ADTRAN Holdings Inc (ADTN) 2009 Q2 法說會逐字稿

Good morning my name is Sade and I will be your conference operator today. At this time, I would like to welcome everyone to the Adtran second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers prepared remark there will be a question and answer period. (Operator Instructions) As a reminder, Ladies and Gentlemen. This conference is being recorded today Wednesday, July 15, 2009.

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, 2008 and forms 10-Q for the quarter ended March 31, 2009. These risks and uncertainties could cause actual results to differ materially from those in forward-looking statements which may be made during the call.

At this time, I would like to turn the call over to Mr. Tom Stanton. Mr. Stanton, you may now begin.

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

As in the last few quarters, I would like to start by discussing the environment in the second quarter. I'll first remind you that Adtran is 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.

The environment for the second quarter was similar to the projections discussed during the first quarter earnings conference call with modest seasonal improvement across most product segments. Although activities around the broadband stimulus package continue to increase through the quarter, we continue to see spending delays, as carriers continue to compliment -- to contemplate potential stimulus projects. However, as expected, sales to the IOCs did increase through the quarter.

In our tier one accounts the environment remained relatively stable to the first quarter with planned deployments and lab progressions continuing to advance. In general, carriers continue to progress towards increasing speeds for both wireline and wireless networks and a continued migration towards packet-based technologies. In our enterprise segment, which is predominantly focused on the SMB market, we saw significant increase in activity, which we attribute mainly to success around our efforts in carrier channels. Although it is yet unclear to see how much of this increase is due to underlying market improvements versus market share gains, it is clear that our Internetworking products were gaining momentum.

From a product perspective, our growth areas turned in a solid revenue performance with Broadband Access growing 41% sequentially, Internetworking growing 33% sequentially and Optical Access growing 27% sequentially. HDSL revenue declined sequentially in the quarter at one of our tier one accounts following an exceptionally strong first quarter. However, when you compare HDSL revenue for the 12 months just passed to the prior 12 months, for this customer and all customers combined, demand remains flat. We continue to believe HDSL revenues for the total Company will be down single digits for this calendar year versus the prior.

Broadband Access revenue actually set a new record for the Company, coming in at $31.4 million. This strength was attributable to an expected increase in Fiber to the Node shipments, coupled with an increase in demand for Total Access 5000 products in tier three accounts. Optical Access revenue was up both sequentially and year-over-year coming in at $13.5 million. This increase was due to continued market share gains and increasing shipments to all major market segments as carriers invested to increase bandwidth for wireless infrastructure. Internet working revenue was up substantially, both sequentially and year-over-year, setting another record at $20.4 million. During the quarter we continued to gain market share in our carrier distribution channels and expanded our VAR dealer base. IP business gateways and ethernet switches led this advance for the quarter.

Moving on to items that will affect our future. Activity for our Total Access 5000 and Fiber to the Node products remains very strong, driven by higher speed DSL, GPON and ethernet conversions. During the quarter, we began meaningful shipments of VDSL2 and GPON products and we continued seeing an increase for bandwidth expansion, as well as a reemerging interest in footprint expansions. We continue to anticipate expanding deployments and the 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 the increasing demand for bandwidth, both wireline and wireless holds great promise for this product area. Internet working revenues, although muted by economic conditions, continue to reflect a broad-based support we are seeing as we continue to focus on carrier distribution channels and grow our VAR dealer base.

The current economic environment has heightened our customer focus on improving operational efficiencies to increase competitiveness and we believe our Company is well positioned in both divisions to extend our market reach in this environment. In addition, we 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 network supplier. I would now like Jim Matthews to review our results for the second quarter of 2009 and our comments on 2009's third quarter. We will then open the conference call up for questions. Jim?

Thank you, Tom. Revenue for the second quarter was $121.5 million compared to $131.2 million in Q2 of '08. Broadband Access product revenues for Q2 of '09 were $31.4 million compared to $31.3 million for Q2 of '08. Optical Access product revenues were $13.5 million for Q2 of '09 compared to $13.4 million for Q2 of 2008. Internetworking product revenues increased 28% to a record $20.4 million for Q2 of '09 compared to $16 million for Q2 of '08. Carrier Systems were $56.2 million for Q2 of '09 compared to $57.7 million for Q2 of '08.

Business Networking revenues for Q2 of '09 were $26.4 million compared to $21.8 million for Q2 of '08. Loop Access revenues were $38.9 million for Q2 of '09 compared to $51.7 million for Q2 of '08. HDSL product revenues were $34.3 million for Q2 of '09 compared to $45.3 million for Q2 of '08. The decline in HDSL revenues is primarily the result of variations in customer order patterns quarter to quarter. As a result of the above, Carrier Networks division revenues were $91.8 million and Enterprise Networks division revenues were [$49.8] million for Q2 of '09. International revenue was $6.4 million for Q2 of '09 compared to $7.8 million for Q2 of '08. To provide the reporting of each of these categories, we have published them on our Investor Relations web page at Adtran.com.

Gross margin was 59% of revenue for Q2 of '09 compared to 60.5% for Q2 of '08. The decrease in gross margin is primarily attributable to startup costs related to VDSL2 and higher transportation and expediting costs in the quarter. Research and Development expenses were $20.7 million for Q2 of '09 compared to $20.2 million for Q2 of '08. Selling, General and Administrative expenses were $24.9 million for Q2 of '09 compared to $25.7 million for Q2 of '08. Stock-based Compensation expense net of tax was $1.4 million for Q2 of '09 compared to $1.8 million for Q2 of '08. Other income net of interest expense for Q2 of '09 was $2.3 million compared to $1.9 million for Q2 of '08. The increase was primarily related to a net realized gain in equity securities. The company's income tax provision rate was 33.8% for the second quarter of 2009 compared to 36.6% for the second quarter of 2008.

In the second 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 a tax provision to be unusually high for that period. Earnings per share (inaudible) $0.30 per share compared to $0.34 for Q2 of '08. Inventories were $48.3 million at quarter end. Net trade accounts receivable were $64 million at quarter end resulting in DSOs of 48 days for the second quarter of '09 compared to 43 days for the second quarter of '08. Unrestricted cash and marketable securities totaled $267 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 products we are engaged in, combined with the impact of the economic environment on carrier and SMB spending and the potential for tier two and tier three spending delays related to broadband stimulus package, make it difficult to predict revenue levels. Assuming economic activity levels remain constant with the current environment, for the third quarter 2009 we anticipate that revenues will increase sequentially in the range of 3% to 5%. For the third 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.

We believe the larger factors impacting the revenue we realized in the third quarter and the full year 2009 will be the following, Spending levels at our tier one and tier two carrier customers, the adoption rate of our Total Access 5000 and the 1100 series platforms, the adoption rate of the OPTI 6100 for tier one carriers, continued growth of Internetworking revenues, the continuing 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.

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

Yes, sir. (OPERATOR INSTRUCTIONS) Your first question comes from Vivek Arya of Bank of America Merrill Lynch.

Morning. Couple of questions. First, Tom, the very sharp drop in HDSL, can you give us some more color around that? I think you mentioned there was one customer. From what I recalled from the Q1 earnings call, this was somewhat of a surprise, so if you could just elaborate on that. Thanks.

Yes, it was, it was definitely one customer. In general, think the market, we had some customers that were slightly up, some that were slightly down, but in general, I would say flat, except for one customer. And as I mentioned on my previous comments, that customer had a very strong first quarter. So we do see that from time to time. In fact, we saw this happen with this exact same customer in the second half of last year. So it's something that -- it was -- I mean we didn't expect it to drop necessarily to that level, but we also didn't expect it in the first quarter to be as high as it was.

And how do you see HDSL trends in the second half of this year?

It's always -- one of the comments I made was the 12-month view of HDSL, which is what we've been trying to get people to look at. And that is more from a longer interval term level because we do see inventory fluctuations and we do see projects that tend to effect HDSL over any short period of time. But in general, things tend to even out. So we're still expecting -- we've been talking about being down single digits for HDSL for the year and that's still where we're expecting to be.

And on Broadband Access, the pickup that you are seeing, I guess Broadband Access and Optical, the pickup that you saw in Q2, is that more related to the IOCs, or is it some improvement in tier one spending also?

In the Broadband Access piece, it was both. We have some Fiber to the Node buildouts that cover the tier one space, as well as we saw a pretty, pretty good uptick in the Total Access 5000 space in the IOCs. And in the Optical space, I would say it was, in general, it was all markets, but we did see a pickup at some of the tier ones that was fairly strong.

All right, and one question for Jim. Jim, last quarter there was $3 million or so I think investment loss that was taken out of non-GAAP. This quarter there is I believe about $1 million investment gain. Should we exclude that also when we look at non-GAAP performance? Thank you.

Well, it's, it's certainly nonoperating performance, but what it relates to is a single security that we've owned for quite sometime and we sold -- had the opportunity sell some shares in the second quarter that related to that piece of other income. I see.

So the tax rate going forward, should we assume it's the normal 35% level, or is it 33.8% or 34% level that we saw in Q2?

Yes as far as the tax rate going forward probably something in the range between 34% and 34.5% would be an appropriate planning range.

Okay. Thank you, and good luck.

Your next question comes from Mark Sue of RBC Capital Markets.

Tom, understanding your revenue guidance, what are some of the qualitative comments coming from your customers about linearity, business confidence, and also their willingness to plan for longer than one quarter?

I would say in general, the environment is very similar to what we saw in the first quarter, that they are, they are as focused on particular projects as they have ever been and they are still watching their spending. I think maybe the difference we saw is in the first quarter, specifically in the IOC market, there was a reluctance to spend on any project because they were really trying to understand what would be stimulus potential and what would not be. And we saw them loosening up on that stance going into the second quarter and as we progressed through the second quarter where it became clear, more clear what would and wouldn't -- what would and would not qualify and we saw some jobs actually being released. And that was probably the biggest difference from, from Q1. With the larger carriers, everything that we had been working on is still progressing and progressing at about the same rate as what we were expecting. I don't know if that answers everything, but--

Maybe, Tom, just on the topic of broadband stimulus, anything else that carriers are pondering? Is it really about in terms of qualification or is it magnitude or is it timing? Any thoughts on what they are saying about the stimulus?

In general, you know, in general, I would say most of them are positive. The ones that we're planning on applying for stimulus dollars are still planning on applying. And I would say that the dollar amounts that we have heard with the various carriers seem to be consistent with what they were planning in Q1. So it's -- yes, I think it's a matter of getting all the paperwork together and getting them submitted and then moving forward, which of course we're expecting to be more prominent in 2010 than in 2009. I think we're just going to be up against a pretty tight time window to try to get any real spending this year, but we're hopeful. We'll see what happens.

I see. So next quarter, maybe into the back of this year, just more fine tuning and continued discussions is how we should expect things to develop?

Yeah, actually I think we'll work down to the point now where people are actually doing planning and engineering work on what they want to submit and what they hope to get, but, yes, we don't expect a strong stimulus uptick in 2009.

Okay. That's helpful. Thank you, Tom. Thank you, Jim.

Thank you.

Your next question comes from George Notter from Jefferies.

Hi. Thanks very much, guys. Just expanding on the discussion around the broadband stimulus plan, I guess for one, I was wondering how you expected trajectory of spending activity from the IOCs to be impacted by the stimulus plan? I guess more specifically, it sounds like you're seeing some loosening here in Q2 and perhaps maybe more in Q3. Do you think as we get closer to the stimulus money actually being available you start to see the IOCs again clamp down on spending, spend less money, try not to have projects around that would get grandfathered out of the stimulus plan, let's say in Q4? Does that trajectory make sense for you?

I mean I could understand the thought process behind that. I don't get the sense that that's -- at least my hope is that's not what's going to happen. I think what's happened this quarter, it's became more clear what would and what would not qualify and there were things that they just want to get done that will not qualify that they started releasing money on. And so I think as we move into the year or into the second half, I would say what doesn't qualify still won't qualify and that they would -- our hope is that they would still release those funds and let us start building those out. So I, I don't sense that there will be a pullback. I think as we move forward in time that they are just more understanding of what it is they need to get done outside of the stimulus package.

Okay, and then -- so for the products -- so do you expect any relief, let's say, between now and the end of the year for the projects that do qualify the stimulus or do you think all of that just stays turned off all the way through when the money starts coming available?

There is some debate on that and there's some discussion about-- because you can -- you can potentially get some type of credit for some of the dollars that you spend. We're not expecting it. We're saying stimulus projects are in one bucket. Ongoing activity is in another bucket. We see the ongoing activity actually loosened up in second quarter. We're still viewing the stimulus bucket as a separate animal.

Got it, okay. And then when you look into next year, once those monies start coming available, any sense for how much of those dollars would be incremental versus what these guys would otherwise spend, then? Is it then all incremental or partly incremental what you expect otherwise next year? How do you get your arms around that?

We don't have, we don't have broad visibility into that. We have specific account visibility and as you can imagine, the stance that carriers would probably take would be its stimulus dollars, which by definition are for incremental builds. They are things that we wouldn't do on our own. So whatever we were going to do on our own, we're going to continue to do. So the definition almost leads itself to truly incremental type analysis. But I would tell you that the ones that we do have visibility to, that is the way they are looking at it. But I can't tell you that everybody's really in that same boat.

Okay. Got it. Can you remind exactly what are the amount of the revenue streams is IOCs?

Jim?

George, that's not a number that we disclose, but maybe it's a number that one might be able to back into while realizing that customers like Windstream and what used to be Embarq logistics did have a reselling distribution arm. This -- tier three, so it's always been a hard number to peg for us because of that.

Got it, okay. Thanks very much, guys.

Okay.

Your next question comes from Paul Silverstein with Credit Suisse.

Jim, two questions. One, could you tell us the 10% customers on the contribution? If I missed that, my apologies.

Sure. There's four 10% customer this is quarter. Qwest came in at 20%. Windstream at 11%. Verizon at 13%. And AT&T at 16%.

AT&T, 16. And the Qwest, I assume was largely FTTN?

Yes. Meaningful portion of that revenue stream is FTTN, yes.

Okay. Question for you, and if I've got the math wrong, my apologies. I'm doing this on the fly. If your HDSL business were down 5% which would be in that single-digit range that you referenced, that would suggest that you guys are thinking that in the second half of the year, HDSL's going to be up a tick. It comes out to about 1% or so. Is that a reasonable -- is that the way you're thinking about it?

Well, the way we're thinking about it over the 12 months, 2009, we -- to get back to what we said, we think it will be down single digits. Where exactly that will fall, we don't know. Again, Q1 was unusually low for a particular customer and perhaps, two and historically we have seen some level of return in the following quarter. In the same sort of way that what happened in the latter part of last year, Q3 was high. Q1 was down, and -- I'm sorry. Q4 was down and Q1 was unusually strong for us.

Jim I want to make sure I understood. I thought the reference about one of your tier ones being down was Q2. Was that also Q1?

No. No, that customer was actually strong in Q1.

That customer was strong in Q1.

So you had a good Q1, you have seen the numbers. Q2, you had one particular tier one that was done. But if you do the math, your first half over last first half was down by 12%. So if I flatten out the strength in Q1 the weakness in Q2, and again, that suggests you're thinking second half of the year is actually going to be up, not down.

If you remember, we had a weak Q4 also.

Yeah. Which was after a strong Q3 in HDSL, but we had a weak Q4 so the comps at this point don't worry us that much.

Okay. Thanks, guys.

Your next question comes from Amir Rozwadowski of Barclays Capital.

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

Good morning.

We've seen a lot of releases out of you folks recently about traction on the TA 5000. I was wondering if you could give us an update in terms of the carrier acceptance and perhaps progress on the platform and if you could give us any color in terms of what contribution to revenues, that would be helpful.

Yes let me just comment on the press releases and what we're trying to do and then maybe Jim can comment on the contribution. What we are -- needless to say, we believe there's a strong potential for an uptick in spending in the IOC market as we move out of this year and definitely into 2010. And we believe we have the right platforms to do that. The reason for the press release is simply to try to communicate with the tier three market on the success that we're having and try to get just as broad of acceptance of that product line as we can. So in and of themselves, every individual press release may not be a large dollar amount, but what we're trying to do is just communicate with the end user base and that's what that whole thing is about. As far as, by the way, the 5000 did have a good quarter.

The 5000 did have a good quarter in Q2 and a large part of that, that growth, if you will, was coming from the third tier carrier area. And in relation to the announcement of the carriers to the announcements, again, as Tom said, one specifically, obviously they are meaningful customers to us, but in terms of each one individually driving that number, it wasn't a meaningful amount. Overall, we had good activity across the tier three carriers in second quarter.

Okay. That's helpful, Jim. And any levels in terms of revenues that we can work with, or are you not disclosing that at the moment?

We typically don't. It was greater than 5%.

Okay, greater than 5%. Great. And then if we look at your growth products as a whole, I mean certainly this quarter we've seen a marked pickup from a year-ago period. How should we think about the progression through the course of the year? Do you feel better in terms of the progress and the acceptance for some of these products than we were three months ago?

To be honest, we feel pretty much in line with what we were thinking. We did see a pickup in the 5000 activity, we were hopeful of a pickup and we just saw it materialize. And we would expect 5000s to continue to pick up through the year. Seasonality in the fourth quarter still always affects us, but we would expect a stronger Q3 than Q2 in the 5000. Fiber to the Node, there are specific projects that are going on and some of those projects dominate the numbers in Fiber to the Node, so I would say a steady Fiber to the Node type activity. Optical, we expect it to continue to gain momentum through this quarter and I would expect a stronger performance in optical than we actually saw in Q2.

HDSL is the one that we're expecting because historically when we've seen a weak quarter, we see a stronger quarter the following quarter. We would expect that to happen in HDSL, as to whether or not getting to the previous question as to whether or not it bounces back the proper amount, we can't tell you specifically, but we would expect a stronger quarter there. And enterprise has got a good run. Definitely with the Internetworking products and we would expect continued strength there.

Great. Thank you very much for the incremental color.

Okay.

Your next question comes from Todd Koffman of Raymond James.

Yes, just a clarification on the Total Access 5000. Were revenues up sequentially in the second quarter?

Yes.

Yes.

And in the, in that product category, can you just give a general split as to what chunk of that TA 5000 revenue came from tier ones versus tier threes?

In general, I can tell you it was larger in the tier threes than the tier ones.

Yes, yes.

And when you made the comment, Tom, that you expect TA 5000 to ramp through the year, do you expect the tier ones to come back and represent a bigger part, or are you expecting that to be driven by IOC?

We expect -- let me just comment on the third quarter. We expect the tier one contribution in the third quarter to be over the second quarter.

Thank you very much. Good luck.

Okay.

Your next question comes from Jim Suva with Citigroup.

Thanks. I think you guys did a great job addressing the broadband stimulus package. So I want to switch gears a little bit and wanted to ask a little bit about AT&T's been talking a lot about reducing the number of suppliers that it deals with. Can you talk about, has Adtran been notified or confirmed as a continuing partner or any discussions going on there that you can help give us some comfort on?

Yes, and I'm going to have to talk a little -- I'm going to have to be a little careful here.

Correct.

Just because the project, or the program that they have isn't fully announced and it's really up to them to announce what they want to announce. What I can tell you is that the existing developments that we've got going on in projects, and as you know, we've won several pieces of business with our Total Access 5000 platform with AT&T, that those existing projects are all continuing on and are as aggressively being pushed as they have ever been pushed and we'll continue to work with them.

I think the real question is later on, what kind of impact does that have past the 2011 type timeframe and there will be areas for us. In fact, there have been areas for us to actually partner with vendors on business that we would not have been able to get in and of ourselves because of the breadth of product line that we have. So our first blush so far has been positive and we'll just kind of see how that turns out over the future and how the program itself changes form over the next few years.

So is it correct to classify that more as a partnership opportunity rather than a big fear of completely being designed out?

I will tell you that's the way we're taking it. And so far with us embracing it from that perspective, it's been a positive thing for us.

Okay. Then a follow-up question. On your guidance, which I believe it was 3% to 5% for Q3, if I heard correctly, typically if I look back over the past several years, it was closer to up 6% or 7% and so I just want to get a little bit of notion or color from you, is this just being a little bit more conservative, of course the environment is a little bit more challenged today, but is there something we should think about as that disconnect there?

Well, let me take a first blush at this, Jim, and if you have any comments you can bring it up. We did, we had a little stronger Q2 than we had expected and we're trying to take that into account. And on top of that, we also have the situation that one of the other callers mentioned, which is there's still uncertainty about what's going to happen in the IOC market, whether or not there is some pullback there, there is some uncertainty about the snapback in HDSL and how big that will be. So I think we're giving it the best realistic spin that we can, given the environment that we're in. And it's -- we're not trying to hold anything back, nor are we trying to be too aggressive. We're just saying with all of these things, assuming half of them will go your way and half of them won't, where do you end up? And it's not a typical environment today and so I wouldn't be surprised if typical seasonal upticks don't necessarily play through in this environment. Jim, do you have anything?

I would agree.

Okay, great. Thank you very much, gentlemen.

Okay.

Your next question comes from Ken Muth of Robert Baird.

Hi. It's James Falkoff on for Ken. Just returning back to the stimulus, can you maybe touch on the expenses side of that and the expenses associated with the dressing of the opportunities? Do you need to do headcount additions to handle the influx of new projects? Can you comment at all on any deviation from an historical operating model needed to address the opportunities properly?

The good thing is, is that products that we have been working on for several years now seem to fit the market need very, very well. So we haven't seen a reason to substantially change what it is--the path that we are going towards. I think what this does is potentially increase the acceptance rate or the sales rate into the same market that we've been trying to penetrate with these new products. So not a big change there. We have done a relatively substantial amount of marketing to this group. We talked about the press releases, but we've also done shows here at the facility where we're trying to bring in literally hundreds of IOCs and let them really get a better sense of what it is that we can do. But those are basically -- in general, I would say the answer to that question is no.

Okay. Great, thanks.

Okay.

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

Yes, thank you. I was wondering, given the strength in internet working and your gradually increasing focus on the enterprise space, what will that mean in terms of recalibrating your sales and marketing organization, if at all? And what kind of impact that may have on your SG&A line going forward?

We don't expect any change in the profile, our enterprise SG&A, or for that matter, SG&A in general through this year. What we have historically tried to do is live within the means that we have and the market conditions we have -- so far in the enterprise space, that has put us still in a position to continue to get market share. If you followed us, we have become more and more focused on particular areas, like carrier channels and we have shifted resources towards making that successful and it has been successful so far, but we don't really see a change or reason to substantially change the overall model of the Company or to be successful there.

Got you. Thank you.

Okay.

Your next question comes from Nikos Theodosopoulos with UBS.

Thanks. Had a couple of questions. The first one is on the Internetworking business, you had a very strong performance. You mentioned tier-- distribution through carriers and VARs. What changed this quarter that those relationships, this business has been around for several years. Was there kind kind of inflection this quarter or did you add any significant new large VAR channel partners or what changed?

I don't think there has been any overnight change in that space. We actually have commented, Internetworking even through this downturn has done well. It hasn't necessarily set records every quarter, but it's come pretty close when it hasn't and we've just seen a gradual buildup of momentum. The change that we really made was probably closer to two years or two and a half years ago where we started focusing much more on the carrier distribution channel as being a very good adjunct and potentially a leader for us being able to get into a stronger way into the VAR base. And you are really just seeing momentum building in that space. There really was no particular item that changed.

Okay, and on gross margin, you mentioned startup costs for VDSL and expediting costs. How does that factor into the rest of the year? Are we going to see the VDSL startup costs continue, do they mitigate and margins should improve again? What's your view on that?

Jim, do you want--

Well, Nikos, we continue to believe that our gross margins for the remaining quarters will be in the high 50s and we will probably incur more normal expediting costs as compared to Q1 for example than we have in the past, but again, we're thinking more in the high 50s for the remaining quarters.

Okay. So the VDSL startup cost wasn't that material and going forward doesn't really swing things?

Well, it does -- I mean it was a decent cost that we incurred in the second quarter, but we have product mix things that affect us from time to time. There are times where we're in the 59s, or even in the 58s where it wasn't a particular product startup cost. So, the costs you see around that just give us a little bit of leeway there because product mix changes from time to time and you just incur different things. Just saying high 50s is something we're comfortable with.

Right, okay. Okay. Just the last question on the guidance for the third quarter, if I listen to the commentary in the call, namely HDSL should be down single digits for the year, that would imply for the next couple of quarters a meaningful improvement and the comments about Internetworking and OPTI doing better, it seems like the third quarter revenue guidance of 3% to 5% seems low versus, even if everything stayed flat in the HDSL business recovered, that would get you to above that guidance. I'm trying to understand-- the comments on HDSL and then the third quarter guidance don't seem to be connecting.

Well, the one thing that we don't have is a perfect crystal ball. So although we can relay to you the general sense of the different product areas and the direction that the momentum on the different sets that they have today, we can't tell you for sure where they are all going to come out. As I mentioned to a previous questioner, we're just taking a look at the overall picture and saying, okay, not everything is going to turn out exactly the way we hope and some things may turn out a little better than we hope and where do we end up and it was really built up that way.

Got it. Okay. Thanks.

And as you know, Nikos, we have some customers that have shown a propensity to stop spending all of a sudden much more in this environment than we had let's say two years ago. So, we're always watchful for that, too, and that's a real situation. I'm not aware of anything like that right now, but typically I am not aware until they stop. So it's just -- it's just getting a sense for the environment and what's reasonable.

Okay. Thank you.

Okay.

Your next question comes from Blair King of Avondale Partners.

Hi. Thanks for taking the call. One question, I was just going to return back to the Internetworking and Enterprise subject. I know you just touched on it a little bit, Tom, but to me, it seems surprising given the strength in both Internetworking and Enterprise legacy amidst the environment that you're in and was just curious if you could help us understand what's driving the momentum particularly. I get the strength in channel distribution, but have you noticed enterprise spending to be increasing or is it still difficult environment, or are you gaining share there, or can you just help think about how we trend that out for the balance of the year?

Yes, and I, I touched on those in my comments because the -- we've had a lot of discussions here and really trying to understand the share gains, or is there really an underlying change in the market there, and let me comment on the piece that we do know. We do know that we were gaining market share and that we've actually been approved in certain areas that we may not have been approved a year ago. So there is a general sense that we picked up market share. I would say in the, in the channel itself, I do think that we went through a period of time where there were inventory reductions going on and although I don't think inventories have built up at this point, I do think the reductions have probably ceased.

So I think you're probably seeing more now of the underlying demand than you may have saw, let's say, six months ago. And I think that played itself -- could have had an impact both on our Internetworking product segment and in our Legacy product segment, which we do not expect to grow, in any meaningful fashion. In fact, we continue to expect those to tail off over time. So I think -- I wouldn't say that the market has gotten more robust. I would say that maybe it has shored up and people are feeling more confident about where the bottom is and because of that, are willing to drive inventories to a lower level.

Okay. Thank you.

Okay.

Your next question comes from Andy Schopick of Nutmeg Securities.

Thank you, good morning. Couple of questions, if I may. International, how much of the international business is still tied directly to Telstra or in Australia in general?

Well, it's a, it's a fair percentage actually. Telstra is and they continue to be a good customer and a growing customer. So it's a fair percentage.

So we really haven't seen a lot of increased penetration into other international markets yet?

I would say that's fair to say, yes.

Okay. Also, on the stock buyback, it appears to me that you have not bought any stock back in either the second quarter of this year or last year, is that correct?

I know for a fact that we did not repurchase shares the second quarter of this year. In terms of last year, I'm not sure.

I'm just looking at the cash flow statements. And any comment at all about the general buyback strategy now in terms of continuing to go forward? I'm not sure what authorization remains.

Yes, and I think it's fair to say that we will continue to be opportunistic. About 3.5 million shares remain on the current program.

Okay. All right. Thank you.

Okay.

Your next question comes from Simon Leopold of Morgan Keegan.

Thank you. I wanted to quickly revisit the gross margin discussion and get a better sense of what maybe happened in the mix this quarter, given that the strength in Internetworking, I would have thought that would have been a favorable element. And obviously there's some moving parts, but maybe if you could shed some light on what mix is doing to your gross margin?

Well, I don't have that level of detail before me, Simon, but I can tell you that the larger drivers on gross margin in the quarter were in terms of VDSL2 startup costs and expediting costs. In terms of product mix, driving any significant changes, I don't see it because most of our products, the vast majority of our products have consistent gross margins and, again, the major things that drive margins from quarter to quarter are things that we saw in the second quarter and it's more to norm to have expediting costs because--Q1, again, we were very fortunate in terms of the timing of our customer order delivery requirements with our production schedule and, again, that is not the norm. So, we could potentially have other startup costs as well, new technologies, new projects that could impact gross margins. But again, we believe that we'll be in the high 50s.

Your next question comes from Larry Harris of CL King.

Yes, thank you. Looking towards the broadband stimulus and the key products, would it be fair to assume, given the press releases and such that the Total Access 5000 would account for maybe a majority of your sales in that area, whereas, say, the total access 1100 might be just project-specific for FTTN? How should we be thinking about what types of products you would be selling broadband?

Going forward into the stimulus package? Yes. Good question. We're confident that the 5000 will play a big role in the broadband stimulus piece. There are, I think, pretty significant projects that the 1100 series Fiber to the Node products are focused in on and if those get approved, that will drive that percentage in a meaningful way. So at this point in time, I would say the majority of the carriers, if you look at just the number of carriers that may apply for broadband stimulus, the majority of those would be 5000 related, but I can't tell you the dollars will end up that way, because some of the Fiber to the Node initially are fairly large in size. Does that answer your question?

Yes, it does. And then just -- I know it's sometimes difficult to ascertain, but the sequential decline in HDSL this quarter, was it perhaps back haul related or was it enterprise-type projects? Do you have any sense as to-- from an application point of view, where the decline was this past quarter?

Well we did ask a lot of questions about what was happening in HDSL and the general sense we got back, there's been no big change in deployment initiatives where HDSL will factor, where HDSL will be impacted. So we did think there was upward movement in HDSL definitely second half of last year due to wireless spend. That probably impacted the number more than any significant change in the SMB market. Going into this year right now, the general sense we have, there has been no change and we're just seeing quarter-to-quarter variations. We have seen an uptick as well and we are seeing continued upticks in our fiber access products, which will be used in many cases in cell site backhaul. So, the general sense is that's not impacting the number in any significant way because when you look at that versus let's say the Q1 to Q2 downtick.

Good. All right, thank you.

Okay, all right.

Your next question comes from Bill Dezellem of Titan Capital Management.

Thank you. Relative to the increase in the accounts receivable that you had, is that an indication to us that your business accelerated in the month of June?

Bill, this is Jim. I think that's fair to say. The linearity on revenue was -- the revenues were higher in the June month.

And that acceleration in June, is that just a normal phenomenon within the June quarter, or is that potentially, not for sure, but potentially an indication that spending is loosening up a little bit?

I don't think we're ready to say that spending is loosening up a bit. You know, many times, particularly in the second and third quarters, the linearity can be a bit random, okay, and I think, I think we're at the point of saying that's the driver basically, is randomness and order flow as we went through the quarter.

One data point does not make a line?

Right, right.

And then jumping to the internet working, if we could, please, to what degree -- you discussed it a lot. But to what degree do you think that there is an economic benefit, or benefit that that group is seeing from the economy? I mean it seems as though that would be most of your businesses, the most driven by the economy. And yet we're not sensing that the economy is improving. So are you seeing something there?

We're not sensing the economy's improving either. So, my sense is, and just from people we have talked to, there just seems to be more of a belief that there's some level of stability in that, that you can't -- that there are projects that just have to be let go and people are moving on some of those projects, both on the carrier space and the enterprise space. But I wouldn't say that there's a large turnaround. Now, we don't have perfect visibility into that, but we're cautious about saying that the enterprise market and the way that we address it as changed substantially. We're more confident in saying we know we've picked up market share and we do know that probably inventory levels have stabilized somewhat.

And then finally, if we heard correctly, the TA 5000 revenues currently more than -- there are more tier three TA 5000 revenues than there are revenues for the tier ones and assuming that we did hear you correctly, when would you anticipate the tier one TA 5000 revenues to overtake the tier three?

Well, first of all, that was true for the second quarter. That hasn't historically been true. So there have been quarters where tier one revenue was ahead of tier three revenue. Over the long-term, the stimulus package throws in a different twist on it. If you would have asked us in 2010, do we think tier one revenues will be larger than tier three revenues, the answer would have been yes. The stimulus package has potentially impacted that in some meaningful way. I think at this point you will see quarter-by-quarter variations. We're very confident that tier one revenues will be up in Q3 versus Q2 but that will be on a quarter-by-quarter thing for a period of time, definitely when you throw in the stimulus piece.

And Tom, following up on your last comment about 2010, the tier three being larger, is that actual incremental business, or is that business that was pushed out in your opinion of 2009 and that will fall in 2010?

That's similar to a previous question, which is stimulus package itself all incremental and do they do -- or will projects that were really contemplated as 2009 pre-stimulus now going to be moved to 2010 and be called stimulus? And my guess would be there is a mixed bag in there. But in general, the people we've talked to tend to view those as separate buckets and that's probably one of the reasons we saw a rebound in Q2 in that IOC marketplace, because people were releasing things that were not going to be stimulus viable. I would view it, and I think the intensive legislation is for this to be incremental spending and I would say that's still the majority of what we're seeing and the things that we can put hard numbers around is incremental spending. That's helpful. Thank you both. Okay.

Your next question comes from Joanna Makris of Brigantine Advisors.

Hi, good morning. With Embarq having ticked down this quarter sequentially, can you talk a little bit about that relationship and potential I guess the relationship with CenturyTel going forward?

Well, we're very -- we're very optimistic about that relationship. CenturyTel has been a good customer to us and has been a customer that is actually utilized products like the 5000. Embarq, as you know, we have very long history with and has adopted many of our products, including the 5000 and we feel we're in a very good position there and that's a relationship that we've worked very hard to get and secure and to keep. So we're -- I do not view the performance this quarter and Embarq as any sign of what the future potential is for us at Embarq or the new Century link.

Thanks.

Okay.

Your next question comes from Tony Rao of East Shore Partners.

Good morning. I have a few product-related questions. Prior, in a prior answer, you touched a little bit on your fiber access products and how they are going to play a significant role in fiber-based backhaul at bay stations. Can you elaborate a little bit more on what types of products would fit into that application?

Sure. The main product that we push is our OPTI 6100 series. We are, of course, putting in fiber access capabilities in Total Access 5000 and -- but I would call that very early. So where we're seeing the benefit today is with our 6100 products and that's -- we sell that to all of the major carriers, AT&T, Qwest and Verizon, although not the telecom piece of Verizon. We do sell to Verizon wireless, as well as the majority of the tier twos and many of the tier threes. Okay.

Yes, it sounds like the -- to me when I look at the TA 5000, that that would be a natural application for that product.

That is a very good application for that product. That's a good application when you start talking about am more ethernet-centric fiber deployment versus a sonic deployment or even an ethernet over sonic deployment and the majority of the carriers aren't to that point yet. So when they are adding backhaul capacity today, by far the majority is sonic-based capacity. Which is why it's benefiting the 6100 more than the 5000 at this point.

So you're planning, though, because there are competing camps out there, but there's a lot of belief that ethernet over fiber will be the choice down the road at some point, so is that what you're trying to get in front of the curve on with the TA 5000?

We are a very big believer that ethernet will rule the day at the end of all of this, or at least for the foreseeable future and, yes, native ethernet over fiber is a very key area that you would expect us to move into.

Right, and then the 6100 would not be applicable in that application? in that application?

The 6100 is much more Sonic-based. So it does ethernet, but it does ethernet over Sonic.

Right, okay. Another question, if I may, on the TA 5000, can you give us a little bit of a feel from an application standpoint of what applications may -- it may find its way into at the tier three type carriers and are they different applications than they would be at the tier ones?

Today, the answer is probably more yes in that the tier one, what we're selling into, we sell into several different applications, but at the bigger tier ones, it's been more ethernet, like ethernet over copper or ethernet transition or ethernet aggregation where in the tier threes, it's up much more broadband DLC, GPON, or just high speed DSL. So there is overlap in that most of the tier three we feel confident we will win those tier one-type applications and then most of the tier ones, we feel like we will win those tier three applications or may have and they are just at different points in the deployment lines, but at this point in time, there is a difference.

Okay, just one last one, on the TA 5000 at the tier ones, when you have already gone through such a lengthy evaluation periods and qualification for certain applications, when you then move to a new application, even if it's in a different group within the carrier, would you say that that makes it an easier job for you to have them look at the prior qualifications done maybe by other divisions within the company?

It definitely helps, but the amount of that help is depending upon the particular operating system or OS or EMS that is used for that particular application. Definitely a help and sometimes it can be a very, very big help. But that happens to be under the same OS umbrella and then sometimes it's less.

Thank you.

Okay. Sade, I think that was the last one because we have overrun our time.

Okay.

All right. So thank you, everybody, for joining us. Sorry we didn't get to all of the questions, but we look forward to talking to you again at the end of next quarter.

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