ADTRAN Holdings, Inc. (ADTN) Q2 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN's Second Quarter 2011 Earnings Release. [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 marketing acceptance of new products, the degree of competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies, and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2010, and Form 10-Q for the quarter ended March 31, 2011. These risks and uncertainties could cause actual results to differ materially from those in those forward-looking statements which may be made during the call. I would now like to turn the call over to Mr. Tom Stanton, Chief Executive Officer of ADTRAN. Sir, please go ahead.

Thank you, Debbie. Good morning, everyone. Thank you for joining us for our second quarter 2011 conference call. With me this morning is Jim Matthews, Senior Vice President and Chief Financial Officer. I'd like to begin this morning by discussing our second quarter performance, along with some comments on what we expect for the third quarter. As stated in our press release, ADTRAN set a new revenue record of $184.2 million in the quarter. Our performance was driven by our growth areas, which grew 48% over the same period last year as our company continues to benefit from increasing demand for higher-speed services in both business and residential markets. In addition, broad-based strength for mobile infrastructure upgrades, the continued migration towards IP services, as well as an increase in demand outside of the U.S., all combined to drive our growth-area categories to achieve a record $132.1 million in revenue, which represents a record 72% of our company total. Looking at our businesses on a product-line basis, Broadband Access achieved its sixth consecutive record revenue level by growing an impressive 71% over the same period last year to $77.1 million. As expected, both the Total Access 5000 and Fiber-to-the-Node platforms contributed to this performance. Strength in the Total Access 5000 was driven by continuing, broad, carrier acceptance with strong growth in both large- and small-carrier segments. It's important to note that although we saw an increase in Broadband Stimulus shipments as we expected, we would characterize this opportunity as still being in the early stages, with an expectation for continuing acceleration as we move through 2011 and into 2012. We also saw a meaningful growth with the Total Access 5000 in the CLEC segment of the market, as competitive carriers increasingly take advantage of the platform's unique abilities to deliver world-class Ethernet capabilities to both business and residential customers. Our Broadband Access business was also positively impacted by our continuing success in the Fiber-to-the-Node product area. This area not only saw the typical seasonal increases, but also increased due to incremental market share gains and a meaningful increase in international revenue. Moving on to Internetworking. This category achieved its fifth consecutive record revenue quarter, growing 18% over the prior year. As in recent quarters, we saw a growth across all our distribution channels, including the various carrier segments and our growing dealer base, where we have continued to increase focus on reseller development. Another area of note is that as in recent quarters, Internetworking saw a growth in every major product segment, although we saw a particular strength in the Ethernet switching and EFM product areas. Optical Access also performed well as expected, growing 30% -- 36% over the prior year. This new record revenue level was a direct result of our market position with both large and small carriers, as we continue to invest in mobile backhaul infrastructure upgrades. Moving forward, we see new areas of opportunities as we continue to position our current product offerings and aggressively pursue development efforts to address arising needs in what will prove to be a very long term and increasing market opportunity. HDSL was down over the prior year with $34 million of revenues. This was below our previous expectations. Although this decline was partially offset by growth in our fiber products, we believe some of the decline was likely due to the traditional pattern pullback after multiple quarters of strong demand. For the third quarter, we expect HDSL will perform in a range between Q1 and Q2 levels. Moving on to a discussion about the rest of our products for third quarter. We expect to see continuing strong performances from our Broadband Access, Optical Access and Internetworking categories, as well as growth in professional services revenues, as ongoing projects progress and new awards come online. We believe strength in our Broadband Access category will continue to be driven by our Total Access 5000 family and Fiber-to-the-Node platform, as carriers continue to deliver higher-speed services, migrate their networks to Ethernet, and as these product lines benefit from increasing activities with international carriers and as Broadband Stimulus bills accelerate. We believe Internetworking will continue to maintain its current positive momentum. Although the enterprise spending environment can be characterized as cautious, increased scrutiny on performance, return on investment, and total cost of ownership continue to increase opportunities for our value proposition. We expect our Optical Access products to continue their strong performance, driven by increasing demand for our fiber-based platforms for mobility service upgrades. Accelerating broadband deployments driven by increasing competition and an intensive upgrade for mobile infrastructure, channel expansion in our enterprise segments, meaningful sales initiatives outside of the United States, government and regulatory initiatives, coupled with an innovative, diverse and expanding product portfolio lead us to believe we will benefit for meaningful growth through this year. I would now like Jim Matthews to review our results for the second quarter 2011 and our comments for the third quarter of 2011. We will then open the conference call up for questions.

Thank you, Tom, and good morning to everyone. Revenue for the second quarter increased 23% to a record level of $184.2 million compared to $150.4 million in Q2 of 2010. Broadband Access product revenues for Q2 of 2011 increased 71% to a record level of $77.1 million compared to $45.0 million for Q2 of 2011. This increase was primarily related to continued growth in deployments of our TA5000 and Fiber-to-the-Node platforms. Internetworking product revenues for Q2 of 2011 increased 18% to a record level of $33 million compared to $27.9 million for Q2 of 2010. Optical Access product revenues for Q2 of 2011 increased 36% to a record level of $22 million compared to $16.1 million for Q2 of 2010. Carrier Systems revenues for Q2 of 2011 increased 54% to a record level of $112.3 million compared to $73.1 million for Q2 of 2010. Business Networking revenues for Q2 of 2011 increased 11% to $35.7 million compared to $32.2 million for Q2 of 2010. Loop Access revenues for Q2 of 2011 were $36.2 million compared to $45 million for Q2 of 2010. HDSL product revenues for Q2 of 2011 were $34 million compared to $42.2 million for Q2 of 2010. As a result of the above, Carrier Networks division revenues for Q2 of 2011 increased 28% to a record level of $150.5 million compared to $117.6 million for Q2 of 2010. Enterprise Networks division revenues for Q2 of 2011 increased to $33.7 million compared to $32.8 million for Q2 of 2010. International revenue for Q2 of 2011 increased 182% to a record level of $23.4 million compared to $8.3 million for Q2 of 2010. To provide the reporting of each of these categories, we have published them on our Investor Relations Page at adtran.com. Gross margin was 58% of revenue for Q2 of 2011 compared to 59.4% for Q2 of 2010. The lower gross margin in the quarter was largely attributable to significantly higher professional services revenue, a significant increase in cabinet shipments related to footprint expansion of high-speed applications, and expediting costs related to specific customer opportunities. Research and development expenses were $24.6 million for Q2 of 2011 compared to $22.3 million for Q2 of 2010. This increase in expense was primarily related to an increase in staffing costs, customer-specific projects and Telcordia expenses related to customer developments and mobile backhaul. Selling, general and administrative expenses were $30.9 million for Q2 of 2011 compared to $28.5 million for Q2 of 2010. This increase in expense was primarily related to an increase in staffing costs and selling activities in the U.S. and abroad. Stock-based compensation expense, net of tax, was $1.8 million for Q2 of 2011 compared to $1.6 million for Q2 of 2010. All other income, net of interest expense for Q2 of 2011, was $4.7 million compared to $3.3 million for Q2 of 2010. The increase is related to an increase in realized investment gains and an increase in interest income due to higher investment balances. The company's income-tax provision rate was 34.0% for the second quarter of 2011 compared to 33.9% for the second quarter of 2010. The tax provision rate for the second quarter of 2011 included the normal benefit from research tax credits, and also included an additional benefit of $130,000 related to new state tax legislation taking retroactive effect from January 1, 2011. The tax provision rate for the second quarter of 2010 included a benefit of $643,000 related to closure of IRS audits for years 2006 and 2007, but did not recognize benefits from research tax credits due to delays in legislation. And again, that last sentence relates to 2010. Earnings per share, assuming dilution for Q2 of 2011, increased 27% to $0.56 compared to $0.44 for Q2 of 2010. The inventories were $86.7 million at quarter end, up $7.7 million from Q1 of 2011. The increase was driven by an increase in anticipated sales volumes and an increase in activities related to installation-services contracts. Net trade accounts receivable were $83.3 million at quarter end, resulting in DSOs of 41. Unrestricted cash and marketable securities, net of debt, totaled $478 million at quarter end, after paying $5.8 million in dividends during the second quarter. Due to the book-and-ship nature of our business and the timing of near-term revenues associated with large projects, it is our policy not to give specific guidance for the quarter or for the year. However, we would like to give color to help you formulate your views on our near-term business outlook. For the third quarter of 2011, we anticipate revenues will be in the range of flat to up mid-single-digit percentage points on a sequential basis. We expect third quarter operating expenses on a percent-to-revenue basis to be in a range similar to Q2. We believe the larger factors impacting the revenue we'll realize for the third quarter and the year will be the following: spending levels at our Tier 1 and Tier 2 carrier customers; the adoption rate of our Total Access 5000 platform; professional-services activity levels, both domestic and international; upgrades for mobile broadband infrastructure; the macro enterprise spending environment; and the timing of revenue related to Broadband Stimulus projects. Tom?

Thank you, Jim. Debbie, at this point in time, we'd like to open it up to questions.

[Operator Instructions] Your first question comes from the line of Ehud Gelblum with Morgan Stanley

Jim, Tom, if I could dig a little bit deeper into the gross margin that you talked about, Jim, you gave 3 reasons for it. Can you start giving us a little more color in how much each of those reasons kind of contributed to the decline in gross margin? And give us a sense as to -- when you're looking at the guidance for next quarter, you're flat to up mid-single digits. How do each one of those chassis services -- how do each one of those play into what you expect the revenue mix to look like next quarter? So what direction should we be looking at on the gross margin line?

Sure. I'll try to answer that question the best I can. I don't have the specific data in front of me in terms of those 3 drivers. However, in terms of a third quarter expectation, we will continue to expect gross margins, again, to be in the high 50s range. However, specifically to the third quarter, something closer to what we actually saw in the second quarter, again because we don't see any sort of meaningful mix shift between those components that I talked about in terms of driving gross margins lower for the quarter. Q2 versus Q3, okay? Hopefully that's helpful.

Yes. But the chassis comment, usually what comes after chassis are blades. Should we be seeing more chassis? So is this kind of an effect of Broadband Stimulus that we see more chassis? Or is it more -- are we starting to put the blades in?

I would agree with your comment that typically, we do see blades after the cabinet shipment. So the timing of that, I would estimate, would be in the foreseeable future. But in terms of pinning that to a third quarter revenue item, it's hard to say at this point, Ehud.

Okay. You said Broadband Stimulus was definitely affected this quarter and will accelerate going to the back of half of the year. Can you give us a sense as to how large that was, and how large you're assuming that will be in your Q3 guidance?

Yes, I would say -- we would say it's in the single-digit millions just for this quarter and expect it to accelerate. I mean there's definitely -- we could get into the double digits next quarter, but I would just say, we're expecting it to be larger than we did in Q2.

And did you expect that -- is that what drove the outperformance in the top line this quarter: the Broadband Stimulus was larger and earlier than you thought? Or was it the other areas and your share gains...

I would say it's pretty much in line with what we thought before. I think we had a couple of things that came in that were stronger. Needless to say, the 5000 was stronger, but it wasn't just in stimulus-specific bids. It was stronger in both large carriers and small carriers, with stimulus and without stimulus. And then we did see some incremental pieces outside of the U.S. that came in fairly strong.

Okay, and then finally, the unearned -- what's on your balance sheet? Your unearned revenue number kind of bounced around. It went up last quarter and came back down again this quarter. If we look at that as -- should we be looking at that as a sort of a deferred revenue number? And what can we read into that decline there?

Well, the decline in deferred revenue really relates only to timing issues. And I think most people know that the fluctuation that we saw -- or the increase that we saw in Q1 was in large part related to an international opportunity. And again, the fluctuation of deferred revenue from quarter-to-quarter will be based on timing of revenue recognition. And as it relates to that specific international opportunity for the third quarter, we expect to see another strong contribution from that individual customer in the third quarter.

Okay, and the final, what can you tell us about 10% customers? In the last quarter, you changed your tune there in terms of what you could say. So what -- can you tell us how many, anything about how large they were or anything?

Well, we can tell you that we had 3 10% customers, and we cannot go beyond that at this point.

Your next question comes from the line of Jim Suva with Citi.

When we look at the details of the different segments, is it fair to say that HDSL was a little bit softer than expected? And then you'd mentioned it's going to increase and be similar between Q1 and Q2 levels. Are we still on track for kind of a -- being down mid- to high-single digits for this year? Or has that declined, because of this quarter taking that number to be not necessarily valid and maybe down a little bit more this year? How should we kind of think about how that product line is trending, since it has kind of a bit of a long tail?

HDSL is unfortunately one of those products that we have probably the shortest lead time. And I'll just remind everybody, our typical time between order and shipment is somewhere on the order of -- well, it's less than 2 weeks. And HDSL probably actually brings that average down to some degree, so it is difficult for us to forecast. The comments that I made in my comments around HDSL were, we think there were a couple of things: One, we did see a pickup in the Optical business which we were expecting, and what we had seen historically is those 2 kind of play off of each other to some extent. And then if we look at the last 2 to 3 quarters, we saw a lot of strength that we were un-expecting. And if you go far enough, we have seen this kind of dips in quarterly revenue following some period of strength. So trying to figure out what is what is a little difficult. So with that, we had pulled back from our previous kind of low- to mid- to high-single digits. And at this point, just trying to give you a view of what we think next quarter will be. And our sense right now is that we're early in the quarter, and as I said, very short lead times. But our sense right now is that we'll see some strength kind of off of Q2 and just gave you a range of where we think the upside may be. Jim, are you still there?

Your next question comes from the line of Greg Mesniaeff with Kaufman Brothers.

Yes, question on breaking out some of your revenue segments by wireline versus wireless or backhaul. In the past, I know you've had some difficulty in being able to obtain that, that breakdown from your customers. I was wondering if there's any granularity you can give us about both in the legacy product area, the HDSL product area, as well as in the growth products. What percentage or what proportion was going to wireless-backhaul applications versus more traditional wireline?

So Greg, Jim. I'll take that. So if you look at our Optical Access category, substantially, all of that -- the vast majority of that would relate to wireless backhaul applications. So that number is fairly well-defined. As we look at HDSL, in our view, we saw a very little wireless-backhaul spending in the quarter as it relates to HDSL.

So most of the HDSL at this point is pretty much confined to more traditional wireline applications.

I think that's true. I mean, we tend to see -- of note, having said that, there are inventory things that happen within, so we'll see a buildup and then a slowdown. But our sense is that there's very little wireless spend this quarter on HDSL, and you were really kind of see the underlying enterprise and business-to-business connectivity. And if we kind of compare this quarter to, let's say, roughly 5 quarters ago or so where we thought we were seeing very little wireless spend, I think it's pretty comparable to that.

Your next question comes from the line of Joanna Makris with Mizuho Securities.

I'm wondering if you could comment a little bit on enterprise trends on a sequential basis. It looks like the revenue in that segment was flat, but you also commented on improving VAR relationships. So anything you can say about demand trends during the quarter and your thoughts on that segment going forward.

Yes, we're bullish on the segment. I will tell you the general feedback we get from the customer base is that there is some cautiousness out there in being able to make sure that they get a return on the investments that they're making. And that has probably actually bode well for us over the last couple of quarters, and maybe even through the recovery or coming out of the recession. But that -- there's still that angst about making sure that there is a fairly short-term return on their investment. The reseller channel grew, and it's grown now for what, Jim, maybe 5 quarters in a row now or so. We continue to see growth in that channel. We do have still a small amount of legacy products in that channel which declined, but the Internetworking segment continued to grow. So that's exactly the outcome that we are looking for. So I would say cautious, but we're still optimistic, and we still believe that we'll continue to see growth out of that channel.

Right. And just really quickly on the international business. You commented on strength there. I'm wondering about the implications of Telmex's lack of video approval as you think about your international business, and then also some general comments on the success you're seeing with the UBE product.

On our Latin American customer base, the franchise, I think you're correct specifically about Telmex not getting the franchise. But our sense is that they are looking for broadband -- higher-speed broadband expansion, and that the product line that we're selling into that area is very, very well-suited for that. It does give them the future upgrade ability if they were to get a franchise at some point into the future. But I think their head is definitely focused on trying to increase customer speeds and footprint. So I don't see any negatives associated with -- any negatives associated, from our perspective anyways, with the delay there. As far as UBE, we are in trials now in Asia and several carriers in Asia, as well as in Western Europe, and those are just continuing to move forward.

Your next question comes from the line of Ari Bensinger with Standard & Poor's. Ari Bensinger - S&P Equity Research: If you could just give us a sense of how to view stimulus spending. Should that be seen largely as incremental revenue opportunities? And if so, your guidance for flat to single digits, up sequentially for Q3, would that imply that the base business, absent stimulus, has sort of reached the peak for the year?

We don't mean to give that implication. I think what we're looking at is the fact that timing with large carriers and small carriers and various initiatives, whether they be large-carrier initiatives or Broadband Stimulus, tend to have push and takes within a 3-month period of time. So what we try to do is aggregate all of those and come out with a most-likely scenario, assuming that all of them do not happen at the same time. If they do all happen at the same time, we're very pleasantly surprised. If you look over the last few quarters, probably more of them have happened than we had experienced, which is kind of the rationale between the guidance that we give and kind of our over-tick above that guidance. But it's just a matter of us looking at that. So I would not say that the underlying business -- we do not expect the underlying business to decrease, but we're saying that there will probably be some give and takes.

Your next question comes from the line of Simon Leopold with Morgan Keegan. Victor Chiu - Morgan Keegan & Company, Inc.: This is Victor Chiu in for Simon Leopold. The Optical and Internetworking sales seem to have slowed in momentum a bit this quarter. Was the delta driven by a comp from a particularly strong Q1? Or are there things that you're seeing in terms of spending patterns from your customers?

I don't think anything is worrying us. If you look at those 2 product lines, Broadband Access, without a doubt, was stronger than we had expected. I would say, those 2 product lines, nothing underlying in the momentum. I think if I looked specifically at Optical Access, I would say the activity around Optical Access has actually been increasing over the last few quarters, and we saw more activity this quarter. So I would say, it probably would have to do more with timing of shipments and when customers specifically have projects in a particular region coming online or not online, but nothing underlying there. Internetworking, we've continued to see strength across the channel. I think -- Internetworking has had several quarters of sequential pieces, and I would kind of say, it's more of what ships in Q1 versus Q2 versus Q3. Nothing underlying there, other than the fact that I would say, there is a significant amount of scrutiny on what customers are spending money on today. Victor Chiu - Morgan Keegan & Company, Inc.: And just a more general question, the decline in overall legacy business was a bit more pronounced this quarter. So just kind of what are your thoughts regarding the trajectory going forward?

That's a difficult one. That decline -- we saw the decline in both the enterprise legacy business and, of course, the HDSL. The HDSL is the one that I think most people focused on because it's the largest portion of it. And we've been seeing the decline in our legacy enterprise business for some period of time, so I don't think that was really that big of a surprise. The HDSL piece was not something we were expecting, that marked of the decline. We are very happy that the growth areas were able to more than offset that. We are very bullish on our growth areas, but to the extent we see a decline in there, we're very bullish that the growth areas continue to grow at a rate that will make that decline basically, a nonfactor. Now having said that, we don't have a whole lot of backlog. Customers do not give us any really type of forecast on HDSL. So we kind of get it and ship it. And if we look back over history, there's some sense that we've kind of bottomed in this area, and that you'll probably see some uptick. And trying to weigh the amount of that uptick, I would say we're probably being slightly conservative on that. But having said that, we've been surprised both on the upside and the downside in the past on HDSL. Victor Chiu - Morgan Keegan & Company, Inc.: So you wouldn't expect the decline to accelerate much.

I would not expect the decline to accelerate. Victor Chiu - Morgan Keegan & Company, Inc.: That's helpful. And just one last question. Just clarifying on your comments on Telmex and their plans. Should we take that to mean that they weren't a very significant contribution to international revenues this quarter? Or are you...

No, I would not say that. Telmex was definitely a significant contributor to our international revenue in the quarter. I think the only underlying comment there that maybe Jim was talking about was the fact that we expect that strength to continue on. That was not a one-quarter phenomena.

Your next question comes from the line of Nikos Theodosopoulos from UBS.

If I look at the U.S. business this quarter, I believe it grew about 13% year-over-year, decelerated from the prior quarters, and that makes sense given that HDSL is predominantly U.S. Do you think that, that is a trough now in your year-over-year growth in the U.S. if HDSL doesn't decline any faster and you've got Broadband Stimulus picking up? Or do you see this kind of a new steady-state kind of growth, and most of the incremental growth going forward will be international for the company?

That's a good question. I need to answer that kind of over the long term because quarter-to-quarter variations, as you know, in our business can kind of skew things for the short period of time. If I look at the different growth segments that we're looking at over the next few quarters or the next couple of years, there are several things that have not come online that we feel are very meaningful. We had talked a little bit about Broadband Stimulus. Without a doubt, I would expect Broadband Stimulus to continue to grow incrementally to our base. If I look at the international revenue, that -- we'd already touched on that. If I look to the OEM opportunities that we have, those have not meaningfully contributed in any way, and those are yet in front of us. And if I look at the optical, both from an Optical Access and kind of a broader product segment, we're seeing things today and are working on things today that will benefit us several quarters from now, that would be incremental to the baseline revenue. So if you look at the baseline revenue on our growth product areas, are those declining? I would say no. So we do see a lot of incremental opportunities to us and basically, a solid base on the type of business we're doing today with our growth product. So I would say the answer over the long term is no.

Okay, all right. Second question, I guess the next 2 just for Jim, or actually both of you on this one. Cash continues to build. Is the company considering buying back more shares? I mean, it's just piling and piling quarter-after-quarter. The company doesn't have a track record of being acquisitive. So just curious, what -- does it makes sense to just keep it on the balance sheet, especially with the stock pulling back after this quarter? Would the company consider either increasing dividend or buyback?

I'm going to let answer -- Jim answer more specifically, but the answer is, as it has been historically, option buyback or share buyback are absolutely a key part of our kind of shareholder value and what we think is a good use of our cash. It is something we look at every quarter. As you know, we are opportunistic about that, but we also have a limited trading window by which we can do things. So that kind of puts a little caveat on what we can do. But no, that is still a -- very much an active part of the way we look at things. And, Jim, anything specific that you want to...

Yes. We have just over 1.9 million shares remaining on the current program, so under current program. So we do have the ability to engage on an opportunistic basis.

Okay, but it doesn't sound as of now there's any plan to raise that authorization.

Well, historically, we have raised that once we kind of get to a level, let's say, in the million-share range. And it is something that we -- of course, it's something that can be acted upon fairly quickly if the Board decides to do so.

Okay. Tom, on carrier spending. Last quarter, there was questions on just the overall environment. There were some that were a little tight. My sense is that probably continued again this quarter. Any -- what do you think it's going to take to change that? Or is that just ongoing for the rest of the year?

That tightness is very specific, so I would not at all call it across-the-board tightness. There are some large carriers that are doing very specific things that they are anything but tight about, and we've seen the benefit of that, and we saw the benefit of that in Q2. I made a comment on -- after several questions on the last conference call about a specific customer. I would say that customer actually increased too, so we're seeing some. But having said that, you have to be in the right area. If you're outside of that kind of target scope, then it's a very difficult time right now. And I would say, most of our products are in the right area for a large percentage of the carrier. So there is tightness, but I would say, it's been no tighter in the product areas we're in now than it was 12 months ago. I would say we're still -- we still seem to be in an area where carriers are focused on.

Your next question comes from the line of Rich Valera with Needham & Company. Richard Valera - Needham & Company, LLC: I had a question on gross margin, if I could. You mentioned 3 things specifically pressuring gross margin now. And it seems like at least 2 of them, that is the higher mix of cabinets right now versus blades and the expediting costs, should mitigate in, let's say, quarters beyond Q3. So is it fair to assume that gross margin maybe trends up a bit towards more historical levels as we move into Q4 and beyond?

Rich, I think that's premature to say at this point. We did say in our comments that we are pursuing new installation services opportunities and -- which would be incremental to operating returns to revenue. And so I think it's a bit premature to make any comment in that direction yet.

Let me just make sure that I kind of maybe break that down to one finer level, which is we have cabinet shipments where we are, in effect, taking somebody else's cabinet, or our cabinet, and we're buying additional material and we're shipping that out to the customer. And as you would expect, the gross margin profile, if I'm reselling in effect a battery or something, is going to be different. And in aggregate, that's a very positive thing for us. We don't have the same type of operating expenses associated with that as we may have with something that we developed ourselves. The second piece of that is we are actively pursuing services revenue where we would actually go out and do installations. And we've seen a pickup in that business, which again, has a different gross-margin profile, although it has a accretive operating-margin profile. So those are the pieces that are coming in that weigh on gross margins, but in aggregate, we believe that they are very beneficial to the bottom line. Richard Valera - Needham & Company, LLC: How about the incremental expediting costs? Should those mitigate at some point?

They should. They should mitigate. I mean, those come in when we see a shift in the business, for instance, where Broadband Access picks up in a very aggressive fashion, and there's a tight time line associated with it. Those hit us, historically, from time to time, but they're not something that we would say would be every quarter. Richard Valera - Needham & Company, LLC: Great. And one final one, if I could. It looks like looking back over the last several years, you've seen about a 5% average sequential improvement in revenue, Q2 to Q3. And you're guiding for sort of flat to, I guess, roughly that range. Is there anything specific that's kind of holding you back from guiding towards historical levels? Is it maybe the Internetworking, maybe a little bit of a slowdown there? Or is it just -- that's just the way things are shaking out, given all the puts and takes?

I'd say that's the way things are shaking up, but I would probably say the -- if you go back far enough, and you really kind of see that type of that growth that wasn't specifically project-related, then a lot of that was HDSL. So HDSL typically saw a seasonal pattern that you could pretty much bank on starting in Q1 and kind of going all the way through Q3, and then Q4 was kind of the wildcard. What our sense right now of being cautious on HDSL, that's probably some what you're seeing.

Your next question comes from the line of Michael Genovese with MKM Partners.

Great. I just want to revisit some of the comments on the interplay between HDSL and Optical Access. It sounds like you said Optical Access was pretty much 100% in the broadband -- sorry, backhaul area, and HDL -- HDSL these days is -- there's only a small piece of that in backhaul but yet, there's a trade off there. And if you're guiding HDSL up to be -- to be up sequentially in the current quarter, does that suggest that Optical Access could be down a little bit in the current quarter?

I will tell you we're not expecting a significant shift in either one of those product areas. So could Optical Access be down, then? It could be because we are a book-and-ship business, but I really don't think so. I mean, we're seeing an awful lot of activity in Optical Access. HDSL, from what we see today, from the ordering activity that we have, albeit it's a short period of time, and the fact that we were at a base that we think was very much non-wireless in Q2, we don't expect it to be down. But the question of ,could either one of those things happen with our backlog being as short as it is, or our current -- or our ship times being as short as this could, although that's not really what we're expecting.

Okay, fair enough. And then just a second question on the inventory levels which continue to increase and you -- this quarter, the inventory level increased. Certainly, it's above your revenue guidance for the next quarter. Can you give us any indication of how much of that inventory, roughly, is in the field, installed in Carrier Networks awaiting revenue recognition? And how much would be raw materials or finished goods that you hold or that your manufacturers hold?

Jim, do you want to speak to that?

Yes. I don't have those details before me, but there's certainly a meaningful amount that does. I don't want to confuse people when I say this, but we do believe that inventories have reached potentially a peak. We are seeing some loosening up in certain parts of our supply chains in terms of certain components, although I did say we did see expediting costs in the second quarter related to certain customer opportunities, okay? So we are anticipating that inventories have seen the peak, and Q3 levels should be in the same range and potentially slightly less than what we saw in Q2.

And I think that, that change is probably going to be more reflected in the inventory that we have here, actually in our warehouse facility, versus what may be in the field. I mean, we're continuing to sell services, and we're continuing to sell kind of longer-term contracts where they may be positioned with the customer. With Broadband Stimulus coming online and with the things we have going with our international carriers, you may see that continue to go up. But at this point in time, we feel that the supply chain is in such an area that we can probably start drawing down some of our internal material and kind of more reflect what our historical basis of internal raw material and internal whip has been historically. So I hope that quite -- that answers that for you.

Your next question comes from the line of Amir Rozwadowski with Barclays Capital.

Tom and Jim, I just wanted to -- Tom, if I may touch base again on the international opportunities. And then obviously, if we look at the revenue contribution this quarter, it picked up pretty significantly from the prior quarters. If we think about sort of the international opportunity going forward, is this -- how sustainable is this sort of revenue level at these levels over the next several quarters, given your visibility into the builds of what's going on in Latin America?

Well, Latin America is one piece, and it was without a doubt a significant piece. But I will say we have won several opportunities outside of Latin America that have yet to start shipping. And trying to add those into these pieces, as things kind of aggregate themselves, is maybe not as clear as you would think. If we talk about specifically the Latin American piece, it is a multi-quarter piece of which we really started initial shipments in -- of any meaningful size, I would guess in Q1. We would expect them to continue on through this year, and there are activities that would be going on through next year, so it's a multi-quarter phenomenon. And then our mission is to make sure that we bring these other pieces online in shipping within a period of time that makes sense. And hopefully, these things dovetail in such a way that we see really positive results.

Do you expect to see then, based on timing, fluctuations off of the levels that you experienced in the second quarter?

We will absolutely see fluctuations. I expect that with our best forecasting U.S. customers, of which there aren't many, but, yes, we will see fluctuations from quarter to quarter.

And then if I may on -- you had spoken a bit about some of your larger customers and what's going on with sort of purchasing there. I was wondering, how should we characterize the Tier 2 and Tier 3 operating environment right now? It seems that based on their CapEx trends at least for the year, they expect fairly significant fairly build outs of their networks. I wanted to see sort of how you guys are seeing sort of purchasing from those types of operators.

I would say in certain areas, it is strong. And I would agree with you. I would say that the Tier 2s and then kind of the more meaningful-sized Tier 3s have specific objectives, whether or not they're for wireless backhaul or for IPTV or just broadband spend. And I would say that's a very good environment for us right now. The Tier 3s, I would say, some of that, the increased activity is centered around Broadband Stimulus. If I look at the last report, 50% of the Broadband Stimulus awardees have not yet even picked their vendors yet. So there's still an awful lot of activity there that I think is yet to come. So I would say that in the Tier 3s, it's starting to happen, but I would not call it the same level activity is what we're seeing at some of the large carriers.

Your next question comes from the line of Simona Jankowski with Goldman Sachs.

I just wanted to follow up on your international customer. Obviously, international was up quite a bit this quarter. Did that customer now rise to the level of a 10% customer? And if not, do you think they might later this year?

We -- well, to answer your question, the 10% customers that we had in the second quarter were all domestic.

Okay, and do you think that the international customer might become a 10% customer, say, in the course of this year or next?

There is absolutely that potential.

Okay. And then relative to some of the other international wins that you commented on that you have, but haven't yet started shipping to, would those have the potential to become 10% customers at some point as well?

Would those? If you let me reach far enough into things like what we're doing in UBE, the answer is yes. If you were to say the projects that right now we're planning on -- that we have won and are planning on shipping, I don't see any right now that really stick out by themselves. In aggregate, the answer is yes. I don't see any one that really sticks out by itself as being, at this point in time, that large.

Okay. And then back on the quarter, it seems that most of the revenue upside, if not all of it, came from Broadband Access. And also, margins -- gross margins were a little bit lower than expected, and it seems like those 2 are related. So can you just, again, kind of specifically, try to pinpoint for us if the upside in the Broadband Access business was driven by the services piece or the international piece or some of the TA5000 and expediting that you saw in that area? So maybe you if can just rank order or quantify those 3 drivers, or if there's another one in the there as well?

The Broadband Access upside in revenue, is that...

Right.

I mean, all of those are in aggregate. So if you say upside, if I can just say Broadband Access, what kind of the growth drivers in Broadband Access would be easier for me to maybe quantify. And the -- I think there's a healthy -- if you understand also that a lot of our international products today is Fiber-to-the-Node. The largest growth that we saw in Broadband Access this quarter on a dollar basis was Total Access 5000.

And that's where the expediting occurred as well?

Yes. That -- we saw some expediting in that, cabinets and things associated with the 5000.

Okay. And that's all domestic, right? And was that expediting activity -- was that related to the Broadband Stimulus or just some of your existing other customers?

Existed -- by and large, existing other customers.

Your next question comes from the line of Todd Koffman with Raymond James. Todd Koffman - Raymond James & Associates, Inc.: Back to the gross margins. With -- when you look at your international businesses, your international deployments generally have -- the products have similar gross margins to the domestic products that you've built out over many years.

They do. Let me add the one caveat, which is that a large percentage of our International business today does have services associated with it. So we will actually do the installation, some of the engineering work and things. So that this piece will actually be, of course, less gross margin, but the product specifically itself has a very similar profile. Todd Koffman - Raymond James & Associates, Inc.: And then just a follow-up on the gross margins. The footprint expansion associated with the success and popularity of the Total Access 5000 has been going on for quite a few years, and yet you've called this out as your margins are starting to maybe tick down a little bit. I was wondering, is there anything else as it relates to the success and popularity of build out of that, that may be a factor? Meaning, have you lowered the price? Or is any other factor on the gross margins maybe coming down a little bit?

Yes. All we can say about the cabinet piece -- and you're right, that they do vary from time-to-time. Sometimes we don't -- we have better visibility to what's going to be ordered so that we don't have the same level of the expedite charges. As far as the pricing environment, it has been a very competitive in pricing environment for some period of time. So do we lower prices? Yes, we lower prices for specific opportunities in order to win the deal. That really hasn't changed. And so that's just kind of our normal course. But I would say that the difference that you saw on the expedited pieces was really due to the performance of a specific RT-fed or RT cabinet at high expedite charges, which sometimes you have a better handle than on what that forecast would be than we did this quarter. Todd Koffman - Raymond James & Associates, Inc.: And one last quick follow-up, totally unrelated, back to HDSL. You said HDSL today is now still being used, overwhelmingly today, for this business connectivity, not wireless backhaul. Is that likely to be the case that the application of HDSL for wireless backhaul is largely behind you, and now it's just the people who are still using it for business connectivity going forward?

That's a multi-million dollar question. And if I talk to carriers, carriers are still using it in areas -- both Tier 2 carriers for what they're offering as services to the large wireless carriers. And if I talk to Tier 1 carriers, they're still using it in areas for wireless build out. So I would say we would still see that, but I think that activity is going to be sporadic, which is kind of what we're seeing actually in Q2. And so the answer to your question is -- will it go down over time? Yes. Is -- do we expect incremental wireless spend on HDSL periodically through the next few quarters, if not the next few years? The answer to that is also yes.

Your next question comes from the line of Larry Harris with CL King. Lawrence Harris - CL King & Associates, Inc.: I was intrigued by the percentage of sales that is in the growth product category, 72% right now. And I was wondering, how high could this go? I guess maybe it could be affected by the HDSL increase in the third quarter? But is this a category that can go to 75%, 80% or more of your total revenues? What sort of target do you have?

We would like 100% to be in growth categories at some point in time. We may not get there, but we could definitely get in the 90s. The whole thought behind our growth-product categories are these are areas where we see incremental opportunities or expansion in capabilities, either in market share or in capabilities that we add from a feature-set perspective. And over time, that transition from the legacy-product area to this growth-product areas will happen. So we want that number to be as high as possible because we see more upside potential in these areas than we do in the legacy areas, which are capped just by the nature of the type of products that are in there. Lawrence Harris - CL King & Associates, Inc.: Are the gross margins on average higher in the growth category than the legacy area?

They are basically in line with -- you may see plus or minus kind of several basis points. But in general, they have been in line with what we had seen in our historical-product areas. Where you'll see the difference is, is that the growth product areas, especially on the carrier side have, many times, services associated with them which will have a different gross margin profile. Lawrence Harris - CL King & Associates, Inc.: Understood. And then on the expediting costs in the quarter, was there any impact, say, from component shortages from Japan, or weather conditions in the U.S. during the quarter that led to higher-than-expected expediting and might be relieved in future quarters?

I think very little from Japan. I think we were fortunate enough to be able to procure what we needed to procure in a short period of time. I think we may even have touched on that from some of the inventory build that we have had, with associated with building of -- making sure that we have supply until the suppliers were able to come back online. So I would say very little there. As some of you may know, we had a fairly dramatic incident during the quarter with tornadoes coming through this area. Trying to quantify that exact cost is difficult. I will tell you we were -- our manufacturing operation and our purchasing operation and many other facets of the company were basically shut down for 6 days, and we had to bring things back up. I do -- would love to take this opportunity, by the way, to commend our employees on the way that they reacted during that situation and being able to keep our customers happy and, really, keep the kind of lifeline operations of the company running. But there is an impact on that. We're trying to quantify that. It's very difficult.

Your next question comes from the line of Marc Singer [ph] with Beastmaster [ph].

Ehud got to my call already.

Your next question comes from the line of Paul Silverstein with Crédit Suisse. Paul Silverstein - Crédit Suisse AG: I know you don't want to give too much detail on the 10%, but can you tell us what the 10% customers were collectively, as a total percent of revenue and total dollars?

Paul, I don't have those numbers in front of me at this point. Paul Silverstein - Crédit Suisse AG: Okay. Jim, could you even say whether it was in line with historical? It had been running about 45% of total revenue with fluctuation. Would you know that offhand? Or...

I don't see any material change off of that range that you mentioned. Paul Silverstein - Crédit Suisse AG: Okay. On the Telmex, I know you addressed this before, Tom, but I just want to confirm. So your expectation is that this particular project runs strong and sell through the end of the year with some incremental revenue next year. Is that a fair characterization?

Yes. When it does run, it runs through the end of this year. Actually, the project in totality runs into several quarters into next year. So yes, the answer to your question is yes. Paul Silverstein - Crédit Suisse AG: Okay, and on the other international business you referenced as new wins, no one win is the equivalent of Telmex, but collectively they could substitute for Telmex. Is that a fair way to look at it?

I think that's a fair way to look at it. I would say incrementally, actually, they're larger than Telmex. Paul Silverstein - Crédit Suisse AG: All right. And on the comment you made on service on your international service, the fact that you international business has a higher tax rate on services and those gross margins run lower. I don't know that you've ever given us much, if any, insight on your services gross margin. Can you share with us what the gross-margin profile on the services piece of the international business, what that looks like compared to your current corporate average gross margin?

Paul, this is Jim. So what we said on services is that although our services revenues have a gross margin less than our normal equipment gross margins, they are accretive to our operating margins. So obviously, that will put them somewhere in between our operating margins and our gross margins. So that's to the extent that we broken it out at this point. We're not at the level where we break out those revenues and margins on our disclosure yet. We don't anticipate to be to that level this year. So that's the level of color that we've given thus far on that. Paul Silverstein - Crédit Suisse AG: So it already attracts [ph] gross margin, but it doesn't adversely impact operating margin?

Well, it's actually accretive to operating margin.

Accretive as in positive to operating margin. Paul Silverstein - Crédit Suisse AG: All right, and finally from me, Jim, I appreciate the level of disclosure you give us. But could you -- given how big the businesses are and how important they are, can you tell us what Fiber-to-the-Node was versus what TA5000 was in terms of Broadband Access business?

I mean that's not something that we do disclose. But I can tell you, Paul, that -- and again, your question is TA5000 versus Fiber-to-the-Node. Is that correct? Paul Silverstein - Crédit Suisse AG: Well, I mean those are the 2 key growth drivers of Broadband Access, which in turn is the first and foremost growth driver of your overall revenues. I'm hoping you could share with us some insight in terms of to what degree it's one versus the other.

Yes. I mean we made the decision several quarters ago to not get to that level of detail, particularly in regards to the TA5000 because again, it's a very competitive situation. We did say earlier in the call that the sequential growth in Broadband Access -- we had a higher dollar contribution on that growth from the TA5000 as opposed to Fiber-to-the-Node. Paul Silverstein - Crédit Suisse AG: All right. One more question, if I may. In the Fiber-to-the-Node business, that international customer Telmex, is that still 50, 50-plus percent of that Fiber-to-the-Node business?

The majority of that is Fiber-to-the-Node business, yes. Paul Silverstein - Crédit Suisse AG: No, the majority of your Fiber-to-the-Node is Telmex?

We have never said that the majority of the Fiber-to-the-Node was Telmex.

No, but certainly a meaningful..

It's a meaningful portion of it, but I wouldn't characterize it as 50%.

We certainly have meaningful domestic customers on Fiber-to-the-Node.

And we started shipping to incrementally new customers in the U.S. Fiber-to-the-Node in the second quarter. Paul Silverstein - Crédit Suisse AG: Tom, any of those incremental new customers would you consider to be sizable Tier 1 and Tier 2-type customers?

Yes. I'm trying to think of what that list was, but yes.

Okay. That's -- I think we're out of time here. So Debbie, we're going to close up here. Thank you very much, everybody, for showing up on our conference call, and we look forward to seeing you 3 months from now.

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