell you for the fourth quarter.

Okay, and so if I -- I guess you were taking kind of a minus 9% as kind of a baseline for normal seasonality. So you think it would be kind of realistic based on the order flow that you're seeing to see a double-digit decline sequentially?

Potentially, that's, that's what our feeling is at this point.

Okay. Okay. Thank you.

Your next question comes from the line of Jason Ader from William Blair.

Hi, guys. How are you? I just wanted to ask you about the decline in the FTTN business and I assume that's one of your largest customers, one of your Tier One customers that you have been talking about for the last several quarters that has been aggressively deploying FTTN. Was this unexpected, first of all? And second of all, what gives you the confidence that it's going to reaccelerate in early '09?

You're right. It is -- the majority of that decline was from a large Tier One carrier here in the US who has been very aggressively rolling out our Fiber to the Node product. As far as unexpected, I mean I think they have become better and better at kind of forecasting their activity. So I think that we -- although we don't know necessarily the magnitude, the exact magnitude, I do -- I would say that we were expecting some level of slowdown in the second half.

As far as what makes us feel that we will kind of restart next year is -- that's the sense we're getting from the customer. So I think they have been pretty good in being able to telegraph to us kind of where things are and I think that they have been fairly accurate in being able to tell us when they want -- when they start activity and over the last two years or so and that's just the message we're getting at this point.

And, Jim, could you give us the 10% customers?

Sure.

Did you give that already?

No, I'll give it to you, Jason. AT&T was 23%. Verizon was 13%. Embark came in at 10%, and Qwest came in at 14%.

Okay, and last question to you, Tom, on the HDSL strength. I imagine that was somewhat unexpected and it sounds like that's driving some of your cautiousness on guidance for Q4 as well. Is that correct? Maybe HDSL was sort of strong and it's still a little bit from what might have been in Q4?

Jason, I think you've been around long enough to see that sometimes when we're high one quarter, we pay for it the next and if we're low in one quarter, we may see pickup in the next. That is driving some of our cautiousness here. Now we have heard many of the same things you listening have heard, which is that there's kind of a renewed demand to increase back haul bandwidth. And that may be what's -- what drove this increase and if that did drive the increase, then we think that will have a longer-term positive impact on HDSL. But I think one quarter into it I think is a little nervous for us. It makes us nervous to say that's kind of hitting this new level of going forward, especially when we're going into what is seasonally a soft HDSL quarter anyway.

And have you guys ever been able to -- I know you've been asked this many, many times. Have you been able to come up with any precise number on what percentage of your HDSL business is going into cellular back haul?

No, we haven't. There's still no good way for us to do that. I will say, a lot of the activity though, we did see a pickup in activity. I can't tell you the exact amount, but I can tell just by the conversations we're having with the customer base that there was definitely a pickup kind of midyear and then going into the third quarter, specifically for wireless. So I would say the wireless content has increased over what it has historically been, but I can't tell you the exact percentage.

Okay. Thank you.

Okay.

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

Tom, Jim, can you give us any metrics in terms of where TA 5000 revenues are at?

Sure, Paul. It was around 5% of total revenue.

And, Jim, I apologize. How does that compare to last quarter?

It's sequentially up. It was a record quarter.

Okay. If I look at the strength of your HDSL, in terms of the activity or from a revenue perspective, your growth drivers, the DSLAM, TA 5000, Internetworking and the Optical Access, would the numbers have been that much better but for the DSLAM? What I'm really driving at, I'm trying to understand, I know your growth drivers are growing and they are growing at a nice clip, but I'm trying to understand whether the growth has softened somewhat or the opposite in that, the 26% growth. Seems like it was off what it would have been or should have been.

Yes, we do kind of break out the percentage. I think optical is still -- we're seeing good, solid growth in optical and we're optimistic that that growth will continue on for some period of time. I think in general we would say that about broadband. No doubt 5000 will accelerate at a faster clip than probably the overall product line over time because of the different applications that the 5000 is in.

The slowdown, that we really saw, we saw some impact in ATM DSLAMs. ATM DSLAMs are a lesser portion of our revenue at this point in time by far than what we ship for IP DSLAMs, but we saw some slowness there. And there is a major Tier One carrier, the largest Tier One carrier in North America that actually, purchases some of our legacy ATM DSLAMs. So we saw some slowness there.

But the biggest impact was really our Fiber to the Node deployment by that other large Tier One carrier, which we're really -- we're feeling very confident that that's a, kind of a deployment rollout that they have planned and that we would see that accelerate again early next year.

Okay. Thanks, Tom.

Okay.

Your next question comes from the line of Todd Koffman from Raymond James.

-- access 5000, I thought you said it was 5% or about $7 million. In my notes, I have that that product line was doing around six million a quarter, but you cited some big record. Am I missing something?

Big record and record, I don't think he said it was a record. It was -- I'm not going to get into the specific numbers, but it's still a relatively -- it's in that order of magnitude.

So it's been hanging around six or seven million for the last couple of quarters?

It's been hanging around that 5% level.

Fair enough. And is the ramp of that TA 5000 over the next couple of quarters still coming together as you would have thought, or is it just stretching out a little bit, given a lot of indecision sounds like you're hearing?

We are seeing some indecision, but as far as what we would have thought, I would say it's probably not substantially different in that we were, the first major win at the Tier One was for a, for ethernet over copper, which we said was going take some period of time to actually roll out. And I would not sit here and tell you that their economic spending level or their CapEx spending level may not have impacted the aggressiveness of that rollout through this year. So I think we probably had a little bit of pullback there that we would have liked to have not seen.

The other two major carriers, which are kind of where we're looking at, as those being the major stepping stones for real revenue impact there. The second carrier, we did get orders in the tail end of the second quarter, we started shipping those in the third quarter. They have not started accelerating yet. I think it's very early on. We're definitely expecting to see some acceleration in that order rate over the next few quarters.

The third carrier, we hope to get approval -- at this point are on track to get approval at the end of this year, which has been our plan for some period of time, which means those would kick on hopefully sometime in the first half of '09.

Thank you very much. Good luck.

Okay, thank you.

Your next question comes from the line of George Notter from Jefferies.

Thanks very much. I guess I was interested in Telmex. Obviously you shipped them quite a bit 1100 revenue back in Q4 of last year. I think the last update had them sort of digesting that infrastructure and you were kind of waiting for them to come back with orders this year. Do you expect to get orders this year still? Do you expect to be able to ship against those orders? What's the update there? Thanks.

Yes, I don't think that we're going to get a Christmas order from Telmex this year. I think -- I would be very surprised. We could, but I would be surprised and I definitely would not expect us to be able to ship that in the fourth quarter if we did receive it.

Has anything changed at Telmex then?

Yes, they are going through their, getting their IPTV franchise and really video franchise. We have progressed with them in that as they have kind of fine tuned what it is they want to do technically speaking, we have gone through different phases of iterations of the products we have shipped them, different software upgrades.

At this point in time we are now IPTV certified within their network so that when they do turn on that service, we hope to be a very big part of that. I think we're one of -- I think we're -- from a certification perspective, we are definitely as good, if not better than our competition there. So I think at this point, it's just a matter of them deciding how aggressively they are going to roll that out and over what timeframe.

Got it. And just one additional question, on the Internetworking business, obviously you've been growing that for sometime now. Sounds like a piece of the growth is certainly coming from expansion of your channel relationships and carrier relationships. I mean if you were able to look through that and look at it, let's say, on a same-store sales basis, particular distributors or particular carriers, would those be growing right now or staying the same or shrinking?

On a same-store sales, and George, this is -- I haven't looked at that number. My sense would be on a same-store sales, that they were probably flat to slightly up. We -- as we have gone through our recruitment activities for our VAR dealer base, we also have gone in and figured out which ones are capable of selling the products and which ones aren't. So the VAR base is not only growing in total numbers, but there's also a mix shift in who those VARs are that we're going through. And that's a good thing long-term because I think longer-term you'll see more capable dealers moving our product.

In the near term, that means that you have a dealer that was producing at some level that may not be a dealer and you have a new dealer coming in and that dealer has to get up to speed. So I think there's a mix shift that effects that, but in general, I would say we're probably flat to slightly up. Now, on the carrier side, that's not the case. On the carrier side, where we're using them as distribution channel or we're using them in some managed service application, I would say there's no doubt we were up.

Thanks very much.

Okay.

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

Cobb?

Yes. Hello?

Yes, you're on.

Okay, great. On the gross margin, looks like it's down about a hundred basis points quarter on quarter. Is it more product mix or are the enterprise products seeing some pricing pressure in this environment?

This is Jim, Cobb. If I can relate back to what happened in the second quarter, as we said on the second quarter conference calls, those gross margin levels were unusually high because of the unusual linearity within the quarter, okay, in terms of us paying nearly no expediting costs, air freight costs, et cetera. Okay. So again, I think the third quarter gross margins are probably a bit more normalized, so to speak, for that revenue.

Yes, I don't think it's -- in fact, I'm pretty sure that it's not because of some kind of underlying aggressiveness in pricing in the market.

Got it. Okay, great. And the 1100 F's, the slowdown there in North America, is it -- is it more of an inventory situation or I mean you're obviously still sole sourced at that carrier? Can you describe a little bit about what the slowdown, a little more detail on the slowdown. Thanks a lot.

Yes, my sense is that that carrier will -- bought equipment, is now deploying that equipment, has been deploying, but is kind of finalizing that deployment for the year as they enter the winter period. And if you think about an outside plan DSLAM and what you have to do to install it, it kind of makes sense.

And that -- what they will do then is start early next year with buying more equipment and maybe not being able to deploy it, let's say, in January or February, but buying that equipment in order to get running, back up again as things stall. And that may be a simplistic way to look at it, but I think that's -- I think it makes sense and I think that's the way they are talking to us about it.

Okay. Thanks a lot.

Okay.

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

Thanks. Couple questions, if I could. Jim, first of all, when you apply the math that you were talking about for Q4, you end up with something that comes dangerously close to flat to down on a year-over-year basis. Is that sort of the, just -- I got to make sure we're on the right track. Is that basically the way we're thinking?

Potentially, yes.

And as you look, then, into Q1 of next year, traditionally your Q1 is somewhat close to Q4, it hugs up pretty closely, yet you're saying that you think this, these FTTN orders that were sort of pushed out a little bit now start coming back again in Q1. When you add that together, the HDSL visibility, would you be expecting Q1 to kind of seasonally stay sort of hugging close to Q4 again or would you expect that to sort of come back to levels of where it would be if things had been kind of in the right quarter when they were supposed to the way this FTTN stuff is?

Well, that's certainly a thought. I think we really have to wait until the conference call in January to talk about that a bit more, Ehud.

Okay. When you started talking about, Tom, that revenue seems to have stabilized in the end of September and kind of picked up again here through October, is that across the board? Is that both at HDSL that's picked back up again as well, or did that never slow down? And what about on the NetVanta side? Did that slow down and pick back up again or were those strong right through those periods?

HDSL did slow down during that period of time and that's getting fairly granular, but let me just say I think it's pretty much across the board where we have seen it stabilize and somewhat a rebound. But I hate to hang too much on that just because it's so -- we're such a book and ship business and things can change overnight. But we saw that kind of pickup in HDSL. Now, fourth quarter is traditionally not a strong HDSL quarter, so some of our cost ships have to do with that also. Internetworking in general just continued to truck on through it.

So that didn't experience the slowdown in September and then it picked back up again. That kind of just trucked right through?

That just kind of kept going.

Okay. And you expect that, as you're looking into Q4, you're expecting that to continue that pace because --

Well, I would expect it, but we also saw last year, I think in general, we see seasonality in all of our products and Internetworking.

So that's one of the things you think maybe will fall off from Q4, just traditionally? Because last year if you so look, your Internetworking was actually flat in Q4.

Yes, I mentioned earlier that we set I think eight records out of nine, which tells you we haven't been able to get past seasonality, too, and that very well could be the case, that the growth we see overcomes the underlying seasonality there. But I, Ehud I think you could understand where we are. We're --

Sure.

Just cautious about it.

Okay. When you are talking about the 9%-plus mid-single-digit, call it 5% for lack of a number, so talking 14% down, you are including Internetworking to be down in that, not to be flat?

We would expect, yes, every product area is typically effected and we would expect that. And they are not all effected by the same amount, so when we look at a number like that, we're really looking more in aggravate at the order flow and trying to say what will all of the buckets do at the end of the quarter.

Right. Okay. So if that ends up being flat, that would be a little bit better than the 14% down?

Yes, it very well could be, but I can't tell you that everything else will be just 14% or however you calculate that number. Some things will be more. Some things will be less.

Right. I'm just trying to get to the pressure points here and there. The last one I wanted to understand a little bit more about was on the HDSL side. Granted it was obviously very strong and it seems somewhat in particular is building out of wireless back haul system for perhaps larger capacity that they are building right now in the second half of the year. My impression was that was a -- one of the bright spots that is actually going on and probably would continue throughout the year.

That particular customer that, Tome you said picked up in mid-year on the wireless side for your HDSL business, did that slow down at the end of the quarter? Because my impression was that would continue going and that perhaps other HDSL business may fall off in Q4, but that would project would continue throughout the rest of the year.

I've heard the same type of things that you may have heard, which is this may be a multi quarter buildup that they are talking about. I will say though that we did see a slowness in HDSL during that slow period of time, as well as other products. So that's got us kind of scratching our head as to how much of this was buildout related and how much is economic-related. And even if it's buildout related may they not move their activity from quarter to quarter in order to normalize things within their own operation. That may be what's gone on.

I will tell you that what we saw in HDSL though was not carrier, was not ILEC specific. So if a big wireless carrier decides they want to increase bandwidth or deploy a new service or, let's say, take care of -- make sure that the service they have has got the right kind of usability in order to keep demand going, that will effect most wireline carriers because those networks aren't just within the footprint of the wireline carrier they may be associated with. Do you understand what I'm saying there?

Yes, no I totally understand. Then last question, given you were down only 4% in the fourth quarter last year, you went back nicely in history to come up with your 9% seasonality number and it does justify that. But then you added the mid single digits on top of that. It sounds to me like you're stretching, given the order growth that you're seeing and you're just adding a lot of dosage of cautious [cautiousism], but that things don't sound that bad right now, you're just preparing yourself, which is perfectly fine, but just want to understand. I mean last fourth quarter wasn't anywhere near down 9% and your order growth seems to be rebounding a little bit. It does sound as though, just bounce one last thing off of you, as though it's totally prudent to be cautious right now and that's a good thing to be, but you are not really seeing the environment fall apart on you right now, aside from that the one FTTN pushout.

I would say the environment is not falling apart on us right now. But in conversations, and we've had fairly recent conversations with some of these carrier customers, in conversations with those customers, there is nervousness at this point in time. And whether or not it's being overly cautious or not, if it turns out better than that, we're going to be as happy as everybody else. But we're not weighing it down unduly. I mean we're trying to reflect the environment that we're hearing right now.

Right. Totally appreciate it. Thanks so much.

All right.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Blair King from Avondale Partners.

Just one question, just to expand on the last point that was made. Obviously it would seem to me that many of the capital budgets have been established already amongst the carriers. So going into '09, obviously you've spoken with your customers and clearly they have given you some indication that there is a slowdown, but going into '09, how bad is it really? I mean is it -- is the decline of 14% in the fourth quarter setting expectations for 2009 or, I mean how do we think about 2009 to the extent that you can let us know?

Well, we can let you know to the extent that we do know. We have some customers that on projects that they have laid out kind of in broad scope what they plan on doing and things like the Fiber to the Node buildout. We have some kind of broad range visibility with some of the bigger carriers on planning on doing with the 5000 and those are all positive things and they look good at this point in time. So if demand isn't there, which they can't really forecast to us, then, then you won't see that activity.

The only other piece of caution that I would throw in here, not that we haven't thrown enough, but the other piece I would throw in here is we did see, although CapEx budgets were in place early this year, we saw by some of the largest carriers shifting from quarter to quarter in activity because they modified what their near-term plans were within those budgets. So even though -- even if they were set today for 2009, I think you just can't assume that that's what's going to happen.

Great. What about, just lastly, on the internet outlook, what -- I think you had talked a little bit about Telmex, but there's this deregulation process in lat Latin America for video services and seems to be a lot of activity internationally and obviously you're involved in many trials. So how do you see international playing out in '09 relative to an uptick --

-- where we are right now. What we're very excited of course about the opportunity that we are already in. We've got the -- we're selling ethernet other copper at this point in early stages in some carriers. We're selling our Fiber to the Node product. We have continuing ongoing trials. In fact, we have won some awards international with the Total Access 5000, which will start rolling out next year.

The reason we won't talk in depth about them at this point is because they are very new customers to us and like if I were to try to explain to you a Telmex story a year ago, it would have been inaccurate because we didn't know that customer enough to know their buying habits. And so you are right, that there is activity going on. Our products not only fit well in the IPTV rollout that's -- that are happening in different parts of the world. They also fit well in some of the loop and bundling activity that's going on in certain parts of the world. So we're hopeful that we'll see some meaningful growth, but we'll wait to see.

Okay, thank you, guys.

Okay.

Your next question comes from the line of Greg Mesniaeff from Needham & Company.

Thank you. Most of my questions have been answered. Jim, just one quick question for you. With the macro slowdown in carrier spending, primarily, or disproportionately attributed to the Tier One carriers. What activities, if any, have you guys done to increase your outreach or focus on the Tier Two carrier base?

Well, I -- I can tell you what we've done, andwe're beginning to see the results of it. We are we're obviously -- we obviously continue to market and see success with our Total Access 5000 and Optical Access products with the Tier Two carriers. They continue to be a significant focus for us.

I think the 5000 is now approved in at least one and in most cases three or four applications within every Tier One. So we've made a lot of headway this year actually in getting those things done. And I spoke on my notes about the 5000 new board with additional lab valuations and things, and definitely true in the Tier Two, also. Let me speak to this one point and then Jim you can add anything you want to at the end there, the sluggishness we see, which you're right, we're talking a lot about the Tier One carriers. Tier Two, there were some areas where we saw slowdown, too. I would call that a mixed bag though. It wasn't all of them, but we did see slowdown in some of those Tier Twos also.

Thank you.

Okay.

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

Thank you. Back on the guidance versus the run rate of orders that have bounced back a bit from the end of quarter weakness. If you look at your current run rate of orders that you've seen in October and extrapolate that as staying constant throughout the quarter, would that correlate to the guidance you gave, or are you expecting the run rate to worsen just based on the customer concern that you're hearing?

We're expecting the run rate to decrease from where it is right now for two things. One is customer concern. The other is that it typically does decrease, sometime -- that decrease usually happens sometime in December. There are times where it happens before that. There are times that it happens late in December, which are usually great years, but we would expect that order rate to decrease from where it is today.

Okay, and on -- just to clarify on a prior question, I got the impression that the weakness or the slowdown that you saw was more carrier-centric. You didn't really see it in the enterprise. Is that fair, the downturn that you saw in September?

I think that, it's kind of surprisingly so because I do think we saw enterprise weakness at the first half of this year, but it -- so if you just look at our numbers, I think you could get that. If you look at Internetworking, I think you could conclude that. The thing that we don't know is if the enterprise environment wasn't going through some type of slowness, what would those numbers have been? So the answer to your question is there probably was slowness, but it didn't necessarily reflect itself in the Internetworking.

Okay, and just last question, are you -- as you dialogue with your resellers in the enterprise market, a lot of them rely on the bank lines of credit to kind of run their business, given the cash conversion cycle for them. Are you getting any concern for them on that, or do you see that as being something that could disrupt their ability to sell your product, or is it not something they have raised as an issue?

It's not something they have proactively raised. It is something we have proactively raised across much of our customer base, just to try to understand where we are and kind of where the risks are. And as of today, I can't say that it's a big concern that bubbles up. It is something we continue to watch, though.

Okay, great. Thanks a lot.

Okay.

Your next question comes from the line of Mark Carol from Morgan Keegan.

-- in for Simon Leopold. And really just one quick question, is that you spoke earlier on the call to share gains within the multiple product lines, kind of keeping you guys held up during the economic slowdown. Could you speak specifically to the competitive environment, any sort of pricing strategy that you might be taking to gain these share?

Yes, I, I would say that the pricing strategy that we have been employing and that we employ in the third quarter is no different than what we've been doing over the last couple of years. I haven't seen any acceleration in price decreases. I think in many cases, if not most, if not all cases, we're usually kind of the aggressive price leader as we go into larger opportunities. Many of our products today, the 5000 is also differentiated enough from a feature set to where, to where there's just a solid benefit in buying that product. We really haven't seen anything that's effected the pricing level.

Okay. Are you seeing any competitors leaving any segments?

I -- I haven't seen anybody actually exit. What we have seen is from time to time you may at least hear about people getting more aggressive in a segment and that they say they are going to enter a segment and they may participate in an RFP that you didn't expect them to. But we haven't seen that in a while. I would say the players have been fairly constant now for probably over a year.

All right. I mean given that, can we expect, then, if you're gaining share with your current pricing strategy, that gross margin may tick up in '09?

Just because the environment hasn't changed doesn't mean that those people -- the ones that are in there aren't still going after business aggressively. I mean our model and the way that we think about the business is high 50s and that's still, that's still the way we think about it. We do think that the environment is a beneficial environment, even if it's a difficult one for our company right now. It's very beneficial in that if you look at kind of our operating metric and our ability to continue to fund R&D and our ability on certain opportunities to get price agressive, compared to many of the other companies out there, I think we're in a pretty good position.

Okay. Thank you.

Okay.

Your next question comes from the line of Ray Archibold from Kaufman Brothers.

Thank you. Couple, I guess more housekeeping items if you will. One, Jim, in the release you talked to the tax credit and that it will be applied retroactively. So we shouldn't look at this as being sort of a fourth quarter having a catch up in that it's going to be than an unusually low rate, we have to go back and restate the prior quarters?

No, no, there will be a catch up in the fourth quarter.

Okay, all right.

The benefit gets applied retroactively.

Okay, all right. Just wanted to make sure I understood that. All right. Secondly, can you bring us up to date with where you are on the repurchase, how much is left on the reauthorization, what the thoughts are going forward regarding that?

Sure. We're going continue to be opportunistic in terms of the repurchase. Right now we have approximately 3.9 million shares remaining on the repurchase program, so, again, we intend to continue to be optimistic.

Very good. Thank you very much.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Scott Coleman from Morgan Stanley. Please go ahead.

Thanks, guys and good morning. Just to focus on Q4 for a minute, Jim, from an OpEx perspective, it sounds like you would expect that to come down from current levels so that you keep operating margin in this mid-20s level, is that right?

Well, we do anticipate OpEx to come down in the fourth quarter, something in a range between what we actually incurred on a GAAP basis, what we actually incurred, say, in the first or second quarter, somewhere between those few numbers on an OpEx basis.

Okay, great. And to follow up on Ray's question, your full year tax rate, assuming the tax credit should be about 34% is that right?

Probably more like around 34.5, maybe slightly higher than that, Scott. But probably somewhere south of 35%.

Okay, great. And then maybe a bigger picture question. So if you take the company back to 2001, 2002, your sales declined I think one it was 15 or 16% year-over-year and then double digits again in '02, clearly entering a more challenging period for the industry. Tom, when you think out over the next year or so you obviously have a different set of product drivers than you did eight years ago, but what's the right way to think about the growth opportunity for the company over the next four quarters or so, beyond Q4 actually?

Well if you, if you would allow me, I would rather talk about that at the end of fourth quarter and the reason is that we probably -- we would have another quarter of visibility as to what the underlying demand is for our legacy products. We're very confident that our growth product areas in optical, Fiber to the Node products, Total Access 5000, that those will continue to grow. The legacy products are somewhat dependent upon that underlying economic environment and things like wireless, back haul increases can dramatically effect that. So I'm going to put that off as long as I can and I think I'm allowed to put it off until next quarter, so I would like to do that.

I will certainly grant you that, but maybe qualitatively, if we think about your product set, if we just take the three growth areas and it sounds like you have a fair amount of confidence that even in a difficult environment, those should grow in 2009. And is it fair to then take the remainder, the legacy product set and apply some sort of recession-type scenario to those products, at least as a starting point? I understand there's no visibility into it, but that's sort of a way to think about the, the various revenue streams for 2009 for Adtran?

Well, I mean that is absolutely one scenario and at this point in time, I think there's some -- you could say there's some logic to that scenario without -- and I think it makes more sense and of course this is what we will try to do, is to break out those legacy product areas piece by piece and try to understand what's going on within each of those and what we forecast for next year. We had expected HDSL, for instance, to be kind of down mid-single digits this year. I think that at this point in time we're actually ahead of last year and now that's true. The environment was not great this year, as you're aware for telecom equipment either, so I think we'll go through that as we get through this quarter and be able to talk more to you about that.

Okay, great. Great. Thanks, guys.

Vanessa, let's have one more question and then I think we'll be at our time limit.

Yes, sir. Your final question comes from the line of Andy Schopick from Nutmeg Securities.

Thank you. You've really covered pretty much everything. Jim, just a clarification on the buyback, there was a piece that was left that was I think going into the prior quarter and then the new authorization was I think 4-plus million shares in April. What did you actually buy back in this current quarter and what was the total cost?

Sure, sure. We repurchased right around 1.9 million shares and it was right around $43 million and it calculated to roughly $23.56.

Thank you.

Okay. Well, thank you, everybody, for coming to our conference call today and we look forward to seeing you in the fourth quarter and talking about our results then. Thank you very much.

This concludes today's conference call. Thank you for your participation. You may now disconnect.