ADTRAN Holdings Inc (ADTN) 2010 Q3 法說會逐字稿

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 effects 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 of Form 10-K for the year ended December 31, 2009 and Form 10-Q for the quarter ended June 30, 2010.

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. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a Q&A session. (Operator Instructions) Thank you. Mr. Stanton, you may begin your conference.

Thank you, Keena. Welcome to Adtran's third quarter 2010 conference call. Joining me on the call is Senior Vice President and Chief Financial Officer, Jim Matthews. I would like to begin by providing you some insight into the Company's performance for the quarter and comment on the outlook for the fourth quarter. Jim will then provide the financial results for the third quarter. We will then open the floor up to answer questions. As stated in our press release, Adtran had record revenues of $163 million for the quarter driven by accelerating demand for higher speed services from residential and business customers in both fixed and mobile applications. Both carrier and enterprise divisions continued to benefit from these trends.

The Carrier Networks Division reported a strong 30% increase in revenues over the same period last year due to a number of factors including increased deployments of infrastructure for higher speed broadband connectivity, accelerating demand for mobile bandwidth as carriers continue to upgrade infrastructure to alleviate network congestion, increased deployments for business ethernet connectivity driven by network convergence, the need for higher speeds and the growing demand for native ethernet services, market share gains with Tier 2 and Tier 3 carriers and a generally improved telecom spending environment.

Our Enterprise Networks Division benefited from another strong performance in its Internetworking category which grew 39% over the same period last year to another record revenue level. This category's performance was driven by continued growth in our expanding dealer base, market share gains and market growth from competitive carriers, market share gains in our SMB router and switch product lines, and an improving enterprise spending environment.

During the quarter our combined growth areas -- Broadband access, Internetworking and Optical Access delivered yet again growing to our record revenue level. For the first three quarters of 2010, these areas achieved revenues of $252 million an increase of $68 million or 37% over the same period last year. Broadband access had a strong performance for the quarter achieving another record revenue performance overcoming a traditional seasonal trend. The strength was driven by the continued acceptance of our Total Access 5000 platform. This platform benefited from an increase in shipments to all our Tier 1, Tier 2, and Tier 3 carrier segments.

As previously mentioned, Internetworking achieved a record revenue level. Growth in this category occurred across all our distribution channels including Tier 1 and Tier 2 carriers, competitive carriers, and our growing VAR dealer base. Our mobility products including Optical Access and HDSL were up significantly as these products benefited from accelerating infrastructure upgrades.

Now moving on to the fourth quarter. As many of you know our business is seeing positive impacts of our focus on Broadband investment, mobility upgrades, and our belief in the convergence to an ethernet-centric architecture. This has lead to revenue growth for our Company this year in excess of 20% and we expect this trend to continue for the fourth quarter. Positive trends impacting our business include increasing order activity from Tier 2 and Tier 3 accounts, and continued robust demand for internetworking and mobility products. For broadband access, we anticipate our Total Access 5000 platform will continue to see increasing revenues resulting from market share wins and Tier 2 and Tier 3 accounts.

As all of you know, our fiber-to-the-node products typically see seasonal decreases in the second half of the year and we expect to see the same pattern for the fourth quarter. Our internetworking products are expected to continue their long pattern of sequential growth as we expect our VAR channels and capitalize on market share gains in Tier 1, Tier 2 and competitive service providers. Our mobility products including Optical Access and HDSL are expected to also be impacted by seasonality. All of these factors allow us to enter the fourth quarter with a higher degree of confidence. Although in totality, our current projections do forsee seasonality.

The factors I previously mentioned coupled with increasing activities we are experiencing outside of the US and the benefit from broadband stimulus lead us to believe we are well positioned for meaningful growth in 2011. Looking forward, our industry is in the early stages of shifting from TDM to ethernet architectures. Rapid adoption of applications is leading to unprecedented demand in bandwidth. Carriers must increase deployment of fiber deeper into their access networks and deploy newer technologies to leverage their current infrastructure.

We feel that Adtran is well positioned to address this transition with the industry's broadest portfolio of access solutions that meet both carrier and enterprise customers needs. We believe Adtran is uniquely positioned providing the full suite of fiber and copper products targeting broad-scale, urban and rural deployments for residential and business applications. At this time I would like to turn things over to Jim Matthews to provide you with the financial details for the quarter. Following Jim's comments, we will then open the floor up to questions. Jim?

Thank you, Tom and good morning everyone. Revenue for the third quarter increased 27% to a record level of $163 million compared to $128.1 million for Q3 of 2009. Broadband Access product revenues for Q3 of 2010 increased 53% to a record level of $45.1 million compared to $29.5 million for Q3 of 2009. Internetworking product revenues for Q3 of 2010 increased 39% to a record level of $29.5 million compared to $21.3 million for Q3 of 2009. Optical Access product revenues for Q3 of 2010 were $18.6 million compared to $20.1 million for Q3 of 2009. Carrier Systems revenues for Q3 of 2010 increased 28% to a record level of $76.3 million compared to $59.9 million for Q3 of 2009.

Business Networking revenues for Q3 of 2010 increased 29% to a record level of $33.8 million compared to $26.1 million for Q3 of 2009. Loop Access revenues for Q3 of 2010 increased 25% to $52.8 million compared to $42.1 million for Q3 of 2009. HDSL product revenues increased 31% to $49.4 million for Q3 of 2010 compared to $37.6 million for Q3 of 2009. As a result of the above, Carrier Networks Division revenues for Q3 of 2010 increased 30% to $128.6 million compared to $98.6 million for Q3 of 2009. Enterprise Networks Division revenues for Q3 of 2010 increased 17% to $34.4 million compared to $29.4 million for Q3 of 2009. International revenue was $8.3 million for Q3 of 2010 compared to $6.7 million for Q3 of 2009.

To provide the reporting of each of these categories, we have published them in our Investor Relations web page at Adtran.com. Gross margin was 59.7% of revenue for Q3 2010 compared to 58.1% for Q3 of 2009. Research and development expenses were $22.8 million for Q3 of 2010 compared to $20.5 million for Q3 of 2009. This increase in expense was primarily related to an increase in staffing costs and customer specific projects. Selling, general and administrative expenses were $29.5 million for Q3 of 2010 compared to $25 million for Q3 of 2009. This increase in expense was primarily related to an increase in staffing costs and selling activities in the US and abroad. Stock-based compensation expense net of tax was $1.7 million for Q3 of 2010 compared to $1.4 million for Q3 of 2009.

All other income net of interest expense for Q3 of 2010 was $4.1 million compared to $2.1 million for Q3 of 2009. The increase is primarily related to an increase in realized investment gains. The Company's income tax rate was 34.8% for the third quarter of 2010 compared to 30.4% for the third quarter of 2009. The tax provision rate for the third quarter of 2010 included a benefit of $522,000 resulting from the exercising of employee incentive stock options in the quarter. The tax provision rate for the third quarter of 2010 did not include a benefit from research tax credits due to delays in legislation to extend the benefit for research tax credits for the year 2010. In the third quarter of 2009, the Company recognized benefits from the research tax credits from FIN 48 adjustments.

Earnings per share assuming dilution for Q3 of 2010 increased 47% to $0.50 compared to $0.34 for Q3 of 2009. Inventories were $70 million at quarter end, up $6 million from Q2 of 2010. The increase was driven in large part by new installation services contracts in the US and Latin America which will be delivered in future quarters and a general increase in inventories to fulfill customer demand and mitigate supply chain constraints. Net trade accounts receivable were $69.4 million at quarter end resulting in DSOs of 39. Unrestricted cash and marketable securities net of debt totaled $367 million at quarter end after paying $5.7 million in dividends during the second quarter. Due to the book and ship nature of our business and the timing of near term revenues associated with large projects, 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. For the fourth quarter, we anticipate revenues will experience normal seasonality but we expect fourth quarter revenues to be sequentially down in the range of mid-single digit percentage points. At this revenue range, we expect third quarter operating expenses will be flat on a sequential basis. We believe the larger factors impacting the revenue we realize for the fourth 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 mobile, broadband infrastructure and improving enterprise spending environment. Tom, back to you.

Okay. Thanks very much, Jim. All right, Keena. At this point in time we would like to open it up to questions.

(Operator Instructions) Your first question comes from Paul [Beland] of Citigroup.

Hi, I have a few questions on the products. The HDSL grew 17% sequentially and the question is how much of it is related to AT&T building some capacity for backhaul capacity and then if that's the case, and the project started a while ago, does it mean that for next year, we're going to see reversion to the mean? The second part I have is about the TA 5000 or Broadband Access as a group. It didn't grow much sequentially. It grew 0.3% so it was flat sequentially after two quarters of very, very strong growth. Could you discuss the customer concentration there, project concentration and then what should be the outlook, what could drive renewed momentum in this category going forward? Thank you.

Sure. This is Tom. Let me try to cover both of those and if Jim wants to add any color he can. On HDSL, there's no doubt we were positively impacted. In fact, I think we've seen that impact earlier in the year and it just has continued to build because of wireless demand and data growth and people not only trying to cover, I think the current demand but also trying to get themselves ahead of the curve to some extent. And we continue to see that strong demand and our conversations with customers lead us to believe that, that's not a just a near term phenomenon that, that is something that will be going on for some period of time. We definitely expect to see an impact into 2011.

We're not at a position yet to try to give guidance on that specific product line for 2011 but we will at the end of next quarter's call. As far as the TA 5000, there are two pieces that you mentioned TA 5000 and then talked about the sequential decline. Actually, the TA 5000 was up and strongly up, if you look at Q2 to Q3 basis or definitely a year-over-year basis. The thing that was actually flat was Broadband in totality and that was impacted by a normal seasonal pattern that we see in our fiber-to-the-node products, so typically if you look at the Broadband category you would see it down, I think maybe mid to low single digits going from Q2 to Q3, that's a typical pattern for us. So you can surmise that if our fiber-to-the-node product saw typical seasonality that the TA 5000 was much stronger than that.

So can you discuss the outlook again, not in numbers, just in qualitative terms, the outlook for the TA 5000 in terms of -- do you continue to grow the number of customers or is there --

Oh, yes, without a doubt. We've added significant customers this year. We added significant customers in Q3 and now most of those were Tier 3 customers, that's probably the most active customer base right now but we are picking up market share. I think I mentioned in my comments we picked up market share in Tier 2 accounts also in the second -- excuse me, in the third quarter, so and I did touch on the fact that I expected the TA 5000. Now typically our businesses see seasonality across-the-board including broadband but I would at this point in time -- I would expect us to actually continue to get momentum in the 5000 through the fourth quarter, so and that's a mix of customer wins and just increased shipments into customers, a lot of which we've just really started shipping into. Okay?

Thanks.

Okay.

Your next question comes from Cobb Sadler from Catamount Advisors.

Thank you for taking the question. I had a question on the international business. I actually missed the number but can you talk about what's going on there, picked up the TelMex maybe starting to buy some more equipment and that was a big increase or back in 2007. I wonder if that's a sustainable trend and then also, what are you seeing in Europe? I guess there's been some talk that you've won a few deals -- access deals in Europe. Is that just more of the same or are you seeing an inflection point there? Thanks a lot.

Thanks, Cobb. I wouldn't call it an inflection point in Europe. I think that we're making progress and we've been working at it for some period of time and we'll continue to work at it but I don't see a near term inflection point. I just think we're going to see steady progress in Europe. In Latin America and it's a lot easier for me to talk about as region than it is customers for obvious reasons but in Latin America we have made significant progress there. And we're -- Jim had talked about the fact that we've actually received orders for some things that caused the inventory to go up a little bit and those are -- we have a very strong potential there. That will play itself out through 2011 but it's a -- we have very meaningful opportunities in Latin America. Very meaningful.

Got it, and then the Optical Access business was up pretty nicely. Is that any new growth initiatives there I guess or is that just going to be a lumpy business and it was -- it happened to be up this quarter?

No. I think a lot of that is also driven by the wireless piece of that and it's -- we saw some of that last year slow down at the beginning of the year and that whole area has picked up a significant amount of steam coming into the second half and we think that its got some legs to it so it was driven mainly I think by the mobility piece.

Okay, thanks very much.

Okay.

Your next question comes from Todd Koffman from Raymond James.

Thank you very much. Tom? You called out a bunch of share gains in the Tier 2 and Tier 3 carriers but in a lot of the Tier 2 and Tier 3 wins that you publicly talked about those are not Broadband stimulus award winners and I was wondering, how do you look at your success as it relates to your incumbency in the award winners of the Broadband stimulus program? Thank you.

I think we're -- our batting average is very, very good when you say incumbency in carriers where we are doing business in, it's very good. I think some of those have won awards and if you take a look at the dollar awards and the size of the awards per customer and where we're positioned with those customers, I think we show very well. We've also, now we are not incumbents in a lot of the Tier 3 accounts and we have picked up quite a bit of those. There's still an awful lot, I think the majority are still yet undecided so there's still an awful lot of -- I know people tend to want to read press releases and count the number of press releases but I can assure you we don't release everything. I would assume that our customers -- our competitors don't release everything. And even if you were to add all of those up in the ones that we have already won, there's still the majority that have not yet decided so there's still an awful lot of activity out there right now, but in the areas where we are incumbent, its got to be close to 100%.

Thank you very much. Good luck.

Okay, thank you.

Your next question comes from Michael Genovese from Soleil Securities.

Great. Thanks a lot. First of all, could you just give us the 10% customer break outs?

Hi, Michael, this is Jim. I'll give those numbers, so AT&T in Q3 was at 19% revenue, Verizon was at 11% of total revenue, and Qwest was at 19% of total revenue.

Great and then my question is I mean, there's not historically a ton of variability in your gross margin line and I don't really think of your different products having different gross margin profiles, but that being said, I mean, gross margins were slightly above my expectations this quarter as was the HDSL performance, so I'm wondering if there's any relationship there. Would the legacy products for any reason carry a slightly higher margin profile than the growth products?

Generally, no, Michael. So generally the products are in the same general range in terms of gross margins.

Okay, fair enough, and then finally for me, you just -- you mentioned a little bit about the inventory, 10% up sequentially. That's usually flat to down I think this quarter, so how much -- can you just put a rough cut on percentage-wise, how much of that growth in inventory would be due to supply constraints and how much is due to maybe better visibility into growth trends, better than seasonal growth trends in the fourth quarter?

Well, I don't have the exact numbers in front of me, but it's really a combination of three things and increasing demand from customers is certainly one of the major reasons inventory has increased along with the installation services contracts that we've been awarded. That was certainly a major reason for the increase. In terms of supply constraints, maybe not as much of the increase was related to that as much of that increase was in the second quarter so to speak, in terms of constraints or supply chain constraints, things are not getting worse. We're hopeful to begin to see things getting better, perhaps at the point of the first quarter when we expect to see inventories to come down at that point, and in terms of inventory levels at the fourth quarter, we're anticipating them to be flattish to the third.

Thanks a lot.

Your next question comes from Amir Rozwadowski from Barclays Capital.

Thank you very much and good morning Tom and Jim.

Good morning.

I was wondering, Tom, if we could speak a bit more about Broadband stimulus. It seems as though we've come towards the tail end of wrapping up some of the awards. I was wondering if you could provide us with some color in terms of what you think the opportunity may be for you folks and maybe even the fourth quarter or 2011.

Sure. So we did start receiving orders actually in the third quarter. We actually had some, I think probably some early orders in the second quarter and we would expect to see those to continue into the fourth but we're really not expecting meaningful shipments in the fourth so the color that Jim provided is net of any big stimulus impact and we are really starting to see those rollout next year. I think a lot of decisions actually will be made in the fourth quarter so I'd spoken earlier about the fact that there were a lot of the majority of them are hanging out there and people to decide what they're going to do if they had been awarded money. And we think a lot of those decisions, definitely a lot of the big ones, will be made in the fourth quarter, but we'll start seeing that roll into 2011 at some point in time, I would expect an impact, some impact in Q1 and then continue to accelerate from that point.

And in your prior commentary about seeing opportunities for growth in 2011, is there any color you can provide us where how much of that is based on current fundamental trends and demand trends and how much of that would be related to broadband stimulus coming in on top of where you see current fundamentals?

Well, Broadband stimulus is one of those that has been very tricky to forecast in. I think we've been very open about our inability to forecast it and so we think that, that will have an impact. That's an upside piece to it but to be honest, the underlying business of what we're doing in the Tier 1 and how that is growing, I talked about the 5000 growing in Q3 and a lot of that growth came out of the Tier 1s and we're very early into that piece. So if I look at that, if I look at the mobility piece which we fully expect to have an impact in 2011 and then I add-on to that the piece that we're doing outside of the US which is -- that's not a could happen type of thing.

That is, we've already started to execute on that. All of those make you feel better about 2011 and then the stimulus piece which very well, which will be meaningful, the problem with the stimulus piece is just trying to get the timing and what the ramp of that is. Does that really start in earnest in Q1 or does it start in earnest in Q3? We don't know that, so a lot of my comments about our ability to grow in 2011 are predicated on really no big event in stimulus although we're very much aware of the fact that it will have an effect in 2011.

Great. Thank you very much for the incremental color.

All right. Thank you.

Your next question comes from Paul Silverstein from Credit Suisse.

Hi, good morning. Jim, can I ask you, I know you don't breakout below 10% but given the pending Century/Qwest I was hoping you may give us some insight what the combined entity would be if that's closer to 30% collectively or not that much greater than the 19% you called out for Qwest?

Well I want to be careful with that, Paul, but I would tell you that, that particular customer was up sequentially in revenue meaning CenturyLink.

Jim so would it fair to say that it's a decent customer for you? It's not a small amount of revenue?

I would agree with your comment. It is certainly a decent customer for us as you would put it. So it's not a small customer. It's not a low single digit customer.

Okay, perfect. That's all I needed. Secondly, Tier 2 carriers or Tier 1, like CenturyLink collectively so FairPoint, Century, etc. Can you give us some sense for what those are collectively as a percent of your revenue?

Paul, I don't have those numbers before me but it's certainly a growing portion of our overall revenue, particularly in regard to the traction we're seeing in Total Access 5000 and our fiber-to-the-node products and even Optical Access.

Yes, Paul I don't have those numbers here either but I will tell you that this year that's been a very strong segment for us.

All right, and last question. I know you addressed this earlier but in terms of wireless, I know historically you've had trouble breaking that out, getting that visibility at the customer level but can you give us any sense for what that wireless backhaul business represents as a piece of revenue?

We have no more ability now other than to say that because of the conversations we've had with the customer, we believe that the upside that we saw was largely driven by wireless so if you take a look at last year, one of the reasons that we were a little more bullish on this year than a lot of people on HDSL was that we had thought we hit the bottom of the wireless bin, that we did not see really a whole lot of incremental wireless spend last year, so that we were really seeing enterprise demand piece and it was going through a recession. So I think, I wouldn't say that the business segment in the US is robust. It's probably picked up some but I wouldn't call it robust so if you could take a look at last year's and this year's and try to look at that incremental piece you would assume a large percentage of that would be wireless.

Fair enough. Thank you.

Okay.

Your next question comes from Ari Bensinger from Standard & Poor's.

It's actually Ari, but everyone is focusing on the carrier piece. It seems like your enterprise segment is really chugging along pretty nicely, Internetworking, if we see a sequential increase for Q4 should grow around the 40% range year-over-year. Can you give us your outlook on Internetworking and just the enterprise sector as opposed to the trends and the carrier?

Sure, and you absolutely bring up a good point. Enterprise has been doing, had a very good year so far this year and we expect it to continue on that way and it's been, the good thing for us is that it's been very broad based so historically, enterprise actually had a good year by over last year. If you take a look at their numbers going through the recession they actually grew last year somewhere on the order of 9% or so, and that's just continued on and that was driven by internetworking which was growing much faster than that, so that same momentum is carried on. We've seen pick-ups in the competitive carrier space as they've been more aggressive in winning market share during the downturn. That's continuing on.

We saw Tier 1 carriers really for the first time start embracing ethernet architectures and the whole concept of IP Gateways. That's been a very positive piece and then we've also won market share and started winning mine share in the VAR dealer base as we continue to grow that on the order of 60% to 100% a year so that's -- all of those things are adding up and starting to gel in a meaningful way. The other piece that I think that has happened is we've introduced some products into that market over the last year or so that have done very well, some low end routers, some higher speed routers.

So if you look at it from a competitive perspective, we stand out from a performance category area and all of those things added up and just continued to fuel it, so we picked up market share. I think there are some reports that showed we picked up 5% or 6% of market share in the SMB router space and all of these things adding up are just really starting to start getting some steam behind that.

Thanks and just on the competitive environment, there's been a flurry of M&A activity, some of your primary competitors of the -- can you give a sense of how you feel the Company is positioned as a standalone or whether you feel companies that are gaining scale through M&A maybe? Maybe (inaudible)?

Yes, I don't, there have been several different M&A things going on and I'm sure you're talking about a specific one and I don't see that as really moving the needle in a negative way. I think one of the things that we had is if you look at the rationale behind some of these, some of them is trying to buy technology suites that companies may not have and for instance in that case, we had the ethernet technology and have been working in ethernet-centric platforms for years so that was just not a driver for us, and then there's the whole idea of whether or not you should buy the market share or can you win it outright and we feel confident in our ability to do that, so we feel very good. We don't feel at all compelled that we need to go out and add size to be more competitive in the markets that we're playing in.

Fair enough. Thank you.

Okay.

Your next question comes from Rich Valera from Needham.

Good morning. Last quarter you gave an updated growth forecast for the HDSL segment for this year you said flat to slightly down and clearly it looks like it would be higher than that now. Can you give an updated growth outlook for HDSL for this year?

Well, it's not going to be flat to slightly down.

That's right Rich. So the year-to-date gain is obviously reflected in the number, so we expect even though the fourth quarter maybe sequentially down, we certainly anticipate the total year will be up on HDSL.

And we expect the fourth quarter to be up year-over-year as well on HDSL.

It would seem it would need to be up double digits or better to make the overall guidance work. Is that fair?

I think that's how the math works, yes.

Okay, and then with respect to HDSL for next year, I know you don't want to give guidance yet but you indicated in your prepared remarks, or maybe in response to a question that you thought the strength in HDSL particularly with respect to wireless would continue into 2011, so is it fair to say that your outlook for HDSL for 2011 has gone up commensurate with how the strength you've seen in 2010 over the last couple quarters? The way you're thinking about 2011, is it significantly higher now than it was a quarter or two ago for HDSL?

Without a doubt. There's no doubt about that. The picture of where HDSL fits into the mobile backhaul network has changed substantially and the speed by which carriers and I don't mean just one carrier but carriers are needing to add bandwidth to their networks has completely changed the profile of the way we look at it over that period of time.

And one more if I could. You were referring to the optical and HDSL together as your mobility or backhaul related business and I think this quarter, folks were surprised by how strong HDSL is relative to optical. Are you seeing anything there that might be a longer term shift or do you think this was just noise in terms of optical maybe being relatively weak and HDSL being particularly strong on the backhaul side this quarter?

No. I mean, I think that they actually both did well and some of it may be just my insight to what we're seeing as underlying patterns and where they're using optical but if you look at the full year and if you look at, I don't say it's a shift. I would say that there is an accelerated use in HDSL but I wouldn't necessarily say that, that means that the optical piece has to be down. I think that both of them can play well but I do think there has been a stronger focus on HDSL, and we have talked in the past about sometimes they turn their focus from one media to the next media or one region to the next region. This does seem to be more broader based which is why I wouldn't necessarily say that, that optical has got any negative winds coming at it in the near term.

I'm sorry one final one just related to that. Is the HDSL strength much broader than AT&T or is it still primarily driven by AT&T?

It's broader than AT&T.

Great. Thanks very much.

Okay.

Your next question comes from Simona Jankowski from Goldman Sachs.

Thanks so much. Just a couple of questions. First of all, I wanted to ask you a little bit about Frontier following their acquisition of Verizon Lines. How should we think about the opportunity there for you? I know you put out a press release about your position there but both in terms of the magnitude and timing, how should we roughly think about that and did you see any of that benefit last quarter or when should we start to see some of that?

Frontier has been a long term customer that we -- I feel that we have a very good relationship with and we feel we should benefit from, or we feel we can benefit and will benefit from them -- they're taking over the Verizon Lines and just the general upgrades that they are doing. We did send out that press release. There's an awful lot of activity that we're engaged in and I would say that without speaking too much for the customer, I would say that our -- we probably didn't see an awful lot of benefit in the third quarter. We would expect that to be things that are still ongoing and be coming up.

Got it. And maybe just back to your guidance for seasonal decline in the fourth quarter. It would seem that with some of that Frontier buildout and some of the Broadband stimulus potentially coming in and then your continued share gains both with the TA 5000 and on the Internetworking side, it would seem that, that would add up to maybe a better than seasonal quarter. Are there any offsets in your thinking that lead you to only expect seasonality into Q4?

Other than the fact that the VAR itself is now higher so if you look at -- if you assume there's a seasonal, that things are going well and the entire set is up higher, still assuming that winter still comes and that things still happen, I think is still a right way to look at it. And if you look at the net of all of that still the numbers are higher than we would have initially thought coming into the year and they are probably higher than we would have thought coming into the third quarter. They are definitely higher than we would have thought coming into the third quarter so it's not like this momentum that we have now hasn't raised what our VAR is into the fourth quarter. It had but we are still very cognizant of the fact things slow down when you get around Christmas.

And then just one last follow-up on the Optical Access side. Obviously that was strong sequentially but it seems like you grew below normal seasonality and if I think Qwest is one of your bigger customers in that business and it seemed like Qwest declined sequentially in terms of revenues. Are those two connected at all and are you seeing a pause at all at Qwest given the merger that's pending there?

No, the first question is the Optical Access being -- I think what we're talking about is the year-over-year comparison, year-over-year was slightly down, sequentially it was up fairly strong and that had nothing to do with Qwest. If you look at our history with Qwest, because they've been a 10% customer for a period of time, if you look at our history with Qwest I think what you'll see there is no different than what you've seen in the past.

And any pause at all or change in behavior there at Qwest or do you see things progressing as they would have otherwise been?

I think we're seeing no change in [pace].

Great. Thank you very much.

Okay.

Your next question comes from George Notter of Jefferies & Company.

Hi, thanks very much guys. I just wanted to ask, I guess expanding on the Century Link/Qwest discussion, when you guys look out into 2011, obviously, that deal I guess would close some time around the end of Q1. Would you expect at that point you would see any spending disruption from that combination in the Qwest side or do you think we just plow through it and they continue to spend as normal through the integration process and through the close of the deal?

We have no reason to believe there will be any pause. I know that there's the potential for pause because when companies get together, maybe they figure out things they may not have known or maybe they change their mind on things. But nothing has lead us to believe from the customer side or from any actions or anything that would lead us to believe that there would be a pause so we're not planning for that.

Got it, okay. And then separately, wanted to ask about the operating margins, 27% and change here in Q3. Historically, you guys have talked about keeping a lid on operating margins around 25% and reinvesting any potential upside above that into the business in the form of R&D or sales and marketing. Is that the perspective now or do you think the Company can run on operating margins that are above that 25% threshold sustainably, any change in view there?

George, I don't think there's really a change in view there. We are running rich so to speak and over time, as we've talked about all the time, we would continue to invest in sales and marketing and R&D to continue to grow the business, and so that philosophy hasn't changed.

I think if you look at the year-over-year numbers you'll see quite an investment actually in R&D and sales and marketing on a year-over-year basis or a year-to-date basis. It's just the fact we're growing faster than we're growing at this period of time.

Got it, great. Fair enough. Thank you very much.

Your next question comes from Ehud Gelblum from Morgan Stanley.

I have a chock-full of questions but I'll try a couple. First of all Tom you spoke about 2011. I know you don't like to get specific but I think you put out the word meaningful as meaningful growth for 2011. Is there anything you can do to put that within a bread basket and compare it to what you've done in 2010?

Not at this point. We will talk about that on the next conference call but not at this point.

Okay, I figured I'd throw it out there. Back to some of the questions on Frontier and Verizon. You said that you didn't see a lot in Q3 in terms of revenue but there's a lot of activity going on over there. What do you -- has to happen? Are there certain milestones that have to get passed? Any O&M types of things -- testing you have to pass to start landing revenue in this Verizon Lines at Frontier?

Yes. We're -- that's not the issue at all. We talked about the fact that let me not talk about specifically about Frontier but just the dynamics of some of the things going on here. We have customers in the US and outside of the US that we are having a different relationship with where we're not only going to be moving equipment but also going to be in some cases doing services like installs or other services for them. And in those cases, we need to be done with those services before you'd actually see the revenue, so I think that's a broader phenomenon that's happening but you would expect that, that would also impact some of our US business.

So this is a rev rec issue off of more than just the box sales, it's off of the services and install?

We absolutely had some of that going on in this quarter which would explain the inventory piece that Jim mentioned.

Makes a lot of sense. The HDSL strength, got to keep beating this one until it's completely dead. Can you give a sense about the linearity of HDSL this quarter and at what point in the quarter did you realize this was going to be another especially strong quarter in HDSL?

Well, the linearity piece is a good thing to talk about anyways because the quarter was actually very linear. We saw from a shipment perspective and we talked about the DSOs or Jim has mentioned the DSOs and what that did, it was a very linear shipment quarter we saw a definite acceleration in some product sets and HDSL would be one of those that just continued to get stronger through the quarter.

So actually HDSL linearity was back end loaded and got stronger as you went through?

Yes, but that probably that infers a little too much. I would just say that it's incrementally stronger every month. It would have been -- We would have been very happy with the first month and we were just more happy with the last month.

Okay, and normally you talk about two weeks of visibility but now it sounds like you've gotten visibility into the middle of next year if not longer for HDSL. How are they communicating this in a way that they've never done that in the past and what's giving you that confidence?

I think it has more to do -- what we tend to talk about is not how much HDSL will you buy. It's more along the lines of what are your plans for adding a particular capacity or what are your plans for infrastructure builds and things like that so it's more of that type of color than somebody saying I'm going to buy XYZ HDSL, so which is why your first question is growth for next year. No doubt we're getting a lot of positive feedback right now and from not only from customers but if we look at what's going on in our backlog and in the order activity we're feeling very positive but nothing has been specific enough to say I'm going to do XYZ in HDSL.

Okay so if you actually went back six months ago most of us would have thought that a lot of your HDSL customers were moving to certainly ethernet-based types of backhaul and they are doing that very quickly and HDSL was going to tread water and start going down. Are the -- is the flip side of the strength at HDSL and the fact these customers are telling you their network plans, are they there for saying their ethernet conversion plans are going at hold a little bit and they are going to roll it out slower and spend more time in HDSL?

I wouldn't make that big of a leap. First of all, you can absolutely deploy ethernet over HDSL and there are a lot of our customers that do that, but I would also say probably that if you look at the bandwidth demand which are very public numbers and some of our customers talk about those numbers, I think the bandwidth demand that they are needing even in rural areas as well as urban areas is just more than anybody would have ever expected. And so I think in areas where they had always planned on using HDSL, I think even those areas are seeing a positive impact and I think that it's just a phenomenon that doesn't necessarily say they have put on hold any ethernet upgrades, although network upgrades tend to take, network conversions tend to take an awful lot of time, but so I would say we're probably benefiting from a couple of different things.

Last question is that was a really interesting comment that perhaps certain geographies were slated for ethernet upgrades while others were perhaps more rural areas where we're now slated to continue HDSL types of backhauls. Do you think some of the strength or a lot of the strength or something that's noticeable may have just come from those areas that were always HDSL where they had to beef up backhaul as opposed to areas going into ethernet?

I don't know that level of specificity. My guess would be from what we're seeing my guess would be that we're benefiting from both.

Okay, just trying to leave a theory in here. Appreciate it. Thanks so much.

Okay.

Your next question comes from Nikos Theodosopoulos from UBS.

Thank you. I had a couple of questions. Can you -- earlier in the call you talked a little bit about inventory and potential business in South Central America. Can you elaborate on that a little bit, I know in the past you had a big spike one quarter due to some big orders in TelMex and nothing really came out of that on a sustainable basis. Can you talk about what you're seeing there now? Is this a similar situation where it's one or two quarter build or do you see a more sustainable growth profile there and is this an existing or new set of customers for you?

Let's talk about what happened to TelMex in the past and start there and see if that answers some of your questions. What we were involved with in the past was in my opinion envisioned to be a broader deployment than what ended up happening and the reason for that is our products are very good at high bandwidth requirements for things like IPTV, and as very public IPTV franchises in Mexico got curtailed and then delayed and then stopped, and so that put a cap or a lifespan on what it was that we were doing. I think my belief is TelMex like other carriers around the world are now realizing it's not just all about IPTV, so that even if you don't have IPTV as your main driver, you've got to do something to get speeds above 1 megabit and there's still an awful lot of unserved areas in Latin America from city-wide or country-wide that need to be served.

And if you're no longer using IPTV as a catalyst you have to wait for the catalyst to happen and in some areas of Latin America, you talked about Telmex, I think Telmex is preferring not to speak for them but my belief is they are definitely invigorated in rolling out a much broader fashion high speed broadband so I would view this project as being to the extent we deal with them going forward, in a substantially different profile than what we saw before. Does that answer your question?

Yes, okay. So your expectation is it wouldn't be a one quarter lump. We should see some sustainable international [bench]?

Our customers -- we're not envisioning what we're doing at this point in time of Latin America to be a single shot project.

Right, okay. And the second question is if I look at the Broadband business, if I look at the fiber-to-the-node product category, and I look at it year-to-date, my sense is that, that business is down if -- and then can you splice that out? It sounds like the TA 5000 continues to grow strongly sequentially yet the broadband category would suggest that the fiber-to-the-node products are now no longer growing. Is that an accurate statement and if not can you elaborate and if they're not growing, do they potentially grow next year due to stimulus or how should we look at that category of products?

Yes, that's not -- fiber-to-the-node absolutely grew, it has grown year-to-date. We did have, if you look at the year-over-year comparison, the piece probably the only piece that I can see that would be down would be our ATM DSLAM which is the 3000 based DSLAM which had been a meaningful piece of business so that piece has dwindled to a no longer meaningful piece of business. Our fiber-to-the-node products have definitely grown and the 5000 products are just basically rocketed so I think both of those two are growing and the way the fiber-to-the-node products are used, it's typically large carriers doing large scale deployments.

If you talk about what I would envision something like a TelMex or something we've talked about before that Qwest does, there are other large carriers right now looking at doing the exact same thing for the exact same reasons. And so those are larger scale, multi-quarter, sometimes multi-year projects and they have a capital flow to them that shows up as seasonality but in general I think the way you categorized it as being a growth product it's not accurate for this year and we don't expect it to be accurate for next year by any stretch.

Is this ATM DSLAM product line less than 10% of the Broadband access category as a whole? Is it getting small enough --

It is now, yes.

It is now. Okay, we -- so going forward, we should still expect the fiber-to-the-node group to grow?

It will. It should absolutely grow.

Right, okay. Okay, great. Let's see. And so I guess just the last question then was you talked about it earlier about the Optical product. I guess the year-to-date growth there I think is single digit, low single digit and last year, it underperformed the rest of the new products. Do you still feel this could be a double digit growth business for you in the next couple of years and if so, why in a very strong year in capital spending in the US, why haven't we seen it perform that well?

That's a good question. Can I see it be double digit for the next couple years? If you give me the next couple years and if you ask me about next year I think it's dependent upon particular carriers deciding what they do in a particular project and it will be driven more substantially next year by wireless backhaul. I really can't answer as to did it or should it, we have expected more performance out of that. The first half of the year in optical was not as strong as we expected, but as we talked about carriers tend to move region by region on how they actually do deployment and we saw a stronger focus on HDSL, and that was anticipated when they shift off of one, we see them shift into another. I would say what's happened in third quarter though which was surprising is we saw a pick up in both of those segments at the same time so it -- I would expect performance in the second half to be more like what we expected the first half on optical was not as strong as we would have expected.

Okay, great. Thank you.

The next question comes from Sanjiv Wadhwani from Stifel Nicolaus.

Thanks so much. Tom, I realize it's book and ship business but it sounds from your commentary that visibility is better going into December than normal historical patterns. Is this coming from Tier 1 or Tier 2 or is it across-the-board? Any color there would be helpful, thanks.

It is pretty much across-the-board. I mean Tier 1, we feel comfortable where we are in Tier 1 and Tier 2s we feel comfortable. It's pretty much across-the-board. Enterprise, we're feeling comfortable. We are typically a book and ship business. I would tell you that I mentioned that we have more confidence going into fourth quarter than we typically have going into a quarter which would lead you to believe our visibility in the fourth quarter is much stronger than it has been.

Got it. That's helpful, thanks so much.

Your next question comes from Simon Leopold from Morgan Keegan.

First, a quick clarification if I might. You may have given this already but just the split between enterprise and carrier?

Yes, for the quarter, carrier networks was $128.6 million and enterprise was $34.4 million.

Great. Thank you, and just moving on to the questions, when we look at the carrier reports in the last earnings period, DSL or Broadband subscriber numbers were pretty bad and I guess what I'm struggling with is to try to assess how much of that is indicative of a long term negative trend for that portion of your Broadband business, barring stimulus? Or is it a positive indicator that (inaudible) because these carriers are losing subscribers because they have an inferior version of DSL that it's a positive opportunity because they need to upgrade to newer, faster speed versions. How are you thinking about that?

Absolutely the latter. I mentioned it in my notes and we maybe have touched on it a little bit here when we were talking about what's going on with Telmex, that we see carriers right now believing that 1.5 megabits and in some cases 7 megabits is just not going to cut it and that they are losing market share because of that. And there is without a doubt a focus on carriers to go out and take a look at where they have ADSL and upgrade that to VDSL2 and get closer to the customer and try to deliver something that's a meaningfully better experience than what they are having right now. I think [DOCSIS] 3.0 has been a very good catalyst for our Broadband business and I think -- we're just early in the upgrade cycle.

So if we follow that with a question about the activity you've had in upgrading Qwest footprint what's the typical bandwidth that those customers are getting in that fiber-to-the-node deployment and what I'm really wondering is it sufficient that they can get a true IPTV experience or is there a need for Qwest to do a further upgrade to raise that bandwidth again?

I'd hate to talk about specific customers. I'm not going to talk about specific customers but I can tell you about customer profiles in general and that is that we've seen customers that are early adopters of ADSL technology upgrade to ADSL2 Plus and some customers are very early in that cycle. If you look at ones that for instance had different focuses than they may have missed that first upgrade cycle and then we have seen customers go back and say okay now, I need to upgrade to VDSL2 and so that upgrade path is not uncommon at all.

So let me ask this slightly different way without getting specific on a customer. If you look at your activities with your 1100, 1200 products for, say the previous two years, what would you say is the average bandwidth or typical bandwidth that their customers are experiencing on those deployments?

It's hard to tell you what the average bandwidth is but I can tell you what I think customers are looking to do and what speeds that they are experiencing, so on the older technology I think 7 megabits is what they were looking at. I think with ADSL 2 Plus and longer reach VDSL I shouldn't say longer reach and some of the VDSL applications they are looking at 15 megabits. We have customers right now that we're doing lap things with that are trying to get to 80 megabits using Bonded VDSL2 Plus and there are other technologies that we're of course working on too, but so I think they fully our customers that have embraced the 1100 fully expect to be able to deliver a full HDTV IPTV experience.

Great. Thank you very much.

Okay.

Your next question comes from Blair King of Avondale Partners.

Okay, Keena, I think this is going to be our last question because we're running out of time, so --

Okay.

Blair?

Great. Thanks for taking the question. I'm glad I got one in. I just have one really since a lot of good questions have been asked but Jim, this would be directed towards you, I suspect. Last quarter I think you'd mentioned that there would be a reversion back to the norm in terms of inventory turns as the supply chain eases and given there's been that build in inventory and seemingly good visibility going forward on order rates, would you expect to see any improvement in gross margin in the fourth quarter?

Well Blair, I'd hate to comment on gross margin other than saying what we said in the past in terms of we expect to be in the range of the high 50%.

Okay.

So I think we need to leave it at that.

I don't think that inventory conversion would necessarily lead to gross margin.

Right.

Okay, that answers it for me. Thanks guys.

Okay.

Well thank you everybody for joining us on our conference call this quarter and we look forward to talking to you again next quarter.

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