ADTRAN Holdings Inc (ADTN) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the ADTRAN's third-quarter 2012 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. At that time I will give instructions on how to enter the queue.

During the course of the conference call, ADTRAN's 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 core 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, 2011, and Form 10-Q for the quarter ended June 30, 2012. The risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which may be made during the call.

It is now my pleasure to turn the call over to Mr. Tom Stanton, Chief Executive Officer of ADTRAN. Sir, please go ahead.

Thank you, Toya. Good morning everyone. Thank you for joining us for our third-quarter 2012 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 the details behind our Q3 results and will then hand it over to Jim to deliver the financial report. We will then open the call up for questions.

As all of you can gather from our recent announcements, the spending environment in most of the markets we address remained difficult during the third quarter, underscored by sluggish carrier spending and a cautious enterprise market. The largest contributor to the shortfall this quarter was continued slowness in the Tier 2 and Tier 3 carrier markets here in the US. This decrease was exacerbated by a substantial sequential decrease in HDSL. Getting more specific, the Tier 2 markets' performance was largely the result of significant project delays, at a particular customer. We believe we understand the nature of these delays and view them as delays, not lost business. The rest of the Tier 2 market remained sluggish however, and came in slightly below expectations with broadband stimulus revenues to the segment showing a sequential increase. Importantly during the quarter, we received a multi-year 90% market share award at another significant Tier 2 carrier. This award is for all broadband deployments network-wide.

Tier 3 carriers also remained slow. During the quarter we saw an increase in broadband stimulus revenues and general Tier 3 revenues due to our continuing market share gains. However, we continue to view the market as underperforming as many carriers seek to get clarity on the USF to CAF transition. This quarter we brought on another 27 Tier 3 customers, and we believe as clarity enters this market, these continuing incremental market share gains will contribute meaningfully to our revenues.

Moving on to HDSL. The decrease in this area was significantly larger than anticipated, with results showing a 34% sequential drop, representing a 49% year-over-year decline. The sequential and year-over-year decrease was driven by a Tier 1 carrier who initiated a significant acceleration of their installed inventory reuse program. Sales of HDSL to this customer represented less than $1 million in the third quarter, a nearly 10-fold sequential decline. The Enterprise division performed again slightly below our expectations, coming in at $30.2 million in revenue. The carrier channels for this business continue to be challenging in both the incumbent and competitive carrier space, with the decline partially offset by growth in dealer sales and sales to new cable MSOs.

Internetworking saw slight sequential growth for the quarter. On a geographic basis, the underperformance as you would expect was centered in the US with revenues coming in at $113 million. Our international revenues including a full quarter of the newly acquired BBA business came in at $49.2 million. Latin American activities surrounding FTTN projects performed as expected, and we continue to expect meaningful although variable revenues for our current project phase, to contribute through the end of 2013. Sales in Europe including BBA also came in as expected. Operationally, our BBA integration continues to track well with our margin improvement plans on schedule. Incumbent activity continued to progress well in Europe where several large carriers have issued RFPs for newer broadband technologies for wide scale deployment.

Speaking more broadly, needless to say our recent performance has not met our standards. After three straight years of exceeding revenue expectations, this year has proven to be a disappointment on several fronts. On a product basis, by far our largest deployment has been HDSL where we significantly underestimated the rate of decline. For the first three quarters of the year, this area has dropped 49% over the same period last year, representing a decline of nearly $50 million. In the midst of the current environment, Internetworking and Broadband Access have been relatively stable with Internetworking up 3% year to date, and Broadband Access without the positive impact of BBA acquisition being down 7%, irrespective of the capital constraints currently impacting that market. Through the year we continue to gain momentum in both Tier 2 and Tier 3 markets, with additional gains in the third quarter as I previously mentioned.

Finally, I'd like to talk about the opportunity that lies before us. In the US, we believe the current USF to CAF cloud will be resolved leading to a significant increase in available funding for years to come. This, when coupled with our market share gains in the Tier 2 and Tier 3 accounts, leave us optimistic about the future of these markets. Moreover, ADTRAN is currently engaged with multiple Tier 1 accounts globally as they seek to implement strategies to offer very high speed offerings to improve their competitive positions. This renewed interest and sense of urgency coincides with the introduction of technologies and densities that make ultra high speed broadband an economically feasible reality.

Our Internetworking division has similar potential. We continue to see success with carrier trials of our new Bluesocket technology, where our virtual architecture and upcoming feature expansion leads to true competitive advantage. In addition, through this year we continue to add up to our reseller channel base, with our total dealer count now at approximately 3,500 here in the US. This, when combined with our growing success in the MSO space, all of which we feel are incremental to our long-standing performance in this category, leave us optimistic. I'd like to remind you that over the five-year period prior to the current slowdown, Internetworking has averaged nearly 34% growth per year, and we see no fundamental reason why we can't achieve a similar growth as economic conditions improve. I'd now like to [turn the call over to] Jim Matthews to review our results for the third quarter of 2012 and our comments on the fourth quarter of 2012. We will then open the conference call up for questions. Jim?

Thank you, Tom and good morning everyone. Revenue for the third quarter was $162.1 million, compared to $192.2 million in Q3 of 2011. Broadband Access product revenues for Q3 of 2012 were $94.5 million, compared to $87 million for Q3 of 2011. Internetworking product revenues for Q3 of 2012 were $35.4 million, compared to $42.5 million for Q3 of 2011. Optical product revenues for Q3 of 2012 were $11.2 million, compared to $22.3 million for Q3 of 2011. Carrier Systems revenues for Q3 of 2012 were $111.6 million, compared to $120 million for Q3 of 2011. Business Networking revenues for Q3 of 2012 were $36.6 million, compared to $44.9 million for Q3 of 2011. Loop Access revenues for Q3 of 2012 were $13.9 million, compared to $27.3 million for Q3 of 2011. HDSL product revenues for Q3 of 2012 were $12.9 million, compared to $25.3 million for Q3 of 2011.

As a result of the above, Carrier Networks division revenues for Q3 of 2012 were $131.9 million, compared to $152.5 million for Q3 of 2011. Enterprise Networks division revenues for Q3 of 2012 were $30.2 million, compared to $39.7 million for Q3 of 2011. International revenues for Q3 of 2012 were $49.2 million, compared to $21.9 million for Q3 of 2011. To provide the reporting of each of these categories we have published them on our Investor Relations web page at ADTRAN.com.

Gross margin was 49.3% of revenue for Q3 of 2012 compared to 51.7% for Q2 of 2012, and 56.7% for Q3 of 2011. The lower gross margin compared to Q2 of 2012 was attributable to a change in customer mix and lower volumes. The lower gross margin compared to Q3 of 2011 was attributable to lower gross margins related to the recently acquired Broadband Access business, and the change in customer mix and lower volumes.

Total operating expenses were $69.7 million for Q3 of 2012 compared to $68.4 million for Q2 of 2012 and $58.4 million for Q3 of 2011. The increase in operating expenses for Q2 of 2012 to Q3 of 2012 was primarily attributable to a full quarter of operating expenses related to the acquired Broadband Access business, partially offset by a reduction in organic operating expenses. The increase in operating expenses from Q3 of 2011 to Q3 of 2012 was primarily attributable to operating expenses related to acquired Broadband Access business and increased staffing costs. Amortization costs included in the operating expenses totaled $648,000 for the quarter. Integration and other acquisition-related expenses included in operating expenses were $252,000 for the quarter. Stock-based compensation expense net of tax was $2 million for Q3 of 2012, compared to $1.9 million for Q2 of 2012, and $2 million for Q3 of 2011. Supplemental information for acquisition-related expenses, amortizations and adjustments in connection with the recent acquisitions are provided in our operating results disclosure. All other income net of interest expense for Q3 was $3.4 million, compared to $4.2 million for Q2 of 2012, and $4.3 million for Q2 of 2011.

The Company's income tax provision rate was 32.4% for the third quarter of 2012, compared to 34.6% for the third quarter of 2011. The lower tax provision rate for the third quarter of 2012 included a benefit from accrual adjustments relating to tax returns filed in the quarter, partially offset by other items. Earnings per share on a GAAP basis assuming dilution for Q3 of 2012 were $0.15, compared to $0.56 for Q3 of 2011, and non-GAAP earnings per share for the quarter were $0.20 compared to $0.61 for the third quarter of 2011. Non-GAAP earnings per share exclude the effect of acquisition related expenses, amortizations, and adjustments related to acquisitions and stock compensation expense. The reconciliation between GAAP earnings per share diluted and non-GAAP earnings per share is provided in our operating results disclosure.

Inventories were $107.2 million at quarter end, compared to $103.8 million at the end of Q2 of 2012. This increase related primarily to timing of acceptances of broadband stimulus projects. Net trade accounts receivable were $102.7 million at quarter end, resulting in DSOs of 58 compared to 59 DSOs at the end of Q2. Unrestricted cash and marketable securities net of debt totaled $500 million at quarter end, after paying $5.7 million in dividends and after repurchasing 724,000 common shares for $15.1 million.

Due to the book and ship nature of our business and the timing of near-term revenues associated with large projects it is our policy not to give specific guidance for the quarter or for the year. However, we would like to give color to help you formulate your views on how -- on our near-term business outlook. For the fourth quarter of 2012, we expect a sluggish economic environment and regulatory uncertainty to -- in addition to typical seasonality will negatively impact our revenues. With that in mind we're planning for total Company revenues to be down in the teens percentage point range for the fourth quarter of 2012 on a sequential basis. We expect GAAP gross margins for the fourth quarter will be roughly flat from third-quarter levels. We expect GAAP operating expenses for the fourth quarter will be down $2 million to $3 million on a sequential basis. GAAP operating expenses for the quarter we expect will include acquisition-related amortizations of $600,000.

We believe the larger factors impacting the total revenue we realize for the fourth quarter of 2012 will be the following. The macro spending environment for carriers and enterprises, regulatory uncertainty in the domestic carrier market, the adoption rate of our Total Access 5000 platform, professional services activity levels, both domestic and international, and the timing of revenue related to broadband stimulus projects. Tom, back to you.

Thank you, Jim. Toya, at this point we would like to open it up for questions.

(Operator Instructions)

Amitabh Passi.

Tom, just a couple of questions, actually one for you and perhaps one for Jim. As you look at your fourth-quarter guidance of the mid-teens decline, can you give us a sense on how we should think about the different segments trending quarter to quarter and perhaps maybe some commentary on HDSL, does it get materially worse or do you think we're kind of troughing at these levels?

Yes, let me cover the HDSL piece first and then I'll let Jim comment on the different segment pieces. So the major decline without a doubt was in the customer that I had talked about and what we were trying to do or what I was trying to do in the comments was to give you a sense of that level, at it being below $1 million. It is possible I guess for that to be lower but I think it would be very difficult. There are some products that we sell to that customer that are not in the reuse program because they're not themselves really retrievable. Peters would be an example of that.

I would expect that level to stay the same. We do see a typical seasonal decline with the rest of that customer base in HDSL, so I could imagine the rest of the customer base coming down to some extent, just because of typical seasonality. Jim, you want to comment on the segment piece?

Amitabh, my comment would be as following. Yes, we are calling a sequential decline in revenues and I think it would also relate to our Broadband Access category, as that would relate to the regulatory environment and potential project movements. And also in terms of the enterprise environment, we would expect a sequential decline there as well for EN revenues and also Internetworking is what we're anticipating as well.

Great. Maybe just as one follow-up, Tom, just on your Tier 2, Tier 3 customer base, you spoke of market share gains with the Tier 2 customer base. Any color who you're taking share from? And then on the Tier 3 side, when do we get clarity on the USF regulatory uncertainty, do you expect that to persist into the early part of 2013?

I would expect it to persist through the early part of 2013. There's another -- there are some rule makings that will be happening towards the -- are expected to be happening towards the end of this year. But clarity on kind of the second phase of that I think is still a little bit -- it's still not there. The answer to your question is yes on that.

We actually picked up market share in both the Tier 2 and the Tier 3 spaces. I mentioned we brought on I think 27 customers this quarter in the Tier 3 space. We have been pretty much averaging in the kind of mid-20%s range now for some time. So that continues to build. As far as the Tier 2 customer, our biggest competitor is Calyx, Tellabs is typically in there. In the Tier 2 space you may see a couple of other ones, but those are typically the ones that we're competing with. Did I answer your question?

Simon Leopold, Raymond James.

A couple things I wanted to see if we could drill down on. One is specific contribution from the acquired Nokia Siemens business. You didn't break it out this quarter explicitly. We were assuming it was in the neighborhood of $30 million. Just want to see if we've got kind of the right range on that value.

Yes, what we're trying to do, because more and more of course the BBA business, which we're now by the way moving on to as we finish the integration is going to be -- we're going to be talking about it as being ADTRAN Europe going forward, so the reason it is blending is because you're seeing us actually push more of our other products through that channel, I'll call it. It's more than a channel as you're aware but through that channel, and we really want to integrate it to the rest of our business which is why it's going to be ADTRAN Europe and while we try to more and more integrate the number. As far as the range that you're talking about, I think you're in the right range.

Okay. Great. Appreciate that. And then you talked about a sequential cost or OpEx decline in the December quarter and just wondering how to think about where that's coming from and how you're actually doing it in terms of is it headcount, is it variable cost between sales and marketing versus R&D, how should we think about where the OpEx decline is coming from?

Well, we try to keep in our business, we have a level of variable costs as you can imagine that everybody has. We also have variable cost in relation to headcount because the temporaries and contract laborers, so we really have gone back through those pieces as well and in some portions of our business that can be fairly high, and have moved a lot of that work internal now. So you're actually going to see an impact both in headcount and in other incremental expenses but the headcount count pieces was largely temporaries and contractors.

Great. That's helpful. And then just one last one. When we talk about the group of customers that are classified as Tier 2 and 3, what percentage of your business are we talking about? What percentage of overall sales come from the group that's classified as Tier 2 and Tier 3 carriers? Both September quarter that you've reported and what's kind of the traditional level of exposure?

Jim, you want to --?

Well, Simon, that's not a number that we specifically break out. However, we do break out obviously the CN division revenues. We break out the international revenues. We also at the end of the year in the 10-K, we break out the 10% customers. Okay? And from that you can draw some level of estimation, I think, to arrive at your number.

So what I'm missing from this equation right now then would be the 10% customer. So maybe the other way I can ask the question would be what's it look like in terms of 10% customers this quarter? How many? How big?

Sure. So what we are able to disclose is a number of 10% customers in the quarter and we had two this quarter. Okay?

Can you give us any color on were any international this quarter?

One was non-US.

Okay. Great. Thank you very much.

Eric Ghernati, Bank of America-Merrill Lynch.

Just want to get some thoughts on what your customer base is telling you as far as not necessarily this quarter, but going like forward maybe a quarter out. I understand your visibility is fairly limited at this point in time, but from your discussions, what are they telling you? Are they telling you that things are going to stay like this through the better part of the first half or is there like some sort of pick-up that could happen in Q1? Any thoughts on this would be great. Thanks.

Sure. I'll caution you in saying that our customers haven't necessarily been able to forecast their expenditures through this year, so --

Understood, yes.

Right. And so to the extent that there are projects that are planned, we did see some slippage through the year and actually some slippage into next year. If I talk specifically about recent meetings, much of the activity, if not all of the activity that was planned this year and didn't make it into this year right now is currently being forecasted as occurring next year.

In the Tier 3 market, I would say it's probably even murkier in that what we're just seeing is just a general slowdown, and when you do go and talk to individual customers, they point specifically at the current USF regulation changes and looking for some more clarity on how they're actually going to be able to recoup some of the funding that's going away before they can actually plan their business. So I would expect that to continue on through the first part of next year. The Tier 2 marketplace like I said things are teed up to start happening again in the first quarter, but with the caution that there's been continuing spending delays.

Okay. The second part, first of all, you mentioned that you had in your Tier 2s and Tier 3s your stimulus revenue was up. Did you mean sequentially or on a year over year basis?

Both.

Both. Okay. The third question I had is on your press release when you pre-announced last time you suggested that you said recent bidding activity in Tier 1 and Tier 2 carrier counts gives you confidence about your position in next year. Just I'm more interested in what you mean by like that with respect to Tier 1 accounts.

Yes, so first of all, let me just clarify. I don't believe we said next year. I think we said in the future.

Sorry. As the markets rebound. Sorry.

Right. So -- and what I was trying to touch on there, I believe I touched on also in my notes is literally the fact that we have seen a change in attitude on broadband deployment by some very large carriers. Some of those carriers, some of those Tier 1 carriers are here in the US and without a doubt we're in a level of activity on planning and understanding what can be done in the different markets that they serve to increase the bandwidth. We're in a level of activity that we haven't seen in a long time with the Tier 1 accounts.

I would say that that's very similar to what's happening to us in Europe. There are a couple of carriers specifically that are very active in trying to understand what they can do with their plan and putting together plans on what they would like to proceed with. So we have not seen that activity. Of course, we're fairly new to Europe and us being able to be involved in those level of discussions. But in the US, we haven't seen that for some time at that tier of carrier. So I was just trying to relay to you that type of information.

And what is the typical seasonality for the acquired NSN business? My recollection is that it should be up on a sequential basis in Q4. Is that not the case?

No, it's fairly new to us, so what we -- all we can do is kind of talk to the sales force that's been there for some period of time. We can get some visibility on what has historically happened, although I would say that that's difficult to actually decipher because it's account by account. But in general I would expect similar seasonalities to what we see here in the US.

Maybe final question for me. If you can just talk about like given where margins, gross margins are at at this point in time, the last time you had gross margin with the [four handlers] was in 2002. Is there -- what's your level of confidence that you can get the gross margins back up to a certain level? Maybe you can discuss like what you think is your gross margin model a year or two from now. At least a year from now.

We haven't revised our targets. As we move forward and we see that there is a requirement to revise the targets we would do that. But as of this point, we haven't revised our target. I'll tell you, a little bit -- the way to think about where we are in the current gross margin area is we have two contributors. We have what's going on in the US and there's some pressure on those gross margins because of the higher level of BBS shipments than non-BBS shipments, and what's happened there is as we got into the broadband stimulus award program, we really saw that as an opportunity to go in and expand market share.

I would say if you look at the number of customers that we brought on, you can see that there -- I would tell you, there's some correlation to the number of customers we brought on and the market entry that broadband stimulus allowed for us. So we went in there with a sole intention of expanding market share against incumbents that had long time history and in some of those cases we got -- you'll see that pressure on our margin line. I will tell you, that was not initially as we entered this year, we were not as maybe expecting the pressure that we're seeing right now, and the reason for that is as we entered the year, the general business, the non-BBS related business was high enough to significantly dilute that. As we progressed through the year and I would -- the general spending in that market slowed down, the BBS component became a larger piece to the gross margin profile. Something very similar to that happens when you add in the ADTRAN Europe piece, where you had a lower margin, contributing to a higher percentage of the revenue and because of that you had higher dilution.

I think as we get through the BBS portion of this you'll see a recovery in that margin. As markets return to normal you'll see more dilution in that margin hit and you'll see more dilution in that margin hit both from non-stimulus broadband projects as well as North American business versus the BBA business.

And how much do you think you can recuperate I guess? That's the question.

We had -- I'll ask Jim to kind of recall what our margin guidance has been in relation to BBA and then maybe we can add some color to it if there's any changes in that at this point.

From the acquired business standpoint, we're anticipating gross margins in the first quarter of next year to be in the range of the mid-40%s due to savings achieved through the supply chain transition. Okay. So that's what we continue to anticipate. So that would certainly improve gross margins from a standpoint of where we are today and where we expect to be in the fourth quarter as well.

Thanks lot.

Did that answer your question?

Yes, thanks.

Michael Genovese, MKM Partners.

Did you have any 10% customers in the quarter?

Michael, yes, we did. We had that question before. We had two in the quarter.

Okay. Great. And then just in terms of CenturyTel, I want to make sure how you classify them. I'm sorry, CenturyLink. Do you consider them to be a Tier 1 or a Tier 2 carrier?

They're a Tier 1 carrier. We consider them to be Tier 1.

Okay. And then finally, a lot of the questions have been asked but now you don't want to break out the BBA revenue separately, the ADTRAN Europe revenue separately, but before going back just a quarter ago, tracking the gross margin improvement in those revenues was a key piece of the story and if we don't have -- if we can't track those revenues, we kind of lose the ability to follow that part of the story. How -- I think you just gave us that mid-40%s for 1Q '13. Does it go up from there, that BBA piece, or is that kind of the normalized margin level in 1Q?

Okay. So the gross margins on BBA from there over the longer term we talked about in the past of there being a second increment to gross margin improvement through engineering design changes to bring the product cost down. That will happen over a longer period of time. So again, that will be viewed as a second increment to increase that mid-40%s range.

Let me just add a little bit of color to that. What we have right now is largely a two-fold approach. One is supply chain really purchasing improvements based off of the combined entity. We have seen a lot of those already happen, although I will not tell you that we probably shipped necessarily all of the pieces yet with that new cost component involved. And then we had the supply chain movement where we were actually moving out of some of the factories that we were actually building some of, was actually built in Germany. We have a two step process on that supply chain movement. Those are the pieces that you'll see continue to contribute and get to that -- the ranges in the first part of next year.

In the second part of next year, and I will say -- I won't even say second part. Right after that, you'll actually start seeing some products that actually are in development right now come to market and you'll see an improvement because of those.

Great, great. And then as a quick -- just very quick follow-up. Do you anticipate next quarter or shortly thereafter, do you think you'll still continue to report domestic and international or do you think you'll do domestic, Europe and other international?

Go ahead, Jim.

So we will continue to disclose international, and if you look at the 8-K that we released today with the earnings you'll see the international breakout and I certainly called it out in my notes.

I'll add just one piece to that, which Jim may kick me here for saying that, but as Latin America continues to contribute and as the European piece continues to grow, I could envision us breaking out a more granular geographic mix but I'm not sure if next year is actually the right year to do that.

Great. Okay. Thanks, guys.

Ehud Gelblum, Morgan Stanley.

Hey, guys, thanks, I appreciate it. I wanted to get a little bit more on the gross margin, understand that a little bit. We get NSN gross margins up into the mid-40%s in Q1. What was that this quarter? I'm guessing it was the mid-30%s. I want to be able to do that math.

That's about right, Ehud, yes.

Okay. Great. And then the other thing that structurally brought your gross margin down this quarter because we only seemed to have added roughly $8 million of so of NSN, it seems the lack of HDSL, did that have an impact? At times HDSL seemed to have a larger gross margin than other products and at other times it seemed to have relatively similar, same with Broadband Access. Did the lack of HDSL and Broadband Access this quarter, did that have a negative impact? I'm trying to understand how long we're going to stay in the high 40%s right now.

Let me answer that. I guess it's not difficult to answer. I want to make sure that I get the point across. HDSL versus our traditional other businesses including the Total Access 5000, and 1100, has been roughly the same margins. But when we saw the decrease in HDSL, we saw a decrease in effect of our non-BBS and non-BBA revenue.

Right.

So it wasn't that HDSL was above what we would consider to be standard margins, it is the loft in that revenue pool in general actually caused the dilution in margins.

Okay. So broadband stimulus seems to be lower gross margin as well.

Yes, I would say broadband stimulus at some accounts. There are some accounts where we without a doubt used that as one of the tools in order to kind of get into those accounts.

Okay. Is the expectation that those accounts will suddenly be higher gross margin once they -- sounds like they're new accounts, you gained share, you've got these 27 new rural customers on I assume presumably competitive pricing with lower gross margin. What are the odds you think that they'll actually be able to -- you'll be able to step up the gross margin there?

On those products where we have gone in and garnered a foothold, in every case we have cost reduction initiatives in order to be able to re-establish the profile that we're looking for. So it's not that I think I'll be able to step it up in those individual accounts. I'll be able to reduce my cost to those individual accounts.

Okay. Which is traditionally how you've done it in the past as well.

Yes, which we're actually just following the same line. I think this has happened historically at some points in time where you'll see a big potential for market share and sometimes we will forward price in order to be able to get that market share and that's exactly what we've done here.

But is it correct to say broadband stimulus continues once this regulatory uncertainty undoes itself in Q1ish, Q2 you'll have continued broadband stimulus deals, so you could -- you might be gaining margin in some and losing margin in others as you continue to gain share.

Yes, a lot of that -- that is absolutely a potential, but right now I would not envision the same type of pricing next year as this year. But there's very much that potential. So I don't want to dilute your thought there.

Okay. International was down $5 million, but seems like BBA was up roughly $8 million, $22 million to $30 million, the numbers you're talking about.

I will caution you, I said in the range. I wouldn't say that it was necessarily that number but in the range.

Okay. So maybe if it was a little bit lower then the delta's a little bit less, but we're still talking about a delta on your other international revenues of $10 million to $13 million, maybe $9 million to $13 million. Was that primarily some of your other large Tier 1 customers like the Telmexes of the world or were there others, a lot of scattered accounts that sort of went down?

In general, I don't think that the -- I think that the market that we saw internationally in general was similar to -- maybe not as bad but similar to the market that we saw here in the US, it was kind of a lackluster market where carriers didn't have to spend, they didn't spend. Our biggest contributor to international revenues is Latin America on a single account basis, and that customer is just -- we're just going to see bumpy revenues, so that customer actually did see a little bit of a decline this quarter.

We'll probably see a little -- we'll see a decline in that revenue next quarter but you'll see it continue to bounce around that number. And as I mentioned, if I look at the current backlog on that customer and the current scope of activity we have including things that are in deferred revenue and things that we have orders on, I would expect that to contribute to our revenues all the way through the end of 2013, and that's assuming no new project phases get initiated which you can imagine we continue to try to open up.

Sure, two other quick questions if I could? As you get more international and you said Tier 1s are assessing what they're doing, do you see Huawei more than you had before? Is that a problem? And then has anyone brought up the concept of using LTE as their -- any Tier 1's as their broadband strategy? AT&T has mentioned it in passing in the US.

I've read some things on that here recently. The direct answer is no. I can imagine that that is a potential for certain areas and I wouldn't say that's not -- certain rural areas, depending on the density of those areas that it may make sense. But it's something that just really hasn't come up in our conversations. We have been very forthright in asking those questions.

As far as Huawei is concerned, I'm sure I've mentioned in the past that we had competed with them in the US, less so in the US, and we compete with them on any of the international business that we go for. We still continue to compete with them but I would say we're probably more effective now than we have been historically. So I would say that carriers are open to looking at alternatives other than Huawei as well.

I appreciate it. Thank you very much.

Bill Dezellem, Tieton Capital.

A group of questions. First of all Tom, you had referenced the high level of Tier 1 activity. Do you expect that -- discussion activity, that is, do you expect that to start turning into revenue in the first quarter or would you anticipate Q1 to be more the typical flat to down revenue sequentially, just on a seasonal basis? And then as you get into 2013 that's where you might start to have a little more success in that Tier 1 revenue level?

Speaking of Tier 1, we really don't want to give Q1 guidance until we get to Q1. I'm going to shy away from that a little. Of the Tier 1 accounts, where we are with the discussions and the activities, there are a piece, for instance, on more than one Tier 1 account right now, and then there are other activities and I will say that they're sometimes, in fact, in most of the cases there are multiple projects going on that address broadband. So in some cases there are two RPs and in some cases there's one but there's additional activity going on.

But because we're talking about large accounts which means that we have to do OS integration, some of that OS integration of course is already done but we have additional work that has to be done, I would not expect that to impact the first quarter of next year.

That's helpful. And then relative to the broadband stimulus dollars and the USF fund changes, is there an interaction between those two that is relevant and worth discussing, or are those really two separate phenomenon's that are being kept separate in the carriers and the government's mind?

Would you repeat that again. The USF funding and what?

And the broadband stimulus going all the way back to the big recession package.

I would view them as separate, but having a similar impact, in that in broadband stimulus it has been difficult for us in some cases to segment what is general business and what is stimulus business, and I think that may just be the nature of the customer base and the activities that they're undertaking. So I think it is conceivable in my mind that broadband stimulus to some extent impacted general spending levels.

And I think when the USF transition was announced with the rules that -- with kind of the framework of the rules, but the rules not in place, I think that put additional pressure on the general spending. I have no doubt that it put additional pressure on general spending, as you can imagine, if you're a rural carrier and there's been a very good job of defining how your revenues are going to decrease, but very little clarity on how the revenues will increase based off of new rules that are yet in place, you can imagine to the extent that that's funding your operating expense that you'd have to do something. And so I think we're seeing that. So I think both of them had impacted the general spending, but as to what level, I think it's difficult to say.

That's helpful. Finally, relative to Bluesocket, to what degree have the challenges that you've been experiencing this year impacted Bluesocket or is that really entirely independent?

To some extent, I think it's independent. Bluesocket has been a -- we're seeing good traction with Bluesocket. We've seen our dealer base actually after some initial training actually start to embrace it, and it feels like it's on its own trajectory. There are enough initiatives going on in education and kind of also municipal spending in relation to Wi-Fi that I think we've seen some positive traction there. I would no doubt that the enterprise market being kind of slow the way it is, at least for our products, may have had an impact on what the potential upside could have been versus where it turned out, but I would -- I guess I'm hard-pressed to say that it has had a dramatic impact. I would say that we continue to be happy with the traction that we're getting.

Thank you for the time.

Greg Mesniaeff, Maxim Group.

Just to circle back to the gross margin question one more time, can you give us any color on your component pricing environment that you're seeing? Has the BBA deal improved that scale basis? Or just give us some color as to what you're seeing in this environment for component pricing.

BBA scale maybe I think really what happens though is when you look at -- when you combine two entities, you find out that price points aren't exactly the same everywhere, and I think we're able to leverage in the BBA business some incremental part savings that we had already incurred on the ADTRAN side, and I think in some cases we actually saw the opposite where ADTRAN was able to benefit on pricing that was in place for the BBA. So I think some of it is scale but a lot of it is actually just where these different points got negotiated to within the two businesses. I don't know, what was the second piece? Did I answer your question?

Yes. Yes. Actually, my follow-up was when you look at your R&D spend, it's in relative terms it's somewhat sticky, given the revenue decline. Can you give us some insight as to where some of your R&D spending priorities currently are, given that Total Access has been around for a long time, obviously, and I'm just wondering what some of the goals currently are for the R&D that you're spending.

Well, let me talk about more near-term spending on our products. First of all, Total Access is just to recalibrate you on that. Total Access I think we're probably talking about the 5000 here is a platform that in effect can morph into many different applications, whether or not that's broadband deployment, whether or not it's GPON deployment, VDSL2 vectoring deployment, which is very hot right now. Or you can do grooming and inter-working of different protocols, so there's a lot of different things that the 5000 does.

The activity that we have going on right now is probably more customer direct centric than it has been in a while and that has to do with some of the activity that I had talked about in the Tier 1 accounts. So on their very stringent requirements both on the 5000 and on the hiX system, which is the ADTRAN Europe system that we have got to get done in order to meet all the requirements that we have signed up for. So there's work going on there. I would say a significant amount of work going on there and that includes not just the platform itself, but there are ancillary pieces like our ONE which is our Optical transport piece which are kind of interrelated to the total Access 5000.

The next large piece of work that is going on on the carrier side is the 1100 series fiber-to-the-node platforms. Some of these RFP and some of these awards envision a fiber-to-the-node platform that is intertwined to the Total Access 5000 and we have some work to do there. We have just recently released our fourth generation of the 1148 series which is a cost reduction for us. It has not yet started shipping but we would expect that to start shipping probably in Q1 of next year. And there's some significant work going on in that area.

Those are probably the two biggest pieces. I do want to touch on the variable piece that you talked about on the expense line on engineering. There are of course variable expenses there that you can move around and tighten up and actually figure out ways to do better, and there's also contract work that goes on in engineering that you're able to reprioritize and take on yourself. So I wouldn't view it maybe as fixed as you had just intimated.

Thank you. That's very helpful.

Paul Silverstein, Credit Suisse.

Two questions, if I may. First off, Tom or Jim, I think you all referenced, Tom actually between deferred revenue that you've got visibility into revenues going through the end of next year. Is that -- do you have visibility into revenues being up, flat or down? Can you give us any incremental insight on that?

And then I hate to ask you to revisit gross margin. I know there have been a lot of questions. I really have been listening. My specific question, gross margin, is the improvement to the mid-40%s that you referenced in previous conference calls, from just cutting over your supply chain, has that already fully been realized in any incremental improvement from here will be the new products, the reengineering? Or is there still more upside to go from supply chain or other factors on gross margin?

Okay. So the first question, Paul, is the 2013 piece I'm talking about was specifically to our Latin American customer. And the reason I mentioned that is I know that there's been some angst as to whether or not that customer disappears this quarter, disappears next quarter, and the reality is that that revenue I would expect even in its current phase and as you know, we've been through I think three -- I'll call it three plus phases at this point with that customer and they tend to kind of drop in periodically. We have not seen that drop-in as of yet. But that's pretty much the way that customer interacts. But we expect that revenue to carry on through next year.

As far as how it actually manifests itself, there are two pieces of that. One is we are still seeing even in the current phase incremental purchase orders that come in. For instance, just towards first part of this quarter, we saw incremental pieces come in under the banner of the current phase that we're operating in. Those are difficult to forecast. Because I will tell you two months ago or a month ago, I would not have expected that to come in but they do. And those will continue to happen through next year.

There's also a large service piece to that business and the service piece and the revenue recognition on some of the hardware and the services themselves are going to be dependent on when those activities actually get finalized. It's regionally based. There are kind of grids of targets that we're trying to go after. Sometimes those grids move. So you'll see variability in that revenue and I think I mentioned that. But that has as much to do with activity going on and when we finalize projects, and then to some extent because of the drop-in orders that we would continue to expect, you'll see that variability from quarter to quarter. I don't know, did I answer your question on that?

Yes. That's fine.

Okay. On the gross margin piece, there are two phases to this first step in gross margins that we talked about. The first is the incremental cost savings that we would see on material or first one we talked about was the material piece. I would say we're -- at this point in time, we are procuring everything at the best cost possible under the current contracts that we have, but we probably haven't realized the total revenue impact because those things have to be procured, go through our supply chain, and then ship before we would actually see that impact. So I'm sure we have not seen the full impact of those cost savings.

The second piece to that initial savings bucket was the actual physical movement of where we're manufacturing and that movement is still in the midst of swinging as we speak. We started shipping our first products at the -- in our Asian manufacturing plant at the beginning of Q3 and we're continuing to shift. I would think by the end of Q4, the majority of those items will be placed at the manufacturing facilities that we long term envisioned them. We'll see that improvement through this quarter as we start receiving and then shipping out that material.

So you'll see that improvement in Q4 but I would say the tail of that improvement may actually last all the way into next year as we actually ramp up volumes, based out of the new manufacturing facilities.

Just to clarify, again I apologize, I know you've addressed this previously, but that movement you're referencing that gets you in that NSN business, that gets you in the low 50%s, consistent with your ADTRAN classic or am I missing something?

I'm going to look over to Jim, because I'm not sure if we actually said -- I think we were looking more at the combined entities when we talked about that, but Jim --

Right, right. That process of change that Tom talked about for the acquired business gets us to the mid-40%s in Q1 is what we're looking at. Now, beyond that for the acquired business, as we mentioned before, we expect to see additional incremental changes, reductions over time through engineering redesign.

Right. And I talked about those. We are actually literally in the midst of developing our R&D activity associated with those. We'll see some of that next year. Some of the RFP activity we have we're making sure that we have the flexibility to continue to add those as those projects ramp up.

But they are less -- they are more difficult to time than the previous pieces we talked about because they do take customer interaction, customer testing, and then ultimately the customer deploying those in some significant number.

Jim did I hear you reference earlier that last quarter that acquired business was in the mid or low 30%s and this quarter it was in the low 40%s? Were those the operable numbers?

For gross margin, no, no. The gross margin ranges or range for the third quarter is still in the 30%s.

Still in the 30%s.

Yes.

Okay. Thank you.

Thank you. Toya, at this point in time it looks like we're about out of time, so I would like to thank everybody again for joining us for our conference call and we look forward to talking to you again in the fourth quarter.

This concludes today's conference. You may now disconnect and enjoy the rest of your day.