ADTRAN Holdings Inc (ADTN) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to ADTRAN's third quarter 2011 Earnings Release. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions).

During the course of the conference call, ADTRAN representatives expect to make forward-looking statements which reflect management's best judgment based on factors currently known. However, these statements involve risk 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, 2010, and Form 10-Q for the quarter ended June 30, 2011. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which will be made during today's call.

Thank you. I will now turn the call over to Tom Stanton, Chief Executive Officer of ADTRAN. Please go ahead, sir.

Thank you, Sharnay. Good morning, everyone. Thank you for joining us for our third quarter 2011 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 third quarter performance, along with some comments on what we expect for the fourth quarter. As stated in our press release, ADTRAN set its sixth all-time consecutive revenue record. This performance was driven by our 3 main product areas, which combined grew 63% over the same period last year. Our Company continued to benefit from increasing demand for higher speed services in both business and residential markets and continued migration towards IP services. This, coupled with a continuing fiber buildout for mobile infrastructure upgrades, and an increase in demand for our products outside the US, enabled the Company to achieve $192.2 million in revenues for the quarter, an 18% increase over the same period last year.

Looking at our business on a product line basis, Broadband Access achieved its seventh consecutive revenue record quarter, by growing an impressive 93% over the same period last year, to $87 million. A meaningful portion of this growth occurred in Tier 2 and Tier 3 markets, and highlights the excellent performance of our sales and engineering teams working in these areas. Over the last 2 years, our employees and partners have done a phenomenal job of introducing ADTRAN to this new market segment and redefining our broader capabilities to our established Tier 2 customers. During the third quarter alone, we received awards from over 20 Tier 3 customers for the Total Access 5000 platform. Looking forward, we believe our momentum in this space will continue to grow for both broadband stimulus recipients and all others in this area.

Broadband Access also performed well with large carriers, domestically, as we saw substantial growth in both the Total Access 5000 and Fiber-to-the-Node product areas. Broadband Access also performed well outside of the US, with solid growth in the Total Access 5000 area. And as expected, substantial growth in Fiber-to-the-Node over the same period last year.

Finally, although off to a slow start, we saw a modest increase in shipments in Q3 for broadband stimulus. And we expect to see another modest increase in Q4, with meaningful pickup beginning in 2012.

Moving on to Internetworking. This category achieved its sixth consecutive record revenue quarter, growing an impressive 44% over the prior year. As in recent quarters, we saw growth across all our distribution channels, including various carrier segments and our growing dealer base where we have continued to increase focus on reseller development. During the quarter we saw particular strength in routers, EFM and our IP gateway product areas. Also during the quarter, we completed our acquisition of Bluesocket, a leading innovator of virtual wireless LAN solutions. We believe the combination of ADTRAN's Enterprise Solutions and Bluesocket's virtual wireless LAN solution substantially increases our addressable market. And allows us to leverage the strength of our channels across multiple markets.

Optical Access grew 20% over the prior year, achieving a record revenue level, and saw growth across large and small carriers. This record was a direct result of our market position as carriers continue to invest in mobile backhaul infrastructure upgrades. I think it's also important to note that in the third quarter we began trial activities with our new optical network edge systems and our 8000 family of ethernet sell side gateway products. Moving forward, we see new areas of opportunity as we continue to position our current product offerings and aggressively pursue development efforts to address arising needs in what will prove to be a very long-term growth market.

HDSL was down over the prior year with $25.3 million in revenues. And although this was below our previous expectations, I'm proud that the acceleration of revenues of our main product areas allowed us to continue to perform well as a Company throughout this year. Moving forward, we expect any declines in this area to be relatively immaterial to the overall outlook of our business.

Total international revenues increased 163% with growth from all geographic regions, driven predominantly from our Broadband Access and EFM solutions. As you know, we typically see a seasonal downturn in our business in the fourth quarter and similarly expect to see a decline this quarter. Regarding broadband stimulus, as I previously mentioned, our current view is that meaningful increases will not occur until 2012.

Looking forward, our opportunities for growth including broadband stimulus, international expansion, enterprise market share, and various other Tier 1 initiatives provides us confidence in our capability to deliver meaningful growth in revenues, operating income, and earnings per share for 2012.

Lastly, I'd like to talk about our operating profile of the Company. From the operating expense perspective, ADTRAN has continued to increase its investment to position us for future opportunities. Our current projection for Q4 shows a moderation of this increase as we now believe we have reached a range necessary to execute on opportunities through 2012.

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

Thank you, Tom, and good morning to everyone. Revenue for the third quarter increased 18% to a record level of $192.2 million, compared to $163 million for Q3 of 2010.

Broadband Access product revenues for Q3 of 2011 increased 93% to a record level of $87 million, compared to $45.1 million for Q3 of 2010. This increase was primarily related to continuing growth in deployments of our TA5000 and Fiber-to-the-Node platforms. Internetworking product revenues for Q3 of 2011 increased 44% to a record level of $42.5 million, compared to $29.5 million for Q3 of 2010. Optical Access product revenues for Q3 of 2011 increased 20% to a record level of $22.3 million compared to $18.6 million for Q3 of 2010. Carrier Systems revenues for Q3 of 2011 increased 57% to a record level of $120 million compared to $76.3 million for Q3 of 2010. Business Networking revenues for Q3 of 2011 increased 33% to $44.9 million compared to $33.8 million for Q3 of 2010. Loop Access revenues for Q3 of 2011 were $27.3 million compared to $52.8 million for Q3 of 2010. HDSL product revenues for Q3 of 2011 were $25.3 million compared to $49.4 million for Q3 of 2010.

As a result of the above, Carrier Networks' division revenues for Q3 of 2011 increased 19% to a record level of $152.5 million compared to $128.6 million for Q3 of 2010. Enterprise Networks' division revenues for Q3 of 2011 increased 15% to $39.7 million compared to $34.4 million for Q3 of 2010. International revenue for Q3 of 2011 increased 163% to $21.9 million compared to $8.3 million for Q3 of 2010. 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 57% of revenue for Q3 of 2011, compared to 59.7% for Q3 of 2010. The lower gross margin in the quarter was largely attributable to higher services related revenue, expediting costs related to specific customer opportunities, and specific customer pricing related to market share expansion. Total operating expenses as a percent of revenues were 30.4% for the third quarter of 2011, compared to 30.1% for the second quarter of 2011, and 32.1% for the third quarter of 2010 on higher revenues. The $2.9 million increase in operating expenses from Q2 of 2011 to Q3 of 2011 was primarily related to operating expenses, acquisition related costs and amortizations in connection with the Bluesocket acquisition on August 4 of this year, Telcordia costs related to Tier 1 Optical Access opportunities, and increased staffing costs.

Stock-based compensation expense net of tax was $2 million for Q3 of 2011, compared to $1.7 million for Q3 of 2010. All other income net of interest expense for Q3 of 2011 was $4.3 million, compared to $4.1 million for Q3 of 2010. The Company's income tax provision rate was 34.6% for the third quarter of 2011, compared to 34.7% for the third quarter of 2010. The tax provision rate for the third quarter of 2011 included the normal benefit from research tax credits. The tax provision rate for the third quarter of 2010 included benefits from employee stock option exercises and FIN 48 adjustments. But did not benefit from research tax credits due to delays in legislation.

Earnings per share assuming dilution for Q3 of 2011 increased to $0.56, compared to $0.50 for Q3 of 2010. Inventories were $87.3 million at quarter end, compared to $86.7 million at the end of Q2 of 2011. And net trade accounts receivables were $89.6 million at quarter end resulting in DSOs of 43. Unrestricted cash and marketable securities net of debt totaled $446 million at quarter end, after paying $5.8 million in dividends and after repurchasing 1.1 million shares of common stock during the quarter.

Due to the book-and-ship nature of our business and the timing of near term revenues associated with large products it is our policy not to give specific guidance for the quarter or for the year. However, we would like to give color to help you formulate your views on our near-term business outlook. For the fourth quarter of 2011, we anticipate revenues will decline in a range of 9% to 10% on a sequential basis. This expected decline takes into account normal seasonality and specific customer inventory levels. Based on certain factors, including customer mix and an increase in our services and cabinet revenues, which we have mentioned before carry a lower gross margin but are accretive to operating margins, we expect gross margins for the fourth quarter will be at the low end of the high 50% range to revenue, as we saw in the third quarter. We expect fourth quarter operating expenses will be flat on a sequential basis. And we believe that the larger factors impacting the revenue we realize for the fourth quarter will be the following. The macro spending environment for carriers and enterprises. The adoption rate of our Total Access 5000 platform. Professional Services activity levels, both domestic and international. Upgrades for mobile broadband infrastructure and the timing of revenue related to broadband stimulus projects.

Tom?

Thanks, Jim. Sharnay, we would now like to open it up for questions.

(Operator Instructions). Sanjiv Wadhwani with Stifel Nicolaus.

General question on carrier spending, given the economy and fears of a recession. Any color on what you're seeing out there from both Tier 1s and Tier 2s?

Sanjiv, this is Tom. I would say the environment really hasn't substantially changed from what we've seen pretty much all of this year and most of last year, which is very targeted spending. Wireless, of course, is still a very hot space. Where there are projects associated with mandatory or regulated buildouts those are very hot. And where there have been acquisitions and people are trying to improve footprint those are still very much ongoing. So I'd say the environment really hasn't substantially changed for us through this year.

And Data Plus is Tier 1s and Tier 2s equally, I guess?

That would absolutely apply to Tier 1s and Tier 2s.

And then second question on guidance, down 9% to 10% sequentially. Seems to be higher than normal seasonality, which seems to be more in the mid single digits, down sequentially. So I know you made a comment about customer inventory levels. Can you just give some more clarity on the guidance and the inventory level comment?

Yes, Jim, do you want to --?

I would agree that it is down a little more than seasonality. And it does relate to a specific customer inventory level. And we're certainly shipping to customer requirements in terms of their deployment schedules and that has something to do with it, as well. But I don't know of any other color we can put on it at this point.

Yes, if you take a look at our business, and if you look at the growth in our business over the last 2 years or so, there's our ongoing run rate business which is going out to all of the carriers and all of the enterprise customers. And then there are very project-oriented things that have very specific time frames associated with it. And I think it's just a matter of us trying to look out 90 days in advance and trying to figure out what we think would happen. I think fundamentally the business is exactly where we would like it to be.

So I understand you might not want to give details on the customer but is this a domestic, international customer? And then is this related to any particular area, whether it's Broadband Access or Optical Access?

The one we're talking specifically is a domestic customer. And that customer buys a broad mix of many different products from us, but the higher piece as in most of our customers is Broadband Access.

Jim Suva with Citi.

It's comforting to hear your commentary about your OpEx level. Now, if I heard correctly, stabilizing for what you see as the outlook for 2012, if I hear that correctly. When we think about that outlook for 2012, one has to ask, then are you anticipating sales growth of mid to high single digits or double-digit growth. Because the September quarter levels, your sales were actually up about 18% year-over-year. But then the December outlook is up closer to about 5% year-over-year. So when you talk about that run rate and how you position the Company, can you help us make sure we don't get too ahead of ourselves about where you see the Company progressing at those revenue levels?

I will to the extent we can. We typically talk about the following year in our fourth quarter conference call. And I would really like to leave it to that point before we actually get into any specifics about 2012. I will say really that relates, though, more to the -- we have had a large increase in our engineering talents in order to be able to meet the committed and projected requirements. We've seen a fairly big uptick in that over the last year and-a-half to 2 years. And really, that's probably the biggest thing that really has affected our operating expense line. So if we look at the forecast of ongoing R&D development versus the team that we have in place right now, that's where we're really seeing a large level of confidence. Which will relate itself over a period of time to what the revenue growth is but it's not a direct correlation. It has more to do with the backlog and us being able to staff up, mainly on the 5000 side and some of the optical developments, to a core mass where we can move forward and feel confident that we have the right people in place.

Then a quick follow-up. I believe you gave some financial goals that you had hoped to have long-term operating margins of 25% or higher. Is that still intact or any changes to that view?

No changes to that view. No changes.

Michael Genovese with MKM Partners.

First, a follow-up on the revenue guidance. Typically, normal seasonality is down about mid single digits, and this is high single to low double. You've talked about specific carrier inventory levels but would you characterize part of the caution, does it have to do with the macro environment at all? Are you seeing any, beyond specific, more of a general weakness in the revenue outlook?

How much the actual macro outlook weighs on us is actually hard to quantify. There's no doubt that we're aware of what's going on in the economy. And when we think about our enterprise business and the potential impact, some of the changes that the carriers may make, that's always a cautionary piece that comes in and maybe dampens things to some extent. But I would say there's nothing specifically associated with that, other than the fact that we're very much aware of it. And when we roll up our numbers we try to be as realistic about the environment as we can be.

Is there a relationship there between what we're seeing on the top line to the pricing environment. When you talk about also specific pricing deals to gain footprint, is there a relationship between those 2 variables? Or are they separate, in your view?

They're absolutely separate.

If I could just sneak in one more. DSOs, very slight down tick. But this is continuing a little bit of a trend that we've seen, actually DSOs continuing to go up a little bit. At the margin, are you seeing customers' ability to pay, are there any of these Tier 3 customers where you're worried about the credit quality or worried about whether these receivables will ever come in the door?

Michael, we certainly look at that on a continuing basis. And at this point we see no real change in our view on the credit quality of our customers.

Or on their payments to us. It's been very consistent.

Nikos Theodosopoulos with UBS.

2 questions. First, on the Internetworking business, very strong sequential performance there. Was that very broad-based or did you have some significant customers this quarter there?

It was very broad-based. Every channel was up. I would say it's the same trend that we've seen over the last couple of years. It was just stronger this quarter. There wasn't a particular customer that stood out. And it was across most of our product lines and it was across every channel.

And on gross margin, you gave some information comparing it year-over-year. Jim, sequentially, what do you attribute the decline? Especially if I look at international being lower, it would seem like the services component declined sequentially, which would have helped gross margin. What led to the sequential decline?

We have services business, both domestically and internationally. And combined, our services business actually increased. So that rate weighed on gross margins, but again, accretive to operating margins.

So services as a percentage of sales was flat or up sequentially?

Up.

So is this level of gross margin, I know you indicated that for the next quarter, do you see this as a steady state going into the future or are there other variables we should consider?

Our view on Q4 is what we stated, a level in the range of what we saw in Q3. And we wouldn't be surprised to see that level in Q1, as well. But going forward, I think it's going to depend on the mix of hardware revenue versus services related revenue as we go forward. But again, we continue to view our services related business as being accretive to operating margins.

Just one last question on the gross margin. The specific customer pricing for market share expansion, is that confined to Broadband Access or is it something you're doing, it's broader in your portfolio?

I think it's predominantly Broadband Access. We always see pressures across all our product lines, as you're aware, but I think predominantly what we're talking about here is Broadband Access.

Jonathan Kees with Capstone Investments.

Just wanted to get an idea in terms of that broadband stimulus, the commentary now is that it will be meaningful in 2012. In past discussions with you, Jim, it sounds like you've been cautious in including that in your business plan. And you discount that into your business plan. Is that still par for the course in terms of how you're looking at the contribution from the stimulus?

We do believe that 2012 we'll begin to see meaningful contributions. So we are at a point to where we're seeing a pipeline. We've certainly seen awards that gives us confidence that we'll see a meaningful contribution in 2012.

I think to the extent we were discounting them, we were trying to discount them for the 2011 time frame just because of the timing of these things is always problematic. And they always take longer than you think.

And then let me ask you about the share gain. Would you characterize the growth in Broadband Access as both market growth and a significant amount from share gains?

Yes. Both.

One last question, if I could sneak it in. You had a good amount of chassis sales last quarter. Would some of that still be the case for this quarter? And when do you think the carton sales will start coming in?

It's not chassis sales that we were referring to. We were referring to actual cabinet sales. And in terms of the line card increment, that's at some point in the future. It's very hard to gauge the timing of that. But as carriers add subscribers, at that point they will certainly order line cards to fulfill that growth.

And we see an ongoing run rate of line cards on a quarterly basis. We do know we're planting more seeds to more cabinets and chassis that we actually ship. I would say we're feeling that effect today but we're also feeling that effect from chassis that we shipped a year ago.

So the chassis or cabinets that you're shipping now or in last quarter, you'll probably see more of a meaningful contribution in terms of line cards next year?

I would say that's typically -- if you think about a chassis or cabinet shipment, getting it out there, getting it installed, which to some extent you'll see that in our services piece, getting it up and running and then really selling on to that. I would say there is a lag time, and a 6-month lag time doesn't seem to be unreasonable.

Simona Jankowski with Goldman Sachs.

Just a couple questions. Just to clarify, first, when you talked about the pricing action primarily around Broadband Access, was that largely constrained to the Tier 2 and 3 segment, or also were you looking at expanding some of your opportunities within Tier 1?

We're always looking at expanding our opportunities across the space. And I would say that, to the extent that we see the ability to go out and grab market share, we're going out and grabbing market share and that would include any opportunities that come up. I think the area that most people are talking about today is probably the Tier 2, Tier 3 space because of the activity there. But any time we have a chance we will go after it.

So did that mean, though, specifically that you had some incremental wins in your Tier 1 customers where that impacted your pricing? Or did that not occur in the quarter?

We picked up market share, I would say, across the board. And trying to actually equate that market share pickup to specific -- I'm trying to think as we answer this. I would say I wouldn't be surprised if I saw it across the board but I can't really tell you how much of it was Tier 1 versus Tier 2 versus Tier 3.

And just the second question was just an update on the opportunity at Centrelink related to the Quest acquisition. I think you mentioned in response to one of the questions that acquisition-related projects are still ongoing. And I just wanted to clarify that implies that you see yourself maintaining or perhaps gaining share in the Quest territories?

We're not going to talk about customer specific things in any great detail, other than the fact that whenever there's movement like that we view it as an opportunity to pick up market share. And we would expect any acquisition or any combination of entities to follow that same line of thinking. So that one would also follow that same line of thinking.

Blair King with Avondale Partners.

It's a follow-up to an earlier one. Just again, trying to get a little bit more color on the inventory build, at a specific customer, and how that ultimately relates to Tom's comments about meaningful growth in 2012. And if there's any way to help us think about how we view an inventory build. Is it a quarter event, a 2-quarter event? Or any color you can give there in terms of how we just model out the next few quarters into next year.

I would view it as a quarter event.

So that implies above normal seasonality could potentially return in the first quarter, particularly given some of the stimulus.

Without giving guidance on the Q1. But what Jim was mentioning in his comments was very much a specific quarter event and a specific customer.

And then just shifting gears, lastly, onto Bluesocket, if there's any way you could give some color around what the incremental revenue stream in Bluesocket was. And then also if there were any purchase accounting adjustments that might have had any impact on gross margin this quarter.

Let me cover the revenue piece and then, Jim, if you'll cover the accounting piece. The revenue that we got from Bluesocket this quarter, because of where we closed and where we were, just trying to make sure the supply chain was in place and things, I would characterize as negligible, really not meaningful. Going into next quarter we would expect it to be low single digit millions. And then right now we have a lot of enthusiasm about where we think that product set, when combined with our products, will actually carry us in the future from an accounting perspective.

Sure, Blair. On the gross margin or the cost of sales from a purchase accounting standpoint, the adjustments there were negligible, as well, as it relates to fairly negligible revenues in the quarter.

Rich Valera with Needham & Company.

First, a clarification on the prior response to the Bluesocket revenue contribution, is that low single digit millions per quarter?

Per quarter.

And then with respect to HDSL, obviously that's been down more than expected for 2 quarters in a row here. Can you give us any sense of your outlook for that business heading into next year? Do you think this quarter's level is a reasonably sustainable level? Could you see a bounceback? Or do you just have no visibility at this point?

I'll tell you, to the extent we think we have visibility we've been proven wrong on HDSL. And that was both last year where it was much stronger than we thought, and then this year where it's been much weaker than we thought. So a longer term outlook on HDSL is difficult. We do know that there's an ongoing run rate that is sustainable for some period of time. As to whether or not we're actually at that ongoing run rate, I really can't tell you. I'll give you a little visibility into actually what we're seeing this quarter, which is actually we're seeing a little bit of strength in HDSL as it bounced back from last quarter. But whether or not that will even carry through the rest of this quarter is difficult to say. Historically, when we've seen businesses do this, we hit a rate where it's really the bottom, and it stays at that bottom for multiple quarters. And we have to believe that we're close to that level at this point in time, which is why we've characterized the changes in HDSL from a decline perspective to be relatively immaterial to the total business.

And just on the international side, last quarter you were talking about a number of opportunities outside of Mexico that you thought in aggregate could have a run rate exceeding the Telmex deployment as you headed into next year. I wonder if you could give us an update on the international outlook outside of Telmex.

I would say that we feel as strong about that today, if not stronger, than we did a quarter ago. So we actually saw good growth outside of Mexico this quarter. And it was pretty much across every region. And the bid activity that we have going on with not only the 5000 but some of our new products like the UBE, it continues to strengthen, not only the bid activity but the actual field trial activity. And we're seeing good momentum in Europe. We've got some wins in South America recently and we picked up some wins in the Pac Rim area. All of these have to yet convert themselves into revenue that we can actually show to you, but I would say we feel as good about that as we've ever felt.

Ehud Gelblum with Morgan Stanley.

A couple clarifications first. Jim, you mentioned that obviously revenue and COGS impact from Bluesocket was negligible. Was there any OpEx impact? I don't know how many employees they had.

Yes, there was OpEx impact. For competitive reasons, we're not disclosing the headcount acquired there, the employees acquired, but there was OpEx. If you look at the $2.9 million sequential increase in OpEx, a meaningful amount of that was related to Bluesocket and acquisition-related costs.

I would say the largest single bucket.

That's true.

You broke out the $1.045 million of one-time merger-related costs. But should we assume an equal amount or a greater amount came from regular ongoing OpEx?

We're not going to break out that level of detail, again for competitive reasons. But, again, a large part, as we said, of the $2.9 million sequential increase would relate to Bluesocket and acquisition-related costs. That's the best we can do.

And that stayed at the same level? Obviously the $1.045 million goes away next quarter?

No, that would continue because that includes purchase price amortizations that would continue. And as revenues do increase, there will be purchase accounting related costs related to cost of sales that will show up, as well.

So we should assume that stays relatively constant between all the different puts and takes. The extra months, you only have them for 2 months. Next quarter it will be 3 months,.

Right.

Higher revenue.

Higher revenue would apply that -- obviously it wasn't accretive to EPS in the quarter that we acquired. But certainly at a point in 2012 we would expect that to happen as revenues grow.

If you look at the margins they actually would have been higher without it, on the operating margin line.

Yes, that's correct.

Can you tell us the total services number so we can get a sense as to how that is impacting gross margin?

That is not a number we break out at this point. When we reach the disclosure threshold of 10% of total revenue we will begin breaking that out. At this point we're not there.

Is it above 5%? Can you tell us that?

We can't comment on that at this point but it's certainly growing.

One last thing on that. Can you at least tell us how many basis points of the gross margin decline came from the increase in services versus the other pieces? Is that something we can get a handle on?

We don't have that level of detail, either, that we disclose at this point. But it's certainly a meaningful part of what's weighing on gross margins. But again, accretive to operating margins.

You mentioned another reason for gross margin decline was expediting. You expedited last quarter as well. Was this, A, to the same customer? And, B, was this a customer that has these inventory issues? And why are they constantly expediting, if they're now 2 quarters in a row?

Expediting can easily change from customer to customer in terms of what's driving it. And again, what it comes down to is how fortunate we are in terms of matching our production planning to the delivery requirements of our customers. So that's going to vary from quarter to quarter and it weighed on this quarter.

And I would say that this quarter's was probably more of a drop in. It was more of, we did not have the normal lead time that we would typically expect.

Was this the same customer as last quarter?

To be honest with you, I don't think so. I'm trying to just remember what that comment was associated with last quarter, but I do not believe so.

And was this associated with a share gain opportunity where this is something you didn't necessarily have an ongoing relationship with this customer for this project and they came to you and said we would like you to take this? And it's a pure share gain and that's why it caught you unawares?

I would say it would be a little bit of both. I think some of it is going into ongoing activities where they're either accelerating or putting themselves in the inventory position that they want to be in. And some of it was share gain where it would have been probably a different product from a different company.

And then lastly, did I understand it right when you said that OpEx levels or OpEx growth was going to moderate next year so that should we assume, if OpEx is roughly the same in Q4 as it is in Q3, should we assume OpEx levels are relatively flat through the 4 quarters of next year, and the fluctuations in revenue pretty much dictate the margin?

I'm going to be a little cautious on that until we get into next quarter and get on the conference call and talk about 2012 in more specifics. The point that we're making there is we don't expect at this point to see the same type of growth that we saw this year. We wouldn't expect that through 2012. There are normal things like pay raises and things that have to factor into that. But the headcount growth, which drove by far the majority of the increase this year, we don't expect to see next year.

Simon Leopold with Morgan Keegan.

This is Victor Chiu in for Simon Leopold. One of your competitors pre-announced their results recently below expectations, citing delays in stimulus. Also, macro event issues too. I know your level of stimulus exposure is significantly less but are you seeing any similar issues? And also, along those lines, how is your visibility regarding spending priorities at that customer that you guys have in common? Are you guys seeing a shift in CapEx dollars from one portion of the business to the other? If you could just give us a little more color on that.

Yes. Without speaking to anybody's, their specific comments, let me just tell you the way that we're seeing things and you can deduct what you think is different. The macro spending environment, as I've mentioned before, we really haven't seen a change in that environment. I think the key is that you have to be in the areas where there is focus, and if you're in those areas, then customers are moving forward. And if you're not in those areas, then they're not. And that really hasn't changed for us in the last year or year and-a-half or so. Which has been a positive thing for our Company.

From a stimulus perspective, I would say, I had mentioned that we did see an increase this quarter. We expect a modest increase next quarter. As to whether or not that's directly online, it's hard to say. I would say it's probably a little soft but I would say in general we weren't expecting a lot this year. So that may have to do with just the expectations of when we think projects will actually come to fruition and actually we start moving product out into the market versus any significant shift. I think in general, it's what we were expecting.

What was the other point, as far as common customers? I think the competitor you're talking about, I think we have several common customers.

Historically your largest customer I think you guys share in common. I just wanted to know -- I know you don't want to speak specifically about the customers but if you would characterize it more as a result of solid business from that customer historically or an improvement in your position at the post.

Maybe characterize it this way. If I looked at our largest customers, I would say we're seeing no surprises and no significant change in the environment.

Jeff Kvaal with Barclays Capital.

I was wondering if you could take us through, obviously not your expectations for the 2012 gross margins themselves, but what you think the moving factors are there. And then we'll draw our own conclusions on whether we think those are ultimately a positive or a negative for you folks for next year.

Let me start and let me ask Jim to step in wherever he wants to add color to that. I think the biggest mover in gross margins is going to be our services business. And when we characterize the services business, there are the pieces where we actually go and do the engineering and the installation of the products out into the field. And then there's another component of that which is the cabinet business itself where you're actually buying other people's equipment. And of course the gross margin associated with buying other people's equipment is different than if you're manufacturing the equipment yourself. Those 2 pieces, which I would say in broad strokes, we would characterize as a services business in the way we're talking about its weight on the gross margins, is probably the largest factor. And I will go back and say, and I think we've proven this out, that it is accretive to operating margins. But at the gross margin level it can be something that we're doing our best to try to communicate to people that this is part of us growing as a vendor. It's what our larger customers and even our smaller customers at this point are expecting from us. And it is absolutely a necessary piece for us to be able to achieve the type of market penetration that we're looking for. More specifically in Broadband Access but that has now moved into the Optical Access area, as well. Jim, any other color to that?

Secondary to that would be any expediting costs that we experience in any given quarter, again based on the matching of production schedules to customer requirements. But certainly the variation in services related revenue is the larger driver.

And we would hope over time that those expediting charges which periodically come up would get to be less. I think some of the things that we're seeing is we've seen, if you look at the last 2 years, a meaningful uptick in our business. And we are continuing to add capacity in order to be able to make sure we meet all the commitments. But there are times where, at least in the last year or so, that we've seen drop-ins that we've had to do extraordinary things in order to meet those. And over time those will just become part of our normal operating profile.

Are you able to tell us how accretive the services business is to the operating margin?

The operating margins of our services business does exceed the operating margins that we're experiencing. We haven't disclosed that yet. That will become a disclosure point, again when we reach the appropriate threshold. But we are experiencing operating margins in excess of our total consolidated operating margins.

And then secondly, on the macro, it seems as though you're not really building that much into that, given you haven't heard too much from your customers. So to clarify, that means that the inventory correction at one of your customers is not really macro related as far as you can see.

It is not macro related.

And then could you remind us how the 2009 changes came in from your customers? Did it take a couple quarters? Was it a lag time? Or how should we think about that?

2009 changes --

When the macro was taken down.

How long did it take for us to actually see the impact?

Yes.

That's a really good question. Because, to be honest with you, it factors into different customers at different -- they don't all switch the light at the same time.

I think we began to see it actually on the fourth quarter of '08.

Yes, I agree with you. I think we actually probably felt it earlier than you would typically think. We saw it more predominantly on the carrier side than on the enterprise side if you go through the recession. But I would say we were feeling it early into the period.

Barry McCarver with Stephens.

I wanted to go back to, Tom, your comments about the contract wins in the quarter. I think you said over 20 from Tier 3s. Can you give us an idea of how many of those were directly related to some stimulus grants? And then maybe what the total demand was? Were there some out there that you didn't win? I was curious as to that success rate and what might be the driving factor that puts ADTRAN over the top in the quarter for those contracts.

To be honest with you, I don't have the exact stimulus, non-stimulus. I think my sense would be a large percentage of those were stimulus related but I don't have the exact number. And to give you maybe a broader perspective on that, the over 20 customers that we saw in third quarter, we saw the same type of thing in second quarter. We didn't mention it on our call, but we picked up roughly the same level of customers in the second quarter. And we picked up a similar level in the first so this is an ongoing thing. The momentum is just very strong in that area. The second part of your question again?

I'm curious as to, if you won over 20, was that 75% of maybe the bids that were out there? I'm curious as to how much of that type of contracting you're winning. And what I'm really trying to get at is, is there a specific advantage that ADTRAN has that's taken some of this market share from the Tier 3 guys?

I can speak to the last one a lot easier than the first one. I would say our winning, I do know that our winning percentage has continued to increase as that customer base has gotten to know us. And we're fairly new to that space. Although we've been calling on them for different product lines, to some extent, over a period of time, we're fairly new to the specific space that the 5000 actually hits. And that percentage has gone up. For competitive reasons, I probably don't want to give you the exact percentage. That does nothing but fire up other people. But we're very happy with where we are right now in that space.

As far as why, I could give you a nice commercial on how great our products are. I think we really do have a superior solution. I think we've got a much, much broader solution set. Not just the 5000, but if you hook at the 5000, the 1200 and the 1100 series, we do things that nobody else can do. And if you look at the real economics of that, not only in the near term, which are very positive, but over the long term I think they prove themselves out. I think a lot of it had to do with us being able to get in there, show the capability of the Company, show the service profile that we provide to our customers, and just open up eyes and ears. And I think once we get past that, we do pretty well.

Greg Mesniaeff with Kaufman Bros.

Jim, can you give us some color on the component pricing environment that you're seeing now?

Haven't seen much of a change, really, Greg.

I would say definitely no. I think you're exactly right, no change.

And my other question is, obviously your overseas business has been picking up. Assuming that continues, what kind of impact are you foreseeing on your receivables profile?

Yes, I think that's going to vary. Thus far, the growth that we've seen hasn't really impacted our DSOs. But when we build presence in certain other markets where it's more traditional to see extended payment terms, we could very well see that. But at this point, we don't.

Larry Harris with CL King.

Couple of questions. First, with respect to UBE, is this just a Europe only opportunity or is this something where you could sell the product in the Middle East, other regions, North America? What sort of markets might be available? And in terms of initial revenues, could we be looking at the first half or the second half of 2012?

From a geography perspective, at a high level, we have trials going on in every major geography in the world. So it's in the Pac Rim, we have things going on in the US, Western Europe. I know that there's activity in the Middle East. As to whether or not we've actually started a trial, I'm not exactly sure. But I know that there's been some interest in that area. And in South America. So I would say it's broad-based. As far as when the actual revenue, I would expect to see probably some incremental revenues in the first half. But I would say to get to be meaningful, especially with the size of some of these carriers, I think it's going to take longer than that.

And then with respect to the $5 million share repurchase program, to the extent you can comment on it, sometimes companies time these things and do the rate of share repurchase either based upon the share price or just to offset stock option issuance. Any comments in terms of timing or any other factors related to the share repurchase program?

Larry, this is Jim. We will continue to be opportunistic, so it will be price-based. In terms of your question on do we only do enough for option dilution, and the answer to that is no. If you look back since the beginning of '04, we've announced, prior to the one that we just announced, 5 repurchases totaling about 24 million shares in all. So we actually do execute on these well and above any sort of dilution caused by option issuances.

Bill Dezellem with Tieton.

We have a couple of questions. First of all, relative to the Optical Access new products that you began testing this quarter, would you please discuss those in greater detail? And incorporate, if you would, your perspective relative to what seems to us as the fact that Optical Access has not grown as fast as some of your other high-growth areas. And whether you're of the opinion that some of these new products that are coming could actually accelerate the Optical Access growth to match some of the broadband Internetworking rates of growth.

Sure. Thank you for the question, actually. So I would say you're right. If you look at the Optical Access piece, the optical piece has not done as well as our Broadband Access piece. Now, I would say that's a tough act to follow. But in general, I would still agree with your comments. I think some of that has to do with our predominant sales of Optical Access gear. And predominantly the type of gear that we have been bringing to market has been more Sonnet oriented gear where, to the extent the carrier wanted to do ethernet, then they were mapping ethernet over Sonnet. And that was really the strong suit of that product line. Carriers have, since the time we introduced those products and starting selling them, have moved on, to a large extent, to native ethernet. And the of products that we are bringing to market now with the ONE, which you can almost think about it as the combination of transport DWDM capabilities into the actual access products themselves are native ethernet. And the 8000 series of products, which are focused specifically at mobility solutions, sell side, backhaul, are native ethernet solutions that I think fit right into where carriers are trying to drive their fiber networks for the future.

And the question as to whether or not we think this will actually increase it, we have very little doubt. Not only have we had trial activity, we've had very good feedback from our customers. And we've actually started shipping some of these products in early stages, but shipping these products in the third quarter. So the answer to your question is yes, we really do believe that this could change the profile of the growth we're seeing in Optical.

Given that you have actually started shipping in small quantities, a little ahead of what I would have interpreted from your opening remarks, what's the implication on the time frame at which you think you could have meaningful revenues from the native ethernet products?

So we started shipping. And let me maybe add a little more clarity as to why we're not jumping up and down about the number of shipments or the fact that we started shipping. If you look at the ONE product, which is our optical network edge product, there would be multiple phases of software development, similar to what we saw with the initial roll-out of the 5000. So as we come out with additional phases it will substantially broaden the market potential of those products. And I would say we're still early in the release of those product phases. So although we have customers online now, we have a lot of good feedback from customers, including fairly large carriers. We still have road map items that we need to deliver for it to really hit on all cylinders.

As far as the 8000 series, that is one that I think will have a steeper ramp profile than what we'll see on the ONE, just because the development cycle is going to be shorter. And we would expect it in 2012. To try to, at this point in time, dial in the exact quarter and what the uptake, is going to be difficult.

And then a completely different question. You did make reference to gross margin in part being impacted by customer pricing for share. And if we understand your strategy correctly from a product development standpoint, you are continuously looking to reduce costs through your engineering process. And the question is, was that reduction in pricing for share really a temporary basis because you see a new iteration coming that's going to have a lower cost and so the pricing that you currently gave is very shortly going to turn into normal pricing?

Yes. The answer to that question is yes. And you're bringing up something that's an historical strong point of our Company, and that hasn't changed a bit. So there will be times where we will see an opportunity for market share. we will address that opportunity with aggressive pricing. And typically very soon after that you'll see us come out with generations of products that will actually reduce our cost point on those and get things back where we'd like them. And I would see the environment we're in today to be no different than that.

Okay, Sharnay, I think we're out of time. So I do appreciate everybody showing up for the conference call today. And we will look forward to talking to you again next quarter.

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