ADTRAN Holdings Inc (ADTN) 2015 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to ADTRAN's second-quarter 2015 earnings release conference call. (Operator Instructions) After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions)

During the course of this conference call, ADTRAN representatives expect to make forward-looking statements which reflect management's best judgment, based on factors currently known. However, these statements involve risks and uncertainties, including the successful development and market acceptance of core products; the degree of competition in the market for such product; the product and channel mix; component costs; manufacturing efficiencies; currency exchange rate fluctuations; and other risks detailed in our Annual Report on Form 10-K for the year ended December 31, 2014, and Form 10-Q for the quarter ended March 31, 2015. 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.

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

Thank you, Keith. Good morning, everyone. Thank you for joining us for our second-quarter 2015 conference call. With me this morning is Mike Foliano, Senior Vice President and Interim Chief Financial Officer.

I'd like to begin this morning by discussing the details behind our Q2 results, and I'll end with some comments on what we see for the future.

As stated in our press release, revenues for the quarter were $160.1 million, slightly higher than expected, mainly due to strength in our domestic broadband sales. Our total carrier networks division revenues, including both international and domestic, came in at $135.4 million; and total enterprise networks revenues came in at $24.7 million. Revenue from our domestic markets came in at $104.4 million or 65% of the total.

International revenues came in at $55.7 million for the quarter or 35% of the total.

On a product basis, our core product areas, which include broadband access, internetworking, and optical, came in at $150.3 million, up 14% sequentially with strong increases in both our broadband and the optical product areas. More specifically, total broadband access revenues came in at $100.7 million, up from $84.4 million in the first quarter, with solid performances in both our fiber-to-the-node and GPON product areas.

Our internetworking product category came in at $33.2 million, essentially flat from Q1. We saw continued strength in GPON ONTs and, conversely, continued weakness in our IP gateway product segment, primarily in our CLEC customer base. Our optical product category came in at $16.4 million compared to $12.5 million for Q1.

On a geographic basis, as I mentioned, total international sales came in at $55.7 million, with EMEA essentially flat from a strong Q1 and Latin America down sequentially, due to project-related timing. Our European business, of course, continued to be impacted by negative sequential currency exchange rates.

In the US market, we saw continued momentum in carrier sales space, driven by Tier 2 CAF spending and a general improvement in the Tier 3 market. This increase positively impacted both product and services revenues. Moving forward, we expect the positive momentum in Tier 2 accounts to continue as CAF phase 1 is replaced by broader and more substantial deployments with CAF phase 2.

Additionally, our progress with securing additional awards with Tier 3s and nontraditional carriers and the continuing incrementally positive movements we expect to see in the Tier 1 space in the second half lead us to believe the US will see solid growth for the year.

Outside the US, our European customer base remains solid, and our G.fast trials and fiber-to-the-node initiatives are progressing well. I mentioned in our last call that we'd be moderating our operating expenses, and in the second quarter we recorded incremental expenses necessary to move forward with that goal.

I would now like Mike Foliano to review our results for the second quarter in 2015 and provide comments on our third-quarter view as well. We will then open the conference up for questions. Mike?

Thanks, Tom. Revenue for the second quarter was $160.1 million compared to $176.1 million for Q2 2014 and $142.8 million for Q1 2015. Broadband access product revenues for Q2 2015 were $100.7 million compared to $108.3 million for Q2 2014 and $84.8 million for Q1 2015. Internetworking product revenues for Q2 2015 were $33.2 million compared to $41.0 million for Q2 2014 and $34.2 million in Q1 2015. Optical product revenues for Q2 2015 were $16.4 million compared to $15.8 million for Q2 2014 and $12.5 million in Q1 2015.

Carrier systems revenues for Q2 2015 were $119 million compared to $128.8 million for Q2 2014 and $100.4 million for Q1 2015. Business networking revenues for Q2 2015 were $34.2 million compared to $42 million for Q2 2014 and $35.4 million for Q1 2015. Loop access revenues for Q2 2015 were $6.9 million compared to $5.3 million in Q2 2014 and $7 million even for Q1 2015. HDSL product revenues for Q2 2015 were $6.4 million compared to $4.8 million for Q2 2014 and $6.7 million for Q1 2015.

Carrier networks division revenues for Q2 2015 were $135.4 million compared to $143.5 million for Q2 2014 and up from $116.0 million for Q1 2015. Enterprise networks division revenues for Q2 2015 were $24.7 million compared to $32.7 million for Q2 2014 and $26.8 million in Q1 2015. International revenues for Q2 2015 were $55.7 million compared to $79.1 million for Q2 2014 and $59.4 million in Q1 2015. The reduction year over year and quarter over quarter includes the effects of the decline in the euro/dollar exchange rate. To provide the reporting of each of these categories, we have published them on our Investor Relations webpage at adtran.com.

Gross margin was 42.6% for Q2 2015 compared to 49.3% for Q2 2014 and 45.9% for Q1 2015. The decline in gross margin for the quarter compared to Q2 2014 and Q1 2015 was primarily driven by the FX impact on our euro-based sales and growth in service-related material sales in our US market.

Total operating expenses were $67.6 million for Q2 2015 or $65.6 million for the same quarter, net of a $2 million one-time restructuring charge, compared to $67.5 million for Q2 2014 and $63.6 million in Q1 2015. The increase in operating expenses compared to Q1 2015 was attributable to increases in R&D and SG&A. The R&D increase was primarily due to Telcordia-related development costs associated with a particular customer. The SG&A increase was due to higher than anticipated selling expenses associated with the higher revenue level.

Acquisition-related amortizations totaled $0.6 million for the quarter. Stock-based compensation expense, net of tax, was $1.3 million for Q2 2015 compared to $1.8 million for Q2 2014. Supplemental information for one-time restructuring charges, acquisition-related expenses, amortizations and adjustments in connection with the most recent acquisitions and the stock-based compensation expenses are provided in our operating results disclosure.

All other income, net of interest expense for Q2 2015 was $3.5 million compared to $2.5 million for Q2 2014 and $3.5 million for Q1 2015. The Company's income tax provision for Q2 2015 was at a rate of 38.12% compared to a tax provision rate of 34.00% for Q2 2014 and a tax provision rate of 39.80% for Q1 2015.

Earnings per share on a GAAP basis, assuming dilution, for Q2 2015 were $0.05 compared to $0.26 for Q2 2014 and $0.06 for Q1 2015. Non-GAAP earnings per share for Q2 2015 were $0.10 compared to $0.30 for Q2 2014 and $0.10 for Q1 2015. Non-GAAP earnings per share exclude the effect of the one-time restructuring charges that I mentioned earlier, 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 at $100 million at quarter-end compared to $93.1 million at Q1 2015. Net trade Accounts Receivable were $89.1 million at quarter-end, resulting in 51 DSOs compared to 60 DSOs at the end of Q2 2014 and 57 DSOs at the end of Q1 2015. Unrestricted cash and marketable securities, net of debt, totaled $310 million at quarter-end after paying $4.7 million in dividends and repurchasing 2,782,287 common shares for $46.3 million.

The book-and-ship nature of our business, the timing of revenues associated with large projects, and the variability of order patterns of the customer base into which we sell, and the fluctuation in currency exchange rates may cause material differences between our expectations and actual results. However, our current expectations are that Q3 revenues will be essentially flat on a sequential-quarter basis. Taking into account euro exchange rates and anticipated mix, we expect that gross margins will be in the mid 40s. We expect that operating expenses for the third quarter will be slightly below our Q1 expense level, net of any additional restructuring charges.

We anticipate a consolidated tax rate for Q3 to be in the high 30s percentage point range for pretax income. We believe the larger factors impacting the revenue and earnings realized in 2015 will be the following: the macro expending environment for carriers and enterprises; currency exchange rate movements; the variability of mix and revenue associated with project rollouts; professional services activity levels, both domestic and international; timing of revenue related to Connect America Fund; and the adoption rate of our broadband access platforms and inventory fluctuations in our distribution channels.

With that, I'd like to turn it back over to Tom.

Thanks, Mike. Keith, at this point we are ready to open it up for any questions people may have.

(Operator Instructions) Rod Hall, JPMorgan.

Hi, Tom. This is Ashwin on behalf of Rod. Thanks for taking my question. I was hoping you could comment on timing for CAF-II related revenue, or at least give us your expectation of revenue recognition from CAF-II products. Also, can you comment on your expectations from [DD] in the second half of this year?

Okay, sure. So on CAF-II, there are -- needless to say, many of the carriers, but not all of them at this point in time have signed up for whatever CAF-II funding that they are going to be receiving. And many of them have already started the planning process.

It's still variable, but my sense is we'll start to see kind of initial pieces of that probably in Q4, but a kind of more accelerated ramp into next year. We are still -- at this point still shipping, of course, some CAF-I projects. That will be shipping out through the end of this year.

As far as our European customer base, no new news there. Basically, they had a very -- a fairly -- a very strong first half. And then we expect them to be seasonally down in the third, and then seasonally down again in the fourth quarter. So you will see a pickup in our US business and a downturn in our European business.

Okay, thank you. I saw you mentioned that LATAM projects were down in Q2 because of timing-related issues. Are they coming back in Q3? Or when can -- ?

Well, that project -- you know, I mentioned that it was down, but I will tell you it was not substantially down. I think it's actually going to be up a little in Q3, but I don't think it's -- the materiality of it one way or the other is small compared to what's happening in the US and, of course, what's going on in Europe right now.

Okay. I have one last question on the enterprise segment. It looks like it continues to be in a decline mode. Can you comment on how the enterprise demand is looking like and your expectations there will be (inaudible)?

Yes. There are two things that are impacting it, and then the rest of the product basis is, I would say, fairly flat. So the downturn that we are seeing in enterprise is due to two reasons. One, the IP gateway business has been down now for a few quarters. It ticked down some again from first to second quarter. I will tell you, marketshare-wise, we are fine. There has been some shift from our IP gateway business to routing business, but that's not the predominant issue there. The predominant issue there is the larger Tier 2 CLECs that are in that space have just slowed down. So that's one of the impacts.

The other impact is we did shift a lot of the GPON ONT business, which was traditionally an enterprise business. The carrier networks division started developing those products, and so we saw a shift that was -- so the biggest growth area that would have been in enterprise today actually is now probably in the carrier networks division with the ONT business. So both of those things kind of impacted it, which is one of the reasons I would ask you to take a look at our internetworking number as kind of more of a bellwether on how that total business is doing, because it includes both carrier and network termination points.

All right. Thank you.

Amitabh Passi, UBS.

Tom, I just wanted to ask a couple of questions. First, just on the CAF phase 2-related funds, are operators starting to spend -- have they received the funds that they are spending already? Or do they still have till August, I think, to accept the funds? I'm just trying to get a sense of the cadence in how the spending is actually manifesting itself. Are you starting to see the benefit? Or do you think it's yet to come?

It's yet to come, without a -- I'm not aware of any type of business that we have received for CAF-II. Everything that we have received up to this point has been CAF-I related. And you are right; it is August for the final dates. I think a lot of them made their decisions on what they are going to do. And I will tell you, some of them right now do have plans to start deployment of that in Q4. But I would say it would be too early to count on that. I think that's still kind of in the flux as to whether or not -- a lot of that will depend on the weather, of course, in Q4 as well. So I would put more onus on that starting next year.

And do you think their overall spend envelope will actually expand? Or will this substitute what they were going to spend anyway? So do you think this is actually net incremental to their spend?

I have no doubt it's net incremental. At least to us. There's no doubt about it.

Okay. And then just a quick follow-up on Europe. You know, I thought previously you had said you would expect momentum to continue to 2Q, and then 3Q/4Q being seasonally down. Q2 came in slightly down. I don't think we saw significant FX movements quarter to quarter. So I'm just wondering, did Europe and your largest customer there come in maybe a little weaker than you had anticipated? Maybe just some incremental insight in terms of what happened.

Sure. And it's probably harder for you to see without knowing exactly what we use for our exchange rates, which we set at a particular time during the month and during the quarter. And so, the fluctuation that you may see in the market may differ from what we actually see here. I will tell you, it was down. It was -- and it was down enough -- it was materially down from Q1 to Q2.

But the total revenue, if you look at -- the best way to look at Europe is first-half versus second-half. So we had a very strong Q1 -- the strongest Q1 with them in our history was -- I think that Q1 was substantially stronger than last year's Q1. And then we saw basically -- I think maybe a slight uptick or flat from Q1 to Q2. And if I look at the half, it is definitely on a non-euro-impacted number substantially.

So we think that that's just kind of the way that they are building out this year. Q3 and Q4 are no change from what we would have thought.

Okay. So just finally, how many 10% customers did you have?

We -- Mike?

We had three 10% customers: one in our international business and two in our domestic business.

Oh, interesting. Okay. Thank you.

Doug Clark, Goldman Sachs.

One quick clarification. You mentioned OpEx to be down slightly. Wondering if that was off of the restructured number -- so the $65.5 million or the actual reported GAAP number? And then second question is more on the gross margin front may continue to take a step down, and kind of assuming that FX, again, didn't deteriorate that much from second quarter to first quarter, which it sounds like it may have. Is all of that gross margin pressure being driven by the services component of CAF?

Yes. So, the first question, which was -- Mike?

It was OpEx, right?

Right. So that was on a -- that was what we had talked about is for the -- it will be down off of the $65 million. Am I correct?

So I think what our guidance was for this quarter was that we would be at or slightly below the Q1 level. So if you look back to that Q1 number, which I believe was $63.6 million, that's our target for Q3. Does that make sense?

Yes. So down -- flat or down slightly versus the 1Q level?

Yes.

Okay.

And the second question was around gross margin?

Yes, just the sequential decline. Is that predominantly due to CAF-related projects?

So there were two impacts, one which -- you are correct; there was an FX impact that, depending on what your number is -- our number that we saw may be higher than what your number is. I don't know what your number was. And then the other is CAF-related projects. And, really, there's two components of that. There's the actual service piece itself, which did grow; and then there's material associated with that service -- for instance, cabinets, and a lot of cabinets when you are talking about projects like this, that typically come in at lower gross margins than products that you actually develop yourself.

Okay. That makes sense. And then one quick follow-up, as well. You had mentioned G.fast in the prepared remarks. Wondering if you can give an update on interest levels, activities, and potential timing of deployments associated with those.

Yes, timing is a little -- timing of deployments, of course, is always suspect to change. Several of these cases, we are talking about Tier 1 carriers. We have a couple of Tier 1 carriers in Europe that are right now in a trial phase with a product, as well as a couple of Tier 1 carriers in North America. You won't see -- we won't see revenue from that this year, because it will take a while to get integrated. But we would expect to see something next year.

Great. Thank you very much.

Simon Leopold, Raymond James.

Great, thank you. I just want to get a quick clarification. In the press release, you talk about strength driven by CAF; and in your prepared remarks and your answers, you have talked about CAF-II really coming 2016. So, really, the strength in the reported quarter is the CAF-I, whereas the CAF-II funds are really more of a 2016 event. I think you've said that; just want to make that clear. Is that true?

That is true.

Great. And then, in terms of gross margin, you did give us some guidance for the following quarter. And we've talked a bit about the June quarter. Can you give us your perspective on how you think about the longer term gross margin trend? It seems as if you had somewhat of a reset from your sort of long-term history of high 40s to low 50s. I'd like to get your thoughts on what you think your gross margin should be like beyond the next quarter.

All right. So there are two components of that. And if you let me just throw away currency and assume that whatever we end up at currency is at the end of the year is where we end up with for a longer period of time. The gross margins that we are looking at right now, with the strength that we see in the US business -- so if I look at the total mix -- I would expect to be in the -- somewhere in the mid to high 40s.

Great. And you mentioned -- this is my last question. You mentioned GPON improving. When I look at some of the third-party market research, it looks as if you have relatively low share in GPON. And I'm just wondering if you could give us a little bit more color in terms of the trends in your GPON product business -- how you see that within the mix and how that affects the overall business model. Thank you.

I would say -- well, GPON is probably and has been over the last two to three quarters -- if not our fastest growing product segment, it was always number two. I would venture to guess that this quarter it was -- and I'm looking at Mike, but I would venture to guess it's probably our fastest --

On a percentage basis.

-- on a percentage basis, (inaudible).

Yes.

So we've picked up more GPON customers last year than any other carrier. So I'm not sure what specific numbers you are looking at.

Well, I guess I'm trying to put it in context. So within the broadband access business, what percentage of revenue -- so it could be $1 million and growing superfast (multiple speakers)?

Oh, yes. Yes, well, it's more than that. I will tell you, it's very material. But if you think about when -- like, when does it actually get to impact to where it's on par with, let's say, our fiber-to-the-node business, maybe, is one way to look at it; and I would say it is still some time away. We have -- you know, the biggest customers, of course, are Tier 1s for GPON. And then you aggregate a bunch of Tier 3s in order to be able to build meaningful presence. And Tier 3s are where we have seen the most success.

We had a slow start in our large US carrier here on GPON, as you are very much aware of. That business has been picking up. But I'll tell you, all of the carriers seem to be in a mix as to where do they use fiber-to-the-node and where do they use GPON? So that variability changes over time. And I will tell you right now we see -- there's more opportunity right now with fiber-to-the-node in the US than I would have told you -- than what we would have seen, let's say, a year ago, both in the larger carrier space and, of course, in the CAF space.

So those two are always playing off each other. So I would say it's going to be some period of time before it eclipses fiber-to-the-node.

And your European customers is a combination of VDSL2 and G.fast, I think? Is that correct?

Well, there's no really G.fast shipping at all right now. So all these trials are very early in their deployment phases. They are just trials. Nobody is shipping any G.fast in production at this point. So European is predominantly VDSL2 and vector VDSL2.

Great. Thank you very much.

Rich Valera, Needham & Company.

Thank you. First, just a clarification on your comments on CAF-II funds, Tom. I think you said you were confident that the incrementals -- was that incremental to what you are receiving in CAF-I right now? Or is there some substitution between CAF-I and CAF-II, and there's something incremental above that? Just wanted to sort of get a sense of the magnitude.

Yes, that's a good question. So I will tell you, for the ones that are doing CAF-I, that will at some point in time -- let's say either end of this year or definitely before the half of next year, my sense will be CAF-I will be done. So in those carriers, CAF-II will replace CAF-I. Absolutely correct. When I was talking of incremental, I was really kind of reflecting back on, like, broadband stimulus, where what we figured out was there were some carriers that actually it wasn't so incremental. It was actually replacement. And I will tell you, in the carriers that we are dealing with on CAF-II, all of these are incremental to their base business cases and kind of operating activity. Does that clear that up?

So these are ones that you are saying that didn't do CAF-I?

Yes. There are quite a few that didn't.

Okay. So there's a lot of new carriers participating in CAF-II, and that's incremental?

Right. And yes.

Is there any way for you to roughly size up the opportunity for you in CAF-II versus CAF-I?

It's substantially bigger. I can tell you that. I mean, there are many more carriers, and the aggregate dollars in each of those carriers is substantially larger.

Great. Next question related to CenturyLink. They've been publicly out there talking about a pretty aggressive vectoring upgrade program -- I think much more aggressive than they've been in the past, potentially upgrading, I think, 8 million lines over the next couple of years. This would seem to be something that you'd be well-suited to participate in.

Is there anything you can say about your potential to participate in that program, and what that might mean for ADTRAN?

I think we have a very strong potential to participate. I don't want to speak for them. I think that we have the best, most well-rounded and highest performance vector VDSL solution out there, and I think that we're very much attuned with CenturyLink in general. But I don't want to speak for them.

But to your question -- do we have a strong potential there? Yes, we do.

And you may not want to comment on this, but could you get a sense of how incremental that might be? You've obviously had historically a significant amount of business with CenturyLink with a variety of products. Any sense of how incremental this might be? Or would this be, you think, more substituting for other products, maybe fiber-based products, that you wouldn't be doing now that they are doing more vectoring?

I view it predominantly, to the extent that we are successful there, as incremental. There is -- we do both fiber-to-the-node and GPON business with that customer. This is, to my knowledge, the very first vectored VDSL. And they are trying to hit specific service rates that, although you could argue that same capital would go to -- could go to PON, I think the mix of capital that ends up being equipment versus engineering and installation when it's PON versus fiber-to-the-node is substantially different. That's why it looks better to carriers.

And so I think that the equipment spend will be higher, and I think our percentage is likely to be higher than what we are seeing on GPON.

Got it. That's helpful. And just one more if I could. I'm not sure how fine you're willing to cut this, but can you say roughly what you think slightly is in terms of OpEx being slightly down in 3Q versus Q1? Is that -- are we talking $1 million to $2 million? Would that be a good number to think about there?

You are --

Cutting it too fine?

I mean, I would like to have some -- a little -- yes. Actually a little too fine.

Okay. Fair enough. Thank you.

Michael Genovese, MKM Partners.

I apologize if this is a repeat question, because a lot of things are going on this morning; I'm not sure if this was asked. But you mentioned on the comments about an improvement in the US Tier 1 market, and I was wondering if you could give us more color on that customer, and that project, and what you're talking about there?

Sure. So, I think I mentioned three things. One was, of course, that the Tier 3 market -- we did see some strength in Q2, and we expect that to continue, which is good. So that's kind of a baseline. There's some CAF effect; but in general, I think that the [USF D] CAF regulation is getting figured out, and you are seeing Tier 3s kind of come out of the hole a little bit, at least for us.

The bigger strength, of course, was Tier 2 accounts with CAF funding. And we've spent a lot of time talking about that in the Tier 1 accounts. And there are -- depending on who you talk to, there is either two or three Tier 1s. We tend to think about it as three Tier 1s here in the US, and there's been some discussion already about potential projects that are going on with one of those Tier 1s earlier on this call, which is, as I mentioned during that question, that we view some of that -- in fact, a large portion of that is incremental to us, which we think could bode well for us over the longer term.

And then on the other Tier 1, we had -- and we discussed this on the last call -- we had other opportunities with that customer, some awards that we had won which we expected to be operationalized at the end of this year and start deployment at the end of this year. And that just remains on track.

Right, right. So with the number three Tier 1, where it seems like maybe there's some incremental opportunity, is that opportunity that you would see now in this season before the winter gets here? Or is that something that is more of a next year opportunity?

I think the answer -- I would be -- let me be cautious here, which I need to be here. So there may be some benefit that we would see this year, but the real benefit is if we have a carrier out there talking about upgrading -- and I'll use the number that was mentioned on the call -- 8 million lines, first of all, that is a long-term opportunity. You can't do that in one season, and it's very material to us.

So, the real upside to that is -- would be when they would start a rollout of that magnitude, which you would not see in a short period of time.

Okay. And then if I can get one more in, just on gross margins, which I think has also been discussed, but you are guiding -- so when we think about mid 40s, is 45 a fair number to think about? And does that imply that the service and product mix is going to change going forward, or is that just really the benefit of not locking in a negative currency view for the next quarter? How do we get such a big one-quarter change? What's the major driver there?

European versus US business. So we would expect the service revenue still to be fairly high in Q3, because these are CAF-related projects. And on many of these projects, if not the majority at this point for CAF phase 1, we are doing it pretty much turnkey. So we are doing an awful lot of the work that's being done. That's going to continue on into Q3 and into Q4. So the big change is you will see a stronger US component and a weaker European component.

Okay, great. Thanks a lot.

Sanjiv Wadhwani, Stifel.

Thanks. Hey, Tom, I just wanted to clarify one comment you made about -- as it relates to mix of capital and equipment is different in GPON and vectoring. I was wondering if you could just give a little bit more details around that. And then in the prepared comments, you also mentioned Telcordia certification. I just wanted to clarify if that's related to the vectoring project, or is that something completely different? Thanks.

Sure. So the first one, on the capital -- if you look at PON, I mean, PON is a great technology. Continues to be the highest R&D component of our development as far as from an expense perspective and focus perspective, because we do believe that longer term the world is going to move to GPON. But that long term may take an awful long time to get there. And the reason is the installation costs associated with pulling fiber and digging up the streets and all the things you have to do, when copper is typically already in the ground and already run to most of these locations.

So if you think about the cost, the total cost, both expense and capital, in order to be able to pull fiber versus connect up to an existing copper line, I think it's kind of self-evident. There's a huge difference there. So that's what I was speaking to.

So, if you look at the incremental cost from an equipment perspective for GPON versus DSL, there's not that big of a difference.

Got it. That's helpful. And then Telcordia?

Yes. Telcordia -- it was a -- as you know, Telcordia is used in the US by Tier 1s, and it was one of those customers. And I probably don't want to get into any more than that.

All right. That's helpful. Thanks.

George Notter, Jefferies.

Hi, thanks very much. Hey, I wanted to go back to the discussion of CAF-I versus CAF-II. You said it's, I guess, significantly more incremental or positive for your business. But help me understand the logic behind that. I mean, I certainly understand that on a per line basis, the subsidy is larger for CAF-II versus CAF-I. But I guess I'm trying to understand why this is incremental.

I guess the logic, if we go back to the broadband stimulus days, even though the operators had more capital to work with, they didn't have more people, bodies, professional services. It was a pig-through-a-python problem, in a sense. And I guess I'm wondering why that wouldn't be an issue right now as well.

Well, it could be an issue as to -- I do think that there's a different approach right now to outsourcing. If you look at even our CAF-I project I mentioned, we are doing a lot of that turnkey now. Our expectation is that CAF-II will follow that same model. So I think there's a lot more outsourcing going on than there was in broadband stimulus.

So, as to whether or not there's still going to be some type of constraint in just manpower, there very well could be. What I was speaking more to, though, is if I look at broadband stimulus, my sense is -- at least with some of the carriers -- that what you ended up doing is replacing -- upgrading the networks in areas that needed to be upgraded anyways. So what you ended up doing is after that broadband stimulus subsided, you ended up, in effect, with a hole in capital spending in some of the market, because they had moved forward projects that were going to happen over the next couple of years.

In CAF, definitely in CAF-II and I would say -- let me just say CAF in general -- when we are talking to carriers, they are absolutely looking at areas and markets that they were not going to build into that they are now planning on building and covering. And these are at areas that would not, in my opinion, have been touched other than for CAF-II funding. So I think it's doing exactly what it was supposed to do, which is target areas that are underserved -- that are underserved for economic reasons -- and bolstering the economic picture on those in order to be able to serve those customers.

Got it. Okay. And then I also wanted to ask about the linearity in the business this quarter. The DSO calculation I got was 50 days. It was pretty low relative to what you guys have put up there historically. Is there something that changed this quarter? Is it more front-end loaded? Is there something going on with collections? Is it something going on with the mix? Help us understand that better. Thanks.

I know linearity -- it's like it's a fairly linear quarter. So, Mike, I don't know if there's a little -- anything, any color you have on that?

Yes. I think the quarter was fairly linear compared to what we usually do. So I think that's pretty much the story there.

Great. Thank you.

Bill Dezellem, Tieton Capital.

Thank you. I have a group of questions, and starting with inventory: the sequential inventory growth was, I believe, the highest in three years or so. Would you talk to us about the implications of that, especially in light of -- thinking about revenues being flat sequentially?

Thanks. This is Mike. I think some of that has to do with some of the project work that's going on in services. So we had talked about large project work happening, and Tom talked about services and cabinet placements, and those types of things. Those are much longer to the revenue recognition cycle. And as that happens, all that stuff sits in inventory until you reach the end. So I think the bigger uptick that's happening there, the lion's share of that, is the effect of this increased build out.

So most of that uptick in inventory is actually in the field right now at some level of turn-up. And it will -- once we get to turn up, it turns into revenue, and the inventory goes back down.

The way to think about that is it's really more of an accounting issue than it is a practical inventory growth.

Yes. Literally, the majority of that uptick is sitting in the field right now, ready to be turned up at a customer site.

That's helpful. And then I don't think anywhere in this call that you have yet discussed the restructuring that you did do and the restructuring that you might do going forward. Would you provide some commentary on that, please?

Sure. As I've mentioned on our last call that we were looking at different areas of the organization to see where we can be more focused on longer term developments and to kind of right size after the acquisition we had during the BBA time, and the incremental engineers that we brought on there, and just took another look at the entire operation. That would then include some site closures. We have somewhere near 40 total sites, and that includes sales office sites as well as R&D sites. R&Ds are typically the larger of those.

So we are going through all of that and looking at how we can be more efficient. That's really what you saw in the second quarter with us just executing on that plan. And our intent is to be able to drop our operating expense exiting the fourth quarter somewhere in that -- I think we said mid-single digits versus Q1. And that's still where our plan is.

Thank you. And then finally, the Latin America -- you mentioned that that region was soft here this quarter, simply due to timing. Would you talk to us about your view of the timing of revenues going forward there, please?

Sure. That customer is always a challenge to forecast, and there are multiple reasons. One is, we do turnkey services with them, and those turnkey services many times have contingencies that are not within our control. So the problem that we have in the US like we just talked about with inventory being in the field -- we have the same issue in Latin America as well. But I will tell you the dependencies in Latin America are typically more complicated, and there are more parties involved in being able to unlock those.

So it just makes that difficult to forecast. They are in the midst, also, right now of rolling out a new product of ours and getting that through the lab. And all of that also adds to the mix of this confusion.

And then they have a tendency of ordering products at the last minute with very little notification. So you can say they are very flexible in the way that they operate their business, and we have to match that. So all of that just leads us to be kind of cautious in how we forecast that. And we always view it better to have an upside surprise here than a downside surprise.

Thank you. Appreciate the commentary.

Roger Chuchen, J. Goldman.

Thanks, guys. I'd like to start off with a big-picture question. Could you maybe compare the similarities and differences of the current period to, maybe, October 2012? If I recall, October 2012 your stock dropped to $16 per share after a couple quarters of setback. After putting up a couple of quarters of okay numbers and discussion of some -- a couple of Tier 1 opportunities, the stock ultimately went up 50% the next three to six months. Now, we fast-forward to today, your stock is hovering at $16 again. And you just reported good quarter, in-line guide.

And as I think about opportunities, seemingly from this call today we are talking about big, incremental spending opportunity related to CAF-II that should kick in late 2015, early 2016. And then your US Tier 1 customer is talking about vectoring, rolling out to 6% to 8% of its footprint.

The question I have is: did I get my facts and opportunities right? And what am I missing? And could you fill in any gaps for me?

Yes, there's a few gaps in that. But I will say, essentially, I understand your question and the bigger picture comment that you're trying to make.

You know, the guess being that we had an international business that came in line too and grew substantially, and then we had a gross margin impact on that at some point just relatively recently.

And then the other big thing is, I think, that there was a Tier 1 opportunity there that was very much single-threaded that, in hindsight, we got ahead of our headlight zone. And it didn't prove out to be the case. And I am not -- if I have intimated to you that I expect CAF-II revenue to be anything meaningful this year, then that is a mistake. All right?

I believe that we will see there's a potential for some CAF-II revenue this year, but I am not expecting it in any material way this year.

I have talked about the Tier 1 opportunity -- in fact, the one that I myself brought up -- has talked about the one that is with the larger Tier 1 here in the US, and I have viewed that as kind of modestly incremental. If we see some upside next year, that would be nice.

There's another opportunity that was brought up on the call today that, yes, we are participating with; yes, we think it could be incremental. Have we won all of the market share or have we seen POs for millions of lines being converted? The answer to that is no.

So, let me make sure that we are communicating properly here. I do think that where we are right now is we have a multi-threaded potential that we just need to manage. So, we have -- in CAF-II it's not one customer; it's somewhere on the order of five or so, all of which are looking at incrementally spending.

Will I get 100% of that market share? Probably not. But if you think -- if you go and look at that list of customers and our relationships and our market share -- and some of these are stated market share, contractual awards with these customers -- we should do well. All right?

I am not proposing that it's the size of our Tier 1 customer that we had teed up and went away at the beginning of this year, but it's incrementally very nice. And should the Tier 1 market go up in the US from where we are positioning it right now? Absolutely. So that's just the basis of where the business is right now.

I will tell you that in 2012, when we were talking about the Tier 1 incremental piece -- although I don't think it actually happened in 2012; it was probably 2013 or so where it started coming out -- that that was -- we were cautious. Arguably not cautious enough, but we were cautious in saying that that Tier 1 carrier has a history of changing their mind. And that's exactly what happened. I would say the environment today, and the number of carriers, and then just the general uplift in the Tier 2 and Tier 3 market is more positive and it's more widespread.

So, it's fair to say that the difference in this cycle maybe versus the last is there are -- you know, the individual opportunities are smaller, but they are more spread out, and so that should reduce concentration risks, if you will?

Yes, but let me just try to recall some of the comments that I believe we made during the call back then. There was a general sense after 2012 that -- at least for us, and I would say in general -- that there was a pullback in carrier spending in Tier 2s and in Tier 3s -- and, in general, even Tier 1s. But definitely 2s and 3s. So our communication was to the fact that, yes, at some point the market in general will recover. But we could not put the timing on when that recovery would be.

But we also had an incremental Tier 1 opportunity that was positive enough to where we weren't dependent on that recovery to the extent the Tier 1 opportunity came to fruition. It did not. And I would say the thing that at least we are hopeful of right now is we are seeing that general recovery in capital spending, at least in the Tier 2 and Tier 3 space, some of it catalyst-driven with CAF, getting better.

Right. And then my next question is -- I just want to go back to that domestic Tier 1 that's been discussed earlier in the call. It seems like they are talking about this change in their network architecture from all fiber to vectoring. And I'm sorry if this was previously covered, but I just want to make sure I understand it correctly.

So I guess -- how do we think about the -- with this change in architecture, how do we think about the access equipment TAM versus may be what they had been doing before? And then number two, what is your -- what do you think is your market share position, given your track record in vectoring?

And then number three, how do we think about the gross margin profile of vectoring given that -- my understanding is that this is primarily a line card swap-out.

Not a line card swap-out.

Okay.

I mean, not with -- it's just not. There are areas where that may be the case, but I would say that that's not predominantly the case.

Okay.

And even to the extent that it is the case, it's more than -- you know, you're really upgrading the capability of that box, which includes backhaul and everything else. So it includes switching and other things.

I will tell you, it's no more of a line card swap-out than saying I'm going to put GPON in a VDSL cabinet. I mean, it's -- a little more to it than that.

As far as change in TAM, my sense -- and I don't want to be biased in presenting, because I think fiber-to-the-prem is a very strong technology case in and of itself. It's just harder to prove it, and it takes a lot more time for payback. And it takes a lot more time for installation, because pulling fiber is difficult. But as far as the TAM, my sense is that you can cover a lot more customers with a lot less capital. So to the extent that you want to cover the exact same number of customers in the exact same number of time, I don't know if there would be a substantial incremental change. But the reason to do that is to be able to cover more customers than you would have been if you deploy fiber everywhere.

And from our perspective, the revenue is not incrementally -- as far as on a per-port basis -- I'll be honest with you; on a per-port basis it's probably stronger. Because if you think about GPON, where you have an OLT that feeds 64 separate customers for each port, VDSL does not. It is one customer per port.

Okay. And how --

Does that make sense to you, or --?

Yes. And just maybe staying on this topic, just running through kind of the public filings of your disclosure of 10% customers, I'm not sure if I got this right, but with respect to that Tier 1 customer, I think in 2012 maybe it was -- the Tier 1 US, that is -- it represented maybe 23% of revenues. And if I'm looking at it right, it went down to 14% in 2014.

So that's a decline of, call it, $50 million to $60 million in that period. And is it fair for us to assume that with this shift in architecture, is there an opportunity for regain share and maybe recoup some of that?

Yes. I mean, there's definitely an opportunity for that. We have to see how it all falls out. So what happened -- and this was why I said there's some nuances to the 2012 story -- of course, what happened in 2012 as well is there was an acquisition of carriers in the US, and one of those acquisitions included a mandate to drive [for a] dual-source situation in a large property in the US that had not been dual-sourced before. And that, hence the decline that you are actually talking about, as well as where the market -- there was a market shift to where rollouts were actually happening.

So the answer to your question, though, we think we have the best product line. We think we have the best price points. And our sense is that the headstart that we have in VDSL vectoring -- we have shipped more VDSL vector ports than anybody in the world. And we are the primary deployment of the largest VDSL vectored rollout in the world. So we think we are well-positioned. But that will have to prove itself out.

Okay. And then on CAF-II, could you maybe help us -- give us some color in terms of how to think about the annual revenue opportunity there?

The reality is, I don't know. I know -- and it's public -- as to what the dollar amount that these carriers are getting on an annual basis in order to supplement the deployment of this technology into their footprint. The thing that is -- and I do believe it is predominantly incremental, notwithstanding the CAF-I versus CAF-II discussion that was earlier in the call.

But as far as them laying out -- we have some customers that are fairly aggressive in their plans, and we have some customers that have not shared with us the timing of their plans. And there's some period of time for them to be able to build this out.

So in aggregate, it's very easy to see the dollar amount. Now, whether or not you want to take 15% of that dollar amount or 10% or 20% of the dollar amount and equate it back to access equipment -- I'll leave that up to you, because that's, here again, very carrier-dependent. And then you have to then just back into what you think a realistic time frame for that deployment is.

Got it. A couple more questions, if I may. And as we look out to 2016, I think on this call you talked about CAF-II ramp, US Tier 1. And then Germany -- the German customer, maybe, ramping enterprise award; and ramp from Web 2.0 customer rolling out 1-gig service. This major Tier 2 buying VC properties.

You are putting color in the way you are presenting that is much stronger than the color I was trying to present. But okay.

Right. So, is there a way to think about kind of the rank order of kind of these magnitude opportunities here?

Okay. But I don't want to be in the position that your earlier comment on 2012 reflects. So, CAF-II is the most solid piece out there, because there are carriers that are signing up for commitments to deploy something. So that feels -- in the carrier space -- and these carriers tend to be more dependable in that when they say something, they typically do it. So of all of those things you just mentioned, that's the one that is pretty solid. We have to execute on the product plan; we have to execute in making sure that we maintain market share. But it feels pretty solid.

The Tier 1 space in the US -- look, would we love there to be a shift towards vectored technology? Yes, because the differentiation we have -- we think we have a better GPON product then our competitor. But the differentiation that I see in vector to be a cell technology versus GPON is substantially more. So just from a competitive position, I am better positioned there. But I am not going to sit here and bet that 8 million lines are going to be converted next year, nor am I going to intimate to you that 8 million lines are going to be converted next year. It would be nice to see, but I haven't seen any POs yet that reflect 8 million lines.

[E&G] will start next year in Europe, and I have a tentative forecast from them. But I am not sharing that forecast, because until I see POs from it and the start date on that actually coming in any meaningful volume, I am not going to discuss it. So I want to make sure -- yes, are there opportunities out there that we have won? Yes. But I am not trying to paint a scenario here that all of this stuff is going to happen like clockwork. Because it won't.

Got it. Thanks, guys.

Okay. At this point, Keith, I think we are out of time. So I appreciate everybody joining us for our call, and I look forward to talking to you next quarter.

And this does conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.