ADTRAN Holdings, Inc. (ADTN) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN's First Quarter 2013 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 judgment based on factors currently known. However, these statements involve risks and uncertainties, including the successful development and market acceptance of core products, the degree of competition in the market for such 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, 2012. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which may be made during the call. It is now my pleasure to turn the call over to Mr. Tom Stanton, Chief Executive Officer of ADTRAN. Sir, please go ahead.

Thank you, Zach. Good morning, everyone. Thank you for joining us for our first quarter 2013 conference call. With me this morning is Jim Matthews, Senior Vice President and Chief Financial Officer. I'd like to begin this morning by discussing the details behind our Q1 results, and I'll end with some comments on this year. We will then open the call up for questions. As stated in our press release, revenues for the quarter were $143 million, slightly beating our expectations. The first quarter confirmed that our base business continued to solidify, both here in the U.S. and abroad, as we started seeing signs of improvement in both our Carrier and Enterprise businesses. Our Carrier Networks division revenues came in at $110 million, flat with Q4, but up from the same period last year. On a sequential basis, sales to U.S. carriers came in essentially as expected, with sales of HDSL continuing to decline and sales of other carrier products flat to their Q4 levels. The decrease in HDSL sales were offset by sales increases in Europe, Middle East and Latin America. On a product basis, the Carrier division revenues were led by Broadband Access, which came in at $72.2 million, slightly up from the $70.1 million in Q4 of last year and meeting our expectations. Of course, revenues on a year-over-year basis were up significantly due to incremental sales from the acquired Broadband Access business, but were also positively affected by an increase of sales to Tier 1 carriers here in the U.S.. Of more importance was the continued activity level we saw in the first quarter around our Fiber-to-the-Premise and vectoring solutions which I will touch on in a moment. As I previously mentioned, HDSL sales were down, both on the sequential and year-over-year basis, coming in at $11.4 million. I do think it's important to note, however, that for the quarter, HDSL represented less than 8% of total company revenues. On a going-forward basis, we believe that a decline in sales in this legacy product area will be relatively immaterial to the company's overall performance. From a customer perspective, we continue to make good progress in our market share initiatives with Tier 2 and Tier 3 accounts. Within the Tier 2 accounts, we continued our drive towards broadband share expansion and we were able to secure either market share awards or new application awards spanning all 4 Tier 2 customers. These applications range from Ethernet aggregation and Ethernet over Fiber for mobile backhaul to Class 5 switch replacement. In addition, we continue to receive very positive feedback on our ONE product series, with various trials and deployments in both Tier 1 and Tier 2 accounts here in the U.S.. And although I will still characterize the Tier 2 and 3 market as having severe regulatory driven constraints, we are making progress nonetheless. As I mentioned in our last call, we continue to see an increase in activity in our international markets driven largely by the acquisition we completed last May. These activities are generally revolving around expansion and upgrading of access infrastructure to integrate new features such as vectoring and GPON. These movements driven by the competitive landscape, the introduction of significant technological innovation and positive regulatory changes continue to gain momentum. Total company international revenues came in at $34.9 million, up 20% sequentially, and up 91% from the same period a year ago. On a sequential basis, we saw strength in Europe, Middle East and Latin America. Moving onto our Enterprise division. Q1 sales totaled $33.1 million, a strong 14% sequential increase, driven by strength in our carrier channels. On a product basis, the increase was driven predominantly by an increase in sales of our Internetworking products which grew 17% for the company, sequentially. The strong series of growth were in the IP gateway and switch product categories. During the quarter, we continued to add strength to our dealer channel, adding approximately 80 new VARs to our program. Also during the quarter, we continued to add to our product capabilities in Enterprise with the introduction of our active chassis switch capability and the introduction of several new Wi-Fi products. We continue to progress with our field trials with our carrier Wi-Fi offload and hosted solutions as well. Finally, I realized there's been some speculation about 2 significant requests for proposals by 2 major carriers, one in the U.S. and the other in Europe. Both of these projects involve significant upgrade and expansion to their existing networks. As you know, it is our policy to refrain from commenting on specific customer activity. However, we can say that we feel positive about the outcome of these negotiations and, furthermore, can state that we have begun seeing initial orders from one of these carriers for the multiyear project. We came into this year optimistic that we are entering a period where many carriers around the world will embrace next-generation access technologies to strengthen their competitive positions and meet their customers' growing demands. And although we are still early in the adoption cycle, the activities that occurred in the first quarter of this year reinforced that optimism. We are confident in our ability to capitalize on recent Tier 1 carrier initiatives, as well as having confidence in our ability to expand our market share in the Tier 2 and Tier 3 carrier space. And we are hopeful that as the year progresses, we will see additional clarity and cap-associated regulation and the corresponding return to spending in the Tier 3 markets. We also believe Internetworking will continue to see growth from market share gains and new product offerings. I would now like Jim Matthews to review our results for the first quarter of 2013 and our comment on the second quarter of 2013. We will then open the conference call up for questions. Jim?

Thank you, Tom, and good morning, everyone. Revenue for the first quarter increased $143 million compared to $139.8 million for Q4 of 2012 and $134.7 million for Q1 of 2012. Broadband Access product revenues for Q1 of 2013 were $72.2 million compared to $70.1 million for Q4 of 2012, and $49.5 million for Q1 of 2012. Internetworking product revenues for Q1 of 2013 were $36.9 million compared to $31.6 million for Q4 of 2012 and $41 million for Q1 of 2012. Optical product revenues for Q1 of 2013 were $8.9 million compared to $12.3 million for Q4 of 2012 and $14.3 million for Q1 of 2012. Carrier Systems revenues for Q1 of 2013 were $92.8 million compared to $90.1 million for Q4 of 2012 and $71.3 million for Q1 of 2012. Business Networking revenues for Q1 of 2013 were $38.1 million compared to $33 million for Q4 of 2012 and $43.1 million for Q1 of 2012. Loop Access revenues for Q1 of 2013 were $12.1 million compared to $16.7 million for Q4 of 2012 and $20.3 million for Q1 of 2012. HDSL product revenues for Q1 of 2013 were $11.4 million compared to $15.6 million for Q4 of 2012 and $19 million for Q1 of 2012. As a result of the above, Carrier Networks division revenues for Q1 of 2013 were $109.9 million compared to $110.8 million for Q1 of 2012 -- I'm sorry, Q4 of 2012 and $96.7 million for Q1 of 2012. Enterprise Networks division revenues for Q1 of 2013 were $33.1 million compared to $29 million for Q4 of 2012 and $38.1 million for Q1 of 2012. International revenues for Q1 of 2013 were $34.9 million compared to $29.2 million for Q4 of 2012 and $18.3 million for Q1 of 2012. To provide a reporting of each of the categories, we have published them on our Investors Relations web page at adtran.com. Gross margin was 48.7% of revenue for Q1 of 2013 compared to 48.2% for Q4 of 2012 and 55% for Q1 of 2012. The lower gross margin compared to Q1 of 2012 was attributable to lower gross margins related to the recently acquired Broadband Access business and the change in customer mix. Total operating expenses were $63.1 million for Q1 of 2013 compared to $64.5 million for Q4 of 2012 and $57.9 million for Q1 of 2013. The increase in operating expenses for -- from Q1 of 2012 to Q1 of 2013 was primarily attributable to research and development and sales and marketing expenses related to the acquired Broadband Access business, partially offset by a decrease in SG&A expenses in our organic business. Amortization costs included in operating expenses totaled $1 million for the quarter. Stock-based compensation expense, net of tax, was $1.9 million for Q1 of 2013 compared to $2.2 million for Q4 of 2012 and $1.9 million for Q1 of 2012. Supplemental information for acquisition-related expenses, amortizations and adjustments in connection with recent acquisitions are provided in our operating results disclosure. All other income, net of interest expense, for Q1 of 2013 was $3.2 million compared to $3.5 million for Q4 of 2012 and $3.9 million for Q1 of 2012. The company's income tax provision rate was 18.9% for the first quarter of 2013 compared to 35.4% for the first quarter of 2012. The lower tax rate for the first quarter of 2013 relates to a benefit related to legislation to extend research tax credits, partially offset by adjustments in the deferred tax asset valuation allowance for the acquired BBA business. Earnings per share on a GAAP basis, assuming dilution for Q1 of 2013, were $0.13 compared to $0.06 for Q4 2012 and $0.20 for Q1 of 2012. Non-GAAP earnings per share for the quarter were $0.17 compared to $0.11 for Q4 of 2012 and $0.25 for Q1 of 2012. Non-GAAP earnings per share exclude the effect of acquisition-related expenses, amortizations and adjustments related to acquisitions and stock compensation expense. The reconciliation between GAAP earnings per share, diluted and non-GAAP earnings per share is provided in our operating results disclosure. Inventories declined to $95.8 million at quarter end compared to $102.6 million at the end of Q4 2012. Net trade accounts receivable were $82.1 million at quarter end, resulting in DSOs of 52 compared to 53 DSOs at the end of Q4. Unrestricted cash and marketable securities, net of debt, totaled $495.9 million at quarter end after paying $5.6 million in dividends and after repurchasing approximately 1 million common shares for $22.5 million. Due to the book-and-ship nature of our business and the timing of near-term revenues associated with large projects, it is our policy not to give specific guidance for the quarter or for the year. However, we would like to give color to help you formulate your views on our near-term business outlook. For the second quarter of 2013, we expect company revenues will increase sequentially in the range of mid to high single-digit percentage points. We expect GAAP gross margins for the second quarter will be in the range of what we saw in Q1. We expect GAAP operating expenses for the second quarter will range between OpEx levels experienced in Q1 of this year and Q4 of 2012. GAAP operating expenses for the quarter, we expect, will include acquisition-related amortizations of about $1 million. We believe the larger factors impacting the total revenue we realized for the second quarter of 2013 will be the following: The macro spending environment for carriers and enterprises; regulatory uncertainty in the domestic carrier market; professional services activity levels, both domestic and international; the timing of revenue related to Broadband Stimulus projects; and the adoption rate of our Broadband Access platforms. Tom?

Thank you, Jim. Zach, at this point, we'd like to go ahead and open it up for questions.

[Operator Instructions] And we'll take our first question from Amitabh Passi with UBS.

Just a couple for me. First, I was hoping you'd touch maybe on the deferred revenue balance declined slightly, sequentially. Just wanted to get a sense of what might have driven that? And then Tom, I'm very intrigued by your commentary around order activity related to 1 of your 2 large, well-talked-about Tier 1 operators. Just wanted to get some sense of how do you see developments progressing through the rest of the year, either with both accounts or one of them? Whatever you can shed light on would be highly appreciated.

So, Amitabh, the question on deferred revenue. The change there is a result of normal revenue recognition as we recognized those deferred revenues. So I don't think there's any sort of significant sort of issue around that change other than that.

Jim, was that related to international or domestic clients, can you qualify that?

It relates more to international.

On the second piece, the -- I think a good thing for us was the fact that we actually had gotten past the award stage down to where we're actually able to move forward with receiving orders. So on the carrier -- on the 1 carrier that I mentioned, we are receiving orders, we would expect to be shipping those orders in the second half of this year. I would say they're a -- the real ramp up for that customer that was still going to occur, I think, we'll see that ramp from the second half of this year through the next couple of years. On the other carrier, we're not in the position to really talk much about that, but other than to the say, I would expect that to be more a 2014 event than a 2013 event. I don't think we would -- we may see orders this year to the extent -- if things continue the way they're going, we would see orders this year, but I'm not sure if we would ship a lot this year.

Hey, Tom, can I just ask one clarification? On these new Tier 1 operators, can you give us some sense of the pricing environment, the margin profile? Was it consistent with your corporate average? Do you think it'll be accretive to your corporate average? Just any rough sense of how we should think about the new pricing action and the margin profile.

Yes, I would say that they're pretty much in line. But I'll caution you on one thing, and that one is, using -- one is a European carrier and it is using the BBA product line. So that one inherently has lower gross margin at this point in time than the U.S. product line for various different reasons. So are they at the average? I would say they're around the point that we would expect them to be for the type of products that they are. And I don't know if I confused you or not, but those are 2 different product lines.

And we'll take our next question from Rod Hall from JPMorgan. Roderick B. Hall - JP Morgan Chase & Co, Research Division: I just wanted to ask a couple of quick questions. First of all, just to follow up on the European commentary. You saw that D-NET came out with a rule about trading and it's the existing [indiscernible] cabinets [ph] will be updated until 2016. I wonder if you could just comment on whether that has any impact to the size of the revenue that you would expect to potentially receive in 2014 that would increase or decrease it? Any other commentary -- color around that ruling will be interesting as well in terms of how it affects the size of the potential deal that you would have over there? And then also just wanted to come back on Enterprise. I mean, those numbers were better than we expected. Did you think that, that strength in Enterprise continues? Do you expect that to continue to get better for you as the year progresses? Is it particularly abnormal in this quarter? Can you just give us a little bit more color around what's going on there?

Sure. First on the European activity. The -- first thing, anything that will help carriers to be able to deploy in a quicker fashion -- broadband, of course, is positive for us, and so we see those moves as positive. I do think that, in the near term, a lot of the rollout that we're hoping to do in Europe is premised around those rules coming into fruition, but they were -- it was going to be rolled out in some form or fashion. In my opinion, betting on those rules or regardless of those rules, I think that there's a requirement for bandwidth and that these things have to be worked out. So I don't think they really affected us for the near term. For the longer term, without a doubt, the fact that there's more clarity on how they're going to do on bundling and how vectoring will work will be beneficial in both adoption rate and the speed of deployment. As far as Enterprise is concerned, it was -- there was nothing that stuck out as far as -- there was no very large things that came in that affected the number. It was a general increase. I would -- as I mentioned on my notes, it's definitely more carrier than VAR, but it was a fairly broad-based increase. So we're hopeful. And I know, as you and everybody on this call knows, one quarter is just one quarter. But we're hopeful that we at least got past the bottom and seem to be moving upwards. So we would expect growth at this point in time, having said the fact that we were one quarter into it.

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

Can you give us any 10% customer detail? And then secondly, maybe walk us through, from your perspective, what has to happen, what the guideposts are, what the milestones would be for dealing with the severe regulatory constraint in the Tier 2, Tier 3 market? What do you think is going to happen there and what would the timing be for that to get better?

Sure, Michael. On the 10% customer, the details that we can provide at this point is we had 1 10% customer and that customer was domestic.

As far as the regulatory hurdles, there are still some work that the SEC is doing in relation to the -- I would say, mainly Tier 2 carriers, there is 1 Tier 1 carrier in there. For the CAF Phase 1 funding that was actually allocated last year, had very little uptick. There are some movement going on there and that would be beneficial. In the overall Tier 3 space, I think that the real problem has to do with the funding models and the way that they actually calculate whether or not you're an overly expensive carrier or not an overly expensive carrier. There was some relief on that. And that they're now being able to allow CapEx and OpEx to be bundled together and there's now a floor, I think it's 15%, I don’t know, Jim, if you remember? I think it's 15% that give some, at least, assurances as to how low your budget may be cut. I think at this point in time, I don’t really see on the Tier 3 piece a significant amount of additional rule change here. I may be surprised there, but I think these things are just rolling out at this point in time and what really need is some time. We really need people to start operating under these rules, realizing where the pitfalls are and where the positive pieces are, and it will just start picking up. So that's the way I view it.

Okay. Can I just ask one. On the Tier 2, you mentioned 4 Tier 2s where there was all some new business, some new -- new awards at all 4 Tier 2 carriers. Is any of that CAF related or were those all separate commercial projects?

Those are separate commercial projects. And in some carriers -- in some areas, and quite a few, we actually had some new applications that we weren't into before. I will tell you, I don't think any of those are shipping yet. Those are all things that we were able to just kind of secure in Q1. And some areas we are into market spaces that weren't into before, we may have had an incumbent in that space. I think the CAF piece -- at this -- we're just looking -- we're just waiting for those funds to release. I think we're in a good position on those CAF funds if that money is released.

Great. And then finally, on this Tier 1 opportunity, where you're starting to see orders and expecting initial revenues in the second half of '13. Is the eventual timing and scope of this eventual revenue opportunity and timing, is that going to become clearer to you over, say, the next 3 to 4 quarters? Or is that something that you feel like you know today how it's going to play out over the next 6 to 10 quarters? What those revenues are going to look like? Or is this stuff that's still being negotiated? Still up in the air and you couldn't really call it today?

I think we have some boundaries, kind of an upper and lower range. But as far as how we fall within those boundaries, I think, without a doubt, that will be clearer as time goes through.

And we'll go next to Rich Valera with Needham & Company. Richard Valera - Needham & Company, LLC, Research Division: I was wondering if you could comment on the Optical Access segment that was pretty light this quarter relative to recent levels, and I know you had some product development going on there and some sort of qualification going on. So can you give us any sense on how you think that might trend for the balance of the year?

Yes, our Optical Access activity -- so I mean, it was low and that's even taking into account that we had an approval with 1 large Tier 1 carrier last year, towards the tail end of last year that we started seeing shipments from, but it really didn't overcome just the overall decline. Our focus on Optical Access right now is more centered around our Total Access system which has the ONE. I'd also mention, we just secured some new Ethernet over Fiber deployments in some -- in, I think, 1 of the Tier 2s last quarter. So you will see that pick up. You'll see some of it in the broadband line, because some of it is based off the Total Access chassis and our ONE products which are really -- the customer receptance of the ONE products has been very good. It has been very slow to get through the approval process. But I really do think that, that will have a very positive impact for us. And it's 1 of those 2 pieces, the Ethernet over Fiber piece out of the 5,000 and the ONE out of the 5,000 really start getting broad deployment. And we're through -- we've got, I think, 2 of the Tier 2s right now that are using the ONE product, but it's very early. And you'll start seeing that pick up as we start picking up more wins and start being able to capitalize on the wins that we have. Richard Valera - Needham & Company, LLC, Research Division: And do you think that's kind of the second half of '13 to start seeing some of that revenue traction?

We're seeing some of it now. The question is when it will overcome the 6100, which is a SONET-based product, when it will be overcome that point? And honestly, I think, to be able to overcome that in the second half of '13 is early. I think it'll probably be sometime next year. Richard Valera - Needham & Company, LLC, Research Division: Just one more, if I could, on the international front. I know you don't want to specifically break out the contribution from the NSN BBA business, but can you give us a sense directionally how that business faired from Q4 to Q1? Was that up as well with the overall international business?

Yes, it was. Richard Valera - Needham & Company, LLC, Research Division: And can you give us any sense of your expectations for that business for this year? I'm guessing, it has maybe a fair bit to do with one of your Tier 1s over there. But I think the perception was it was quite light in 4Q. Do you see that business kind of generally being stronger than those of 4Q levels this year and kind of ramping from those levels?

Yes. Yes, we're actually -- yes, we do. Yes.

And we'll go next to Simon Leopold with Raymond James. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: A couple of things I was hoping to clarify. In terms of the new Tier 1 opportunities, can you provide some framework to help us think about the size of these opportunities in terms of what you're thinking in total revenue? And then the competitive aspect of whether these are sole-source opportunities or whether you are really looking at a share of a larger project? If you could talk about the 2 of them independently?

Sure. So the European opportunity is -- well, both of them, I will characterize in total opportunity is hundreds of millions over 3 to 4 years. And the one in Europe is -- there is a competitor that is approved as well. The one in the U.S. is multifaceted, and then some portions of -- and let me call it multi-projects. So there are a couple of projects. And the one in the U.S., one of them there would be a competitor, and then the other one would not. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: Great. And when you first acquired the business from Nokia Siemens, I think you talked about the plan to really migrate customers from the former Nokia products to your own organically developed platforms. Can you give us some perspective or sense of how that transition's either happening or how you see it happening?

Yes. So I don't believe we've ever said that. I think -- in fact, I'm pretty confident that we said from the very beginning we were going to continue on with the MSN platform. That their customers -- well, that is the entrenched to -- the platform actually has no -- it's not a platform that's handicapped from where it can go. In fact, there's some very positive attributes to the platform and that we were not going to try to force some type of upgrade or some kind of replacement, and that is still the plan. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: And so you're investing in those products to eventually evolve them to new generations and build out a -- essentially a second portfolio based on that, is that a fair way to think about it?

That is. I will tell you what we're planning and still, in fact, are working on to this day, on driving more and more value out of -- which is the -- if you look at the development of these 2 kind of fundamental platforms that we have, the hiX system and the 5000, about 80% of that work is kind of higher-level software development where we can absolutely be able to build one and use it in both. So we're really trying to maximize that. I would say, to the extent we're not far along as we would like to be, it's because we have some very large customer opportunities that are driving a greater share of our R&D development than I would have guessed year ago. Both of them are still working towards that end result. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: And just one last one. Some time ago, you had acquired Bluesocket for the wireless LAN market. It was not part of your commentary behind the strength of the Internetworking. I just wonder if we could just kind of check back on the status of that business?

So Bluesocket had a -- actually a very good fourth quarter. And the first quarter, I would say, was probably affected by that. It wasn't dramatically down, but it wasn't up. So that's why we really didn't mention it, we just mentioned the 2 pieces that drove the majority of it. It is still -- I mean, it actually had a very good year last year and we're seeing actually no decline in activity around Bluesocket. So I didn't mean -- not speaking about it didn't necessarily point to the fact that we saw poor performance there.

Our next question from Simona Jankowski with Goldman Sachs.

Just a couple of questions and a follow-up. So your guidance for mid to high single-digit revenue increased in the second quarter compares to your historical seasonality in the second quarter that's typically been more in the double digits. And when I couple that with your commentary on improved activity levels, it just seems like it might be conservative or perhaps can you just kind of point us to what are some of the offsets that are holding back your guidance?

Well, Simona, I think we certainly want to be very careful on the view that we give to the Street. That is a number or a target or a range that we think that we can very reasonably achieve. And there are a number of moving parts where you continue to be a book and ship business and there are some level of uncertainty related to that aspect. But all in all, that's how we feel about the business.

I will tell you also that, that goes back -- it depends on how many years you go back as to what the typical seasonality would be. So that's a variable number. And the business has shifted. I mean, we saw the business really shifting maybe 2 years ago as HDSL became less the driver, which had a very specific seasonal nature to it. And things like broadband became more important, which may be more project related. So I think it's harder and harder to relate just -- to rely just on, let's say, 5 years of historical seasonality, because I think within of those 5 years, you'll see some fairly dramatic swings.

Okay, that's fair enough. Also I wanted to follow up on the comment you made about having won some new business including for some new applications in the Tier 2 space, specifically. And it didn't sound like any of those revenues showed up in the first quarter, but can you just comment on when you expect those Tier 2 wins to translate into revenues?

They'll translate throughout this year. I mean, some of them will start in this quarter and some of them -- actually, I think, most of them will probably start this quarter, but -- and then they'll ramp up or they'll complete. So they'll -- just going forward, we'll see them this year.

Okay. And just the last one I had is on the international market where you talked about increased activity, and that business was actually over 20% for you sequentially. Do you view that as the beginning of a sustained improvement for your international business this year? Or do you think it's likely to remain lumpy?

Jim, do you want to take a stab at that?

Well, we do see an improvement. There is potential it could be lumpy though, as with various parts of our business. That's...

Yes. I mean, that you had -- if you had asked me what you are asking me today, do we expect it increase through the year? The answer to that would be yes. I think, to be honest with you, the farther out we get, one of -- you know if you were to try to tell me, ask me, what is the international business going to do in Q4? I think that would be a difficult question to answer. But going forward, in the near term, do we expect it to increase, the answer is yes.

And we'll take our next question from Sanjiv Wadhwani with Stifel. Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division: Tom, there's been some mixed signals about Tier 1 U.S. carrier spending. And I was wondering if you could sort of just give us some comments about how you saw that trending through Q1 and sort of do what you think is going to happen in Q2 with the sort of overall Tier 1 spending?

Yes. I know there has been and that's one of the reasons that I commented with a little bit more granularity on the U.S. carrier spend. To us, the carrier spend was basically flat in the U.S. with the exception of, we saw a decline in HDSL which we think is just a secular decline in that particular product area. And then that, of course, that decline was made for on the international market. So I mean, we really didn't see a significant change in the spending pattern. Activity levels typically pick up in the -- in Q1. They absolutely picked up this quarter compared to fourth quarter where people are typically winding down, but the environment itself felt very similar, the U.S. environment or the U.S. spending pattern was similar to what we saw in Q4, which is why we ended up with kind of a flat U.S. carrier spend level. Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division: ; I guess, the question is that's typically better than normal seasonality, isn't Q1 sort of a slower start, and things kind of start ramping maybe toward the end of the quarter into Q2?

It depends on how quickly they ramp down in Q4. And I think it's a 50-50. I mean, I think it's tough to say that they would -- that they were typically down. If they are, they're down probably less than 5%. And if they're up, they're typically up less than 5% unless there is a big market share shift. It's pretty much what we would've expected actually.

We'll take our next question from Ehud Gelblum with Morgan Stanley.

A couple of questions. First of all, it sounds like BBA grew sequentially. If we were to exclude that from the Broadband Access group, would broadband have grown sequentially as well? So I guess what I'm saying is that the growth in BBA is sequentially more than the $2 million increase that we saw in the Broadband Access, that's one. The second, you used to talk a lot about services, Jim. And the growth in service, especially as your Tier 1 in Latin America, that business grew. What -- where are services? Can get a sense has that continued to grow, and is that having an impact on margins and where do you think that goes forward, especially in your 2 big Tier 1 wins that you'll be rolling out for the next couple of years. And then looking at gross margin, can you give us some puts and takes this quarter versus last quarter, the 40, 50 bps that gross margin expanded and where do you expect that to go going forward, with all the puts and takes we're talking about?

Yes, let me try to answer your first question, Ehud. The sequential growth in the international business was actually -- was in excess of the $2 million that you mentioned, okay? Did I cover the entire question on the first one. I want to make sure I caught it.

So basically what you're saying is that the growth in the Broadband Access was due to growth in BBA and then some. And so ex-BBA Broadband Access core, actually -- and Broadband Access essentially declined sequentially? Is that...

You're right. It was basically flat. It was basically flat.

It was basically flat.

Okay. So the growth in BBA was up $2 million?

In terms of your services question, Ehud, the relationship to total revenue over the last couple of quarters really hasn't changed that much, if that helps, okay? Now in terms of, on a go-forward basis, I think it's going to depend on how newly awarded business will grow in relation to total services, okay? And that's going to be hard to say at this point, all right? So we had the hardware side of things at play with the new award. I know that doesn't answer your question, but that's kind of just it.

The puts and takes on gross margin going forward, given it sounds as though when this European Tier 1 comes in on the second half in terms of revenue, it sounds like the margins a little bit less. And I also wonder, as you get into the U.S. Tier 1, is that going through -- is that going directly or is that going through your partner Ericsson that you've done some of that business in the past and how does that impact gross margin? So how should we be modeling gross margin throughout the rest of this year and into next year?

Well, the question in terms of how to model gross margins for the rest of this year and next year -- all we have at this point, Ehud, is a quarter outlook for the current quarter. We certainly have opportunities at play that are not finalized yet. And which may or may not have any impact on gross margins. So it's really too early to say at this point. So that's really all I can say. I'm not being helpful, I know, but at this point, that's all I can say.

Well, let me try a couple of other things then. International was very strong, up around $6 million sequentially. It sounds as though the BBA was up only a couple of million. So the rest, we assume, that they're -- the other $4 million of international strength came from your traditional customers, like your friends in Latin America?

Right. That's right.

Okay. What inning are we in their build? I know we have several phases of that build-out. There was a period of time when there's a pause in their build-out, now it seems that they're back. Is this a late stage build-out or they're still early or in the middle?

Let me cover a piece of that. So this is a multiphase, and the way we will look at this build-out is we complete Phase 1, then we go Phase 2, then we have a Phase 2 plus and we are kind of in the middle of that. We fully expect there to be a Phase 3 and a Phase 4 and probably a Phase 5. So if you look at it from a number of phases that we are, I'd say we're very early. And if you look at the penetration rate, with the type of speed that are trying to get to, I have no doubt we're very early in the build-out there. The problem that we have that makes it difficult to forecast is that those phases kind of get dropped in periodically, and then you how to react to them and there's not a lot of forecasting of that upfront. But I would say we're very early in the build-out.

Okay. And Phase 2 plus is almost complete or Phase 2 plus has just started?

Well, I mentioned, I think last quarter, that I expected the current activity level with Telmex to be meaningful at least through this year and I would expect it to be longer than that at this point.

Okay. I appreciate it. One last thing if I could. Internetworking was strong again in Q1, it was strong in Q1 of last year and then fell off as the year went on. The previous year, in 2011, it was the opposite, started low in Q1, got stronger as the year went on. This year, we're starting off strong again. What's the seasonality you're looking at in Enterprise and what makes that thing tick as we go throughout the year?

Well, I think last year, we had some strength. But that strength actually was being carried over from Q4, and we were -- as we got into Q2. But there's no doubt that towards the tail end of Q1, we saw some softness, but it wasn't clear at that point in time what the driver was. But we -- then we saw that continued softness through Q2, and would say that's not the way it feels today. The actual -- the order rate actually increased through the quarter and we're early into this quarter. But we're still feeling pretty positive that we're in the right direction.

And we'll take our next question from Barry McCarver with Stephens, Inc.

Just a couple of things you've already touched on, just that I wanted some clarity on, I guess. In terms of the progress in Tier 2 and Tier 3 spending, you mentioned in your prepared comments despite the continued difficulty in the regulatory environment, do you feel like that spending is coming from these carriers really loosening up and starting to look at their budgets? Or was it more just maybe product enhancements on your part or spending they think they had to do regardless of the regulatory environment? Trying to get the idea there.

I don't get the sense that there's a lot of loosening. I kind of characterize the environment on a previous question as being similar to Q4, and Q4 was not a loose environment for Tier 2 and Tier 3 spending. So I would say in the majority have not -- I would say, the majority of the carriers that we deal with, it's still a tight environment. And we're -- really the way that we're going to be able to grow that business at least until that regulatory clarity comes in is through market share gains.

Okay. And then secondly if I can, back on margins. I understand your guidance for the next quarter, but looking specifically at BBA and your outlook there, you mentioned those are still running below your typical margin. Any expectations this year that that's going to improve significantly or longer term?

Longer-term, without a doubt. This year, we'll see some improvement as we go through the year on a cost basis, we'll see improvement. We're already seeing some improvement. We actually saw improvement through most of last year and into this year. And we have some fairly dramatic cost decreases which will be coming in. But some of those are not scheduled until next year, those have to be actually scheduled with customers. So do we see it getting better in totality? Absolutely. We think our cost base is going to go down. What our gross margin is going to be on any particular quarter is also going to be dependent on the customer that we actually sell to then.

And we'll take our next question from Eric Ghernati with Bank of America.

Jim, as far as your core BBA business excluding NSN. What's -- how should we think about the expectations for those going into second quarter? Clearly it does sound like the NSN business is going to have a bigger ramp into Q2 as opposed to the core BBA business. Just wanted to see if that assumption is correct?

I think that that's a reasonable assumption. We are seeing an increase in activity in both areas. But I think BBA, in terms of the acquired BBA, would be sequentially up, probably to a larger extent.

Let me add one comment, which makes that a little bit -- you would think it would be a fairly clear question to ask, first of all, of course we're still a book-and-ship business. But some of that revenue associated with the, I'll call it, the organic international business, the non-BBA business, is just depending on installations. It's a lot -- some of that is now service-oriented business or even the recognition of the revenue is dependent upon service installation completion. Which to some extent is in our control, but not to the majority, not to the majority that is in our control. So it's difficult. We needed to leave ourselves some wiggle room in the way that we think about that international business. And so probably -- it's tough to say that specifically where it will be in Q2 at this point in time.

Okay. Another question is with respect to the gross margin. I mean, it sounds like the NSN business is -- just doing some quick math here, actually saw some pretty sizable improvement in gross margins. I'm Just curious as to why you -- your guiding for flattish overall gross margins despite the fact that we've -- it sounds like you still have some cost reductions to be had in the business, which will improve on a sequential basis into Q2.

Well, you all saw -- we mentioned a couple of times on the call that the gross margins on the BBA business is much more volatile than the gross margins on the non-BBA, the 5000 business. And the reason for that has to do with the chassis sales versus line card sales, which can impact us and actually have a meaningful impact on our gross margins. So even if we have cost reductions coming in depending on what our current view of chassis sales versus line cord sales, then that would still have an impact on what those gross margins will be.

Okay. And just like a -- as a follow-up on the Internetworking business. It's been under quite some pressuring throughout last year, this year it's off to the very strong start in Q1. It does sound like counterintuitive to what we're hearing from the carriers here in the U.S. where they say, it looks small, medium-sized business, which is the target market for your Internetworking business is still under pressure. Do you think there was a little bit of a -- I mean, you said there was broad-based improvement. But don't think that some of that maybe just this inventory replenishments related or something like that, can you just clarify what's happing?

Yes. To be honest with you. I could be -- there could be some of those that's inventory related. I know our sense of the strength in -- so let me take the 2 pieces and take them apart. One is my comment that was there was no one customer that actually was way above other customers. That in general, it was a broad-based improvement, which leads you to believe unless the whole customer base had the same inventory adjustment problems that, that wouldn't be the case. And then the other piece that I can just comment on is that if we look at the order flow and how the order flow appeared in the quarter versus last year, last year we had a fairly strong Q1 and then it disappeared on us through the rest of the year. And if I look at the order flow of last year, I would say this year has a different order flow, that it's actually stronger as we exited the quarter and continued to have some strength. So that gives us some sense that -- I would not say that there was an inventory adjustment in there, I'm not aware of any, but I - it absolutely could be true. But the sense is, right now, that we have seeing better strength there, so -- and we'll know at the end of next quarter. But that's our feeling at this point.

Okay. And just one last question. I mean, if you were to look at your U.S. Carrier business and you strip out the portion that goes into Internetworking and also the portion that goes into HDSL, I mean, is it fair to say that going into Q2, the environment, as you look at it, hasn't really changed much and that you're more positive on your international business rather than your U.S.-based Carrier business that is non-enterprise?

Okay. When you say less -- maybe less positive, we saw basically, for the non-HDSL business, flat is basically -- we saw the U.S. Carrier business from Q4 to Q1. We typically, and we still expected to see some seasonal uptick from Q1 to Q2, right, whether or not that's muted seasonality or whether or not you go 2 years back or 5 years back to figure out what that seasonality is, it's really up to you. But so we would expect to see some level of uptick in the U.S. business, but I wouldn't characterize that level of uptick because -- being driven by any change in environment. I would say, the environment right now, my guess would be that the environment would be the same for this quarter as it was last quarter, which was the same as it was in Q4.

And we'll take our next question from Mark McKechnie with Evercore Partners.

So mine is kind of a bigger picture question. In your commentary, you talked about a carrier Wi-Fi offload project, and wanted to dig in a little bit. I'm assuming a lot of that's related to Bluesocket. But I'd like to know, do you think this could be a material contributor this year or next? And what are some of the products that you'd be shipping into the carrier Wi-Fi offload area?

Okay, my comment was really -- so I will say, on carrier, when I talk about mobile carrier, we did pick up some ones in Ethernet over Fiber for our Total Access product line, which I just want to make sure there's the distinction between that. The other comment that I made about Wi-Fi and carrier offload were specifically about our Bluesocket products. We are in trials at several, meaning, more than 2 carriers, to either do carrier Wi-Fi offload or, in some cases, looking at it for multi-premise Wi-Fi solutions that are hosted. And we view both of those as very legitimate and potentially large opportunities for the Bluesocket piece. Of course the amount of development that you have to do in order to fine tune these for each of the individual carriers can be somewhat burdensome. So we are going through an awful lot of prioritization on those developments. But it had -- but I would say, the carrier space in general is one that I feel we are relatively untapped and -- or is untapped for us, and we see good promise there. The only other pieces that we are using also carriers as a resale agent and they've already started doing that, they started doing that I think towards the tail end of last year, Jim, and we'll see a pickup in activity when they're actually just reselling this product as, in effect, a channel to market for the product.

And we'll take our next question from Bill Dezelem with Tieton Capital Management.

A couple of different questions. First of all, relative to gross margins in the first quarter, relative to the fourth quarter, it was lower and yet revenues were slightly higher. And hoping that you can give us some clarity on that. And then secondarily, in Latin America, what are your thoughts there relative to all of the chatter about breaking up some of the larger carriers and the potential delays or negative possibilities that could lead to for ADTRAN in terms of spending?

Do you want to cover...

So Bill, I just want to make sure I understand your first question. You're talking about the gross margin variance from Q4 to Q1, is that correct?

That's correct.

Okay. And we did increase 50 basis points, okay? So I want to make sure you I understand your question. I think you talked about a decline?

Jim, the implication is that I didn't do my math right. Let's just skip the question, and I'll come back later.

Okay. As far as the second part of the question, which is what's going on in Latin America. So our products -- when we initially started our first phase of products, sales of our Fiber-to-the-Node products there, they were initially driven for the potential of IPTV and offering television service. That has been the initial drive that somewhat fell through. In fact, it did fall through as far as the carrier being able to secure that franchise. And we saw a lull in business. That was kind of the first phase, we saw a lull in business. And then the drive started being towards higher-speed Ethernet. And what has driven us from that point forward to this point in time has been high-speed Ethernet. I think a lot of the chatter around what's going on in Latin America in regards to the break up of services has much to do with television franchise capability and what's going to ultimately be allowed there as much as anything else. There's -- I don't think there's any doubt that if a carrier is using our equipment and they are able to offer IPTV services or franchise-for-video that, that would be a great bolster to our sales potential within that particular carrier. And it would also, in some instances, force an upgrade of the existing infrastructure into a higher-speed infrastructure, which of course is positive and we've experienced in different areas. So, yes, if it doesn't curtail what our growth potential could be, if there's -- if these things don't come to fruition, it does. But does it actually stop our business? I would still go back to say that the majority of our business today, into Latin America, is driven by a simple Internet access at a higher-speed and we don't see that really changing.

We'll take our next question from George Notter with Jefferies. George C. Notter - Jefferies & Company, Inc., Research Division: I wanted to ask about the HDSL business. I think you said earlier that any decline in that business going forward will be immaterial to financials. And I think you also said HDSL was around 8% of sales this quarter. Is it fair to assume that HDSL is disproportionately smaller as a percentage of operating profit relative to sales? Or how would that stack up?

So HDSL was $11 million. And I think -- I would just put this little caveat. I think I said relatively immaterial. So if HDSL sales -- it's $11 million or whatever the number is, I think everybody is in agreement that it won't go to 0 anytime in the near future. So we just think that the movements from here on will just have less of an impact. HDSL, from a gross margin perspective, we've always said has been in the corporate average. I will tell you there's no R&D to speak of associated with HDSL, so from an operating income perspective, I would say, it probably is positive. But to be honest, I don't know if that would -- it's been -- there's been very little R&D in that product area for quite some time. And those engineers have been moved over to the broadband area. So gross margin-wise, of course, that's a -- when our gross margins were in the high 50s, it was a -- basically in line with what our gross margins are. At this point in time, I'll be honest with you, I haven't looked at it specifically. At this point in time, I would say that it is above our corporate average, it would have to be above our corporate average at this point. George C. Notter - Jefferies & Company, Inc., Research Division: Okay. And then the other question I had just had to do with the NSN broadband business. You guys had talked about some warranty expense filtering through that product line this year. Can you just remind us when that warranty expense would run off, and I have to assume that help on gross margins at some point?

Jim, would you...

Yes. Last quarter, I think we talked about it lasting to some extent through the second quarter. George C. Notter - Jefferies & Company, Inc., Research Division: Got it. Okay. Great. Is that a big driver of gross margin in that business? Or is it small relative to the mix? I think you talked about chassis line cards, et cetera.

No, chassis line cards are a much bigger mover than that expense.

Right.

I mean, for the size of that business, it was a material piece that happened that we're looking through. But in the overall aggregate, I mean, without a doubt, the chassis line card piece is the bigger piece. Okay. Thank you. I think were out of time. So I would like to thank everyone for joining us on the call, and we look forward to talking to you this time next quarter.

And this does conclude today's conference. You may now disconnect and have a wonderful day.