ADTRAN Holdings Inc (ADTN) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN's Second Quarter 2017 Earnings Release Conference Call. (Operator Instructions) During the course of the conference call, ADTRAN representatives expect to make forward-looking statements, which reflect management's best judgments, based on factors currently known. However, these statements involve risks and uncertainties, included in 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 cost, manufacturing efficiencies and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2016. 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 the Tom Stanton, Chief Executive Officer of ADTRAN. Please go ahead, sir.

Thank you, Lynne. Good morning, everyone. Thank you for joining us for our second quarter 2017 conference call. With me this morning is Roger Shannon, Senior Vice President and Chief Financial Officer.

I'd like to begin this morning by discussing the details behind our second quarter results, and I will end with some comments on what we see on the future. Roger will then discuss our Q2 performance in more detail, and he will then open the call up for any questions that you may have.

As we stated in our earlier press release, revenues for the quarter were $184.7 million, a second quarter record, and up 14% over the second quarter of last year.

Our networking solutions revenue, including both international and domestic markets, came in at $155.5 million, up 12% over the same period last year. And our Services & Support revenues came in at $29.1 million, a 21% growth over last year.

Revenue for our domestic markets came in at $146.7 million or 79% of the total, while our international revenues were $38 million for the quarter or 21% of the total.

On a year-over-year basis, our domestic revenues increased 10%, and our international business was up 31% over the same period last year. Both numbers were driven by increasing demand for our ultra-high-speed solutions.

Moving down a little deeper, our Access & Aggregation category had a strong performance, up 36% over the same period last year, with growth both domestically and internationally.

Customer Devices was down 17% over the same quarter last year, impacted mainly by an accelerated ethernet infrastructure build, which occurred in Q2 of last year.

Finally, our Traditional Products & Other categories were down 38% versus the same quarter last year, mainly due to the expected slowdowns in our older-generation HDSL products.

I mentioned last quarter our efforts on a broad-based of technologies, including G.fast, NG-PON2, 10-gig PON, and of course, our Mosaic Cloud Platform developments. These development efforts are targeted for not only expanding our market share in our existing customer base but also enabling our expansion into adjacent markets. I'm glad to say in the second quarter, we made progress on both fronts.

During the quarter, we exited our G.fast and Mosaic tech trial and moved into full deployment or production status with a major Tier 1 carrier here in the U.S. During the quarter, we completed lab testing and began first deployment of our 10-gig EPON solution with a major U.S. cable MSO, a significant milestone for our company. The quarter also saw us launching our first Tier 1 deployments of our XGS-PON solution, utilizing the industry's first-deployed virtual OLT, with a Tier 1 U.S. carrier.

This implementation utilized our Mosaic software-defined access platform. And as of today, we have over 10 global Tier 1 carriers who have either selected or are field trialing Mosaic for deployment.

Also yesterday, we announced our trial with Deutsche Telecom for the world's first 212 megahertz G.fast solution, providing over 1 gigabit of speed with enhanced upstream performance over a single pair of copper.

And finally, I'm pleased with our announcement yesterday of our contract win with NBN, the government-owned carrier in Australia, to provide software, hardware and services as they move forward in deploying their fiber-to-the-curb network. This was a material win for our company, and we expect to begin shipments in the first half of 2018.

Looking forward, our focus remains on being the world's most comprehensive access solution provider, with clear industry-leading solutions for software-defined access, fiber access and ultra-high-speed copper. With the world's most complete access virtualization products, we believe we are well positioned to capitalize on the evolution and access as carriers around the world upgrade their infrastructure to meet customer demand. I'd now like Roger Shannon to review our results for the second quarter of 2017 and provide some comments on the third quarter of 2017 as well. We'll then open up the call for any questions that you may have. Roger?

Thank you, Tom, and good morning. I will speak about our second quarter results and discuss what we see for the next quarter. During my report, I'll be referencing both GAAP and non-GAAP results.

As Tom stated, ADTRAN's second quarter revenue was $184.7 million, which is up 14%, compared to $162.7 million for quarter 2 of 2016, and up 8% from $170.3 million we reported last quarter.

Our Network Solutions revenues for the second quarter were $155.5 million, up 12% from $138.5 million for Q2 of last year, and up 8% from $143.6 million recorded for Q1 of 2017.

Our Services & Support segment continued its strong year-over-year and quarter-over-quarter growth as Q2 2017 revenues were $29.1 million, up 21% compared to the $24.2 million earned in quarter 2 of 2016, and up 9% versus the $26.7 million recorded for the first quarter of this year.

Across our revenue categories, Access & Aggregation revenues for quarter 2 2017 were $138.6 million, up 36% compared to $102.2 million for quarter 2 of 2016. Customer Devices revenues for the quarter were $33.8 million, down 17% compared to $40.9 million for quarter 2 of 2016 and down 7% compared to $36.3 million for quarter 1 of 2017.

Finally, Traditional & Other Product revenues for quarter 2 2017 were $12.2 million, down 38% compared to $19.6 million for quarter 2 of 2016 and down 12% compared to $13.9 million for quarter 1 of 2017.

Looking at revenues geographically. Domestic revenues for quarter 2 were $146.7 million, up $13.1 million or 10% from $133.6 million we recorded in quarter 2 of last year, and up $27.4 million or 23% from $119.3 million in quarter 1 of 2017.

Our international revenues for quarter 2 were $38 million, or up 31%, compared to $29.1 million in quarter 2 of last year, but down 26%, as expected, from the $51 million of quarter 1 of 2017. We've published the reporting of each of these categories on our Investor Relations web page at adtran.com.

For the quarter, we had 2 10% of revenue customers. Our GAAP gross margins for the second quarter of this year were 45.8% compared to 48.5% in the second quarter of 2016 and 43.3% in the last quarter. The year-over-year decrease in our current quarter gross margins was driven primarily by higher domestic services and international revenues versus the same period last year. Our gross margin improvement over last quarter's results is attributable to higher domestic revenues and a favorable mix of services.

Total operating expenses on a GAAP basis were $68.2 million for quarter 2 of 2017 compared to $64.1 million for quarter 2 of 2016 and $66.7 million for quarter 1 of 2017. While our SG&A expenses were down quarter-over-quarter, our R&D expenses were up over last quarter as expected.

On a non-GAAP basis, our Q2 operating expenses were $65.5 million compared to $62.3 million in quarter 2 of last year and $63.8 million last quarter.

The quarter-over-quarter increase in operating expenses was the result of customer-specific research and development projects. The year-over-year increase in operating expenses was the result of the previously mentioned customer-specific projects, performance and equity-based compensation, amortization of acquisition-related intangibles and ERP project implementation expenses. The difference between GAAP versus non-GAAP operating expenses in Q2 is due to amortization expenses associated with our Active EPON and RFoG product acquisition in the third quarter of last year and equity-based compensation.

Operating income on a GAAP basis for the quarter just ended was $16.4 million, up 11% compared to the $14.8 million reported in Q2 of last year and up 134% versus the $7 million that we reported in quarter 1 of 2017. The increase in Q2 GAAP operating income as compared to Q1 is attributable to higher revenues with stronger gross margins that were slightly offset by higher operating expenses. The year-over-year increase in operating income is attributable to higher revenue, partially offset by the previously explained lower gross margin percentage and higher operating expenses.

Non-GAAP operating income for Q2 2017 was $19.2 million compared to $16.8 million for quarter 2 of last year and $10.1 million for quarter 1 of 2017. As described in our supplemental information provided in our operating results disclosure, stock-based compensation expense, net of tax, was $1.4 million for quarter 2 of 2017 compared to $1.3 million reported in quarter 2 of last year and $1.5 million in quarter 1 of this year.

Expenses related to the amortization of acquired intangibles were $582,000, net of tax, compared to $293,000 in quarter 2 of last year and $713,000 last quarter. All other income, net of interest expense for Q2 2017 was $1.4 million compared to $1.6 million for quarter 2 of 2016 and $1.3 million last quarter. The year-over-year decrease in all other income is a result of lower investment gains in the quarter versus the comparable period. As previously communicated, gains and losses from our FX hedging program resulting from an increase in our international business were recognized in other income.

The company's tax provision for Q2 of 2017 was an expense of $5.5 million or an effective tax rate of 30.6% compared to a tax provision rate of 37.8% for quarter 2 of last year and 20.3% in quarter 1 of 2017. The decrease in the tax rate versus quarter 2 of last year was primarily due to stronger international revenues in the current quarter.

As we discussed last quarter, quarter 1's lower tax rate was primarily due to benefits recognized from foreign tax filings and a greater mix of international revenue. Net income for Q2 2017 was $12.4 million compared to $10.2 million in quarter 2 of last year and $6.7 million in quarter 1 of 2017. Non-GAAP net income for the second quarter of 2017 was $14.4 million compared to $11.9 million in quarter 2 of 2016 and $8.9 million last quarter.

Earnings per share on a GAAP basis, assuming dilution for the second quarter of 2017, were $0.26 per share compared to $0.21 per share in quarter 2 of last year, and $0.14 per share for quarter 1 2017. Non-GAAP earnings per share for the second quarter of this year were $0.30 compared to $0.25 per share for quarter 2 of last year and $0.18 per share for quarter 1 of this year. Non-GAAP earnings per share excluded the effects of amortization of acquired intangibles and stock compensation expense in each respective quarter. We've provided a reconciliation between diluted GAAP earnings per share and diluted non-GAAP earnings per share in our operating results disclosure.

Now turning to the balance sheet. Unrestricted cash and marketable securities, net of debt, totaled $249.3 million at quarter end after paying $4.4 million in dividends, and repurchasing just under 595,000 shares of common stock for $11.8 million during the quarter. For the quarter, ADTRAN produced $11.5 million of cash flow from operations.

Net trade accounts receivable were $79.9 million at quarter end, resulting in a DSO of 39 days compared to 50 days at the end of the second quarter of 2016 and 45 days at the end of quarter 1 2017. The year-over-year and quarter-over-quarter improvements in our current quarter DSO are attributable to customer mix and the timing of shipments within the quarter.

Inventories were $114 million at the end of the quarter just ended, up from $112.8 million last quarter. The increase in the inventory in the quarter was due to customer-specific projects.

Looking ahead to next quarter, the book-and-ship nature of our business, the timing of our revenues associated with large projects, the variability of order patterns of the customer base into which we sell and the fluctuation in currency exchange rates in international markets we sell into may cause material differences between our expectations and actual results. However, our current expectations are the third quarter 2017 revenues will be flat versus the quarter just ended. Taking into account the potential impact of currency exchange rates and anticipated mix, we expect that our third quarter gross margins on a GAAP basis will be flattish with the quarter just ended. We're also expecting GAAP operating expenses for Q3 2017 to be flattish with the quarter just ended.

Finally, we anticipate the consolidated tax rate in the third quarter to be in the low 30% range.

We believe the significant factors impacting revenue and earnings realized in 2017 will be the following: the macro spending environment for the 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; the timing of revenue related to the Connect America Fund projects; the adoption rate of our Broadband Access platforms; and inventory fluctuations in our distribution channels.

Finally, I'd like to encourage our listeners to visit ADTRAN's new Investor Relations website by going to www.adtran.com and following the Investor Relations link. We have made our Investor Relations website much easier to navigate and much more user-friendly. We have also added resources such as interactive financials to provide insight into our performance.

With that, I'll now turn the call back over to Tom.

Great. Lynne, at this point, we're ready to open up for any questions people may have.

(Operator Instructions) And we'll take our first question from Rod Hall with JPMorgan.

I just wanted to ask a couple of questions. First of all, could you guys comment on the large G.fast customer in the U.S? Like how much revenue was that in the quarter? And how are you feeling about visibility there? If you could just talked a little bit about that. And then, also, I know last quarter you guys talked about these fiber access delays that I think pushed some of that G.fast rollout into the second half. What -- can you update us on those delays in terms of access? Are they still planning delays out there? Is that not now moving forward a little bit better?

So I appreciate the call. So we did start shipping this quarter. I wouldn't call it a material shipment. But then, to be honest with you, just to get it in into production is a material move, so we're very happy with that. If you'll recall, there are 2 phases of that project. So there's an out-of-region phase and an in-region phase. The out-of-region phase, which is outside of their traditional footprint, is actually what started. The in-region phase is still targeted towards the second, well, tail end of the year, third-ish -- third quarter, fourth quarter, right around that pivot point. And we just expect it to ramp from here. So I would say the initial shipments started, and we expect -- we just expect it to ramp from here. They have told us about some particular projects. I think they've actually been in the press, a little vocal about that as well. I know there's been some things written on it. But exactly what that ramp will be, we still don't know. And at this point in time, I'm not -- I don't think that there's any material things impacting the deployment of the service. So I just think we're expecting a normal ramp. Did that answer your question?

Yes. I just -- I was just wondering like if it -- if that's ramping on through the third quarter, why is the guidance just flat? Is it because you guys think that the likelihood is that the acceleration really happens more towards the back end of the year, sounds like that's kind of what you're saying. I just wanted to clarify that.

Yes. I think you're exactly right. Without -- this is something we have no track record on. So without having that track record, it's kind of hard to forecast. But my expectation is, is they'll get better at it, they'll get faster at it. They'll be more aggressive at selling it, and it will just kind of build throughout the year. So I would expect more momentum in the fourth quarter than the third quarter.

And could you make some comment about those planning delays that you guys had flagged earlier in the year? Is that still a factor? Or do you see those kind of moving forward a little bit quicker? Or what's happening...

Yes, I'll be honest with you. That's kind of slipped in my mind, exactly what we were talking about planning delays. I know that there were issues initially in -- with getting the fiber to some of the MDUs. There were also issues with kind of just normal when you're going out and selling out of region, the tactical and logistical plans in that. Having said that, I don't want to speak for that customer. And that's a very touchy customer, about that. And I'm -- as far as I'm concerned, we're doing a fantastic job.

Okay, and great. And I just -- one other thing on the MSO customer, is that a new customer for you? And I mean, could that be a 10% customer, is it all already? Could you just give us some kind of color on that MSO deal that you guys talked about earlier in the call?

Not a 10% customer by any stretch. Never has been a 10% customer for us. I wouldn't say they're -- we may have sold them some things, but it's practically a new customer, I don't know. It's because we sell switches and things to a lot of different customers. But for infrastructure, without a doubt, a new customer.

And we'll take our next question from Richard Valera with Needham & Company.

I was wondering if you could give us an update on your international customers, particularly your German one and how they were in the quarter and how you see that trajectory for the balance of the year?

I think they were pretty much right on track, maybe a little stronger than we expected. What we typically see with that customer is they kind of Q1 is typically strong and then we see them tail off towards the tail end of the year. Last year was a little bit of an anomaly. But that's what our expectations are here as well. We would, at this point in time, expect them to tail off in the third and fourth quarter. Fourth quarter is kind of sometimes they come in and want you to do incremental work for them. We definitely got hit with that last year. But at this point in time, that's not what our plan is.

Got it. And then there's a CPE-related program you've been talking about with that customer for a couple of years now.

Yes, thank you for remembering. Yes...

Can you give us an update on that? It sounds like you're closer to that maybe...

We started shipping, yes. So that was really good. So we actually did ship. We shipped a little bit in Q1, if I recall, Roger than, we, of course, we shipped in Q2. It has not ramped yet. That service is, I don't know how broadly available it is yet, but we would expect that to ramp on through 2018.

Great. And just final one. Mexico, it sounded like had been in a bit of a holding pattern due to I think some sort of political and regulatory stuff there. Is there any update there? Or still kind of status quo...

It's -- yes, the update is no change. They really are still -- they are -- we have, as you know -- you may know, we had several things that are queued up in the lab and ready for approval. But as far as capital budget for our type of equipment, we have not seen a change.

And we'll take our next question from Paul Silverstein with Cowen.

Two questions, if I might. One, following Roger, going back to the GT question. I appreciate there's sensitivity about any individual customer. But there's been some recent press about GT and the German regulatory authority having conversations. The regulators apparently want [things] to open up. The networks regulators always want carriers to do and GT talking about how that would adversely impact rollouts if they had to do that. Any insight you could share there? I saw the recent announcement on the G.fast trials, but any insight that you can share? And then the other question is, Roger, if you could give us an update on your thoughts on where gross margin can go to and the key drivers in getting there. Now that you've done Mosaic, I would assume that would have -- as that gets traction, I would assume that would have a meaningful positive impact. And I know there's some other offsets in the services side, et cetera. But if you could update us, that would be great.

Yes. So as far as GT is concerned, I mean this is not a -- there's periodically negotiations that say that go on between carriers and their governments. And if you'll recall, Paul, that happened about 1.5 years ago or so when they really started talking about super-vectoring. And through that negotiation, they got the right to expand their footprint by another 15% or so. I do think that without -- in Europe, there is a strong demand for bandwidth, which is one of the reasons that you're seeing faster movement on G.fast as well. But as far as them talking to us directly, we really see no change in the plans. They plan on rolling out -- continuing to roll out vectoring. They plan on rolling out super-vectoring next year, and then you'll see them follow on with G.fast. Now that's the current plan of record that they shared with us. As far as gross margins, do you want to touch that?

Yes. So as far as gross margins, like we mentioned, the gross margins for the quarter we just ended were slightly above our prior expectations, kind of driven by the mix both within the product set and with services. We're guiding for gross margins to be flattish in the next quarter. We've consistently said our expectations are for gross margins to go up. We -- if you recall, our quarter 1 gross margins were negatively impacted by the higher shipments on the greenfield [MSANs,] our European Tier 1. I'm not going to, at this point, get kind of beyond where we're looking into, into the next quarter on the mix. We do -- there is variability within the services. We consistently say that services is lower than the corporate average gross margin but is accretive at the operating income level. But we do see some variability in that mix, and we saw that in the current quarter.

Guys, one more, if I might. Returning to Rod's question on the new cable customer that you referenced. Maybe I misheard, but in terms of -- I understand it's not 10% today. But could that be a 10% customer in terms of the project -- to the projects you're doing for them? Does it have that type of potential over time?

They're -- stated -- the answer is, it does have that potential over time, but I don't think I would expect to see that near term.

And we'll take our next question from Simon Leopold with Raymond James.

I wanted to just follow up and clarify the gross margin in the last quarter. And I did hear the answer to the last question, but I'm still a bit confused. So you had indicated that you expected, I believe, a lower gross margin for June than you've reported, given that we thought it would be kind of flattish versus the March quarter. And I guess all of this has attributed to that trend, the expectation to the international mix, basically higher international coinciding with a lower gross margin. Yet in this June quarter, we saw a very dramatic shift in international from the last 2 quarters. I guess what I'm really trying to understand here was, were you surprised by this mix shift? And so should we think that in this quarter, you had a negative surprise, meaning, your international business fell off, completely offset by a positive revenue surprise that netted out to gross margin upside? Am I reading too much into this? Can you help me understand?

Yes. I think you are. First, I don't think -- I mean, I'm not sure about the comment about material change from what we're thinking in revenue on international. But let me -- so there are a couple of things that without, on a macro perspective, international versus domestic like always has an impact. Where we saw improvement that came -- that we were happy about, one is -- well, the biggest one is probably in the services gross margin profile in the U.S., that we saw a meaningful uptick there. Some of that is, I think, we're just getting better at it. Some of it has to do with the services mix itself. But if I look at the mix of services versus any other mid-quarter, first quarter has typically got a different feel to it. It wasn't -- there wasn't anything really strange about the mix. I just think -- honestly, I think we're just getting more efficient at it. We've been doing it now for a couple of years, and I think we're managing it better. And that was probably the biggest material change from what we thought coming into the quarter.

Could you geographically... (inaudible) surprise you?

And we also stated the -- pardon, say that again.

So I just want to confirm that the geographic mix shift in June did not surprise you, you expected that?

No. The international business came in, it's pretty much exactly where expected on a revenue and a gross margin profile perspective.

Okay, that's very helpful. The other thing I wanted -- I really wanted to ask about was the opportunity and prospects you see out of BT in light of the fact that BT recently has seem to renew its interest in fiber to the home technology. And it looks like they're issuing some new tenders. So while you didn't get a leading position in their G.fast initiative that you participated in, it sounds like they're looking at some new prospects and fiber to the home technology and perhaps being encouraged by the regulatory agencies in the U.K. Could you talk a little bit about how you see that market opportunity evolving for ADTRAN?

It's -- I can't. I mean, any time there's an opportunity in the access space with a customer of that size, then we tend to focus on it and typically win more than our fair share. But I would tell you that a tender with a company -- and we have been through -- we just went through a tender with them, takes a very long time. So it would be something that -- and it's -- it would be real speculative to talk about, and I think that even understanding the sizing of that opportunity right now is probably premature. But it is something that we would be going after, of course, and we've already got relationship and things [built within] that carrier.

And one last one, you also announced the NBN deal yesterday. Could you give us some perspective on how to think about the materiality of that particular opportunity?

It's one that we have been excited about and have been working towards literally for over 2 years. It's -- they are -- because they're a government entity, they're very public with the -- I think even our press release when we talk about reaching over 1 million homes. It's a material win for us. So it's -- I think the key to us now is getting out of the lab and getting it rolling out. And we feel good where we are. We have already had a relationship with them that was strengthened with our Mosaic Cloud Platform, which is being used to manage a large percentage of their access networks. So I don't know what else to tell you other than yes, it is a material win for us. We think that it will actually be meaningful in our numbers, and the key to us now is to be able to execute on finishing up the lab process.

So just to close on that NBN comment. I assume this is something they're multisourcing, that they've been purchasing Broadband Access products from others in the past, I assume.

It is a multisource -- yes, there's more than one source in their network in most areas at this point. But let me just say, we feel pretty good with how we're positioned.

And we'll take our next question from Michael Genovese with MKM Partners.

First question on the XGS-PON deployment with a Tier 1 U.S. carrier, was there actually revenue in the second quarter? How material was it, if so? And is it -- has the timeline of that moved up because I thought it was going to be a 2018 event?

Yes. I think what I was trying to touch here, so there were a couple that are further along as far as the carrier's plans. The MSO one is one that's fairly far along. The -- of course, the G.fast here in the U.S. is fairly far along. NBN is fairly far along. This one is less far along. The reason for me to bring that up is really the fact that we're the first vendor to actually produce and be able to ship a virtual LLT in a Mosaic environment. And although this is being rolled out, I would say it's probably -- it's not something in and of itself, but I think will be material in the short term. I think it's more a longer-term play.

Okay, great. And then my other question or questions are sort of bigger picture in nature. A couple of related questions here. I think in this kind of pre-5G era that we're in, you seem to be in the sweet spot because there's not a lot of wireless access going in, and it seems like to get to 5G, carriers realize they have to upgrade their wired access networks. So -- but still at the same time, we have a lot of copper still in the last 1,000 feet. So the first question is, in a couple of years, when 5G positively in flex, when 5G access spending starts to go up, do you still think wired access will still be in the sweet spot at that point? Or will we -- we'll sort of see a shift to wireless spending? And then secondly, how long until fiber all the way to the Prem becomes a bigger business than these solutions that have copper on the last 1,000 feet?

Yes. That's a really -- that last one, of course, is a really good question. So let me start with the 5G piece. And we actually see 5G as being accretive to the business. The key with 5G is, as the technology proves itself out, what are going to be the use cases but just to build that infrastructure itself, which like you said, it's going to be predominantly fiber similar to what 4G is. Just a multitude, that kind of exponential growth and connection points is really good for the access business. So we see the build of that network being accretive to our overall performance. Where does -- to the extent that we are able to deliver a gigabit plus of services over copper in a much more cost-efficient manner than fiber, I think there's still a real demand. And I think people are positioning themselves for a fight let's say between now and 2020, on being able to keep that residential customer in-house, so -- or in their -- within their domain. So when does it go to fiber? It's a -- without 5G, we'll probably help push that, because you'll have a lot more routes and that will help, but it's that last -- that access to that fiber, which is why G.fast is so popular at this point in time. That last piece will not be really driven by 5G. So it's probably some time. And I think the strange thing is, as you probably can remember, it wasn't that long ago that we thought 50 megabits was the most you're getting out of copper. And we just did a trial where we're delivering 1.2 gigabits over copper and meaningfully changing the economics of deploying that type of service to a customer. So if I would have told you the data would be wrong, and more than likely, it would be too -- I would say data was probably too quick because we're able to continue to find things out. When it moves to fiber, I think that will be great. It's a strong business for us, we're well positioned with what we're doing with virtualization and our whole XGS-PON and NG-PON2 efforts, but I still think that the period of time is still a ways away.

And we'll go next to George Notter with Jefferies.

I guess I wanted to ask about the professional services business. Just philosophically, I think the way to characterize the bigger picture here is somebody is bigger operators essentially kind of windstreams of the world, others they're experiencing cost pressures in their business and they're pushing more and more of that labor piece onto the vendors. Can you just talk about -- are you seeing that increasingly? Are you getting more efforts to engage with you on services and what's your approach to doing that business? Is it all business is worthwhile? Or are there certain pieces of the business that you would like to do and turn away other pieces? Like how do we think about services philosophically over time for ADTRAN?

Yes. So yes, I think the frame of the question is different than the way we frame it. We don't view them as pushing that off, we view them as business that we're trying to go after. We think it's accretive. We think we're getting better and better at it. We think we're getting more efficient. And it's not just a matter of how good are you at handling your internal peace. One of the keys to this is having an ecosystem of contract, support personnel that can actually -- that you can work with and you can get to know and you can drive kind of point to deficiencies with those particular contractors. So we like the business, and we absolutely are trying to grow that business. We do say no, we -- at the end of the day, it has to be something that is good for our shareholders and good for the company to be able to do. But I would say we're getting good at it. So I think if it makes sense for other people, there's a chance -- there's a good chance it will make sense for us. Having said that, we still say no periodically. Interactions with other customers has grown. Actually, just in the last 6 months, we've had more people come to us, can talk to us about what we can do for them. One of the things that drives that is if you look at the CAF spend itself. If you look at some of these projects related with particular cities or particular regions where they're trying to grow, they just don't have the staff there and to bring them on board -- and then figure out how to handle them longer term is difficult for them. So if we can come in and offer effectively a turnkey service where we do project management, we meet our dates, we meet our cost targets. That's meaningfully important to them. So it's a good business for us, George, and I don't see us backing away from that at this point.

And we'll go next to Greg Mesniaeff with Drexel Hamilton.

I wanted to ask you guys about some data points relative to your increase in international sales, which were up 31% year-over-year. With that, your -- number one, your SG&A seems to be very nicely under control as far as levels; and number two, your DSOs came down year-over-year and quarter-over-quarter despite the pickup in international. So I'm wondering how you could sort of give us some backdrop as to how you're managing to put up those types of data points in the face of a higher international sales mix?

Greg, that's a great question. It's -- first of all, I give a lot of credit to our team. Our relationship with our customers and our collections process and just the mechanics of that are very strong. This year, this quarter in particular, we've seen really good linearity across the quarter, across the months. And those sales -- and that has had some positive impact. And just the mix of the customers themselves, there's -- we've had long-standing and good processes in place for how we work with them, how they pay. So it's just been -- on our part, a continuous improvement in working with them, and then improving our processes on getting those collections done.

Probably the biggest impact was linearity. We had a very linear quarter. And if you think about our international customers, they tend to be strong at the first half of the year, right, so they were stronger at the beginning of the year -- or the quarter than the back-end of the quarter.

That's right.

So is it fair to say that vacation season in Europe is going to probably to be a factor in the flat guide you gave for the third quarter?

We would expect our European business to be down in the third quarter.

And we'll go next to Doug Clark with Goldman Sachs.

My first one is kind of a conceptual customer question. If you look at some of your core customers, specifically the U.S. Tier 2s in general, there are some liquidity and M&A-related potential disruptions. I'm just wondering if your conversations and your outlook for those customers reflects any kind of conservatism in that or if you just see them continuing to spend on projects regardless.

You always have to be mindful of that. But at the end of the day, you know, you factor in what you know, and one of the things that we always have going for us is we tend not to get too far ahead of our headlights. So talking about next quarter, especially when you're talking about projects that you're doing an awful lot of the work associated with. And it allows you plan a little better and a little tighter that we typically would. We've had discussions about potential impacts, and right now, we are being told no changes that, in fact, we're being encouraged to make sure that we don't let off the gas and slow anything down. And I have no reason to discount that, other than the fact that I do know that there's the potential for that any time that you have a meaningful change in ownership. So we'll just be mindful of that and continue to try to factor that in.

Okay, great. That makes sense, and that's helpful. My other question is a bit of a two-part just looking in the second half of the year. Looking back at past years, the services mix did pick up in the second half. I'm wondering if that's -- as a percentage of sales, I'm wondering if that's a reasonable expectation to be made. And then also last quarter, you had talked about some projects causing kind of higher R&D and OpEx levels that might trail off. Is that still the case going forward?

That is the case, but they won't trail off next quarter. So they're continuing on. And you are correct in that, in the guides that we gave in the third quarter does include a pickup in the services business.

And we'll go next to Bill Dezellem with Titan Capital.

I have a couple of questions. First of all, relative to your inventory levels being up versus 1 year ago, would you anticipate holding these inventories at this level given that your business run rate is now higher? Or are you thinking that you're going to be able to bring those down?

That inventory level, Bill, is up due to customer projects. And that increase has been primarily in field inventory. So we have equipment out at customer locations and sites that's in the process of being deployed. So I think a lot of that is just -- you kind of do the nature of the projects that are underway with those customers.

Yes, Bill, let me add one little piece to that. I think where our inventory level was a year ago was not optimized either. So my hope is we tend to think of inventory as -- internally we tend to think of inventory as kind of net of field inventory because field inventory is something that we, de facto, have purchase orders on and are trying to finish up and that's kind of a different drive. So if you look at just inventory in-house, it's basically flat as I cry from Q2, and I would love to see some improvement depending on what the demand level is and our ability to forecast that demand level though. If it's kind of flattish I would be happy with that.

Great. So the net of it is the increase, we should be happy with it because that's product in the field being -- that's ready to be deployed and the in-house, you're very comfortable with that positioning?

Yes. I would like it to be better because we probably have operations, people listening to this call. I would like it to be better, but we're not in a bad space. I do know if you get too tight, you run into problems. But I do think we can improve from here.

Great. And I hope those operations people do what they need to do to make that.

They're doing a great job. Keep it up.

Let's jump to R&D for just a quick moment. You had mentioned earlier in the comments that the increase in R&D was a function of customer projects. Are you in a position to talk about what those projects are? And how long you anticipate the higher spending to last with those projects?

Sure. It's really one project that's driving, if not the majority -- if not all, then by far the majority. And that is an NG-PON2 RFP that is out on The Street. And in fact, we've announced it right, I mean, Verizon's had mentioned that. We're doing a trial with them. And that's the biggest impact. They are -- that is a technically -- it's a -- it's definitely a next-generation network. So it includes components. It includes everything that you would think off as next-generation SD access. And it incorporates functionality that was not included in what we would call the access domain 2 years ago. So it's a technically, an aggressive project. So we're -- that's driving our staffing level.

Great. That's helpful. And then lastly, cap spending. Would you provide additional color on how you were seeing that unfolding, both this year and in the future?

I would expect it to probably pick up from Q2 to Q3 a little. It was down a little from Q1 to Q2. But that is all based off of when projects get closed. They have particular milestones that they have to meet. And you tend to see a pickup in sign-off activity and getting things turned up as those milestones approach. So I think you'll see some variability in that. But basically, it's kind of at a run rate that's consistent with what we've talked about.

And as we go forward in the coming years, would you anticipate basically holding at this run rate, is that kind of the way to think about it?

I think for the Tier -- for the -- let me just call it the Tier 2, right? The rate of return, I always get that, the rate of return...

Yes. The price cap carriers.

Yes. The price cap carriers. The rate of return carrier piece will be coming on. So that hasn't yet started. And in fact, there are many, many RFPs out there associated with -- I think it was over 100 different [A-CAM] customers that are also going to participate in CAF, and those have not started yet.

And when will those start by your estimation?

I would probably -- early 2018. Just say first half 2018.

And we'll go next to Tim Savageaux with Northland Capital.

We're in the start kind of on the major Tier 1 engagement front. When these big deals appear to be stacking up a little bit, sounds like you're at least potentially on the way to 4 new 10% customers. But you feel free to correct me on that. But I wanted to kind of title around to focusing on Verizon in terms of whether you're close enough to begin to size that opportunity. I think last quarter, you talked about some acceleration in activity. You just made a reference here on this call to a lot of R&Ds. So as -- well, and you've mentioned these big deals, and I will say I think Verizon's doing a NG-PON2, not XGS-PON, so that other comment was about another Tier 1 carrier.

Yes. And by the way, I didn't say that, that was a 10% opportunity. The other one. I just said that it takes some time.

Oh, I know that, I know that. And I would speculated that, that CenturyLink at least from my perspective. But as you look at these -- well, since I brought it up, I mean, if we look at G.fast, NBN, cable MSO, you've already talked about the potential for those over time. I assume you'd put Verizon in that category as well.

That's correct.

And given that we're getting pretty close, I'll ask you since it's my tradition on this call to ask whether you'd care to talk in a more granular fashion about that. Verizon opportunity relative to either the kind of commitments they're tossing around with Corning or what we saw in the original BPON ramp for Verizon back in the day, understanding they're smaller from a wireline perspective than they were.

All right. And probably one thing I should mention, right, the more 10% customers you have, the higher it is to be a 10% -- the harder it is to be a 10%.

Understood. Difficulty of the math, but I think a good news problem overall.

Right. And I understand -- and I definitely understand your comment on Verizon. And the problem I have here is I can't talk about what their strategy is without getting, of course, them upset. So if the way that we think about the project and through conversations with different people at Verizon, we feel it is, without a doubt, is material as anything that we're doing. And so the key to this -- the key to that coming to fruition, of course, is every carrier changes their plan. And so the key to this is how much of what their current plan is holds up, either it gets bigger or smaller over time. But the only way that we can think about it is based off on the current information we have, and based off the current information we have, it is a very large opportunity. You can ask me a specific question that you think I can answer, I would do that, but I don't...

You know what, I will take that. I think that's great. And I did want to follow up. Because I think there was some lingering concern heading in on CenturyLink in M&A and Frontier kind of falling apart a bit about how the U.S. business might fare. And at least, as I look at it, and the question is to kind of confirm and amplify on this. It looks like your network business, and that has taken out CPE services in the U.S., was very, very strong in the quarter, up something like 50%, 60% sequentially, 40% year-over-year. I wonder if you could talk about that kind of U.S. network product-focused business and what's really driving that. Because that's -- those are sort of the hyper growth numbers and maybe not the sort we would expect to see if we peel back these onions, right? What's -- taken out the legacy where you saw a big decline year-over-year taking out CPE, et cetera.

I think there are multiple things. Without a doubt, we have one large customer that is doing a fairly extensive 100 MB rollout. And that 100 MB rollout has been very positive for us because of our market position there. And the fact that we have a very broad products that are going into there. That customer also, as you know, does fiber access as well. And I think we've done a good job of -- on picking up market share within that segment as well. But you have multiple carriers either looking at deploying -- they're all talking about how do I keep my customer. And some of that has to do with true end-customer demand. Some of that has to do with the fact that you've got major cable companies here in the U.S. that everybody knows is in the midst of rolling out 3.1. And so as you know, if you lose that customer, it's very difficult to get them back, right? So I think you have a lot -- all of the carriers, regardless of their financial situation, trying to figure out what are the key markets that they have to hang onto and then how do they deliver something, let's say north of 75 to 100 MB that actually allows that customer to be sticky and they can withstand the 3.1 rollout. And I think at a macro perspective, that's just what's happening. And I think it's going to get heated as we roll into 2018 because of the fact that, that's when you really start seeing meaningful deployments from the MSOs.

We'll go next to [Owen Hirschman] with AIG Investment.

(inaudible) Following up on the last question. If you look at the overall picture compared to 6 months ago and certainly 1 year ago both, if I can ask you (inaudible) separated out between the (inaudible) what would you say from 50,000 feet? Are we beginning to see the pressure for reinvestment at this point finally after years of, kind of false starts and lulls? What would give you any conviction that this time will be different?

I think we're past the false start phase. I think from at least just for my perspective, we have been thinking for some period of time that there were 2 things that were positive to get the market going again. And as I'm sure you recall, our investors recall, it was way back in 2012 that we actually saw the decline in investment in the access market here in the U.S. and it's taken up until last year. And we started seeing it increase last year, of course. And I think the 2 catalysts were the one we just spoke about, which is the competitive landscape changing with the deployment of 3.1 in the MSO space. And the second I think was CAF. I think CAF was a catalyst to get people building again and relooking at their architecture and thinking what they could do with it. And I think those 2 drivers are what got us here today. And so we don't feel like -- we feel its past of false starts. That does not mean there won't be bumps in the road, because at the end of the day, we're still selling to a relatively handful of customers, so any change in one customer can affect it. But if you look at the overall scope of what's going on from the largest carriers here in the U.S. to the smallest, they're all on the same train. And they're all doing the same thing. There's differences in timing on any individual one, but the movement is upward. So I think the difference is those 2 catalysts coming into real play here.

Okay. And just going back to what you were referencing. And NG-PON to being a very difficult project from a technical perspective. Are there still in questions on being able to do anything from a technical perspective as opposed to just fine-tuning things? Meaning is there any lack of optical components necessary to hit price points and be more even specific on the question.

No. There was not a question of feasibility. This is all about implementation.

Thank you. We'll go next to Fahad Najam with Cowen.

I had a question on the G.fast opportunity. If I go back last quarter, you had sort of walked through a scenario where you still expected the ramp on the G.fast opportunity with this Tier 1 U.S. operator to start in the second half '17. Do you think that has moved forward and you saw the ramp in the second quarter? And then, just to be clear, this 10% -- this XGS wasn't part of the 10% revenue, right?

It was -- that was not. The XGS was not a meaningful piece to that. And as far as the ramp, nothing has really changed. We thought we'd start seeing initial shipments in the second quarter, that was we saw, and we would expect it to just kind of ramp from here.

So on a sequential basis, you expect the ramp to come in third quarter ramping up to fourth quarter with these...

Yes. Honestly, to be more direct, we expect it to be higher in the third quarter and then higher in fourth quarter. But we expect that ramp to continue to go on through 2018.

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

This does conclude today's program. Thank you for your participation. You may disconnect your line at any time, and have a wonderful day.