ADTRAN Holdings Inc (ADTN) 2009 Q4 法說會逐字稿

Good morning. My name is Christy and I will be your conference operator today. At this time, I would like to welcome everyone to the ADTRAN fourth-quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' prepared remarks, there will be a question and answer period. (Operator Instructions). As a reminder, ladies and gentlemen, this conference call is being recorded today, Wednesday, January 20, 2010.

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 Form 10-Q for the quarter ended September 30, 2009. 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.

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

Thank you, Christy. Good morning, everyone. Thank you for joining us for our fourth-quarter 2009 conference call. With me this morning is Jim Matthews, Senior Vice President and Chief Financial Officer. I'd like to begin this morning's discussion by talking about our Q4 performance before we move on to a review of 2009, and I'll end with some comments on 2010.

During the quarter, our Carrier Networks Division benefited from the deployment of new applications within our Tier 1 customer base, market share gains in other market segments, and the continuing impact of wireless infrastructure upgrades. Our Enterprise Networks division saw the benefit of its growth areas dominating its legacy product base.

From a product perspective, our growth areas delivered another solid revenue quarter. Combined, these areas demonstrated a strong performance, growing an impressive 42% year-over-year. Specifically, Internetworking revenue was up 46% year-over-year, setting another record at $23 million. This is particularly notable given that Internetworking revenues have typically seen a sequential decline in the fourth quarter. With this continued growth, Internetworking revenues now represent 76% of total enterprise network division revenues.

Broadband access revenues grew 46% over the prior year as a result of the record level achieved by our Total Access 5000 platform and continuing deployments of fiber to the X products. Revenue for the Total Access 5000 platform was up both year-over-year and sequentially across all market segments and with every major customer. Fiber to the node revenue, although up year-over-year, declined sequentially as expected.

Optical Access revenue grew 30% over the same period last year, coming in at $16.3 million. This growth was due to market share gain and increasing shipments to all major market segments as carriers invested to increase bandwidth for wireless infrastructure. HDSL performed as expected and was sequentially down in the quarter.

Looking back on 2009, although economic conditions continued to be difficult in the first half of the year, we did see stabilization materialize in the second half. For the year, traditional product revenues declined 17%, more than we originally anticipated due to the effects of the economy. Of course, the largest component of our traditional products is HDSL, which was down 16%. This decline was nearly offset by continued expansion of our growth products, resulting in a total company revenue decline of 3% for the year 2009. Despite a difficult environment and stimulus uncertainty, our growth areas combined grew 14% over the prior year, with each of the three achieving new record revenue levels and all poised for longer term growth.

The customer base for the Total Access 5000 platform increased substantially in the second half of the year and we now have well in excess of 100 carriers who have selected or are now deploying this platform. Additionally, our fiber to the node products continue to show growing acceptance as carriers continue to invest to upgrade services to their subscribers and migrate their networks to packet based technologies. The bidding activity around our Total Access 5000 and fiber to the node products continue to gain strength in both the US and abroad. We anticipate that expanded global deployments will contribute meaningfully to the growth of these platforms for many years to come as carriers continue to invest in carrier Ethernet, fiber connectivity, and broadband service upgrades.

For the year, our Optical Access category achieved another record revenue level as wireless infrastructure upgrades drove demand, predominantly in our Tier 1 customer base. For the year, the enterprise network division grew 4% over the prior year, led by Internetworking revenue, which grew a strong 22%. For 2010, we expect the Total Access 5000 and fiber to the node platforms will continue to grow across all carrier classes, driven by fiber deployments, carrier Ethernet conversion, and higher speed broadband. We expect our fiber to the node and GPON products, augmented by new product introductions, will benefit from the reemerging interest in bandwidth expansion to deliver new services, as well as interest in [FTTP] expansion resulting from the broadband stimulus activity and service provider consolidation.

Our Carrier Ethernet products should continue to benefit from expanding Ethernet conversion initiatives spanning across all carrier customer segments. In addition, we think our OEM relationships, as well as our continued focus on markets outside the US add meaningful future potential -- although as you may expect, timing of these opportunities is uncertain. Internetworking will continue to maintain its current positive momentum, with benefits from market share gains and new product offerings such as our newly introduced Unified Communications products.

During 2010, we believe we will see sporadic revenue increases in certain fiber and copper products as wireless carriers augment their backhaul bandwidth capacity, utilizing a mix of different technologies. The broadband stimulus package has the potential for material impact in 2010 and beyond. Although it has the potential for material impact, the timing and magnitude remains uncertain due to evolving requirements, process obstacles, and customer uncertainty at this point, and we do not believe we will expect to see a meaningful impact in the first quarter of 2010.

Looking forward we continue to participate in a large number of opportunities related to broadband stimulus plan and I hope to report more definitive news as the year progresses. Overall, we maintain that Adtran is well positioned for meaningful growth for the future. I would now like Jim Matthews to review our results for the fourth quarter 2009 and our comments on the first quarter of 2010. We will then open up the conference call to questions. Jim?

Thank you, Tom, and good morning, everyone. Revenue for the fourth quarter increased 11% to $124.2 million compared to $112.4 million in Q4 of 2008. Broadband Access Product revenues for Q4 of 2009 increased 46% to $28.3 million compared to $19.5 million for Q4 of 2008. Optical Access product revenues for Q4 2009 increased 30% to $16.3 million compared to $12.6 million for Q4 of 2008. Internetworking product revenues for Q4 of 2009 increased 46% to a record $23 million compared to $15.7 million for Q4 of 2008. Carrier Systems revenues for Q4 of 2009 increased 31% to $56.9 million compared to $43.5 million for Q4 of 2008. Business Networking revenues for Q4 of 2009 increased 30% to a record $27.9 million compared to $21.4 million from Q4 of 2008.

Loop Access Revenues were $39.4 million for Q4 of 2009 compared to $47.5 million for Q4 of 2008. HDSL product revenues were $35.4 million for Q4 of 2009 compared to $41.7 million for Q4 of 2008. As a result of the above, Carrier Networks Division revenues were $93.9 million and Enterprise Network Division revenues were $30.4 million for Q4 of 2009. International revenue was $7.7 million for Q4 of 2009 compared to $8.1 million for Q4 of 2008. To provide the reporting of each of these categories, we have published them on our Investor Relations page at adtran.com.

Gross margin was 59% of revenue for Q4 of 2009 compared to 60.1% for Q4 of 2008. Research and Development expenses were $21.2 million for Q4 of 2009 compared to $20.4 million for Q4 of 2008. Selling, General and Administrative expenses were $25.9 million for Q4 of 2009 compared to $25.7 million for Q4 of 2008, and stock based compensation net of tax was $1.8 million for Q4 of 2009 compared to $1.3 million for Q4 of 2008. All other income net of interest expense for Q4 of 2009 was $1.3 million compared to a loss of $900,000 for Q4 of 2008.

During the fourth quarter of 2008, the Company recorded net realized investment losses of $2.3 million in its marketable equity securities portfolio as a result of significant market declines in the equity markets.

The Company's income tax provision rate was 32.3% for the fourth quarter of 2009 compared to 19.1% for the fourth quarter of 2008. The tax provision rate for the fourth quarter of 2008 was lower primarily as a result of recognition of research tax credits for the full year as legislation was enacted in the fourth quarter 2008. Additionally, in the fourth quarter 2008, the Company reduced its tax provision as a result of increased tax credits attributable to an increase in domestic content of products we manufactured during 2008. We should note that until legislation passes providing the benefit for research tax credits beyond 2009, our tax provision rate will be unusually high.

Earnings per share assuming dilution for Q4 of 2009 were $0.29 compared to $0.27 for Q4 of 2008. Inventories were $45.7 million at quarter end. Net trade accounts receivable were $68 million at quarter end, resulting in DSOs of 50 days for the fourth quarter of 2009 compared to 43 days for the fourth quarter of 2008. Unrestricted cash and marketable securities totaled $305 million at quarter end, after paying $5.7 million in dividends during the fourth quarter and after repurchasing 596,000 shares of common stock for $13.1 million.

Due to the book and ship nature of our business and the timing of near term revenues associated with large products, it is our policy not to give specific guidance for the quarter or for the year. We would like to give color to help you formulate your views on our near-term business outlook.

We expect first-quarter revenues to be down in the range of mid to low single digit percent on a sequential basis due to seasonality. For the first quarter, we believe we will execute in a range consistent with our historic operating model at the achieved revenue level. We believe the larger factors impacting the revenue we've realized in the first quarter will be the following -- spending levels at our Tier 1 and Tier 2 carrier customers, the adoption rate of our Total Access 5000 platform, upgrades for wireless infrastructure, the award and timing of broadband stimulus funds and program participants. Tom, back to you.

Thanks, Jim. Christy, at this point we're ready to open up for questions.

Thank you. (Operator Instructions). Your first question comes from Jim Suva of Citigroup.

Great. Thank you, and congratulations on a great quarter. Just a quick clarification. When you talked about the tax rate being higher in 2010, I assume that's because the tax research and development credit has not passed; is that fair? And what type of tax rate should we expect before and then after such change in legislation?

Sure, Jim. Yes, that is because the legislation has not yet passed. We've been told to expect it to pass some time during the second or third quarter of next year. Assuming it does pass, we expect a credit in the area of about $2.8 million for the total year 2010.

Okay, and then on your gross margins, you saw really nice improvement in the December quarter. Should we expect to see nothing outrageously of a decline, but maybe like a 50 basis point decline in March quarter? How should we think about the seasonality and your great improvement in gross margin this quarter looking forward to the March quarter in 2010?

Well, we certainly don't provide that level of granularity in the color we give on gross margins, although we do anticipate gross margins to continue to be in the high 50s for the first quarter. And Jim, I think that's about the best we can do at this point.

Great, thank you and congratulations.

Thank you.

Your next question comes from Paul Silverstein of Credit Suisse.

Tom, in terms of the growth of your optical business relative to the wireless backhaul and the implications for the decline of HDSL and other copper based systems, ADSL, et cetera -- can you give us some more insight? I know you've gone into this issue in the past. Can you revisit and give us more insight in terms of the tradeoff between the growth in optical and the decline in copper relative to the wireless backhaul opportunity?

Well, we can tackle that from a couple of different perspectives. First of all, let me get the premise right. When we're talking about wireless backhaul, I don't think ADSL is a portion of that. I think we're really talking about HDSL and the impact of HDSL as things move to the fiber. And we saw a strong indication of that I think in the third quarter where we saw a depressed HDSL number, but a very meaningful uptick in our optical number, and a similar nice fourth quarter with our optical business but still yet a depressed HDSL number. So we think the net of that can very well be positive as people move -- we need to continue to win market share and get our piece of the optical business, but we think that can be a positive move. And I've talked about the average price per unit -- I think there was a fairly lengthy discussion on the last conference call about that. But we think the net is still very positive for us.

I'll pass it on, thank you.

Your next question comes from Sanjiv Wadhwani of Stifel Nicolaus.

Thanks, a couple of questions. Tom, what are you thinking about carrier CapEx in 2010, just broad strokes?

We see the same reports that you see, Sanjiv, and I think our focus has been more so, although carriers tend to move their dollars up and down on a year-over-year basis. We tend to try to focus on where they're actually going to spend the dollars. So we think there will be more robust spending in 2010 in wireless backhaul. I think most people are of like minds on that. If you get to some of the smaller carriers actually or let's say some of the Tier 2s and larger Tier 3s, we think there's actually incremental movements up in CapEx or definitely shifts towards the type of products that we can sell. So in general, I don't think it's going to be a robust environment, but I think you have to be at the right place and be selling the right products.

Got it, and then for 2010, as far as HDSL expectations are concerned, are you expecting it to be down maybe not as much as 2009 or as much as 2009, any color there?

Well, the short answer to your question is we do expect it to be down. We would be surprised to see it down at the same level and explain that. I think that what happened to us and us trying to understand what's going on in the HDSL business, I think 2008 -- if you'll recall, the third quarter of 2008 was a very, very strong quarter. I think it may have been the second highest HDSL quarter in the history of the company. A lot of that was wireless backhaul, and I think there's a good chance of what we were seeing in 2008 was a shift towards more wireless backhaul being part of the underlying HDSL number.

And as we entered 2009, I think that the underlying -- let's say the non-wireless backhaul portion of HDSL was probably hurt by the economy. I think that probably was happening in 2008 also and the last half of 2008, and I think as we rolled into this year, we saw people -- we saw that refocus on the fiber optic piece of wireless. And I think the underlying HDSL business was just depressed because of economic conditions. So we don't expect -- we didn't see that same kind of real big upturn in HDSL in 2009. So I don't think we have the same cliff to fall off of in 2010. And because of that, we think that the numbers won't be depressed as much, although we're not going to try to put an exact figure on it.

Got it and one last question for Jim. 10% customers for Q4?

Sure, Sanjiv. AT&T came in at 20%, Verizon at 12%, and Qwest at 18%.

18%?

Yes.

Thanks.

Your next question comes from Todd Koffman of Raymond James.

Thanks very much. You called out really strong Total Access 5000 revenue in the third quarter. Was that more than 10% of revenue? And then totally unrelated to that, in the conversation about HDSL, you've been doing around $35 million now a quarter for the last few quarters. How does that split between wireless backhaul versus traditional business, wireline connectivity?

On your first question, yes, we're definitely over 10%. We're going to just for competitive reasons probably not give more granularity than that. We don't expect it to fall below 10% going forward, so we're pretty comfortable with that characterization. As far as the piece on HDSL, and that is wireless versus non-wireless, I really do wish we knew the number. We ship to warehouses, typically RBOC warehouses, and from there, it goes out into the field and we're not privy to exactly what the locations are or what the specific use is. I would say there's no doubt in 2008 that the HDSL number was more shifted towards wireless. I would say in 2009 it was less shifted towards wireless, but it's hard for us to get any more granular than that.

Thank you.

Okay.

Your next question comes from Vivek Arya from Bank of America.

Thank you. Good morning. Two questions. First, Tom, what's to prevent HDSL from declining double digits in 2010 also? Because it appears that your newer products are cannibalizing in some instances a lot of HDSL sales, and in some other cases, the carrier small and medium size activity has not picked up. So could you please help us understand what would help stabilize HDSL sales?

Yes, sure, sure. Let me just give you my perspective on the market. I think it is predominantly a Tier 1 market, so we don't see nearly the activity in the Tier 2 or the Tier 3s and never have. I think that their business connectivity models are just different. And so a lot of business deals falls into the Tier 1 carriers.

And if we look at the Tier 1s, there's an underlying use of HDSL, which is business connectivity, interoffice connectivity, just general connections. And for instance if you look at how CLECs actually do business, predominantly that's T1 connected utilizing lines from the incumbent carrier. There's an underlying level of business there that, although we would expect it to decline over time, we don't expect to see the same type of decline that we saw in 2009 attributed to that. The wireless piece comes and goes, so there are times where we'll see an increase in specific areas and then there are other times where we won't.

We think in 2009, we saw a very strong focus on fiber connectivity. You saw that in our fiber business. We thought that was actually a positive thing for us. But in 2010, we're not saying that that fiber focus will change. We very well could remain at the same level that we saw in 2009. We think that will be positive for us on the optical side of the business. We don't think -- of course it will not void the HDSL piece of the business, but we're right now under the belief that the hit that HDSL was going to take in wireless has probably been taken.

Got it, and secondly, on Broadband stimulus, if you look at the kinds of carriers and other entities that have applied for funding, does that line up with who you thought would apply for funding? I'm really trying to get at -- is that a sustainable source of upside or do you think it could be a one or two quarter lift? And then just a one off thing for you or do you think that it can actually sustain over the next few years?

Well, I think that the -- let's talk about broadband stimulus and step back just to get our understanding anyway or relate to you our understanding where broadband stimulus sits.

The first round, as you know, we're going through right now, and I think about 18 awards or so have been awarded. So a very small number of the first round total available funding has been awarded today, although we expect that to continue on, and at this point in time I think the NTIA and RUS are saying they will have all of the first round of funding to be sent out by end of February.

If you look at the current take on the first run, as far as if you look at the 18 people that have been awarded, which is a very small set to be looking at -- it's not substantially different than we would have expected. Probably a little bit more than half our last mile at this point in time in what's been awarded. We would expect there to still be a last mile component, which of course we will probably fare the best.

The second and third round of the funding is still scheduled for later this year with all of those awards being made by the end of September. I think September 30th is the current target date. I don't expect that to change. That has been something that's stayed consistent throughout all of this.

And there are some rules that have just come out recently I think in the last week or so regarding where that's going to be spent or at least the target areas of where that's going to be spent, and a large percentage of that is towards areas that we play in. So I'd say at this point in time the way the new rules have come out, they're aligned with where we thought they were going to be.

Now all of these awards are made by September 30th. The last piece of news I had on when they had to be spent or how long the implementation cycle could be would be somewhere around two years. So I think we're talking about awards being made, some dollars being spent, but the dollars continuing on for at least some period of time.

And just one last question on margins. As I look at the performance over the last three years, your gross margins have been around 59% to 60% -- very strong in that range. Operating expenses have been about 38% or so of sales, so operating margins have been about the delta 21% to 22% of sales. What's going to bring them out of that 21% to 22% band? Is it just faster sales growth? Like what will it really take to help you grow margins beyond this 21% to 22%? Thank you.

This is Jim. As we implied in our press release, we do expect 2010 to be a growth year in terms of revenue. We also expect OpEx to grow, but not as high a rate as revenue, which would cause the operating income line to move towards the mid 20s for the total year. So that's our thought on it at this point.

But I'll just add this one less positive comment, and that's the mid -- the range that we're in right now is not a range that's uncomfortable to us, and we have to continue as we grow the revenue line to invest in being able to continue that growth.

Okay, great. Thanks and good luck.

Your next question comes from George Notter of Jefferies.

Hi, thanks very much, guys. I wanted to ask about the TA5000 customer count. I think you said it's well over 100 customers now. Can we get the comparable numbers? Do you have that number for Q3 end and then maybe the year ago quarter as well?

We don't. I will tell you facetiously it was less and substantially less. We picked up an awful lot of customers this year, so if I look at it from a year ago number -- first of all when I said it's way over 100 or substantially over 100, I really mean it's not 110. My nervous about getting granularity on that is there's an awful lot of competitors that really try to dig into what's going on with the Total Access 5000, and I'd just like to be prudent about what we talk about it. But it's substantially more, and we picked up an acceleration of customer acceptance through the year, so we picked up more in the second half of the year than we did in the first half of the year.

Got it, okay. And then I want to ask about broadband stimulus also. I think you said on the monologue that you're not going to get the benefit in Q1. I know if we go back to October, you were saying you would get the benefit starting in Q1. And I don't know that I heard you say exactly when you think you'd start to see that kick in for you from a P&L perspective. Is there a new target now? Would that be Q2, it would be Q3? And then also, how do you think about the timing of revenue recognition? I know that for RUS deals traditionally, it's taken some time to get those over the goal line from a rev rec perspective. What are your thoughts there? Thanks.

George, this is Jim. If there were statements earlier on about a potential impact in Q1, it was before we saw the slips we've seen over the last few months, and there's been at least two slips in terms of the timing of the announcement of the awards.

Sorry to be defensive about that, but I think we've tried to caution people that we're dealing with the government and we're dealing with carriers, and those two things don't necessarily mean that all the time lines will be met. But we're in effect -- because of the fact that it's government and carriers that we're talking about, are trying not to forecast specific dates on when we would actually see a benefit for the revenue, which is one of the things I've tried to mention as far as total impact and total timing.

It's real easy to go to different sites and talk about it and see how many awards are actually -- have been made. Once those awards are made, then you have to then deal with the carriers' time line on exactly when they implement those awards. We can say definitively 18 awards have been made. At this point in time, the expectation is that all of the first round awards will be made at the end of February.

You can surmise that there actually may be a benefit in Q1, because some of those first round awardees are ADTRAN customers, that we could see a benefit in Q1. Where we are right now is we're not going to try to forecast that, because there are -- there's nothing in stone that we can say that this is the trigger point and this is actually when money starts flowing.

Got it, great. And then just the follow-up was timing of rev rec. Does it take longer to get revenue recognition on a RUS deal once you ship the product to the customer?

Typically, George, it does not. We're not expecting a delay beyond what we see now in terms from the shipment date.

Got it. Thank you.

Okay.

Your next question comes from Cobb Sadler of Catamount Strategic Advisors.

Thanks a lot. I had a question on the gross margin. It looks like it was up about 90 basis points quarter on quarter and affected last quarter by rush orders, so I'm assuming you had less rush orders this quarter. Was that the sole increase in the gross margin or was it more product mix?

This is Jim. I think it would be fair to say that we had less expediting costs in the fourth quarter than we experienced in the third.

Okay, and on the EF&I vendors into the smaller carriers, have you done any work or do you guys have any idea what their lead times are versus normal lead times? I'm just wondering if they're overwhelmed with the amount of stimulus orders they're getting now.

I'm not aware of anybody being overwhelmed by stimulus orders. We did see -- and this is a broader topic, we did see some tightening in overall supply chains in Q4, especially at the beginning of Q4 which loosened up towards the end of Q4. But specifically to EF&I, I'm not aware of any tightening.

Okay. And then on the Internetworking side, can you break it out? Were you strong on the enterprise switching side or the IP telephony side? And what's responsible for the growth there -- any new distribution partners or what's behind that strength there?

Really, it was fairly broad based. Internetworking in general has continued to grow. We saw good growth last year out of our switching products. Of course, the 900e, which is our IP gateway products, continues to just really shine. So I'd say it's fairly broad based.

Okay, great. Thanks a lot.

Okay.

Your next question comes from Simon Leopold of Morgan Keegan.

Great, thank you. Let me start off with hopefully a simple one. Accounts receivable have been creeping up slowly. Just wondering if we should read anything into that and what's behind the trend?

Simon, receivables is up more in the fourth quarter than it typically would be. And as we entered the fourth quarter, we did see extended lead times on certain components that caused us to ship later in the quarter, although our order flow for the fourth quarter was fairly typical. It was fairly linear until the beginning part of December, and then it fell off as it would normally do. But the revenue recognition was loaded a little more heavily to the back as we resolved the lead time issues as we approached the end of the quarter.

So resolved means that we should anticipate maybe a little bit lower DSO in the next couple quarters?

I would anticipate it. Somebody drops in an awful lot of XYZ and we don't have it, we may have an issue. But there was no doubt that the supply tightness actually moved out some meaningful shipments into the second half of the quarter instead of the first half.

Okay. Understanding that the forecast for Q1 and normal seasonal effects, that all makes sense, so no pushback there. But just wondering if there are some other aspects to it, particularly some of the maybe project activity around the TA5000 for sell-side backhaul at some of your larger customers. Has there been any deferrals or delays in projects that a quarter ago you expected would be ramping?

No. There haven't been any deferrals or delays. Now in general when we're talking about the Tier 1s and where they are with their timeliness versus where we would like them to be if I look back over the last year or so, there continued to be movement. But not substantial movement, and I would say no, there are no big delays in Q1 that we were expecting.

So given the disclosures on the top customers, AT&T was down sequentially by a chunk, and just wondering what might be behind their purchasing less in the December quarter?

Well, seasonally they're almost always down, number one, and number two, they were a very strong optical customer in the third quarter. And I would say we typically see them go down in the fourth quarter, and we saw that. And if you had to pick a product area, I'd say it's probably optical.

And then just one last one. You talked about your outlook for international sales and the prospects there, which make sense. Just wondering how much of that would be based on trying to go direct and maybe put a little bit of pressure on your operating expenses and how much might be betting on or partnering with a larger Tier 1 partner to go international?

Our comments around OEM relationships would be very similar to government relationships, in that when you have two large partners or two large entities that are trying to drive your -- that you're betting on for revenue you can be surprised. So all of our comments, I'd say the majority of our feeling right now has been around the direct channel, because I think that's more near at hand or at least more drivable from us. There are specific opportunities with OEMs that are not international in nature that we feel very confident in, but my comments about international are direct.

Okay, great, thank you.

Okay.

Your next question comes from Blair King of Avondale Partners.

Hi, thanks for taking the questions. I have just a couple of questions that try to come back to the margin discussion. It sounds like, Jim, there was a fairly linear order flow in the fourth quarter which helped drive the sequential gross margin improvement. Would you expect similar order flow pattern in Q1?

Blair, it's very hard to say at this point.

Okay.

We can talk about what the normal Q1 order flow is.

The normal flow in Q1 is typically it starts off slow in January and it increases as we go through March. It's the normal order flow. But in terms of whether or not we incur less or more expediting costs in the third quarter because of customer request dates it's very hard to predict at this point.

Okay, and then you'd mentioned last quarter that the OpEx line would grow sequentially, given some development projects that were taking place. And I guess the question is if there's any granularity around the OpEx line that you could give us for the first quarter relative to some of the projects that were taking place in the fourth quarter, if those have completed or if we should expect to see the OpEx trend continue to move a little bit higher?

We do believe in the first quarter that OpEx would move slightly higher on a sequential basis.

Okay. All right, appreciate that. Thanks, Jim.

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

Yes, thank you. Just wanted to focus a little bit on the Internetworking and Enterprise Revenue segment. I'm wondering if your plans call at any point for introduction of a wireless mobility product? And if so, if you can give us some read on what you guys are thinking in terms of either developing something internally or maybe looking to acquire some technology?

When you're talking about wireless mobility, you mean, I can -- ?

A wireless LAN type of a system approach.

As in a WAP based or wireless access point type product?

Yes.

Okay, so the answer to that is yes. We've actually had a first generation of our wireless access product that we're delivering now, and of course we're working on subsequent products to that or subsequent branding out of that product offering and actually a new generation of that. We also -- now we're shipping one, other ones will be shipping this year. We also have introduced our first 3G connectivity product on our router products, which show how typically used for fallback on our routers and allow people to be actually connected through the 3G network.

And along the same lines, as you continue to pursue your strategy in the UC market, how are you going about that? Are you trying to forge partnerships with some of the computer vendors or can you give us some color as to what your approach is?

We announced, I think last quarter, our first UC product, which is actually a Microsoft-based desktop client and server model that works in conjunction with our 7100 series IP-PBX's. And what that allows us to do is actually get the unified communication type services to the end-user, so they can do things like click to dial and very advanced call routing. It also -- because of the nature of the product and at the same time, this is a higher level product than maybe a smaller size SMB would traditionally buy. We announced the increased capability of our product to handle up to 2,000 users. So it's a fairly big move in Q4. All of that is ADTRAN product.

Thank you.

Okay.

Your next question comes from Ari Bensinger of S&P.

Yes, thanks, all my questions have been answered.

Okay.

Your next question comes from Larry Harris of CL King.

Yes, thank you and congratulations on the results for the quarter. I noted in terms of the gross margin guidance, as you've previously indicated you expect it to be in the high 50s. But I was just wondering -- as maybe some of the mix changes, maybe HDSL becomes a less a percentage of revenue, the optical products are perhaps a greater percentage, same thing with Internetworking. Do you think that will have any quarter to quarter impact in terms of gross margin?

Larry, this is Jim. Any impact in that regard, we still believe that it will be within the high 50s in terms of gross margins. Certainly there's going to be variations quarter to quarter, but again not outside of the high 50s range. Us being a book and ship business certainly is hard to predict mix from quarter to quarter as well, and that's why we're so guarded in terms of being specific on gross margin. But if you look at our various product categories, our general product categories, they're fairly consistent in terms of the gross margins that they provide.

I would add that what tends to be the bigger swinger for us -- and when I say bigger swinger, it may move it 1 point one way or another -- will be expedited charges. So when we typically see a lower gross margin from quarter to quarter, a lot of times what we'll find out is that orders were placed for a product that wasn't expected, which is not atypical of our customer base, and we're having to scramble to get the material in here and get them built.

Just another question relative to Embark, I guess they undertook the Century Link transaction. But I noticed there hasn't been any commentary with them as a 10% customer over the last couple of quarters. Has there been any change in terms of relationship with that account, or are they taking a second look at their capital expenditures?

Now that is such a customer-specific question, that I would really get in trouble if I answered it as much as I would like. I will tell you -- let me just say Century Link is a very good customer of ours. We're very hopeful for the future, but I really can't say much more than that.

I understand that completely. Okay, thank you.

Okay.

Your next question comes from Bill Dezellem with Tieton Capital Management.

Thank you, a couple of questions here. First of all, would you please discuss the reasons that you believe the TA5000 customer wins accelerated through the course of 2009? And tying in with that, what is the typical lag time from a customer win to the time that you begin to receive meaningful revenues from the customer?

Sure. I think one of the biggest reasons for the increase in the order rate has been just actually our delivery of new features. So the Total Access 5000 does a significant number of different things from aggregation to Broadband DLC to fiber to the prem. So there's a lot of disparate things, which is one of the real benefit for the product, because it can actually be put in place and do business class services as well as residential class services. And there's really not a product out there that can compete from a feature perspective with the overall capabilities.

But having said that, when you have such a capable box and you have multiple tiers of customers -- as you know, we're selling to Tier 1s, Tier 2s, and Tier 3s -- you're having to juggle which features get done what, and we just continue to work on a backlog of engineering priorities associated with specific customers for that product line. And as time goes on, it opens up new opportunities or it allows the customer to actually start purchasing something as we make the commitments we may have given them six months or a year before. So I think that's probably the biggest rationale for what we actually saw there.

And the lag time?

The lag time unfortunately varies from customer to customer. Tier 3s -- the smaller the carrier, typically, the faster the conversion or the faster they actually start accepting the product. So we have had some instances where we are awarded the product win and we will get an order next week, the following week. If you're talking about the Tier 1s, you can be awarded the product and you will ship it 2.5 years later.

Back to your point about the feature backlog, are you seeing that your R&D group is catching up with the feature requests? Or as time progresses, are customers identifying even more things, and therefore you're either just holding your own and not decreasing that feature backlog or you're in fact seeing the feature backlog increase?

To take a snapshot at this point in time, I would say that we are more than holding our own. I think we're getting through a very major development. We've had some very strong feature releases in 2009 that really unleashed a lot of backlog, which is why I think you saw that acceleration through 2009 of the acceptance rate of the product. And the reason I say, that's if you take a snapshot, because if you look at 2010, there are yet other markets that aren't necessarily directly correlated with where we're selling today that the Total Access 5000 was envisioned and architected to be able to play in, and that will lead to a whole new set of requirements, a whole new set of customer applications that we have yet to embark on in a meaningful way. We have started development, but we haven't hit that crossover or that crunch time point yet.

And does that tie in with the international market, or is that something entirely separate? And if it's entirely separate, would you discuss in further detail what you really meant there?

It is both for the US market and for markets outside of the US, and I would rather not discuss that at this point for obvious reasons.

And then one final question. It appears as though you were right on the verge of your growth rate accelerating as the traditional products become a smaller percentage of your revenue, gross products become a larger percentage of your revenue, and you're saying that traditional products will decline at a slower rate in 2010 than 2009. And clearly the growth products are getting some real strong traction with the positive 42% revenue growth. Is that a correct way to be thinking about your business as we go through 2010 -- that the growth rate should be accelerating?

I can tell you that's exactly how we think about the business. If we look at what happened to our traditional products from 2008 to 2009, we believe that there is a recessionary impact and a conversion impact on the wireless side that accelerated that decline. Having said that, we were okay with that decline. We knew that those products were going to decline, and we thought coming out of the year, the performance of our growth products were strong enough to where we were very comfortable with how the year turned out. Having said that, 2010 should not be a recessionary year and we expect growth. So I think the way that you characterize it is actually the way that we tend to look at it ourselves.

Great. Thank you.

Your next question comes from Ehud Gelblum of Morgan Stanley.

Tom, I think you mentioned before that the broadband stimulus money --once it gets released in September of this year, September 30th, that it would be spent over two years. Is that what you had thought before? I thought there was going to be -- the spending requirement was going to be tighter as opposed to two years.

Well, you bring up a good point and you're probably talking about a Supercom discussion that we had, which we subsequently did come out and say no, the awards are X. So the answer to your question is we do have a better understanding of what that process is, and that process is one that allows at least a two year timeframe for the buildout to happen. The only thing that hasn't changed, of course, is the September 30th date is when the awards have to be made by at this point in time.

So it is relatively new that the spending could be spread out?

From the week after Supercom?

Right.

Okay, yes, so yes.

Appreciate that. Now -- Qwest seems to have been pretty strong now for a little over -- about a year, they're in the $20 million to $25 million per quarter rate -- I know this comes up every so often. But is that -- when you look at the strength of their spending over the last year -- is there some sort of an initial project build that's been going on, and at some point over the next couple quarters the initial project build ends and we go to more of a run rate basis that might be lower than $20 million to $25 million a quarter for them?

Again, very customer-specific question. Let me just say we're very comfortable with where we are with Qwest, and I think that Qwest is one of those customers we expect to have a long-term relationship with and that we have a lot of things going on and we don't see with the mix of products that we're now selling to them -- by the way, they are a very good 5000 customer and use that for multiple applications and really started rolling into that in the second half. We're very comfortable with our long term prospects and our medium and short term prospects with Qwest.

So you think it should stay roughly at the same level, you expect it to?

I don't want to talk about Qwest specific capital expenditures, so I'd rather not get any more specific on that.

Okay. Appreciate it. As you look at HDSL, this question came up before, but I'm trying to get a little more granular. The two main end markets were HDSL or enterprise connectivity and wireless backhaul. Both are conceptually moving to Ethernet services. It appeared that the wireless backhaul is moving faster, I think? Would you characterize that? And would you say that -- I know you don't have great visibility. Would you think that the split between enterprise connectivity is end market for HDSL and wireless backhaul -- do you think the split has changed over the last year?

I think definitely the split has changed over the last year. I think that we saw an increase -- and for fairly obvious reasons that we saw an increase in 2008 towards the tail end of 2008 as people just wanted to connect up or needed to connect up their wireless network. And HDSL was the game in town, and they really started hitting hotspots or trouble areas that may have been more rural than they would necessarily hit where they have fiber or can actually trench fiber. We saw that happen in 2008, we saw that not happen in 2009. But we did see then fiber connectivity happen in 2009, which we tend to characterize as being more urban than what you saw with HDSL.

That conversion that you're talking about the Ethernet I think is absolutely happening. I would say that where we are with Ethernet over copper and where we are with some of our fiber products, we have a fairly good visibility to that. And although people are getting today their Ethernet connectivity as a service that they buy from the carrier, because the lack of a native Ethernet infrastructure in the US, it is still predominantly delivered -- by far predominantly delivered over a TDM infrastructure, and that there will be some time for that shift to happen. And our goal is to make sure that we're positioned right when the native services start being delivered. But it is predominantly today over TDM infrastructure and it will take some time for that conversion to happen.

Okay, and then as you look into HDSL for 2010, you said you obviously expect it to be down but not as much as it was this year. How do you expect the skew between those two, the story to change next year? Do you think that the wireless end market falls faster than the enterprise or vice versa?

I think it's a really good question. You know where we are with our Ethernet over copper market share in the US, so you can understand what our feelings are there. I think that you'll see -- in the larger areas you'll see conversion to native Ethernet. I think you're seeing a little bit of that today. I think you'll see that accelerate in 2010. Our hope is that you'll see a meaningful acceleration in the copper connectivity using native Ethernet because of where we are with market share, but the timing of that has been very, very fluid. So I'm not sure if I really answered your question.

Which do you think falls off faster?

Which one do I think will be adopted faster, fiber or copper?

No, as you look at wireless versus enterprise, your two end markets for HDSL, you think the buying falls, but which falls off faster?

I think we saw a good chunk of that fall off this year in wireless, in 2009, so --

Wireless should be more steady than enterprise as the end market for HDSL?

You're saying which baby do I like the least, and only -- I don't see the native Ethernet copper infrastructure having enough mass in 2010 to substantially change the profile of the business customer. And we're expecting it to go down but it's going to be -- the decline of that will be driven by the availability of a competing technology. And so we characterize what happened in 2009 as being more wireless demand decrease, not Ethernet conversion, because the majority of those Ethernet services were -- by far the majority were deployed over a TDM infrastructure.

Right, but you are expecting HDSL to be down again?

We are expecting it to be down. We are absolutely expecting it to be down, but I won't tell you if it's going to be more wireless driver or Ethernet business driven because I don't know.

Okay. I appreciate it. Thanks, very helpful.

I think we have time for one more question, Christy?

Your final question comes from Brian Coyne of Wedge Partners.

Thanks for taking my call. I'll take a chance to come back to the gross margin question and I guess really just your longer-term view of the opportunity for that to expand. And I guess if you think about the HDSL decline in 2010 not being as much as it was in 2009, you've got growing volumes of your other products growing -- and perhaps some product specific costs related to the Total Asset 5000, maybe they don't run quite as hot as in 2009, at least a portion that shows up in R&D are capitalized. Why shouldn't we think that you guys ought to be comfortably over the 60% range on the gross margin side after let's say the next three or four or five quarters?

This is Tom. I would say the reason for that is number one, history. So if you look at where we've operated in the past, this is a company that has gone through several -- over the last three to four years, several legacy product transitions. We talked about what happened on the enterprise side, us finally flipping over to by far the revenue being driven by our growth products after being a TSU/CSU manufacturer for years. And if we look at the -- as those transitions happen, what you'll see us do is continuing to use the flexibility we have in order to garner market share at a faster rate. So if things were to stay static, I would agree with your argument. We continue to plan on aggressively pursuing market share with our new platforms and using the flexibility that we have to continue to grow the top line.

Got it, that's all I had. Thank you.

Okay, all right. Well, thank you very much, everyone, for joining us on our call and we look forward to talking to you next time.

Thank you. This does conclude today's conference call. You may now disconnect.