ADTRAN Holdings Inc (ADTN) 2009 Q1 法說會逐字稿

Good morning. My name is Cassandra and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

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

And now, I would like to turn the call over to Mr. Tom Stanton, Chairman and CEO, and Mr. Jim Matthews, Senior Vice President and CFO. Sir, you may begin.

Thank you, Cassandra, and good morning, everyone. Thank you for joining us for our first quarter 2009 conference call. With me this morning is Jim Matthews, as Cassandra mentioned, Senior Vice President and Chief Financial Officer.

As in the last couple of quarters, I would like to start by discussing the environment in the first quarter. I will first remind you that ADTRAN has a book and ship business, and any short term data is suspect in its ability to predict longer term results. But given the current economic environment, we feel compelled to add as much color as possible in regards to current customer activity. As we mentioned last quarter, order flow in the early part of the period was good. This strength moderated during the second month and resumed during the latter part of the quarter.

The carrier segment acted much as anticipated with cautious spending and targeted areas of focus. Tier one carriers came in slightly above expectations, with tier two and three carriers being incrementally more cautious as they contemplate utilization of the recently enacted Broadband Stimulus Package. Enterprise came in as expected with strength in Internetworking sales through carrier channels as we continue to gain market share. Traditional enterprise products weakened, as expected. From a product perspective, there were no major surprises in the quarter.

I will start with HDSL, which was up both sequentially and year-over-year. We attribute this strength to normal quarterly variations and the continued pressure on increasing wireless back haul capacity. Broadband Access was up sequentially, driven by expected increases in Fiber to the Node shipments. Operational activities of our TA5000 continued to progress well through the quarter, and we expect increasing strength through the year. However, we did see some spending delays in the quarter, attributable to regulatory uncertainty in some of our tier two and tier three accounts, as I mentioned previously. Recent order activities suggest that some of the regulatory uncertainty is beginning to resolve itself and we expect this uncertainty to resolve itself further as we move through the year.

Sales of Optical Access gear to tier one carriers remained relatively flat to the fourth quarter, although we did see a decline in the category overall. Given the current economic environment, our Internetworking category had a solid quarter with revenues up from the prior year. A stronger than expected performance in our carrier channel was offset by seasonally soft traditional channel as that channel continued to feel the brunt of the current economic environment. As expected, our legacy traditional products, which of course do not include HDSL, were down on both a sequential and year-over-year basis. Historically, Q1 typically represents the lowest revenue point in a given year for the Company, and we expect this year to follow that same pattern.

The activity around our Fiber to the Node and Total Access 5000 products, both from a bidding and lab perspective, continue to be strong as we progress through the quarter. We began receiving orders for new features, including VDSL2, and as you may expect, we are seeing significant interest in footprint and bandwidth expansion around the US. We continue to anticipate that expanded deployments and addition of new applications will contribute meaningfully to the growth of these platforms well into the future. For Optical Access, we continue to believe despite our gains to date, that we are in the early phases of Optical Access conversion and that increasing demand for bandwidth, both wire line and wireless, holds great promise for this product area.

Internetworking revenues, although muted by economic conditions, continue to reflect the broad based support we are seeing as we continue to focus on carrier distribution channels and grow our dealer base. As I mentioned last time, the economic situation has heightened our focus on improving operational efficiencies across the board. That will lead to a Company with greater flexibility and increased capacity. I believe that our results today reflect the impact of that focus. In addition, we continue to believe this environment is one where companies with strong operating models can aggressively pursue market share and continue to fund R&D efforts to open up future opportunities. Although in the near term we will continue to be impacted by macroeconomic headwinds and regulatory uncertainty, we are positioned well to weather this environment, and over the long term, prevail as a preeminent access supplier.

I would now like Jim Matthews to review our results for the first quarter 2009 and our comments on 2009 second quarter. We will then open up the conference call for questions.

Thank you, Tom, and good morning, everyone. Revenue for the first quarter was $110.4 million compared to $119.9 million in Q1 of '08. Broadband Access product revenues for Q1 of '09 were $22.2 million compared to $28.6 million in Q1 of '08. Optical Access product revenues were $10.7 million for Q1 of of 2009 compared to $11.2 million for Q1 of '08. Internetworking product revenues were $15.3 million for Q1 of '09 compared to $14.9 million for Q1 of '08

Carrier Systems revenues were $42.7 million for Q1 of '09 compared to $51.2 million for Q1 of '08. Business Networking revenues for Q1 of '09 were $20 million compared to $21 million for Q1 of '2008. Loop Access revenues was $47.6 million for Q1 of '09 compared to $47.7 million for Q1 of '08. HDSL product revenues was $42.9 million for Q1 of '09 compared to $42 million for Q1 of '08. As a result of the above, Carrier Network's division revenues were $87.1 million, and Enterprise Network's division revenues were $23.3 million for Q1 of '09.

International revenue was $6.9 million for Q1 of '09 compared to $6.4 million for Q1 of '08. To provide the reporting of each of those categories we have published them in our Investor Relations web page at ADTRAN.com.

Gross margin was 61.1% of revenue for Q1 of '09 compared to 58.6% for Q1 of '08. The increase in gross margin is primarily attributable to lower transportation, expediting, and unit costs per sales in dollars. Research and Development expenses was $20.9 million for Q1 of '09 compared to $19.6 million for Q1 of '08. The increase in Research and Development expenses was primarily attributable to an increase in activities related to customer specific development efforts. Selling, general and administrative expenses were $23.7 million for Q1 of '09 compared to $25.5 million in Q1 of '08. Stock based compensation expense net of tax was $1.6 million for Q1 of '09 compared to $1.8 million for Q1 of '08. Interest income was $1.6 million for Q1 of '09 compared to $2.3 million for Q1 of '08. The decline in interest income was attributable to lower interest rates.

During the quarter of 2009, the Company recorded net realized investment losses of $3.2 million in its investment portfolio, primarily related to other than temporary impairments of marketable securities as a result of significant declines in the equity securities markets that continued in the first quarter. Tax affected this reduced diluted earnings per share by $0.03 for the quarter.

The Company's income tax provision rate was 26.3% for the first quarter of '09, compared to 36.5% for the first quarter of '08. During the first quarter, the Company completed a review of its estimated tax deductions for the years 2005, 2006 and 2007, related to Section 199 of the Internal Revenue Code. This review resulted in a $1.7 million benefit being recorded in the first quarter of '09, reducing the Company's income tax provision for the quarter. The increase in tax deductions was attributable to an increase in the calculated dollar value of domestic content of products we manufacture for those years. Also in the first quarter, the Company recognized their usual benefit from research tax credits. Legislation providing this benefit was not in effect during the same period the prior year, causing tax provision to be unusually high for that period.

Earnings per share, assuming dilution for Q1 of '09, were $0.24 compared to $0.26 for Q1 of '08. Inventories were $49.7 million at quarter end. Net traded accounts receivable were $56.8 million at quarter end, resulting in DSOs of 46 days for the first quarter of '09 compared to 54 days for the first quarter of '08. Net cash provided by operating activities for the first quarter of '09 were $24.5 million. Unrestricted cash and marketable securities totaled $241 million at quarter end.

We would like to remind you that we typically do not give specific guidance on revenues. However, given the environment, we feel compelled to assist you in developing your opinions on future revenues. 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 impact of the economic environment on carrier S&P spending, make it difficult to predict revenue levels. Assuming economic activity levels remain constant with the current environment, for the second quarter of '09, we anticipate that revenues will increase sequentially in the mid to high single digit range. For the second quarter, we believe we will execute in a range consistent with our historic operating model at the achieved revenue level.

For the total year 2009, we anticipate profitability will be in a range consistent with our historic operating model as well. We believe the larger factors impacting the revenue we realized in the second quarter and the full year of '09 will be the following. Spending levels at our tier one and tier two carrier customers, the adoption rate of our Total Access 5000 and 1100 series platforms, the adoption rate of the Opti 6100 with tier one carriers, continued growth of Internetworking revenues, the continued negative impact of the economy on our traditional product revenues, timing of implementation of the Broadband Stimulus Package, and order trends and traction at newer international customers.

Tom, back to you.

Thank you, Jim. Okay, Cassandra, at this point we'd like to open it up for questions.

(Operator Instructions). Your first question comes from the line of Nikos Theodosopoulus from UBS.

Thanks. I had a couple questions. First of all, if you could give the 10% customer levels, and then, on the gross margin, I wanted to get a feel for how much of that was any product mix related to that, and how sustainable is it going forward?

I'll take those questions. In terms of the 10% customers, AT&T came in at 29% for the quarter. Verizon at 11%. Embark at 10%, and Qwest at 18%. Now, in terms of our view on gross margin expectations as we go forward, we are still anticipating gross margins in the high 50s. The reason for that is that as we bring new projects on, new customer projects on, from an initial revenue standpoint, there will be start-up costs, and again, we anticipate that potentially those will bring margins back to the high 50s level for the longer term.

So in this particular quarter then, what got you way above your target? I mean, I know you mentioned lower transportation costs and so forth, but can that have such a material move? Was there more of a product mix?

In terms of product mix, Nikos, the gross margins for each of our product areas are fairly consistent. What we saw in the first quarter was a very linear quarter. You probably picked that up from the lower DSOs than we typically have in the first quarter. That enabled us to avoid significant expediting costs in terms of material expediting and shipment costs, air freight costs. You know, those costs were very, very minimal in the first quarter. Okay? So, it's all back to efficiencies and a very linear quarter, which enabled us to plan, very effectively, production flows as they relate to order.

Nikos, if I could add one other point. We have had a heightened focus on efficiencies both from a transportation and from a manufacturing perspective. You know we manufacture some percentage of our goods here in Huntsville, Alabama. So, I think the caution that we see in trying to raise that target, at this point, is that it's fairly early into those efficiencies taking hold, and trying to understand which ones will prove out over time and to what level is a little difficult, so I think we're just more comfortable in the high 50s until we have some quarters behind us.

Okay. And Tom, the guidance for the next quarter up sequentially, I mean, given that you've seen towards the end of the quarter a better bookings trend and so forth, is it fair to say, and you maintain the view that the first quarter will be the bottom for the year, that the carriers are sounding more willing to spend after a tough fourth quarter and early first quarter? That is a fair assessment?

You know, I hesitate to say that the carriers are less cautious because I think that they're still very targeted. I think what we've seen is some of the activities that have been planned for some time are continuing to move forward, really as we expected. So, maybe a good piece there is nobody is pulling back any more. I'd say the one area where we've seen a change in tone is probably with those tier two and tier three carriers, and I do think the broadband stimulus package is directly relevant to that, and so, the amount of activity we're seeing in that space has gone up dramatically. When I say activity, I'm not necessarily saying orders. The activity would be in a lot more planning and a lot more discussions about what they want to do, than we've seen any time in the near past.

Okay. Great. Thanks.

Okay.

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

Hi, Tom. Hi, Jim. Good morning.

Good morning.

Couple of questions. First of all, you can see that the effect of the tier two and tier three spending when you take your 10% customers and subtract them from your total, and you look at that over the last year. In September, it was $55 million for the non-10%ers. In December, $60 million. And now, it seems to have dropped to $35 million, and I'm guessing that's the effect of your tier two and tier threes. Can you just explain a little bit as to why? I see there's regulatory uncertainty, but the uncertainty seems to just be around if they're going to get lots of free cash from the government, or not. Why would that affect their spending now, and I think if anything, it would just delay their thoughts about how much extra they would spend. I'm just not quite understanding why it would impact their ability to spend right now in the near term on what they need to normally spend. And then when you look at the FTTN business which seems to have pushed up a lot, obviously Qwest popped up as an 18% customer now, what stage of the process? Was this a one quarter build? Will this be a two, three, four quarter build? How long will Qwest be able to stay there at 18%, and how long will the FTTN? What are the legs behind the FTTN build-out as we look at the rest of the year?

First on the tier two and tier three, I'll try not to speak for them. I'll give you my summation of general feelings that I've heard. It is true that it will enable a significant amount of increase in spending in that space to the extent that people qualify and move forward with those projects, and I would say that the uncertainty is easing. I would say it's not where anybody would like it to be, but we did see it easing as people started to understand the rules better. Not all the rules are set in place yet. There's a notice for rule making, and I believe sometime in June, those will actually come out. So, there's still some uncertainty as to what will qualify and what won't qualify, and I think pre-planning on jobs is a particular area of concern because to the extent these are jobs that were going to happen anyways, they would not qualify.

So I think you see more scrutiny about what it is that they would say that they were going to do versus what it is that the stimulus package enables them to do, and initially, when those rules first came out, I think there was just kind of a freeze, a let's not do anything and let's see what will qualify. Let's not shoot ourselves as we try to work through this package. That is easing to some extent. It's still not where we would like it to be. I think every month it gets better. But the sooner the rules get out and people actually start submitting for the money and it starts flowing, I think you'll see a change in activity.

As far as Fiber to the Node, I don't want to talk about any particular customer. I would say that Fiber to the Node, in general in the US, we would expect the increase in sales that we saw in the first quarter is not a one quarter phenomena . So, we would expect to see increasing sales, and my guess would be, at this point, that you would see from a kind of slope perspective, similar activity to what we probably saw last year in the overall

So that should probably get better as the year goes on, even from where it is right now?

At this point in time, I would expect it to, yes.

Okay. One last thing. Optical Access seems to be sort of stuckish in the 8, 9, 10, $11 million range? Do you expect a lot of optimism?

In the tier ones it did okay. We do see some seasonality in the first quarter in the tier ones, and we saw it do okay. Where we saw a slowdown was actually in the same thing that hit us in the general marketplace, with the tier twos and tier threes. I think there was just really a let's stop and see what we're going to do for the year kind of attitude in Q1, and so, it was in the tier two and tier threes where we saw some slowness in the quarter.

So, tier twos and tier threes had actually been flat sequentially with where they were in Q4? They were actually $10.8 million then, and $10.7 million now, but if your tier two and tier three had been actually flat until this regulatory uncertainty, where would your Optical Access have been?

Well, you would have seen an increase. I wouldn't try to forecast what that number is, but would you have seen an increase, no doubt, from where we are because the tier ones were essentially flat, and we would expect an increase from the first quarter level, in the tier ones going forward, so I think some of it is going to be to what extent the tier twos and the tier threes come back, and at what level. I do think that it really does revolve itself around the current.

Broadband?

Yes, the current regulatory uncertainty.

Okay, appreciate it. Thank you.

Next question comes from the line of Paul Silverstein from Credit Suisse.

Thanks. Tom, Jim, can you all give us an idea of what the TA5000 contribution was. If you gave that before, I apologize. Maybe I missed it. Also, can you address Qwest? I know you don't want to give too much information about a particular customer, but where do you figure the legs are on that FTTN deployment? It obviously had a big impact on your quarter. I think it was less than 10% last quarter. So, it looks like it was up $10 million sequentially. If you could give us some insight there, that would be appreciated.

As far as the 5000, it was less than 10%. We did, as I mentioned before, I think see a slowdown in the tier twos and tier threes that kind of brought to that. We did see the activity, by the way, pick up towards the end of the quarter in the 5000, and there's no doubt that we'll see sequential increases in the 5000 from just where we are, looking at the first part of this quarter and the tail end of last quarter. That real slowdown kind of happened towards the tail end of January, and through February, and we saw it start picking back up. As far as Fiber to the Node, here again, I will not talk about any specific customer. I get in trouble when I talk about specific customers and their plan. As I mentioned to the previous question, we do expect though, Fiber to the Node to carry on through past Q1 and accelerate, and have a similar profile, albeit the total numbers may be different, but a similar profile to what our Fiber to the Node business did in last year.

Tom, on the 5000, is it now somewhere between 5% and 10%? Is it getting close to that 10% mark?

It actually has in previous quarters passed the 10%. You would expect we're kind of in that broad range.

Okay. Thank you.

Your next question comes from the line of Amir Rozwadowski from Barclays Capital.

Thank you very much, and good morning, Tom and Jim.

Good morning.

One of the areas I wanted to discuss with you or get a little bit more color on is potential impact from strikes at AT&T, and how you are looking at that in the current quarter?

The potential impact of strikes? Historically, we've gone through situations like this and if your horizon is broad enough, which means spanning a couple of quarters, we typically don't see an impact that's really meaningful to us. There have been times in the past where you'll see a run-up before a potential strike and then a moderation or a slowdown afterwards, or sometimes you'll actually just see the slowdown and then the pick-up after the strike has remedied itself. But, it's usually, if it happens to be if it falls on a particular month boundary or something, and the nature of our business is so book and ship that it typically doesn't have a big impact to us, so we're really not expecting any major changes at this point.

Okay. That's helpful.

If the strike were to go on for a few months, that would be a different animal, but that just hasn't been the case.

So, have you seen that sort of order pick-up here in this situation, or no?

You know, I don't believe so.

Okay.

Just general sense is the answer is no.

Okay. And then, just a little bit more color on sort of the order patterns or your outlook for the year. You know, it seems as though, Tom, you had mentioned that another material down tick in spending is probably unlikely at this stage of the game. Is that a fair way to think about things?

Yes, I don't know if I said that. I mean, at this moment in time, it feels unlikely.

Okay.

But you know, it's a very volatile market. We've seen huge swings from month to month. I'll take you back to a bad period in our time which was end of the third quarter of last year where we saw a fairly substantial decrease out of the blue. So, I wouldn't say that it couldn't happen.

Okay. You're not ruling out the possibility, but it seems as though things have somewhat stabilized from your current visibility levels?

Current, yes, I would say so.

Okay. That's very helpful. And then, in terms of your share repurchase plan, obviously you have been very supportive of that plan in the past, and given sort of the near term volatility of the market, probably have not been as aggressive. When should we think about you probably stepping on the pedal a little bit more in the future? Or, what factors need to come into play for you to get a little bit more aggressive once again?

Well, we're going to continue to be cautious, although we're at the same time, we're going to continue to be opportunistic. Obviously, I can't say whether or not we're going to go in as aggressively in the second quarter as we did in the third. But again, I think the only thing I can say at this point that is we will continue to be opportunistic but still with a level of cautiousness given the volatility in the markets. Amir, I think we just would be better to leave it at that at this point because we really can't anticipate. Okay?

Great. No, that's helpful. Thank you very much, gentlemen.

Next question comes from the line of Vivek Arya from Banc of America.

First, Tom, in Broadband Access you mentioned that we could see improvement throughout the year. If I look at 2008 in Broadband Access sales, I think were roughly down 29%, 30%, in the second half versus the first half. Why would this year be different?

You know, what I was specifically talking about was the profile of Fiber to the Node products, and that the market in general we see to follow a pattern that is similar, and I would say to your point, that last year, Fiber to the Node products were a major driver in our overall Broadband Access product category. So, you could actually conclude that, and I haven't checked your numbers and I don't know if Jim has them in front of me, as to whether or not that's, but I'll take it as that's roughly kind of where we came in at. The difference this year may be, although the profile will be the same, quarter-to-quarter boundaries may fall slightly different. And probably, the big unknown is there's, I think, a market for the 5000 that is absolutely maturing from where we were last year, and we'll see. We're very hopeful to see incremental pick-ups from last year versus this year.

So whether or not it follows the same profile, I'm not going to try to give you third and fourth quarter guidance on Broadband today, but I do think that there are different ires in the mix this year than there were last year.

Secondly, on the Business Networking segment, sales have been down sequentially for the last two quarters, presumably because of the macro weakness and lower enterprise spending. When do you think we start to see a pick up in that segment?

If I was trying to look at a company and look at the drivers, I would not put the Business Networking segment as necessarily a driver. There are components to that. One of them are some of our legacy gear TSUs, some of our TDM IDs, that we don't expect to rebound. Our belief is that they probably have slowed down in a faster fashion because of the current environment, but we would expect those, in general, to be declining over time anyways. The real drivers in our Enterprise segment have been, and continue to be, Internetworking.

I characterize it as solid, which means it didn't grow, but in the environment with the additional pressures, we were okay with the results, and we would expect those to be the drivers, which include the 900E product line as well as our NetVanta product line, and some additional products we've brought to market here over the last six months or so, with new switches and new IP gateway products, that those are the items that we would expect to grow.

And in selling and marketing expenses, Jim, there was quite a bit of a drop in the first quarter. Were there any one-time events there, or is it just generally, the lower volume of sales?

Oh, no. I mean, I think we first mentioned this perhaps in the fourth quarter call, that we have a particular focus on OpAc, and improving efficiencies in OpAc, and you saw some of that in the fourth quarter and a large part of it happening in the first quarter. So again, a continual focus on OpAc because of the economic environment that we're in, and we will continue to focus on OpAc to keep them at consistent levels, if you will.

And I'll add this one point and it speaks to one of the very first questions, which is from a gross margin perspective, there's no doubt that that focus on OpAc helped us increase gross margins too. That focus remains today because although any particular space may be good or you're seeing some light in some particular space, and I think the overall economic environment really hasn't substantially changed.

One last question, Tom, if I may. How do you expect HDSL to trend through the year? Because, what we've often seen with different companies is first half there's a lot of back haul business and second half that capacity is absorbed. So just in general, how do you see your HDSL segment trending through the year? Thank you.

Well, in general, trying to equate our numbers to a different company's numbers, sometimes hasn't worked. Daxports in relation to HDSL, whenever we've tried to do that math, we've never been able to quite get the numbers to jive. In general, what we see is HDSL accelerating through the year to the third quarter and then you see it drop off in the fourth quarter. There are times where, because of a particular order, we may see the quarter differentials skewed, but in general, that's been the case and that's what we would expect to see at this point in time through this year. Really, no major difference. There is, no doubt, a heightened focus on wireless back haul, but that focus has been there for some time. Particular projects may move the numbers around a little bit, but I would expect to see a similar trend to what we've seen over the last, probably, eight years or so.

Thanks a lot. Good luck.

Your next question comes from the line of Jim Suva from Citigroup.

Thank you very much, and congratulations. A question on the gross margins. You had talked about returning to your historical operating model, in kind of the high 59 gross margin. If I look at the sales forecast of an outlook of mid to high single digits, typically, one would reasonably assume that you'll have higher efficiencies in yields and operating efficiencies due to higher sales rates, and historically, higher sales have resulted in higher gross margins for you. So I guess coming back to the question about returning to high 59% gross margins and if you're at 61% now, last year gross margins went up 190 basis points from Q1 to Q2. Why shouldn't we expect gross margins to go from 61% to say, maybe, even an increase of 100 basis points, yet you're kind of talking about the high 50%?

Jim, Jim Matthews, I'll try to address your question there. It comes back to the fact that we outsource about two-thirds of our manufacturing, which has a highly variable cost content. Okay? So as revenues go down, we reap the benefit of that. Now, as revenues go up, again, the variable cost component will go up as well. So because of that, because of revenue fluctuations or when we have revenue fluctuations, we haven't seen as much of a change in gross margin as it relates to volume. Now, you might recall in 2007, and coming into 2008, gross margins down ticked a little bit and that was because of new customer start-ups in terms of shipments, and we expect that that will not be unusual going forward. Again, when we incur start-up costs for initial shipments of awards or new technologies. So that's why we continue to be cautious on gross margins and still call it at the high 50s going forward.

Okay. And as a quick follow-up, when you say high 50s going forward, do you mean including Q2, or the longer term, because it seems like Q2 would still be a big step down?

We're talking about the longer term and that being the target range, and as more quarters get behind us and we can see where that stabilizes up, we may actually take a look at whether or not that makes sense. It hasn't been that long ago, at least in Telco years anyways, it hasn't been that long ago when we had to kind of revise up from mid 50s. We've got a couple of above 60 quarters behind us in the history of the Company, so we're just going to be cautious in saying that everything's in here and said at this point. Even having said that, there will be times as we have seen in the relatively recent past, where we can be rolling along and see a point, or a 1.5 point, down tick with no fundamental change in the business, and we just want to make sure people understand that.

Right. But it's not unreasonable to expect a still 60%, because a point, or a 1.5 point, would still give you a six handle on the front?

Yes, that's true. And, I guess I would be very cautious. You know, you start off with would we actually see an improvement from Q1, and I would be very nervous about saying that we would see an improvement from 61%.

Then my last question. On inventories, there was some build there. Can you walk us through that. What's going on there? Traditionally, you haven't had a build in Q1 even though sales have been going up in Q2.

Yes, well, I mentioned in my comments that we did introduce some new products, and one of the one that's we've introduced and I think it's to a point now to where there's actual real market acceptance is VDSL2. Whenever we have a transitions like that, which is kind of a fundamental transition from ADSL2 plus the VDSL2, with some level of volume behind that, you may actually see our inventory pick up. In this case, the majority of that pick up is in the 1100 series Fiber to the Node products. You'll actually see that pick up. Truly, we're not concerned about that. I can understand it being different than what we do on average, but it is something that we think will work itself out, probably this quarter and if not, within two quarters, but more than likely this quarter.

Great. Thank you very much and congratulations.

Thank you.

Next question comes from the line of Colby Synesael from Kaufman Brothers.

My questions have been answered at this point. But, if you could just give us an update on your international strategy as it relates to some of the relationships you might be building with some potential resellers, as well as what types of products you think you're going to be focusing on, as well as what areas?

Sure. Our focus has been, over the last year-and-a-half to two years, really trying to drive Total Access 5000 and our 1100 and 1200 series Fiber to the Node products into areas where their network evolution mimics our development profile. In that area, we had had some success in Latin America. That project still remains active and we still have hope for continuing involvement as that project moves forward.

The other area where we have seen some success, we have seen some success in Asia. In fact, through the Q1, we've actually won some EFM business. We've now got the 5000, 1100 series in a relatively small number of carriers. We're in trials, working through things, labs in several. I think we've probably won six or seven different carriers. We're actually now selling the 5000 or 1100 series products. It's still early in the cycle, but you're going to see us focus in Asia.

Western Europe has a profile very similar to the US in regards to their network evolution, so the same type of requirements and the same type of benefits that play through in the US will also play in Western Europe. So, you're seeing us focus on those accounts also. Now, having said that, trying to sell to some of these larger Western carriers is very similar to trying to sell to some the large US carriers in that it's a very long gestation period. But, we're in there without a doubt with our products in labs and working on it, but I don't see near term changes that would affect the overall numbers at this point.

Have you given a long-term percentage of what you think international should be for the Company, and whether it's maybe a year, or two, or three years out?

We haven't given a percentage. There's no doubt, it should be a meaningful portion, and by that I mean in excess of 25% over the long-term. But, we haven't tried to bring that granularity in. We have a hard enough time, to be honest with you, forecasting the US market where we have an awful lot of history in trying to forecast when jobs will get awarded and when jobs will actually get integrated in these large networks and actually roll out, and that can be, easily, a couple of years. So, that's really why we haven't put more granularity on it is because really at this point in time, there's no good sense to be able to do that.

And I assume for practically all those sales you'll be using a channel?

Not necessarily. In some of the larger carriers in Western Europe, although sometimes we will have partners, in most cases, I would say, with the large carriers anyway, we're in there direct.

Okay. Thank you.

Next question comes from the line of George Notter from Jefferies.

Thanks very much. Just a quick question. Tier two and tier three operators, I guess I was trying to figure out what percentage of sales for the Company do those accounts represent, normally, in a typical quarter? Thanks.

George, this is Jim. We haven't disclosed that number, but I think that overall, people can infer that the number was down in the first quarter because of the reasons stated.

I guess historically, I've been thinking it's anywhere from 10% to 20%. Is that a good range to use?

George, I'm not sure at this point. Okay? Again, I'm not sure what the range would be at this point.

Okay. Thanks.

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

Thank you. I wasn't quite sure if I missed it. I apologize. First, quick housekeeping. What did you say or what do you expect in terms of tax rate for the year and the coming quarter?

Sure, Simon. This is Jim. So on a normalized basis, we're expecting something around the range of about 34.5% on a GAAP basis.

Okay. Great. And more of a trending question and getting back to sort of the TA5000 product cycle. It seems to have been bouncing around this 5% to 10% range, and you've sounded pretty upbeat about the pipeline and you've talked about the opportunities. If you could give us an update and revisit the applications in terms of rank order, where you see the best opportunities, where you see the earliest opportunities, and refresh us in terms of how we might think about this product contribution, let's say out six months or out a year in terms of the evolution you're anticipating? Thanks.

That's a good question. Let me try to first tackle it from a customer base perspective. In the tier ones, of course our focus has been to get the 5000 established within those networks and within the management systems that those tier one carriers have and that's been an ongoing effort for the last two years or so, and at this point in time, I would say we were successful in getting those established and integrated into their network. So, at this point in time through Q1, I think, which is maybe at the tail end of Q4 but definitely through Q1, we're at this point in time shipping to all three tier one carriers in the US.

Now, within those carriers, in every one of those carriers, we have multiple application that's we're working through, so we're shipping the first application to all three, albeit they're very early in the stages of shipment. Definitely, the last two. It's not a secret that AT&T was the first one that we started shipping to with ethernet over copper. So, that was the goal. We've met that goal.

At this point in time, we're operationalizing additional applications in all three of those carriers, and they run the gamut of broadband DOC applications in one of them, to IPD SLAM implementations, to ethernet over copper, and we have ethernet over copper awards in more than one tier one carrier, but they have not all been implemented yet.

In terms of the ethernet over copper applications, I think there are two variants on that. One is sell side back haul and the other is enterprise. Can you maybe drill down?

That's true. Initially, I would not have characterized them as distinct variants. At this point in time, I would say at least in some of the tier ones, they are distinct variants. I am pleased to say that we have won those distinct variants. So they will be ADTRAN gear moving forward in the ones where we're the most active. The sell side variant of that is something I know is not yet in deployment. There are internal goals that we and our customers have on getting those deployed, but they're not imminent. They very well could be this year, but they're not going to be in the second quarter or probably even in the third quarter, so we'll see those come on line, and the focus at this point in time with ethernet over copper, to the extent it's being deployed, is on business.

Now, there are variants yet again or different phases of that business deployment, and we'll see additional phases of that business deployment come on line, and right now, they're scheduled for towards the tail end of the third quarter. So in general, we would see ethernet over copper being more robust definitely in the second half than we'll see it in the first half.

If you allow me then, I'll go down to the tier twos. Their focus is Broadband Access and Broadband DOCs. We've got all of the tier twos deploying some level of the 5000. There are still some approvals, some of which will actually happen as early as this week, with some of the tier twos, that will continue to broaden the appeal of that product. I think that the thing for us there, the real trigger for us there will be for them to kind of get their spending plans where they want them in relation to the Broadband Stimulus Package, and then move forward. And, I think there's a very good chance that they will move forward in a more aggressive manner with this package in place than they would have moved forward before that.

If I kind of connect the dots of all these opportunities, it sounds like Q4 could be the first quarter where we could sustainably get above 10% of sales. Am I leaping to too broad a conclusion?

Yes, the thing is there are enough variables. One of the things I would mention, and I don't want to put too much optimism into the general feeling about that, but as of right now the 5000 is doing well in the second quarter and we're very much early into it, but you know, some of those orders actually were received toward the tail end of last quarter. So I wouldn't go as far as to say that, but we would expect more activity in the second half than in the first half, and probably, more activity in the first half of next year than the second half of this year.

The real kind of swing thing that may move things more aggressively or less aggressively will be to the extent that the administration can implement on the Broadband Stimulus plan and give some people some level of certainty as to what's going to qualify and what's not going to qualify, and kind of unleash that angst that's right now in the market around it.

Thanks. That's very helpful.

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

Yes, thank you. If I could just return to the gross margin discussion earlier. The commentary centered around improvements due to better transportation costs and logistics costs. I was wondering if you could comment on the current environment you're seeing for silicon pricing, and also pricing for outsourced manufacturing as well, and whether that was a contributor to any positive trends?

Yes, I would say the environment is kind of when we talk about business in general, I would say the environment was relatively stable. There was probably some ability to remove costs but that wasn't a first quarter ability. That's probably been true over the last three quarters or so. I wouldn't say that that was the biggest driver, though. I think transportation costs. I do think, in general, we managed the operation a little bit better and it was more linear, in not just the shipping and flow, but in also the way that we actually built products internally here in Huntsville. It was just a more efficient operation. I think there probably is still some price elasticity or ability to see additional building material costs drops, but I wouldn't say that's been the driver, or I wouldn't necessarily forecast that to be the driver.

Thank you. And then, the sort of the second part of that question was, are you seeing your tier one, particularly your tier one customers, as they face the challenging economic environment and the slowdown in spending, is it fair to say that you haven't really experienced any additional pricing pressure from them to extract better pricing? Or, put it a different way, has pricing been fairly stable for your products?

I would first say that the tier ones do a fantastic job of trying to get as much as they can out of us and that ongoing pressure hasn't changed. But I would say in general, it's been consistent for some period of time and really no change in that environment. I think they do a very good job of trying to make sure their dollars go as far as possible.

So it's fair to say that you've maintained a fairly acceptable pricing environment, that's acceptable to you, clearly?

Yes, I would think so, and I would think our gross margins kind of reflect that.

Right, right. Just a final follow-up. In the area of HDSL, clearly you've he's referenced the strength in wireless back haul which continues. Any comment on the non-wireless back haul aspect of HDSL? Are you seeing higher percentage of disconnects with small, medium sized business customers impacting that business? In other words, is the ratio of enterprise related to wireless back haul continues to shift into the wireless back haul significantly?

That's a good question. I'm sure it's one that many people have and all we can do is infer the answer to that because we do ship to fairly large warehouses where these go out, and then, we never get to touch the end user, and the inferences that we would draw upon would be what's happened to our kind of traditional SMV Enterprise business, which has, without a doubt, seen a fairly significant decrease over time. So I would say that that shift has to be happening, that we have to be seeing more of an impact on wireless, but I can't give you much more granularity than that.

Thank you.

Okay.

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

Just one more quick question on gross margin. You said that it's going to tick down a little bit because of the new product ramp. What new products are you talking about that are ramping going forward that haven't already been shipping for quite some time?

You know, Jim's right here, I'll let him finish this. I think, Todd, he was talking about things in general. There are no things that we see in the near term that would be like that, but in general, we do have project oriented things where sometimes we'll go in there and initially push on that, and then, when we do introduce a new product. And probably, one piece that is new, and I just spoke about it, would be something like VDSL2 changeover, where depending on the customer, you may see that. I really don't foresee any of that in the near term, but that's the type of transition that from time to time will actually tick gross margins down.

Thank you.

Jim, you have anything else to add to that?

I was referring primarily to the VDSL as well.

All right.

Your next question comes from the line of Blair King from Avondale Partners.

Just a couple quick questions. In terms of the activity that you have been seeing in the tier two and tier three carrier market, is there any way to prioritize kind of what the level of activity is with regard to the projects that they've been working on? Is there one or two types of applications or services, if you will, that seem to be running at the top of the list there for those guys?

Yes. You can characterize it in general as better coverage. For instance, in the stimulus package the focus is underserved and not served for broadband. So, in the not served, that's a fairly easy thing to understand. You either have broadband capability or you don't, and in those cases, I would characterize it as footprint expansion, where the ability to deliver that service is going to be there and it wasn't there prior to that.

In the underserved, although the actual definition is yet to be defined, the FCC is working on that, underserved is well, the speed is not high enough. If you're delivering a 500K service or 700K service, you need to upgrade that speed or you may need to upgrade that speed, and so it's broadband footprint expansion as well as capacity or broadband capability upgrades, and those are predominantly what the talk is. Now, there's an awful lot of talk also, we introduced some GPON products here recently, including some new ONT products, and there's a lot of talk about GPON as well as traditional DSL broadband.

Okay, that's interesting. So the application's really more just sort of high speed data. You're not seeing a lot of activity on more interesting projects along the lines of IP TV or anything like that being utilized.

In the tier twos and tier threes, I would say at this point, the way I think about it is IP TV is a service that rides on top of a bigger broadband pipe. You are correct in that more tier twos and definitely more tier threes are interested in delivering IP TV service today than they were six months ago. So yes, that as an application that rides on top, that would be correct.

From a competitive standpoint, do you feel like you're pretty well positioned to benefit from the Broadband Stimulus or are there some rules associated with which vendors can participate in that program?

There are rules. I would say at this point that the rules, and they're not fully defined, so we've got that kind of caveat, but at this point in time I would say we are well positioned. It is a customer base that we have been working with for years now, and I think they know us pretty well and we know them pretty well, and, I think our products fit the right space. But in a general sense, I would say there aren't many people that I can't think of any strong restrictions that would keep many other players from playing in the same market.

Interesting. All right. Thank you very much.

Okay. Cassandra, I think that pretty much wraps up our time here. So, I would like to thank everybody for participating today on our conference call and we look forward to talking to you next quarter.

This concludes today's conference call. You may now disconnect.