ADTRAN Holdings Inc (ADTN) 2011 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. Forward-looking statements include, without limitation, statements as to the plans and terms of the transaction between Nokia Siemens Networks and ADTRAN, and ADTRAN's growth opportunities and the potential benefits of the transaction. However, these statements involve risks and uncertainties, including the successful development and market acceptance of core products, the degree of competition in the market for such products, the products and channel mix, component costs, manufacturing efficiencies, the risk that Nokia Siemens Networks and ADTRAN will not proceed with the transaction for any reason, 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 September 30, 2011. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which may be made during the call.

Phyllis, do you have a first caller? Are you still there? Do you have a first caller on the line?

Yes sir. Paul Silverstein, Credit Suisse.

Paul? Hello?

Let me -- we have comments of course we want to make at the beginning of the call, so if we are still on, then let me start.

First of all, good morning. Sorry about the confusion there everyone. I am Tom Stanton. Thank you for joining us for our fourth-quarter 2010 conference call. With me this morning of course is Jim Matthews, our 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 2011. I'll end with some comments on what we expect this year.

As stated in our press release, ADTRAN achieved revenues of $175.3 million in the quarter, which brings the year to a record $717.2 million, an increase of 18% over 2010's total year revenues. During the fourth quarter, as in the rest of the year, our growth was driven by our core product areas which grew 32% over the fourth quarter last year, more than offsetting a decline in our legacy product areas.

Both Carrier and Enterprise divisions benefited from these trends. Combined, our core product areas achieved $134.4 million in revenues, representing 77% of our Company total.

Getting into a little more detail, our Broadband Access category achieved 49% growth over the same period last year. The Total Access 5000 platform and our fiber-to-the-node products both performed as expected, providing strong contributions. This area benefited from meaningful growth with both domestic and international carriers.

Our Internetworking category achieved its seventh consecutive record with sales growing 37% over the prior year as we continue to refine our expanding domestic dealer base. This category also benefited from an increase associated with earlier service provider awards. From a product perspective, similar to recent quarters, this growth was broad-based and was positively impacted by growth in nearly all Internetworking product segments.

Optical Access had a mixed performance with solid results in the tier 2 and tier 3 space, but this category was negatively affected by a slowdown with two tier 1 wireless customers. Our 8000 series of sell-side gateways and our Optical Networking Edge products continued to move through the approval process at several tier 2 carriers, and our tier 1 approval with our OPTI line continued its progression as well.

HDSL revenues came in as expected, essentially flat with the third quarter of 2011.

2011 marked an excellent year for ADTRAN. Over the last two years, our core product areas have more than doubled, with these new areas now representing nearly 3/4 of our total Company revenue, allowing ADTRAN to transition from its legacy product areas. This growth has come from solid execution on multiple fronts. Our carrier business was highlighted by solid progress in tier 2 carriers, tier 3 carriers, as we continue to introduce ADTRAN to this new market segment. Exiting 2011, this progress accelerated and we left the year in a solid position for broadband stimulus projects and the potential for long-term buildouts associated with the USF transition to Connect America.

Our Carrier segment also benefited from a substantial increase in revenues outside of the US. I know you're all familiar with our success in Mexico. But I am proud of the fact that, in 2011, we saw over 20% growth in every geographic region around the world.

Of course, from a product perspective, Broadband Access leads our Company's growth with an impressive 65% total year growth. This segment was followed by Internetworking, which grew 36% for the year, a number consistent with the solid performance we have seen from this area over the last several years. During this year, we added over 300 new domestic dealers and increased our sales force, both of which we believe will be building blocks for the future.

For the total year, Optical Access category achieved another record revenue level by growing 25% as mobility upgrades drove demand in our Carrier customer base. We continue to expect that recently introduced optical products will provide new opportunities for this category as carriers upgrade bandwidth capabilities in both fixed and mobile networks.

The year also marked the acquisition of Bluesocket and the planned acquisition of Nokia Siemens Networks Broadband Access system. Both acquisitions have the potential to substantially enhance the long-term future of our Company. Bluesocket brings market-leading technology to our portfolio, enabling us to increase our relevance and enhance our participation in a very high growth component of the enterprise business. The NSN Broadband Access business, on the other hand, helps ensure our long-term success in our efforts to evolve ADTRAN into a global solutions provider.

Although the outlook for our traditional customer base remains strong, it is still our believe that in the years to come, ADTRAN's growth will be influenced by our ability to expand our geographic presence and our relevance with tier 1 carriers around the world. Although it is true we have seen some success with our current initiatives, the NSN Broadband Access business, with its entrenched incumbency at large carriers outside of North America, will without a doubt substantially accelerate our initiatives and increase our odds for long-term success. With the expected first year revenues of between $140 million and $180 million, an operating cost profile well below its historic levels, and the addition of a group of seasoned professionals with domain knowledge and relationships, we are very excited about the long-term possibilities.

For 2012, 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-curb, GPON, active Ethernet and ultra broadband Ethernet products will benefit from investment in bandwidth expansion, government and regulatory driven footprint expansion, and Ethernet conversion initiatives spanning all Carrier customer segments.

We also continue to expect our professional services capabilities will add incremental revenues in 2012 and beyond, as carriers seek cost-effective ways to accelerate deployments. We anticipate our continued focus on markets outside of the US will add meaningful revenue growth in 2012. We believe Internetworking will continue to maintain its current positive momentum with benefits from market share gains and new product offerings such as our virtual wireless LAN offering.

During 2012, we believe we will continue to see the benefits of carrier optical deployments for bandwidth upgrades with acceleration in our optical networking edge and sell-side gateway products.

In summary, on a macro level, increasing competition, driving accelerating global broadband deployments, and intensive upgrade to mobile infrastructure, channel expansion in our Enterprise segment, meaningful sales initiatives outside of the United States, government and regulatory initiatives around the world, the benefits of our planned acquisition of NSN BBA business, coupled with an innovative, diverse and expanding product portfolio, lead us to be optimistic about the years ahead.

I would now like Jim Matthews to review our results for the fourth quarter 2011 and our comments on the first quarter of 2012. We will then open up the conference call for questions. Jim?

Thank you Tom. Good morning everyone.

Revenue for the fourth quarter increased to $175.3 million compared to $165.3 million in Q4 of 2010. Broadband Access product revenues for Q4 2011 increased 49% to $74 million compared to $49.7 million for Q4 2010. This increase was primarily related to continuing growth in deployments of our Total Access 5000 and fiber-to-the-node platforms.

Internetworking product revenues for Q4 2011 increased 37% to a record level of $43.1 million compared to $31.6 million for Q4 2010. Optical Access product revenues for Q4 2011 were $17.3 million compared to $20.2 million for Q4 2010. Carrier Systems revenues for Q4 2011 increased 24% to $101.3 million compared to $81.7 million for Q4 2010. Business Networking revenues for Q4 2011 increased 30% to $45.2 million compared to $34.8 million for Q4 2010. Loop Access revenues for Q4 2011 were $28.8 million compared to $48.8 million for Q4 2010. HDSL product revenues for Q4 2011 were $26.7 million compared to $45.8 million for Q4 2010.

As a result of the above, Carrier Networks division revenues for Q4 2011 increased to $134.2 million compared to $130.3 million for Q4 of 2010.

Enterprise Networks division revenues for Q4 2011 increased 17% to $41.1 million compared to $35 million for Q4 2010. International revenue for Q4 2011 increased 215% to a record $26.8 million compared to 85 -- I'm sorry -- compared to $8.5 million for Q4 of 2010.

To provide the reporting of each of these categories, we have published them on our Investor Relations page at ADTRAN.com.

Gross margin was 56.6% of revenue for Q4 of 2011 compared to 58.6% for Q4 of 2010. The lower gross margin in the quarter was largely attributable to higher services related revenue, including cabinet shipments and customer mix.

Total operating expenses were $58.1 million for the fourth quarter of 2011 compared to $58.4 million for the third quarter of 2011 and $52.1 million for the fourth quarter of 2010. The increase in operating expenses from Q4 2010 to Q4 2011 was primarily attributable to expenses related to the planned NSN broadband acquisition -- or Access acquisition, rather, amortization in connection with the Bluesocket acquisition, Bluesocket operating expenses, increased staffing costs and (inaudible) costs related to Tier 1 Optical Access opportunity. Acquisition related expenses, amortizations and adjustments related to Bluesocket and the planned acquisition of Nokia Siemens Networks Broadband Access business net of tax were $1.1 million for Q4 2011.

Stock-based compensation expense net of tax was $2.4 million for Q4 2011, compared to $2.3 million for Q4 2010. All other income net of interest expense for Q4 of 2011 was $4.2 million compared to $3.9 million for Q4 of 2010.

The Company's income tax provision rate was 31.3% for the fourth quarter of 2011 compared to 26.3% for the fourth quarter of 2010. The tax provision rate for the fourth quarter of 2011 included benefit from research tax credits, FIN 48 adjustments and favorable movements in state apportionments. The tax provision rate for the fourth quarter of 2010 included benefits from recognizing research credits that recorded retroactively for the entire year as a result of legislation during Q4 of 2010 to extend research credits for 2010 and benefits from the employee stock-option exercise.

Earnings per share, assuming dilution for Q4 of 2011, was $0.48 compared to $0.56 for Q4 of 2010.

Inventories were $87.8 million at quarter end compared to $87.3 million at the end of Q3 of 2011. Net trade accounts receivable were $76.1 million at quarter end, resulting in DSOs of $40 million. Unrestricted cash and marketable securities net of debt totaled $476 million at quarter end after paying $5.7 million in dividends.

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 2012, we anticipate revenues will be in the range of flat on a sequential basis. Based on certain factors, including customer mix and an increase in our services and related cabinet revenues, which we have mentioned before, carry a lower gross margin but are accretive to operating margins, we expect gross margins for the first quarter will be at the low end of the high 50s% range percent to revenue as we saw in the fourth quarter. We expect first-quarter operating earnings expenses will be in the range of third-quarter 2011 levels, plus incremental acquisition related expenses and amortization of our round $500,000 or so. Also as a result of delays to extend legislation for research tax credits for the 2012 year, we anticipate our tax rate for the first quarter will increase to a rate of approximately 36%. We believe the larger factors impacting the revenue we realize for the first quarter of 2012 will be the following -- the macro spending environment for Carriers Enterprises; the adoption rate of our Total Access 5000 platform; Professional Services activity levels, both domestic and international; upgrades from mobile broadband infrastructure; and the timing of revenue related to broadband [stimulus] projects. Tom?

Thank you Jim. Phyllis, at this point, we are ready to open it up for any questions there may be.

Nikos Theodosopoulos, UBS.

Good morning. Just a couple of questions here. Maybe you guys can comment on, now that the year is done, what was -- how many customers you actually had that were 10% customers and who they were, given the growth in international and Tier 1 Tier 2? Just trying to get a sense of how customer diversification has changed over the course of the year.

Sure. That's a good question. Jim?

Sure. Diversification has certainly we believe had a positive impact during the year. For the year, we see two 10% customers. Again, our policy is to comment only on those in the 10-K when we publish that.

Two 10% customers. Do you have like -- okay. So in terms of how big they were, are you going to wait for the K or can you give any color on that?

We'll wait for the K.

Okay, all right. Then, on gross margin, you gave -- can you give some input as to the -- it was slightly down sequentially. I guess, if I look at the last two quarters, gross margin and operating margin have both come down a little bit sequentially each quarter, and the services mix was part of the rationale behind the gross margin. But if it's accretive to operating margin, why haven't we seen operating margin more stable? Can you give some color on that?

Sure. Good question. So you may recall, in Q3, we closed the transaction of Bluesocket. Now, Bluesocket did bring on with it some operating expenses. We do believe that Bluesocket at some point this year will begin to become accretive, but that was certainly a part of the increase in OpEx and did impact our operating margins. Also, as we disclosed in the supplementary or supplemental information, we've had some acquisition related expenses that had impacted the third and fourth quarter as well. Okay?

Then you mentioned gross margin next quarter would be low end in the high 50s%. Are we looking at something flattish sequentially again? (multiple speakers)

Something in that range is the way we think about it.

Okay. All right. Thank you.

Mark McKechnie, ThinkEquity.

Great. Thank you for taking the call. A couple of questions related to Nokia Siemens, if you can. Still on track for an April close, I assume?

Yes, we are still on. That's still what we are shooting for, yes.

Got you. You said some comments that I wanted to dig into a little bit on the call. You said you gave the revenue range but you talked about a dramatically lower operating expense level. Can you give us a sense how many employees or how you bring that down, and how many employees you get from Nokia Siemens versus how many they had on close?

The range that we are thinking about in the Nokia Siemens is somewhere between 300 and 400 employees that would come over. If we were to look at that business the way that it was operating let's say two years ago, which is when we really first started looking at the business, the number of employees was in excess of 1000. So that may give you a sense of what we are talking about.

Got you. So do you think when you bring them on board and I guess for the June quarter, September, I know you're not giving guidance out there, but that this is going to be a profitable division on the operating level when it comes over?

I think there is a -- to be honest with you, I think there are some things that we want to do on the cost, on the product cost front that have some stages associated with them. I think thinking about it in that kind of area is the right area to be thinking about, but I can't tell you explicitly if it will be slightly above or slightly below.

But for the year, as we said on the conference call that announced the acquisition, we do expect the first full year after the close of the acquisition will be neutral in terms of diluted EPS. So, that would relate to operating income for the particular acquisition that we are talking about.

Got you. A couple of other questions separate from Nokia Siemens. That's helpful. On your total 2012 outlook, do you have, for your core business, kind of a base level model of how -- what type of growth you're planning for for 2012?

We typically don't give guidance for the year. We do expect organic growth, but again we do not give guidance for the year.

Got you. And one question, I want to get a sense for how you think about you had slowdown at your two big tier 1 operators here in calendar '11. Of course, AT&T obviously had a slowdown in spend relative to their T-Mo acquisition. What kind of signs are you seeing out of that customer relative to is there going to be a return to some sort of level of spending, bigger picture, or maybe even a catch-up, or how you're thinking about planning your products for the transition that happened there and the resolution?

I think the general tone we hear, and I don't want to talk specifically about any customer, but I think the general tone we hear is that, in the larger customer, it is generally positive for this year. Having said that, we are really not going to try to plan for a significant change in the overall environment. If that does happen, it will be kind of a positive upside to us I think. So when we talk about upward trend on our legacy products or our core product areas, that's really without any significant bump in those large tier 1 carriers, although there is that potential.

Got you. One last housekeeping question, then I'm done. Your tax rate going up there in March to 36%, what do you see for the full year? Is that a one-time event in March or is that going to be the new level?

It really depends on when legislation is passed on the R&D credit. If you look back to 2010, you might recall that the legislation was actually passed for the 2010 year in the fourth quarter of 2010, so there was a retroactive impact. So whether or not that happens this year, we don't know. We truly don't know. So the 36% represents our statutory tax rate, less the usual incentive credits that we get from the state of Alabama, and less deductions for domestic manufacturing as well. Those are generally the amounts that make up the net rate of 36%.

Now, going through the year, from time to time, we do see adjustments or benefits from FIN 48 adjustments, but those are very difficult to predict in terms of timing. Also, as we saw a little bit last year, we do see some level of benefit in terms of tax benefit from the exercise of employee stock options. Again, those are very difficult to predict as well. So, we will typically have some variation in our tax rate from quarter to quarter, but from what we can see today, 36% is a good assumption going in for Q1.

Great. Thank you very much.

Sanjiv Wadhwani, Stifel Nicolaus.

Thank you so much. A couple of questions. On the international side, obviously a nice uptick, both sequentially and year-over-year. I'm just curious. Last quarter, the third quarter, I think more than half of your revenues came on the international front outside of Telmex. Any color this quarter as to what the non-Telmex contribution was on the international side?

That's not a number that we break out, but I think we can tell you that we saw positive movement in all of the regions. So we really -- I mentioned in my notes that we saw over 20% growth. I would say that we actually saw that growth accelerate in all of the regions in the second half of the year versus the first half of the year.

That is some sense of it, yes.

Got it, that's helpful. And then the second question, also in the third quarter, I think you have a little bit of an inventory buildup at one customer. I think that was supposed to be sort of a one-quarter issue. Just confirming that that's behind us and it's sort of back to normal with that customer.

That is behind us and we are back to normal.

Perfect. Thanks so much.

Rich Valera, Needham & Co.

-- (technical difficulty) guidance, but in the past you've talked about kind of I think a target of at least double-digit organic revenue growth. Certainly, I think you exceeded that in 2011. Any color you are willing to give on 2012? I know it looks like you would have been at kind of a mid single-digit year-over-year growth rate in Q4 and Q1 based on your guidance. Is there any reason we should think of perhaps an acceleration in the back half of the year as maybe some of these inventory issues are behind us?

Do we -- let me answer this by talking about the normal profile and what we expect to have happen this year. We normally start off kind of slower in the first quarter and accelerate in the second and third quarter, and that's been our historical trend. We fully expect to do that again this year. That has to do not only with the seasonal aspects of the weather, it has to do with the project timing of projects that we have engagement in today. So, we would expect to see that acceleration through the year, and then you typically see a seasonal downtick in the fourth quarter. At this point in time, we don't see any change to that historical profile.

Okay, so understanding you expect to see some maybe I'll say typical (technical difficulty). I'm not sure if that's what you're saying, but that would imply improvements in year-over-year growth rates as well. Is that a fair assumption?

You mean as we go through the year, Rich (multiple speakers)?

Yes, exactly. As you work --

That's the way we think about it.

Okay. That's helpful. Then on the Latin American business, last quarter you gave us an update on your expectations of how the large opportunity in Mexico would sort of play out. I think you expected some continuation in 2012. Can you give us an update on what you're expecting from that large customer in 2012?

Sure. I think the one caveat here is the variability in the ordering patterns of that customer, which can be quite large. Having said that, I think the big news for us was, coming into this year is that we were awarded the phase 3 portion of their buildout, which is the next movement forward. We had been working on their phase 2 now for about a year or so. We expect that to start shipping at some point this year. So we expect to continue on with phase 2 through this year with both some product shipments, but more and more service related activity as we bring that network up. Then we expect to start shipping phase 3 this year at some point from a product perspective, and then you'll see that product shipments go through this year and through next year and then the ongoing services associated with bringing up phase 3 through next year as well.

Great, that's helpful. Then on the ultra broadband product, I think you've talked about having a pretty healthy pipeline of opportunities internationally on that. Any update on what you're expecting in 2012 from that new product?

We are still expecting good things. I would say the progress is still very strong. In fact, it's picking up as carriers figure out exactly where they want to use it and what the capabilities are. I would still say we are still early in that process, and kind of more second half of this year than first half is where we're thinking.

Okay. That's helpful. Thank you.

Todd Koffman, Raymond James.

Thank you very much. Can I get a sense of how big the Bluesocket contribution was? I'm guessing that's in the Internetworking segment, which looked good.

That's right. This is Jim. So it came in the range of the low single-digit million dollars in terms of revenue for the fourth quarter, and it was slightly up from the third quarter.

When you talked about expanded dealer channel, was that related to the Bluesocket product offerings?

What I was talking about was not related. We did see some expansion because of the Bluesocket dealer base coming on board. But the majority of that expansion was from organic activity that's been going on for multiple years. We've actually brought that number on or more now probably over the last four years as we continue to refine that base. I would say, from a Bluesocket perspective, maybe one of the more positive pieces is not so much that the Bluesocket dealer base comes onboard, which I'm very glad they have, but the fact that we are now able to open up a lot of our dealer base to being able to sell that product, which is a real shot in the arm for the distribution of that product.

Just one last one. In the Optical Access segment, it was down pretty sharply. How much of the Optical Access business you are doing is tier 1 versus tier 2, tier 3?

Well, less this quarter than the previous quarter, without a doubt, because that's really where we saw the downtick. If you looked at the tier 2s and tier 3s, they actually did pretty good, but we saw a downtick probably more in one tier 1 than the other. So in aggregate, when that number gets -- you're kind of getting a baseline right now of kind of tier 2 and tier 3 activity because they were the larger customer base in the space. When it goes up from here, it's usually driven more by the tier 1s.

Thank you very much. Good luck.

Jim Suva, Citi.

Congratulations to you and your team there at ADTRAN. I had two questions. The first is has there been any change to the order patterns or the visibility given the removal of the pending M&A out there? I guess everybody would say specifically regarding AT&T and T-Mobile. Just kind of your view on the order patterns and visibility there.

The second question is on your operating expense. Can you give us some guidance for SG&A and R&D, given the Bluesocket integration? Does that include some costs associated with M&A or exclude it, just so you know and can help model going forward? Thank you, gentlemen.

Let me cover the M&A portion of the tier 1s. First of all, talking about a specific customer is troublesome, but in the tier 1 space in general, we have not seen any change in behavior. We are hearing the same chatter about what could happen and what may happen. I would say our contacts are more positive this year than they were coming into 2011, but no real discernible change in behavior at this point.

Jim, do you want to cover the second piece?

Sure Tom. So Jim, on your second question, in terms of the OpEx view for Q1, we related that really to our Q3 2011 levels. If you look back, our GAAP operating line was $58.4 million, and so we are expecting that for Q1, plus, as I said on my notes, about another $500,000 as it relates to activities, primarily with NSN BBA.

Now, in terms of your comment about Bluesocket, the integration related costs for Bluesocket are really pretty much over, but there are some amortization costs. Those are detailed in our supplemental information that we disclosed with our earnings release. Does that help?

That's wonderful. Thank you. Again, congratulations gentlemen.

Thank you.

Simon Leopold, Morgan Keegan.

Thank you very much. I wanted to touch on a couple of things. One is just to get an update on your perspectives for the stimulus program, how you see that shaping up. What was it in the fourth quarter? How do see it as a contributor to first quarter, and what's your outlook from a stimulus perspective for 2012?

I think we started talking maybe in the third quarter or so about it kind of being in the single-digit million and expecting it to increase incrementally from there, albeit at not a big change into the fourth quarter. That's exactly what happened, so it actually did pick up again in the fourth quarter. We again expect to see another pick up in the first quarter. I would say probably that rate of change going into Q1 is -- we are interested in seeing what that is. We are hearing a lot more activity. A lot of people are getting fiber where fiber was the issue. A lot more people are getting the go-aheads on their deployments, so we're feeling that momentum pick up but -- and expect a stronger Q1. I would expect to see that rate of change accelerate going forward into this year.

Do you have kind of an expectation for the full-year stimulus contribution?

We've been very reluctant to give that number, only because there are so many variables associated with that, including whether or not they take the money. There are of course still several awards, a significant percentage of awards that haven't been made yet. So we haven't other than to say it would be meaningful to the Company and we still would stick by that.

Okay, and then shifting over to the international business, clearly this was a great quarter. It sounds like you're trying to tell us that it's more than just Telmex, that you've had good growth across the board. I want to see if there are some metrics you can give us to help us understand the breadth and sustainability of the international business, particularly in light of the pending Nokia Siemens position, whether that potentially creates a pause of customers waiting to maybe make some purchases until that deal closes. So I'm just trying to get a sense of linearity of international during 2012.

Let me start with 2011, I think was actually very linear with the exception, so where we saw any swings of meaningful size with Telmex, and I would say in general they were actually more linear than we would've expected them through the year. We don't see a change in that. It's a general positive trend similar to the positive trend that we have been seeing in Internetworking now for some number of years. The overlap between our existing customer base, including all of our global customers, and the NSN BBA customer base is very, very small. So to the extent that they're -- we don't expect any delays, and in many cases we are really talking about apples and oranges as far as where there could be delays.

Great. Thank you for the clarification.

Jonathan Kees, Capstone Investments.

Great, thanks for taking my questions. I just had a couple. I wanted to (inaudible) can dig down a bit more, the inventory still was pretty high relative to I guess last quarter. Just trying to get an initial idea in terms of (inaudible) was just more work in progress, or was it more just finished goods?

Jim, do you want to answer that?

Jim here. Inventories have gone up. Obviously, they've begun to moderate as they did between Q3 and Q4. It has increased coming through the year. A lot of that really relates to our services related business, which at times can be rather inventory intensive. As we look at Q1, we are kind of expecting ending up Q1 with the same sort of levels of inventory, so that's kind of how we are looking at it at this point. We do expect, as we go through 2012, that we will see improving turns of our inventory overall but again, we are dealing with a services business now that does require us to carry more inventory.

Let me add a little color, if you will, to that. So what we have done is as we've gone into the service business, things like cabinets and having them ready for shipment prior to orders actually coming in become important, because carriers will have a large work crew sitting there waiting for you to finish your particular piece. So we actually saw a buildup of that. We saw actually an increase in shipments in the fourth quarter of that type of activity. We are talking about the fact that we would see the ramp up of project related activity in Q2 and Q3 of this year, and a lot of what we are doing today is associated with that. So, I do think we'll be able to get inventory down over the long term, but at this point in time with where we are with customer activity, we really just felt it was prudent to make sure that we had product on the shelf.

Okay, so that makes sense. Basically, you've got some business, some upcoming business here and you've got -- you want to have the right (inaudible) products inventory to satisfy that business. So that makes sense.

Yes, that's exactly right. If your remember, we actually got hit with some expedite charges periodically through the last couple of years where we were trying to catch up. We are really trying to get ourselves in a position to where we don't have to have that risk, not so much with the cost, I mean that is an issue, but really whenever you're doing that, there is the chance you won't be able to ship. That puts the customer in a very difficult situation, so we are really trying to take a different approach to that.

Okay, great. My other question is [I just want to get] in terms of the Ericsson partnership, is that still something that could be a driver in 2012, or does that take more of a back seat now?

Everything that has been in place remains in place with that relationship. I think the real key is kind of where the customer, the end customer, for that is going to drive their network and at what speed. That's always been the most difficult piece. The Ericsson piece itself though, a great company to work with and really no issues.

All right, thank you very much.

Great quarter, guys.

Thank you.

Greg Mesniaeff, Kaufman Brothers.

A question you on the tier 2 and tier 3 color you gave on the Carrier business, namely that it was fairly robust relative to the tier 1 customers. How much of that was just organic growth and how much of it was market share gains against competitors? Any color you can give on that?

Yes, well, first, let me give you the difficulty on that, because there are many customers, especially when we're talking about tier 2s, where we are approved with other vendors. As to whether -- did I ship more in that quarter than the other vendor? That's probably easier to say. But was it a market share shift or was it the markets that we're in grew at a faster rate, the particular regions that we said. So having given you that color, we do believe we picked up market share at tier 2s. There's no doubt that we picked up market share in the quarter at tier 3s because that's a segment that was fairly new to us and we had no incumbency.

Right.

So trying to say what was what is difficult other than to say we think we probably benefited from both.

Got you, okay, that's very helpful. Then one other question. As you look further out into 2012 post the NSN acquisition after it closes, what kind of sales and marketing infrastructure do you foresee for ADTRAN globally in terms of a direct sales force vis-a-vis indirect distributors? How is your current structure going to change, and what kind of implications could that have for the OpEx?

I think, first of all, the numbers that we are talking about transitioning, which is in the 300 to 400 range, includes what we believe to be the required sales component for that business as well as the engineering and all of the other pieces. So our expectation, at least for a reasonable period of time, so I'll just throw out there kind of a twelve-month period of time, would be that 300 to 400 range would be a range that we would be able to, from an SG&A perspective, be able to maintain as we transition the business and as we start seeing growth come out of it.

As far as the actual channel itself and the make-up of the channel, very similar to what we do with our own product, which is if there's a mixture of partners and direct sales, I would say that NSN piece is probably more skewed towards direct than we are. But in general, I would still say that the make-up of the 300 to 400 would be what we would expect to take on with no really significant growth pass that. (multiple speakers).

Got you. That's very helpful. Thank you.

Jeffrey Kvaal, Barclays Capital.

Yes, thank you gentlemen very much. Could you help us a little bit with the drivers of the gross margin trajectory over the course of the next few quarters? It sounds as though you're expecting some services contracts to ramp up so that we should be careful to model the gross margins to be ticking down a little bit over the course of 2012?

This is Jim. Not necessarily. And again, we're talking organically at this point.

Yes.

It really depends on the mix or whether or not there's any further mix shift between hardware versus services related business, I should say. Right? So the way we think about 2012 in terms of gross margin is kind of where we are now, in that range. But again, whether or not we end up there is going to be based on whether or not we see any larger shifts towards service than what we anticipate now in terms of overall mix. Okay?

Yes, okay. Good. Actually that's better than what we had thought.

So secondly, as far as NSN goes, the inorganic piece of that, I typically think of NSN overall as having a growth and operating margin structure that is dramatically lower than where you are. To what extent or how quickly do you think you can get that up to the corporate average, or in the vicinity of the corporate average maybe is a better way to put it.

Let me start with I understand where your perspective is coming from and I would tell you that, if I was bringing on more than 1000 people, that your perspective would be right for this business as well. So I think maybe one thing that can easily get lost is the fact that what we are bringing on is not the business as it was operating in the operating model that it had traditionally been at while it was under the NSN piece. It will take us some time to get the gross margins where we would like them to be. We absolutely will start right out of the gate moving on that. We are thinking about roughly a twelve-month period of time to get everything where we want it to be, although we -- there are some stairsteps in both an operating level and from a gross margin level, and I would say more from a gross margin level, that we will see throughout that first 12 months. We'll see a benefit in the first 30 days and then we will see another benefit probably six months into it. Did that answer your question?

Yes, yes, it does. Thank you very much.

Michael Genovese, MKM Partners.

I appreciate the comment about no change in order patterns, noticeable discernible changes in the tier 1 market. Yet it does seem like an Optical Access. You obviously referenced something with lower buying from two tier 1 customers there. I was just wondering if you could give us more color about if that's a temporary phenomenon, if you expect that to come back, if more maybe about if new products are needed to sort of re-accelerate that optical backhaul business, any color would be helpful. Thank you.

Yes, sure. My comment was more probably in the guise of a positive bias and was there any type of rush to repurchase versus maybe just a normal uptick in activity that we would expect. I'll tell you it's early in the quarter, but I would -- our feeling is that we would see things return in the optical space to more normal levels and that the tier 1s would be a large percentages of that return to normal levels.

My other comment was really just more are we seeing any type of dramatic uptick in ordering patterns? And I would say no.

So just to clarify, obviously when you're talking about this quarter, that's the same platform that was -- that underperformed last quarter. You're saying, in the early returns, you're seeing a tick back up perhaps in the first quarter?

Although I probably really shouldn't be commenting on the first quarter, and I will tell you we are, what, two weeks into the first quarter, but the answer to your question is yes.

Great. Thanks.

Ehud Gelblum, Morgan Stanley.

Thank you, appreciate it. A couple of random questions I had. I know you're not breaking out your main 10% customers, but can you give us a sense as to what the breakdown this quarter looked like between all tier 1s and tier 2, 3s, and how that rough split compared to Q3? I mean you've talked about it, but just kind of hear some sort of quantitative --

Can we -- I mean -- Jim, I'm going to leave that up to you.

Well, yes, that's --

Maybe a growth rate of each sequentially?

Well, we had a sequential decline in revenue overall. We talked about it in the call some, at least on the optical piece, some of that being related to tier 1. If you look at that and if you also look at the HDSL business which was basically flat, that should kind of give you a sense, I would think.

Also, you saw a sequential decline in broadband Access. A lot of that really relates to one sort of tier 2 carrier who's deployed a meaningful amount of gear this year. Okay? So that certainly moderated in Q4.

(multiple speakers)

Does that answer your question at all?

That's actually very helpful. And so I know, for the purposes of discussion, CenturyLink is a tier 1.

They are tier 1.

They are tier 1.

And what we have is we have multiple tier 2s that are, as you know, have very public projects that are going on that have very definitive timelines. I would say that, in all of those cases, they behaved exactly the way we expected them, so I think that the communication was very good. But we did see a downtick at the wireless tier 1 carriers, as I mentioned in my notes, for Optical.

Okay, and that brings me to the next question. The spending on Telcordia, which I believe is also related to Optical Access and perhaps wireless, how -- can you quantify how large that was in the OpEx this quarter? Was it constant with Q3? Are we done with that spending, so does it come back down again in Q1?

I think we are done, we are done now. We don't expect a significant spend in Q1. I think we did have spend in Q4. It may be slightly down from Q3, but we had spend in both quarters and they were things that we would mention.

Okay. But the size of that, was that roughly -- can we get a sense as to how big that was? So we should see a step function down in OpEx, all else being equal, which it usually isn't, but that piece would come down? Was that roughly $1 million or not?

Well, I hate to get that granular, Ehud, but perhaps I can come back to the sort of guide that we gave on Q1 OpEx. We tied it pretty much to our Q3 levels of $58.4 million with a $500,000 incremental add for NSN BBA activities.

In that $58.4 million?

In addition to --

In addition.

-- in addition to the $58.4 million. So the $58.4 included some integration costs which will actually slightly increase by that $0.5 million or so that Jim is talking about. If you look at the core OpEx, we are still expecting to get to be basically flat and then we're talking about an incremental ladder either for Bluesocket that we saw in Q3 or other incremental costs on top of that kind of flat Q3 normalized rate for the core business or for the ADTRAN business.

Okay. Why wouldn't it some down from this Telcordia stuff coming off?

The Telcordia stuff will come off, but there are things that come in. It was just Telcordia. I have sales meetings. They're just things that happen in Q1 that happen every year. Just in aggregate, that's where we think things will be.

So those Telcordia expenses were related to a deal that you have, a deployment that you have.

Yes, right, on wireless.

With wireless (multiple speakers) Optical Access. When do you expect that to hit the P&L? Is it a Q2 event? Maybe is a Q3 or Q4 event?

We are hoping to see maybe first piece of that in Q1. I don't think -- it will not be a big piece in Q1, but of course any time you ship the first thing of anything to a tier 1, you're happy because that means you've gone through a lot of the gates. So the first piece of that we would expect in Q1, and see a ramp up from there.

I will tell you this is a tier 1 and schedules do shift. That's our current expectation.

Is this a two or three or four quarter event, or do you think this is ramping to a sustainable multi-year deployment the way your FTTX business at Qwest had been first couple of years?

We would expect it to be a multi-year thing.

Okay. Can you comment a little bit about the competitive environment? I guess in the US your main competitor would be Calyx in the tier 2, tier 3s. Internationally now that you're doing so well there, I'd imagine you're running into Huawei a lot more than you were in the past. Is there price aggressiveness anywhere between either of those two customers, and how does that play into what you're seeing?

I would say there's price erosion. I think, in the broadband, when we really started entering the tier 3s probably as much as the tier 2s, I think you saw able trying to defend the ground that they had, and that led to us being aggressive in order to grab some footprints and market share. I would say it's probably more less of a Huawei thing than other vendors.

But yes, the answer to your question is yes, we see price aggressiveness in the Broadband Access business. We have for some time. It probably has accelerated over the last year or so as we really started getting some traction, but it's nothing that I would venture to view of being out of control or anything really out of the norm of what we would've expected.

Okay, great. Two other quick questions. How will you -- at what point will you know how many employees you're actually getting from NSN? I believe you made offers to I think you said close to 400. How do you know how many you'll end up with?

It will be towards the end of this quarter. As far as -- the exact timing is when the offers go out, I'm not exactly sure actually sure, I don't think exact offers have actually gone out yet, although we've talked to many, many of the employees. Then there is a period of time, and I think it's 30 days or so, so if you think about mid February-ish where they go out and then 30 days for a response, it's towards the end of March.

Then finally, can you give us a sense as to how large services has now become as a percent of the total, or at least how much is --?

It's still less than 10%. It actually grew in the quarter, but it's actually less than 10% still.

Okay, but it was up sequentially?

It was up.

Has it been up every single quarter this year?

Probably. I would think so, but I'll leave it to -- Jim, do you know, do you have it?

I think so. I don't have every quarter in front of me at this point, but I think so. I'm not sure though.

Okay, I totally appreciate it.

At this point, I think we're just about done, so this will be our last question.

Larry Harris, CL King.

Thank you. Just a couple of questions here. Looking at the NSN transaction and the euro having declined, does that affect any of the economics of the transaction?

This is Jim. So, yes, a large portion of the revenue is based in euros. There are a portion of the revenues that are US dollar-based but, again, the larger portion is euros. In our planning and integration, we will be building in natural hedges coming from the supply chain. Also, if you look at our OpEx base, it's largely euro-based as well. So we plan to have a substantial amount of natural hedges built into where that will certainly mitigate any fluctuations from quarter to quarter in the value of the euro.

Understood. The other question is with respect to HDSL. You mentioned that was pretty flat here this quarter. Would that be your sort of expectation going into 2012?

Our expectation are to see levels somewhat consistent, although there would be some level of variation from quarter to quarter, but some bit of a consistency with Q3 and Q4 levels on HDSL is the way we think about it. But certainly over the longer term, HDSL will continue to decline.

Okay, thank you. Congratulations.

Thank you, everyone, for joining us on our call today, and we look forward to talking to you again in a quarter.

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