ADTRAN Holdings Inc (ADTN) 2010 Q4 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 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, 2009, and Form 10-Q for the quarter ended September 30, 2010. These risks and uncertainties could cause actual results to differ materially from those in forward-looking statements, which may be made during the call. Thank you.

It is now my pleasure to turn the call over to Mr. Tom Stanton, CEO. Mr. Stanton, you may begin your conference.

Thank you, Nicole. Good morning, everyone. Thank you for joining us for our fourth quarter 2010 conference call. With me this morning is Jim Matthews, Senior Vice President and Chief Financial Officer. I'd like to begin this morning by discussing our Q4 performance, before we move on to a review of 2010, and I'll end with some comments on what we expect in 2011.

As stated in our press release, ADTRAN achieved all-time record revenues of $165.3 million in the quarter. The outperformance was driven by revenue acceleration in our growth areas, which grew 50% over the same period last year, offsetting a normal seasonal decline in our traditional product areas. Our growth areas benefited from increasing demand for higher speed services from residential and business customers, in both fixed and mobile applications, and the continued migration towards IP services. Both carrier and enterprise divisions benefited from these trends.

Combined, our growth areas achieved a record $101.4 million in revenue, representing 61% of our Company total. The Carrier Networks Division reported an impressive 39% increase in revenue over the same period last year, and our Enterprise Networks Division benefited from another strong performance in our Internetworking category, which grew to another record revenue level.

Getting into a little more detail, our Broadband Access category set a new record, achieving 75% growth over the same period last year. As expected, the Total Access 5000 platform led this growth. But this area also benefited from a meaningful contribution from our professional services group, as carriers took advantage of the expanded solutions we offer.

As previously mentioned, our Internetworking category achieved another record revenue level as a result of our expanding of our dealer base, and market share gains in Tier 1, Tier 2, and competitive service providers. Our mobility products continue to perform well, with Optical Access growing 20% over the prior year, achieving a new record level, as carriers continue to increase investment in network upgrades. HDSL also showed another strong performance, as expected.

Looking back on 2010, we clearly saw the effectiveness of our strategies, as we experienced strong outperformance across most categories. Revenues from our combined growth areas expanded 40% for the year, leading this outperformance, as we gained market share, and our customers increased investment in the strategic areas our solutions address. Additionally through the year, we saw renewed strength in HDSL, as carriers increased deployments to cost effectively and quickly add capacity to their mobile networks.

For the total year, our Broadband Access category grew an impressive 58%, leading our overall revenue growth. The customer base for the Total Access 5000 platform continued to increase in 2010, and we began to see meaningful shipments from prior awards. Our fiber to the node products benefited from an expanding product set, which was embraced by both domestic and international carriers. Carriers around the world are seeing the requirement to increase their service offerings, and many are realizing the benefits of a complete network solution, encompassing the diversity of deployment strategies that our Total Access product line now offers. From fiber to the curve, to fiber to the node, to fiber to the premise, to our newest Ultra Broadband Ethernet products, ADTRAN now delivers the most complete set of solutions to meet the complex needs of individual carriers.

For the total year, Internetworking revenue grew 39%. Growth occurred across all product areas, including routers, Ethernet switches, IP gateways, access termination products, and of course, our IP PBX segment. In our enterprise group, we were pleased to see both quarterly and full-year growth across all of our distribution channels. Our focus on recruiting the industry's most capable value-added resellers, while continuing to extend our presence within our carrier channels, positions us well for the future.

For the total year, our Optical Access category achieved another record revenue level, as mobility upgrades drove demand in our carrier customer base. We expect recently introduced optical products will provide new opportunities for this category, as carriers upgrade bandwidth capabilities in both fixed and mobile networks.

For 2011, we expect the Total Access 5000 family and our fiber to the node platforms will continue to grow across all carrier classes, driven by fiber deployments, Ethernet migration, and higher-speed broadband requirements. We expect our fiber to the node, fiber to the curve, GPON, active Ethernet, and recently introduced capabilities, such as OTN and Ultra Broadband Ethernet products, will benefit from investment in bandwidth expansion, government and regulatory driven footprint expansions, and Ethernet conversion initiatives expanding across all our carrier customer segments. We also expect our professional services capabilities will add incremental revenues in 2011 and beyond, as carriers seek to cost effectively accelerate their deployments.

In addition, we anticipate our continued focus on market share, markets outside of the US, will add meaningful revenue growth in 2011. We believe Internetworking will continue to maintain its current positive momentum, with benefits from market share gains and new product offerings, such as unified communications and unified threat management. During 2011, we believe we will continue to see the benefit of mobility upgrades in fiber and copper products, as wireless carriers augment their mobility network capacity, utilizing a mix of different technologies.

In summary, on a macro level, increasing competition driving accelerating Broadband deployments, and intensive upgrade of mobile infrastructure, channel expansion in our enterprise segment, meaningful sales initiatives outside the United States, government and regulatory initiatives, coupled with an innovative, diverse, and expanding product portfolio, lead us to be optimistic about the year ahead.

I would now like Jim Matthews to review our results for the fourth quarter 2010, and our comments on the first quarter 2011. We will then open the conference up to questions. Jim?

Thank you, Tom, and good morning to everyone. Revenue for the fourth quarter increased 33% to a record level of $165.3 million, compared to $124.2 million in Q4 of 2009. Broadband Access product revenues for Q4 of 2010 increased 75% to a record level of $49.7 million, compared to $28.3 million for Q4 2009. This increase was primarily related to continuing growth in deployments of our TA 5000 platform, and professional services revenues recognized in the quarter.

Internetworking product revenues for Q4 of 2010 increased 37% to a record level of $31.6 million, compared to $23 million for Q4 2009. Optical Access product revenues for Q4 of 2010 increased 24% to a record level of $20.2 million, compared to $16.3 million for Q4 of 2009. Carrier Systems revenues for Q4 of 2010 increased 44% to a record level of $81.7 million, compared to $56.9 million for Q4 2009.

Business networking revenues for Q4 of 2010 increased 25% to a record level of $34.8 million, compared to $27.9 million for Q4 of 2009. Loop Access revenues for Q4 of 2010 increased 24% to $48.8 million, compared to $39.4 million for Q4 of 2009. HDSL product revenues increased 29% to $45.8 million for Q4 of 2010, compared to $35.4 million for Q4 of 2009.

As a result of the above, Carrier Networks Division revenues for Q4 of 2010 increased 39% to $130.3 million, compared to $93.9 million for Q4 of 2009. Enterprise Networks Division revenues for Q4 of 2010 increased 15% to $35 million, compared to $30.4 million for Q4 of 2009. International revenue was $8.5 million for Q4 of 2010, compared to $7.7 million for Q4 of 2009. To provide the reporting of each of these categories, we have published them on our Investor Relations web page at adtran.com.

Gross margin was 58.6% of revenue for Q4 of 2010, compared to 59% for Q4 of 2009. The lower gross margin was largely attributable to professional services revenue recognized in Q4 of 2010. It is important to note that this new revenue stream was accretive to operating margins in the quarter.

Research and development expenses were $22.5 million for Q4 of 2010, compared to $21.3 million for Q4 of 2009. This increase in expense was primarily related to an increase in staffing costs in customer-specific projects. Selling, general, and administrative expenses were $29.4 million for Q4 of 2010, compared to $25.9 million for Q4 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 $2.3 million for Q4 of 2010, compared to $1.8 million for Q4 of 2009. All other income, net of interest expense, for Q4 of 2010 was $3.9 million, compared to $1.3 million for Q4 of 2009. The increase is primarily related to an increase in realized investment gains.

The Company's income tax provision rate was 26.3% for the fourth quarter of 2010, compared to 32.3% for the fourth quarter of 2009. The tax provision rate for the fourth quarter of 2010 included a benefit of $480,000 resulting from the exercise in employee incentive stock options in the quarter, and a benefit of $4.5 million as a result of legislation to extend research tax credits for the year 2010. In the fourth quarter of 2009, the Company recognized normal benefits from research tax credits. Earnings per share, assuming dilution, for Q4 of 2010 increased 93% to $0.56, compared to $0.29 for Q4 of 2009.

Inventories were $74.3 million at quarter-end, up $4.3 million for Q3 of 2010. The increase was driven by higher than anticipated volumes related to new installation services contracts in the US and Latin America. Revenues related to these contracts will be recognized in future quarters, and net trades accounts receivable were $70.9 million at quarter-end, resulting in DSOs of 39 days. Unrestricted cash and marketable securities, net of debt, totaled $396 million at quarter-end, after paying $5.6 million in dividends during the fourth quarter, and repurchasing 251,300 shares of common stock for $8 million.

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. However, we would like to give color to help you formulate your views on our near-term business outlook. For the first quarter of 2011, we anticipate revenues will be flat to slightly down on a sequential basis. This represents year-over-year revenue growth for the first quarter to be in excess of 25%. We expect first quarter operating expenses will be in a range similar to what we experienced in the third and fourth quarters of 2010.

We believe the larger factors impacting the revenue we realize for the first quarter and the year will be the following. Spending levels at our Tier 1 and Tier 2 carrier customers, the adoption rate of our Total Access 5000 platform, professional services activity levels, both domestic and international, upgrades for mobile Broadband infrastructure, an improving enterprise spending environment, the timing of revenue related to Broadband stimulus projects.

Tom?

Thanks, Jim. Nicole, we're now ready to open it up for any questions people may have.

Thank you, sir. (Operator Instructions)We will pause for just a moment to compile the Q&A roster. Your first question is from Todd Koffman of Raymond James.

Thank you very much, and congratulations on a good quarter. Tom, in your prepared remarks, you called out international as a meaningful growth opportunity for 2011. Historically, that's been a relatively small, less than 5% or something, of ADTRAN's business. Can you give any more color on why you called that out?

Sure, Todd. We have, as you know, been really increasing our focus on trying to sell products outside of the US for some time. And we have some historic customers that have bought some things time to time, in -- mainly in Latin America, and we've seen some traction there that we feel very comfortable with, that we've got some good progress going on. Jim had noted the -- one of the reasons for the uptick in inventory is the fact that we actually have some products in place right now in country, right now, actually going through an installation process, which of course gives us a greater level of surety as to where that customer actually stands.

Just a quick follow-on. What's your latest and greatest thinking regarding the HDSL business, as you look out the next few quarters?

That's a good question. We've seen some very strong growth in -- well, let's say uncommon growth in 2010, or unexpected growth -- probably not so much uncommon, it's just unexpected. Because we, like a lot of people, were expecting it to start tailing down, and we saw the pick-up due to wireless spend actually bolster that more than we had planned, and we had to adjust for that. Coming out of the year, it feels, to be honest with you, very similar to the way it felt most of last year. There's still an awful lot of activity around HDSL. There's an awful lot of planning going on around HDSL.

So, we wouldn't be bold enough to say that we expect a growth year in HDSL. We would still take a look at the full year, not knowing. As you know, we're very much a book-and-ship business, but not knowing what the full 12 months would look like, we'll still be conservative and try to say and talk about it being down, kind of in the single-digit range. But it could very much surprise us again this year, like it did last year. And I would tell you it's starting off in a -- it feels -- the environment right now feels strong.

Thank you very much. Good luck.

Okay. All right, thank you.

The next question is from Paul Silverstein of Credit Suisse.

Paul?

Hi, sorry. Couple questions, if I may. First off, can you all share with us the 10% customers, and what they contributed?

Hi, Paul, this is Jim. So, AT&T was at 16% for the quarter. Verizon was at 10%, and Qwest was at 19%.

Okay. And I know you don't want to give too much on any individual customer, but given the Century/Qwest merger acquisition, can you give us any color on what you all are seeing there?

Yes, from our opinion and from the conversations we've had, which we still stay very well connected, we see no change in behavior and really no change in major plans. I think that we haven't seen a slowdown, as you -- as Jim kind of just reflected in our numbers, so we're still very -- feeling positive about the ultimate combination and merger and what that opportunity could bring, but we haven't seen any change to date.

Okay. And one more question. On the Broadband Access piece, Jim, Tom, can you all give us any incremental color -- hopefully numbers, but if you don't want to go there, some incremental color in terms of how much of the growth is a function of TA5000 and how much is a function of your FTTN TA1100 business?

The -- the majority of the growth, it depends on what period of time you're talking about. In almost any period of time, it's -- the growth has been driven by the 5000 platform. The major piece of the growth has been driven by the 5000 platform. The fiber to the node stuff goes through some seasonality, of course, because of the new customers we're bringing on in 2011. I think we're going to see growth in both areas. So, it will be interesting to see which one outgrows which. But in 2010, it would definitely -- Total Access 5000, that was the driver.

Tom, this past quarter, was fiber to the node up?

Are you talking about sequentially, or year-over-year, Paul?

Sequentially.

No.

And is that business still largely -- I hear you talking about incremental customers coming, but is that currently still largely levered to TelMex and one or two others?

Well, I mean, the bigger -- the biggest customer we have to date in fiber to the node is a US customer.

Right, Qwest. Okay.

And I would say that we shipped -- we recognized very little revenue, relatively small amounts of revenue outside of the US, and we expect that to change going into 2011.

Great. I appreciate it. I'll pass it on.

By the way, I think the right way to think about the fiber-to-the-node is flattish.

Flattish for 2011, Tom, or flattish for the current -- for Q1?

Excuse me. Glad you asked that question, because people would have misunderstood. Flattish on a sequential basis from Q3 to Q4.

From Q3 to Q4. And so, you're not -- going forward, can you give us some insight on what you're expecting from FTTN going forward?

Well, you know, it typically sees a seasonal pattern, and we would expect to see the same seasonal pattern it typically sees, which is -- it actually typically picks up at the -- sometime in the earlier part of the year, as budgets get released. And then it kind of peaks around second to third quarter, and a lot of times you'll see it flat second to third, and then it usually tails down just a little in the fourth quarter. I would say general direction-wise, that's what we would expect. Hopefully that all the numbers would be bigger, but that's what we would expect.

Okay. And Tom, did you all quantify Broadband stimulus impact?

We did not.

Could you?

There was some Broadband stimulus revenue. I would not say that it was a meaningful mover in the fourth quarter.

Are you expecting that to increase significantly in Q1?

I wouldn't try to forecast the specific quarter. We expect it to be definitely more meaningful in 2011 than in 2010.

Okay. Thanks, guys.

Okay.

Your next question is from Paul Leone of Bank of America.

Hi. Thank you. I'll just continue with the last question. On Broadband stimulus, first, can you describe the competitive landscape from your point of view, how do you see -- who is the -- who are the competitors? And then, if it comes the way you see it, is it going to be meaningful in 2011 already? And here, I'm referring to -- do you think that shipments and revenue recognition could be in the same year, or will revenue recognition be at the later part? Thanks.

Sure. I think there are few competitors in that space. Some companies that have been at it for a long time, specifically selling to the Tier Twos and Tier Threes, and then there's been some that have kind of started dabbling in it more than they had historically. We think we're positioned well. We've got a number of wins, both across Tier Twos and Tier Threes. And, as you well know, there are an awful lot that have yet to be decided, and we think we are well-positioned and definitely our fair share of what is yet to be decided.

So yes, we would expect it to be meaningful in 2011. And as far as the revenue recognition piece, it really depends on the customer. So I would say in general, in our Tier Two space, we would expect to be able to recognize revenue definitely in the same year. Let's say in the same calendar, or -- not calendar, but 12-month period. For some of the smaller ones where they go through distribution and there may be some type of [RUSS] funding, a lot of those, the distribution channel may front that and we would see it, and some of it we won't. So I think it will be a diverse group, but in definitely a large percentage of the cases, we would expect it in the same 12 calendar months.

Is revenue recognition in this case different than revenue recognition -- is it longer or shorter than revenue recognition with your current businesses?

It depends on the customer. So you can almost think of it as the larger the customer, the more it is very much similar to what we're doing today. Let me make sure Jim -- Jim, definitely --

Well, you know, the bulk of the revenue that we recognize today is based on shipment, and as we look at Broadband stimulus, there is -- there are -- there can be situations where the revenue recognition is delayed a bit, depending on who the customer is, based on certain milestone requirements that may be a part of the contract. So, as Tom said, it's really going to depend on who the customer is. And I think that's going to apply to both Tier Two or Tier Three type customers.

And going back to the first question, I think I didn't clarify my question. Do you think that you're going to see competitors such as Juniper, Cisco, kind of large companies, Alcatel, in the space, or do you think that this space, Tier Three, Tier Four carriers, and Broadband stimulus, is more left to smaller companies like yourself, Calix, and others?

I think that you -- we're seeing them today, and I think -- but they're typically being successful in different areas of the market than where we're competing. So, the Broadband stimulus can cover multiple areas of a network, including middle mile, as well as access. And I think you're seeing some success and -- with some of those vendors in areas. I'm not aware of them being successful directly competing with us in the access space.

Last question on the same topic. Money or spending was awarded already, as far as I understand, the majority of it was awarded already late last year. What takes so long to select the vendors?

You have to ask that -- you have to ask the customers that. So, they -- some of them know what they want to do. Some of them are yet going through RFP processes or different processes right now to figure out what vendors they want to use for what. But, that's -- the awarding of the money of the government basically naming who was going to get money from a carrier perspective, and the award from the carrier to the vendor, are two disjointed events.

Thank you.

Okay.

Your next question is from Ari Bensinger of Standard and Poor's.

Yes, thank you. You talked about Q1 guidance of flat to slightly down. Can you give more color per segment? And also, you talked about a growing professional services business. Can you help quantify that business, and as it grows, how will it impact gross margins?

Jim, do you want to --

So, as far as the services-type business that we spoke of in our prepared remarks, we did see a nicer increment in Q4. We did mention that it impacted gross margins. However, it certainly was accretive on operating margins, which is very, very important to us. Now, to add a bit more color to that, if we were to remove the effect of those professional services revenues, in terms of the impact on gross margins, we would see gross margins closer to what we experienced in Q3, to kind of give you a flavor on the impact on margins. On gross margins, rather. But again, I want to emphasize that from an operating margin standpoint, those revenues are certainly accretive, and we look forward to those revenues growing as we go through 2011.

Right. And also, any color on per-segment basis?

Well, as far as on a per-segment basis, you know, we would expect that our traditional products would probably be sequentially down. Certain parts of our growth products typically are sequentially down in the first quarter, like Optical Access, potentially Internetworking, Broadband Access, I think, is going to be, again, based on overall activity that we see in Q1 as to how much of an offset we might see there in terms of a potential sequential uptick. But again, that's going to be based on the activity that we see in Q1.

Great. Thanks. Very helpful.

Okay.

The next question is from Simona Jankowski of Goldman Sachs.

Hi. Thanks very much. Wanted to ask you, first, about AT&T's recent announcement on accelerating the move to LTE. Can you just give us some insight on how that might flow through to you, in terms of both your HDSL business and also any offsetting opportunities in terms of their Ethernet over fiber roll-out?

I'm sure -- to be honest with you, it's going to be -- it's unclear to us right now exactly how that acceleration will manifest itself, and what exact access technologies they'll be using for different reasons. And you can think of it as a regional play. You can also think of it as kind of an urban versus rural connectivity. Our opinion is that our sales to AT&T for the mobility pieces, at least through 2011, will be kind of consistent with what we have seen in the past, and that will affect both our HDSL business and our optical business. And, as to exactly how they actually roll out LTE to larger sites, we do think Ethernet over fiber will be a larger play to that, but it's just unclear exactly what the timing will be on that.

And, I guess, in terms of your relative positioning there, obviously you're very big there, on the HDSL side. What is your position on the Ethernet over fiber side? Is that -- is that a similarly big business for you, or does it have the potential to be, so that if that were the direction they went at the expense of HDSL, it would be net-net accretive to you?

Well, our position with AT&T right now is -- we sell, of course, HDSL. We sell Ethernet over copper, and we sell optical gear for their backhaul network. But the native Ethernet over fiber business is not a business that we participate in.

Okay.

We sell Ethernet over SONET. That type of product set.

Okay. All right. And then, the other question I had is on the Optical Access business, which was better than seasonal in the fourth quarter. And it seems like that drove some of the upside in the quarter. Can you just give us a little more insight on what drove that, and was it led by your biggest customer there, or was it broader than that?

Yes, the Optical Access activity that we saw in the fourth quarter was actually fairly broad. It was not across a single customer.

I would say take another look into that, I would say it was definitely mobility capacity adds.

Okay. And then, just last question is on your off-margin targets, which are -- obviously, your margins have been kind of running ahead of your mid-20s targets for a couple of quarters now. And it seems like, if anything, with you expanding into services, that's likely to continue. I mean, do you feel like the mid-20s is still a reasonable target for your business model? Or, at this point, would you assume that something in the high 20s is sustainable?

We're still targeting the mid-20s as our long-term target.

And you think that investment would be on the product side or on the services side, as far as increasing investment in OpEx to get to that target?

It would actually be multiple facets. As we grow the business we typically will add, and we have over the last few years, add more to the R&D line. We would continue to do that. We've also added to the sales and marketing people in the field, especially as we were breaking outside of the US. And then, services -- the services pieces, a lot of that is work that actually would flow through, and is variable with the cost of the project. So I don't know if there would be a whole lot of infrastructure that's kind of pre-positioned for that growth. I think that growth and that expense has [come], as that business came along.

Got it. Thank you very much, appreciate it.

Okay.

Sure.

The next question is from Amir Rozwadowski of Barclays Capital.

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

Good morning.

Hi.

Just wanted to talk a bit more about sort of the growth trajectory of the business here, if I may. With the fourth quarter results, you've got four consecutive quarters of accelerating top-line growth. And if we look toward your guidance, certainly a bit of a step down in terms of that growth trajectory at 25% year-over-year, but fairly healthy, and certainly above your full-year growth for 2010. I'm just trying to understand sort of the sustainability of this growth level. You had mentioned that HDSL right now, from an operating basis, you would expect it to be down single-digits. But it seems like you've got a number of other factors where you're continuing to see new revenue opportunities with a number of carriers. So, just trying to gauge sort of at what level you think that sort of growth is sustainable.

Well, you have to -- the way we're looking -- and here again, we're talking about a full year that hasn't -- that is still 12 months away from us, and I agree with you. We have an awful lot of drivers. I think in my comments, I listed a lot of those drivers. Those drivers are not just with our current Broadband customer base, but an expansion of that customer base that we're much more comfortable talking about than we were going into 2010. So there's an awful lot of opportunity there.

If you look at the Q1 guidance, the Q1 guidance is basically taking a look at historically what happens, what happens to these product areas on a percentage basis, and kind of deriving those off of the new top line numbers, which of course, we're comfortable with going into next year, even with that type of increase, because of where the baseline has moved to. But trying to get more granularity, we can list to you the opportunities and where we think the potentials are, both on a product and a market segment, but trying to tell you exactly what that will be is going to be difficult for us to do.

But it is fair to say, Tom, that right now, given the number of initiatives you have out there with your carrier customers, that the growth trajectory that you see, at least for the near term, seems to be -- you're pretty optimistic about the growth trajectory, at least for the near term.

There is no doubt, we do not believe we have topped out. And, yes, if you look at all of the pieces that are still laid in front of us, we talked about the fact Broadband stimulus hasn't happened yet, we -- there are opportunities. There's some OEM relationships that are yet to come online. There are awards that we have won and have already kind of started installing, that we have not yet really seen fully kick in yet. So, there are an awful lot of opportunities out there yet.

Great. That's very helpful. And then, I know you have touched upon the gross margin decline on a sequential basis here in the fourth quarter. You mentioned there's a little bit more activity on the services side. How should we think about that from a mix perspective, going forward? Do you expect a larger contribution of services, or was this more of an initial planning phase that sort of impacted the gross margins this quarter?

I would think -- we are actively trying to grow our gross margin. As Jim said, it is something that's accretive to our operating margin. There is a well-known impact, as you sell services, that the gross margin is not the same as what we're getting on our products. And so, do we expect it to grow next year? Yes. Do we think ultimately it will lead to a stronger bottom line than if we didn't have them? Answer to that is yes.

That's helpful. Thank you very much for the incremental color.

All right. Thank you.

The next question is from Rich Valera of Needham & Company.

Thank you, good morning. I just wanted to clarify the answer to that last question, with respect to gross margin. It sounds like maybe what you're saying is the third -- I'm sorry, the fourth quarter gross margin is sort of a new baseline, based on an expected higher level of professional services. Is that fair?

I think that's not a bad way to look at it, assuming that we keep the same level of services that we had in the fourth quarter. And to give you a sense, without getting too granular on the exact details there, but to give you a sense, we would be strongly in the 59s kind of numbers if we didn't have the services piece. But again, our operating margin would be -- would be less than it is today. So, to take that down, I think our product margins are very stable, and they've been at the same stable range now for a long period of time. And incrementally, as we add services, you'll see a degradation in gross margins but an increase in operating margins.

Great, thank you. And Jim, I was wondering if you could provide some color with respect to both tax rate and your investment income for 2011, sort of what you're thinking about on those two -- two fronts for 2011.

Well, you know, in terms of the tax rate, in terms of an effective rate for 2011, we're thinking, for planning purposes, in the range of about 34.5%. Now, as you know, as we go through the year, there are specific discrete items that may impact an individual quarter on a positive note, as we saw coming through 2010. It's very difficult to forecast that potential, but from an effective tax rate standpoint, we're thinking in the range of 34.5%. And Rich, sorry, your other question?

The investment income, which was fairly meaningful in 2010, just wondering if we could expect anything close to a similar level in 2011.

Well, you know, it's -- I guess there's a potential for that, but it's very, very hard to predict, based on how the market's going to react and how we manage the portfolio going forward. We did see, in the fourth quarter, the effect of some level of rebalancing in the portfolio. Also, we saw the impact of the sale of one security that we've been involved in since the late '90s, prior to the Company going IPO. And we trimmed some of our positions there, because the stock has done very, very well. Okay. And so, that's some color on what we saw in Q4. Whether or not that continues going through 2011, I think, is difficult to say at this point.

Okay. Thanks for that color.

Okay. Thank you.

The next question is from Mike Genovese of MKM Partners.

Great. Thanks a lot. Two questions. Number one, it looks like you haven't really seen a ramp yet in international sales, international is about 5% of the quarter. But we're hearing about more and more international wins. Do you have -- can you give us any help with expected revenue recognition from overseas customers?

Yes, I mean, I think the right way to think about it is, that -- you're right, we did see an awful lot in the fourth quarter. There was an awful lot of activity associated with customers outside the US. But there wasn't an awful lot of revenue generated. And we would expect it to ramp up pretty much through the year. So, I mean, I think there's a very good chance Q1 will be stronger than Q4, and you'll see Q2 grow from there, and Q3 grow from there. So, I think that our thinking about that is you'll see a strong ramp, and you'll probably see an increases -- increase on a percentage of total revenue throughout the year.

All right. Okay. And then -- and then, you're talking about mid -- kind of a mid-20s operating margin target, but you're pretty solidly in the kind of mid- to high 20s right now. And as we think about these opportunities, whether it be stimulus, or international expansion, or any of the other laundry list of positive drivers that you gave, I mean, are there any of those in particular that are really going to require an increased level of operating investment in the business, to where we would think that this operating margin would tick back down to the mid-20s?

Well, I think the difference is long-term versus short-term. So, what Jim stated was what our long-term goal is, and that's what we would like to -- make sure that people are realizing that over the long-term, that's the way we're planning our business. But over the short-term, you're right to point out that in last year we beat that, and for some period of time we've been comfortably above it, and there's no inflection point on the expense side that we see really pushing that in the near term. That's really more of a long-term planning. So, I think if we continue to post strong numbers over the next few quarters, there's a very good chance we would exceed that.

Great. Thanks a lot, and congratulations.

Thank you.

The next question is from Ehud Gelblum of Morgan Stanley.

Hi, guys. Thanks, appreciate it. Couple questions. First of all, when you talk about the services side and the gross margin involved there and the impact it has on gross margin, how should we be thinking about the gross margin of the services business? Is that like a 30% gross margin? A 35%? How should we be looking at that as we model things out?

Well, Ehud, we -- our services revenue isn't yet at a level that we can actually -- that we would actually disclose that, but in terms of the operating margin on services business, it's very nicely above our stated operating margins.

Should we assume that the -- that there's no OpEx associated, so that the operating margin, you're talking about it being above your 27%, is the operating margin for services pretty much the same as gross margin?

That is correct.

Okay. Can you give us a sense as to what that margin is, as we kind of model things out and we say -- so it's obviously not 25%? But, is that like a 35% number? So if I were to model services growing at a certain pace, I would know what to do with the whole business? Is it above 35%?

Well, again, I would hate to disclose that, other than what we've talked about in terms of the impact on gross margin. We talked about the impact on gross margin in the fourth quarter, as an overall gross margin. And so --

But I'd say, in the general sense, if you figure that right now we're operating in a high 20s, from a product operating margin perspective, and we're saying that this higher than that, it's not in the 40s. So, I think your thinking in the 30s range is probably a good way to think right now. As that grows and scales, we'll see how that does, and see if we can improve it, but that's not a bad way to think about it.

Excellent. Now, it sounds, though, from what you've said in the past, as well as now, that it will grow as the year goes on -- or should grow.

We fully expect it to grow this -- in 2011.

But then, you said in an answer to a previous question that we should be looking at the current gross margin as being a good baseline going forward. Wouldn't the gross margin come down?

Yes, that's -- that's -- you're absolutely right. That's the baseline going forward, based on -- for the revenue and the percentage of services that we have today. So you're right, I mean, you're liable to see a tick in that, if we were to have an extraordinarily strong services revenue in any particular quarter.

But overall, we certainly expect that our hardware revenues will continue to grow as well.

That was my next question. So as you're talking about services --

I think the question is whether or not the relationship will change.

Correct.

I think it's too early to tell at this point.

Okay. So, the commentary before that services revenue definitely grows as the year goes on, does not necessarily mean it grows as a percentage of revenue, it just means that it grows, and hardware should be growing as well.

Hardware, we fully expect to grow as well.

Right.

Okay.

A lot of things, of course, they're interrelated.

Correct. Now, moving to one of the big contracts, the big one in Latin America that you've been talking about in the past. Clearly, it wasn't in Q4, but international revenues were essentially flat, like people talked about before. You're saying it's going to get larger as you get into Q1, and larger throughout the year. Can you go back to some of the commentary that we talked about, and kind of rehash some of that as to how large that particular contract could be?Could it be $5 million in Q1, coming out of that particular contract? Could it -- $10 million by the middle of the year? The end of the year? How should we looking at that international contribution from that large customer?

Ehud, I don't think we're at a point to where we can be that granular at this juncture, in regards to any single customer. But overall, we expect that it will provide a material contribution, certainly material contribution in 2011, and we'll begin to see, as Tom said, a nice impact in that regard in the first quarter.

And I'll add a little more color, why we're maybe dancing a little bit around this question. It's because it has to do with the customers that are actually involved, and their ability to get it installed and get them up and running, and us recognizing that revenue. And sometimes there are pieces of that that are within our control, and sometimes they aren't. So, I think it's -- the buckets that you're talking about aren't -- don't scare me, as far as them being too large. I think it's just a matter of trying to say, will this actually happen in this particular quarter or the next quarter, is where the nervousness would come in.

Right. Understand. Now, when you talk about material, is that, again, the technical GAAP definition of material, as in 5%? Or how should we be trying to interpret the word material?

Ehud, I think -- that's too granular at this point.

I think the buckets you talked about were the -- kind of the right way to be thinking about it.

Okay. And how long does that contract go for? Is that a couple years?

There are -- there's no -- there's no fixed time around it. There's -- the way to think about this particular contract is phases of deployment and periods of time when the customer's trying to get things done. And, typically, the way this customer operates is, as you get kind of halfway through it, they talk to you about the next thing.

Okay. And last thing, I know people asked you about HDSL earlier, and that is obviously -- you have the least visibility into what's going on with HDSL. But every so often, you do give us a sense as to what you think the next year might bring in terms of just the full year. Should we be looking at this as a -- as a double-digit decliner? As a mid-single-digit decliner? As a mid-teens decliner?

We'll give you our best guess. And as you know, based off of the last two years, our best guess is worth exactly what you paid for it.

Right.

But, our -- I mean, we are absolutely seeing some strength in talking to customers, we're hearing that that strength is going to continue on for some period of time, and that makes us feel better. But we're coming off of a strong year, and all of us realize that there's just a lot of fluidness in the way that the wireless carriers are planning their network right now.

So, we just feel not comfortable saying flat. We're not comfortable saying growth. It very well could grow this year, but we're not comfortable saying that. So, we're coming out of kind of a mid-single-digit decline, which we think is probably just a reasonable view on what the HDSL market should do. We don't expect a double-digit decline.

Okay. That's all very helpful. Thanks very much.

Okay. Thank you.

The next question is from Sanjiv Wadhwani of Stifel Nicolaus.

Thank you. Jim, just to clarify on the services piece, you said it's not large enough to disclose. I'm presuming it's less than 10% of revenues, and I'm curious whether it's actually even 5% of revenues?

It is -- it is less than 10% of revenue. And, as we go through the year, we actually don't anticipate, at this point, to reach 10% of revenue.

Okay. So, the 5% level, can you talk about that?

I mean, it's probably a little bit lower than that, yes.

Okay. And I'm curious, is this associated largely with one customer, or are there multiple parties involved here, as far as customers are concerned?

In this particular quarter, the fourth quarter, it was largely with one customer, and we should see that expand as we go through 2011.

Got it. Okay. That's helpful. And then, second question, if I look at sequential growth, the overall growth was 1.5%. At the same time, your -- two of your three largest customers, Verizon and AT&T, fell sequentially. Qwest grew sequentially. I'm curious, was the growth overall skewed towards Tier Two and Tier Three customers, actually?

Yes, of course, we saw growth on our international -- I mean, our enterprise side as well.

Right.

But, yes, we saw -- we definitely saw some good interaction in the Tier Two and Tier Three space.

Got it. Okay. And one -- one, actually, last follow-up on the services piece. It's fair to assume that services grew sequentially from 3Q to 4Q, and if that was the case, then what was that growth?

Services grew 3Q to 4Q? Yes. I think it grew from basically very close to zero, to the levels that you and Jim just talked about.

All right, perfect. Appreciate that. Thanks so much. Congratulations on a great quarter.

Thank you.

The next question is from Jim Suva of Citi.

Thank you. I have two questions. I'll just give them to you right now, because they'll probably be answered by different people. But congratulations on great earnings. You guys have done a great job. The question is, first of all, on the outlook of flat to down slightly, when we look at, historically, at least the last four years of your business, there's only been one year that was down, Q1 versus Q4. And that was down 1.8% in March of '09. All the other quarters have actually been slightly up.

So, can you help me understand what's different now in your outlook, versus what I would view as -- historically, it's actually flat to slightly up? And then, the second question is, on your services revenues, is it fair to consider those revenues to be more stable, or is there a lot of seasonality with the services revenues as one progresses through the various quarters of the year? Thank you very much, and congratulations again.

Jim, you want to take the first one?

Yes, in terms of the seasonality question on services revenue, I think a lot of it has to do with where the customer is based, as it might relate to weather. So, if we have a Latin American customer, maybe not as much seasonality may apply there. Now, in terms of the guidance, our guidance of flat to down, as I -- I mean, yes, I pretty much agree with what you say with history. We're either slightly down or slightly up. Okay? And flat to down, I think, where we actually end up is going to be based on activity levels that we see in the Broadband Access category, okay? Whether or not we exceed that guidance range that I gave you. So, at this point, it's our best guess.

Great. Thank you. And again, congratulations on great results to you and your team.

Thank you.

The next question is from Blair King of Avondale Partners.

Yes, hi. I just have one question, a follow-up on a couple of the questions that had to do with the international opportunities. Obviously, Latin America has been a nice bright spot for ADTRAN over the past couple of quarters. But Tom, maybe you could expand on some markets or some regions outside of Latin America that also give ADTRAN some confidence in the growth in -- of international business this year.

Sure. Actually, I'll -- let me modify a little bit about perception of what's been a bright spot and what's not been a bright spot. Although we've done an awful lot of activity in Latin America, we have yet to see the meaningful revenue potential materialize there. We're very confident because of where we are with both positioning people and actual products in the field, but we haven't seen that yet. So that, to us, is something that's yet to come. We also have been doing an awful lot in Western Europe, and there's an awful lot of opportunity, both in the Ethernet over copper, Ethernet over fiber type products, as well as Broadband in general.

In the 1100 series, we just came out with a new product which we introduced in Europe about two months ago, called the UVE which is Ultra Broadband Ethernet, which was actually designed and built in conjunction with some Western European carriers. They saw some very particular needs they have. This drive towards getting to 100 megabits is not a US-centric drive. It is a drive that's happening around the world, and an awful lot of them are looking at the fact that fiber to the prem makes sense for some portion of their build.

Fiber coming out of the central office or DSL coming out of the central office makes sense for some portion of the deal, but there's a very large gap in between. And we're seeing an awful lot of inquiries and actually sales picking up in Western Europe, some in Asia, in South America, other than just the customer that we've talked the most about. So, I think it's a fairly broad-based piece. Turning those into material revenue, getting them to ship, getting them recognized, those are all issues that we're going to have, but it's not a single-customer event.

One last follow-up question, in terms of the -- in terms of a couple others on the OpEx side. Is there an investment that needs to be made in places like Western Europe or Asia, that would lead the operating margin lower over the next several quarters?

If you take a look at the growth that you've seen over the last year, although I would agree it hasn't kept up with our revenue growth, and because of that, our operating income has increased. But if you look at the growth in the sales in the R&D line, a very large percentage of that is geared toward pre-positioning, the types of things that we're looking forward to in 2011. So, I don't see a watershed. You may see it tick up as the year increases. We tend to try to track that with revenue growth, but I don't see an awful lot of pre-positioning that's going to be out of the norm of what you've seen from us over the last two years.

All right, super. Thanks, Tom. Thanks, Jim.

The next question is from Nikos Theodosopoulos of UBS.

Thanks. Couple of quick ones. Just back on professional services, are all those revenues recognized in the Broadband segment?

Yes.

Okay. Is there a possibility that that would expand into like, optical, or is it really just a -- a -- services that it's tied to outside plan type of deployment?

It's -- at this point in time, I don't expect -- I don't expect -- in the near term, I don't expect anything meaningful outside of the Broadband segment.

Okay. Okay. And was there any positive impact from Frontier, given the upgrades they were doing? I think last quarter you mentioned that there was not much of an impact. Did that start impacting fourth quarter results, or is that still revenue that has to be recognized in the future?

We've got a very good relationship with them. They are definitely moving aggressively with their product, and we are one of the beneficiaries of that. And we saw that in the fourth quarter.

Okay. And just, last, back on the tax rate. I think, Jim, you said the effective tax rate would be 34.5%. I'm trying to understand why it would be that -- why would it be that high? I think the effective tax rate this year was 31% to 32%, somewhere in that range. Why would it go up in 2011?

Well, you know, a couple of things here. First of all, we had some discrete items impacting each quarter as we came through the year, as a net positive. And also, you probably noticed on the Earnings Release, where we did receive the benefit of the R&D tax credit of $4.5 million. Now, there is a meaningful portion of that that relates to stock option exercise, related of to engineering employees that are included in the R&D credit calculation. And the benefit of those stock option exercises are included in that calculation.

So, the question is whether or not that would be continuing going through 2011. We have to account for the effect of that in the quarter that it actually happens. So, we have to be very, very careful about how we talk about a tax rate, until an economic event actually happens. So -- so those are mainly the two components that are accounting for the difference, so to speak, that you're talking about.

Okay. And just, sorry, one last one. You mentioned earlier about things that you look forward to in 2011. One of them was OEM relationships that have yet to come in. And, I think we're familiar with the Ericsson relationship that you have. Is that the one you're talking about? Are there others? And, if you can, just update us on what's happening with the Ericsson relationship.

That is getting very specific, but yes, there's only one, and that is something that's progressing. And the way that we view that, without trying to time the exact timing as to exactly when that will occur, all of that is moving forward. So, it's not explicitly in our near term view, as to something that we're going to recognize. But we still that as still moving forward, still a great potential, and still something that's yet on the horizon.

And, when -- if and when that starts, you would view that as additive, or replacing sales you would have done direct?

Without a doubt, additive.

Okay, all right.Great, thank you.

The next question is from Simon Leopold of Morgan Keegan.

Thanks a lot. Most of my questions have been asked, of course. Just a couple of quick ones, actually. One, is kind of just thinking big picture about the year. Coming off of this first quarter guidance, if I were to apply normal seasonal patterns just on that kind of scenario, it seems that your growth could be in the mid-teens for all of 2011. And I just want to see if you see anything flawed in just applying that kind of scenario.

I understand the math. And the definition, of course, is how far back do you want to go back to define seasonality. What I want to be careful to do is not give second-quarter guidance on the call here. But, I would say the trend of us, the general trend of us getting larger in the second quarter and then larger in the third quarter and then typically a decline, albeit that didn't happen this year, typically a decline, there's nothing that keeps us from thinking that that won't happen again this year.

We started to see some changes last year, where customers were really trying to get their act together. And if you look at it on a customer-by-customer basis, you can see some of them operated differently than what they had historically in the past, and we have yet to see what they're going to do this year. We break out our 10% customers, and I think if you just look at the revenue flow from that 10% list over the last couple of years, you can see there's been some shift there in the way that they have operated. So, I would hate to try to guess that at this point in time, but I think the general trend of Q1 and Q2 being up, and then Q3 being kind of slightly up and then Q4 typically being down, is still the way we would think about it.

Okay. And then, just the last one is, trying to understand what might have been the surprises in the fourth quarter for you, relative to the forecast you gave us. And maybe a second part to that question would be, more specifically, was there any, really -- looking at your, let's say, top five customers, any new projects coming into the mix? Or are those kind of new projects still in the pipeline? So, what's sort of the story to the upside?

No new projects, other than one that was already talked about. And I wouldn't call it new. It was new in that it was kind of the first time we've recognized revenue for a specific builds that were going on with that customer. That was not a 10% customer. But in general, no new projects. I think it was just continuing at a pace that was a little bit swifter than we expected. We typically see a down tick in Q4 across all of our customers. We didn't see that this time. So, they continued on in earnest longer into Q4 than we would typically have seen.

So what surprised you, then, is sort of what I'm trying to get at?

Well, you know, if you look at it, if you look at the larger customers, I mean, some of the larger customers continued to buy on. The Tier Two and Tier Three space that we talked about came in stronger than we would have expected. We would have expected to see a more seasonal decline than we saw in that space, and that largely showed up in the Broadband space.

Okay. Great. Thank you very much.

Okay. Nicole, I think we're past our time now. So, I'd like to thank everybody for participating on the call today, and we look forward to talking to you in three months.

Thank you. This concludes today's conference. You may now disconnect.