ADTRAN Holdings, Inc. (ADTN) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN's Second 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, 2013 (sic) and Form 10-Q for the quarter ended March 31, 2013. 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, Josh. Thank you for joining us for our second quarter 2013 conference call. With me this morning is Jim Matthews, Senior Vice President and Chief Financial Officer. I would like to begin this morning by discussing the details behind our Q2 results, and I'll end with some comments on what we see for the future. We will then open the call up for questions. As stated in our press release, revenues for the quarter were $162.2 million, exceeding our initial estimates. Highlights for the quarter included a greater-than-expected rebound in our Enterprise business, increasing strength in our EMEA business, market share gains with Tier 2 carriers and a slightly stronger Tier 3 spending environment. Our Carrier Networks division revenues came in at $123.3 million, up 12% sequentially led by our Broadband Access category. The increase was driven by market share gains in our domestic Broadband Access business, as well as an increase in shipments to Europe and the Middle East. Our Enterprise division's Q2 sales totaled $38.9 million, a strong 17% sequential increase and a 24% year-over-year increase, driven by our Internetworking category, which on a combined product basis, including both Enterprise and Carrier products, grew 19% sequentially and 26% year-over-year to a record $43.9 million. Total company domestic revenues came in at $127.5 million with International revenues coming in at $34.7 million. On a product basis, as I've mentioned before, Broadband Access had a solid quarter as we saw the benefits of our market share expansion into Tier 2 and Tier 3 U.S. markets and the benefits of our recent Broadband Access acquisition. The strongest product areas were the TA5000 platform followed closely by the hiX 5600 platform. The TA5000 performance was positively impacted by Tier 2 market share gains as well as a slowly improving spending environment in the Tier 3 space, as carriers began to acclimate to the new CAF regulations. Likewise, the hiX platform benefited from improvements in Europe and the Middle East. Our Internetworking product category also performed well with solid sequential growth in all major product areas. Our router product area led this growth followed by Carrier Ethernet and IP gateways. From a channel perspective, we saw an increase in sales in both carrier distribution and our value-added resellers. During the quarter, we added approximately 100 new value-added resellers to our programs. Other activity of note in the quarter for the Enterprise division included our NetVanta products being selected by a major European Tier 1 carrier for a wide-scale delivery on managed Ethernet services. And during the quarter, the Enterprise division secured primary vendor status for wireless LAN services at a domestic Tier 1 carrier and a domestic Tier 2 carrier. I had mentioned at our last call, RFP activity surrounding 2 major infrastructure upgrades and I view these 2 opportunities as progressing well from our last call. We will commence shipping our vectoring technology to one of these carriers based in Europe this quarter. The other carrier, a U.S. carrier, remains a 2014 revenue opportunity. Looking forward into the next several quarters, we believe our business will be positively impacted by several factors. First, we have begun to see signs of spending environment improvement, most notably in our Enterprise business. The broad-based nature of this improvement gives us some confidence that it is a sustainable macro improvement. Secondly, as I mentioned above, we are starting to see the effects of improved clarity relating to the USF to CAF transition. And although we will not characterize the environment as back to normal, we are seeing improvements nonetheless. Finally, our market share gains and global expansion is timed well with carrier cycles associated with the roll out of ultra high-speed access. As carriers around the world embrace next-generation access technologies to strengthen their competitive positions and meet their customers' growing demands. As most of you are aware, there are several major carriers who have already laid out their plans for this cycle, and we believe we are in the very early stages of this major infrastructure upgrade. I would now like Jim Matthews to review our results for the second quarter 2013 and our comments for the second quarter -- third quarter 2013. We will then open the conference call up for questions. Jim?

Thank you, Tom, and good morning, everyone. Revenue for the second quarter increased to $162.2 million compared to $143 million for Q1 of 2013 and $194 million for Q2 of 2012. Broadband Access product revenues for Q2 of 2013 were $81.6 million compared to $72.2 million for Q2 of 2013 and $106 million for Q2 of 2012. Internetworking product revenues for Q2 of 2013 were $43.9 million compared to $36.9 million for Q1 of 2013 and $34.9 million for Q2 of 2012. Optical product revenues for Q2 of 2013 were $16 million compared to $8.9 million for Q1 of 2013 and $14 million for Q2 of 2012. Carrier Systems revenues for Q2 of 2013 were $105.5 million compared to $92.8 million for Q1 of 2013 and $126.8 million for Q2 of 2012. Business Networking revenues for Q2 of 2013 were $45.4 million compared to $38.1 million for Q1 of 2013 and $36.6 million for Q2 of 2012. Loop Access revenues for Q2 of 2013 were $11.3 million compared to $12.1 million for Q1 of 2013 and $20.7 million for Q2 of 2012. HDSL product revenues for Q2 of 2013 were $10.3 million compared to $11.4 million for Q1 of 2013 and $19.5 million for Q2 of 2012. As a result of the above, Carrier Networks division revenues for Q2 of 2013 were $123.3 million compared to $109.9 million for Q1 of 2013 and $152.7 million for Q2 of 2012. Enterprise Networks division revenues for Q2 of 2013 were $38.9 million compared to $33.1 million for Q1 of 2013 and $31.3 million for Q2 of 2012. International revenues for Q2 of 2013 were $34.7 million compared to $34.9 million for Q1 of 2013 and $53.6 million for Q2 of 2012. To provide the reporting of each of these categories, we have published them in our Investor Relations web page at adtran.com. Gross margin was 49.2% of revenue for Q2 of 2013 compared to 48.7% for Q1 of 2013 and 51.7% for Q2 of 2012. The higher gross margin compared to Q1 of 2013 was primarily attributable to a more favorable customer mix in North America. The lower gross margin compared to Q2 of 2012 was primarily attributable to a less favorable customer mix in North America and a higher mix of revenue from the EMEA region in Q2 this year. Total operating expenses were $65.7 million for Q2 of 2013 compared to $63.1 million for Q1 of 2013 and $68.4 million from Q2 of 2012. The increase in operating expenses from Q1 of 2013 to Q2 of 2013 was primarily attributable to higher sales volumes. The decline in operating expenses from Q2 of 2012 to Q2 of 2013 was primarily attributable to a reduction in R&D sales, marketing and G&A expenses in our organic business, partially offset by the addition of a third month for a full quarter of operating expenses for our recently acquired Broadband Access business. Acquisition-related amortizations totaled $0.9 million for the quarter. Stock-based compensation expense, net of tax, was $1.8 million for Q2 of 2013 compared to $1.9 million for Q1 of 2013 and $1.9 million for Q2 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 Q2 of 2013 was $2.8 million compared to $3.2 million in Q1 of 2013 and $5.9 million for Q2 of 2012. Q2 of last year included a bargain purchase gain of $1.8 million related to the acquisition of the Broadband Access business. The company's income tax rate was 41.4% for the second quarter of 2013 compared to 35.7% for the second quarter of 2012. The higher tax rate for the second quarter of 2013 relates to adjustments in the deferred tax asset valuation allowance for the acquired Broadband Access business, partially offset by a benefit related to a research tax credits this year. Earnings per share on a GAAP basis, assuming dilution for Q2 of 2013, were $0.17 compared to $0.13 for Q1 of 2013 and $0.33 for Q2 of 2012. Non-GAAP earnings per share for the quarter were $0.21 compared to $0.17 for Q1 of 2013 and $0.38 for Q2 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 $87.8 million at quarter end compared to $95.8 million at the end of Q1 2013 and $103.8 million at the end of Q2 of 2012. Net trade accounts receivable were $103.5 million at quarter end resulting in DSOs of 58 compared to 52 DSOs of the end of Q1 2013 and 59 DSOs at the end of Q2 of 2012. Unrestricted cash and marketable securities, net of debt, totaled $419.9 million at quarter end after paying $5.4 million in dividends and after repurchasing 3.2 million common shares for $67.4 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 third quarter of 2013, we expect total company revenues will increase sequentially in the range of mid to high single-digit percentage points. Although gross margins have continued to improve this year, our European business continues to be at lower gross margins as compared to our organic business and large fluctuations in volume between those 2 businesses can drive variations in our consolidated gross margin. For the third quarter, we expect consolidated gross margins to decline due to increased volumes in our European business as a result of newly awarded business from a large carrier. We expect GAAP gross margins for the third quarter will be in the mid to high 40s percentage point range. We do expect gross margins will begin to improve in Q4 of this year as we begin to see some benefit from product cost reductions. We expect GAAP operating expenses for the third quarter will increase slightly on a sequential basis. We anticipate a lower tax rate in the third quarter due to improved profitability of the recently acquired Broadband Access business because of higher sales volumes. We expect the consolidated tax rate for Q3 to be in the mid-20s percentage range -- percentage point range to pretax income. We believe the larger factors impacting the total revenue realized for the third quarter of 2013 will be the following: The macro spending environment for carriers and enterprises; 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, back to you.

Thank you. Josh, at this point, we'd like to open it up to questions.

[Operator Instructions] And we will first go to the side of Rod Hall with JPMorgan. Roderick B. Hall - JP Morgan Chase & Co, Research Division: Tom, I just wanted to get you to comment a little bit more. You said that you'd seen the spending environment continue to improve. Could you give us a little bit more detail on, regionally, where you see things improving from a macro point of view? And also, talk to us a little bit about the split between Enterprise and Carrier on that. I mean, are you seeing improvement on both sides of the equation? Or do you think it's mostly Carrier that mostly that you're referring to? And I have one follow-up to that.

Sure. So I would say the biggest improvement we saw was actually in our Enterprise division, but that improvement included a CLECs. So we saw a good pickup in our CLEC business, as well as our standard Enterprise business selling to end users. Secondly, the Tier 3 space actually did fairly well for us this quarter. And it had been dragged out for a year or so. So that was the first time we saw some pickup there, which we do think has to do with the CAF regulation, the changes in those regulations that happened earlier this year. And people just starting to understand more how to work with the new environment. And then lastly, without a doubt, we saw Europe starting to pick up, especially towards the tail end of the quarter. The order flow from Europe was fairly strong. Roderick B. Hall - JP Morgan Chase & Co, Research Division: Okay. And then I also wanted to -- you said you commenced vectoring shipments this quarter, I assume that means you've actually recorded revenue for that vectoring equipment.

When I say this quarter -- excuse me, when I say this quarter, I mean, third quarter. Roderick B. Hall - JP Morgan Chase & Co, Research Division: Right, okay. So you would expect some revenue in the third quarter from that vectoring equipment and then I wondered -- can you just confirm that that's the case? And then also talk to us just a little bit about the ramp of those shipments, how you expect that to go over in the next few quarters?

Yes. So I think there'll be seasonality in this customer just like there typically is, so I would expect a lower fourth quarter. I will say that the shipments this quarter are going to be meaningful in the third quarter, which is one of the things that Jim touched on. And then we would expect them to pick back up some time similar to what we saw -- had seen here in the U.S., which is sometime in the first quarter you'd see that pick back up and then you'd see them accelerate. Without a doubt, our view is at this point of the business, that we'll see next year will be substantially larger than the business we will get this year. Roderick B. Hall - JP Morgan Chase & Co, Research Division: Okay. And then you said on the TA5000, you said it was strong. And you had share gains in Tier 2 carriers. Is that share gains in existing footprints? Do you expect those share gains to continue? Or could you give us a little more color on that? I think that's my last question.

Sure. So in 2 of the Tier 2 carriers, it was just flat out new applications that have gotten approved. So you can kind of consider that to be new footprint. In the other 2 of the Tier 2 carriers, one of them was an ongoing continuation so, really, no share gains there. But in the fourth one, which was the largest one, we're really just starting to monetize the 90% market share award that we actually achieved last year.

Our next question comes from the side of Amitabh Passi with UBS.

This is Jim Hillier for Amitabh. I was hoping you could maybe give us a sense for, directionally, how the NSN BBA business trended in the quarter?

Really, we -- from -- I will tell you that, that customer is, or those customers, some of them have longer forecasting periods and place orders with more lead time than what we would typically see here in the U.S. So we have greater visibility and because of that, greater backlog visibility to some of those customers. But I would say that the order trend is up, just kind of accelerated from the beginning of the quarter.

Okay, got it. And then it also looks like you saw some quarterly improvement in Optical Access. Could you discuss some of the trends you're seeing there?

Yes. Probably, the -- I would to the biggest thing that happened there is we had talked last year about the fact that we were finally getting approval at a very large Tier 1 carrier here in the U.S. and that actually started shipping, so and that's for sell side backhaul. So that was a pickup. But then in general, we just saw just a general kind of pick up from, really, a low base in Q1, so I don't want to overplay that, but the most notable thing was actually that Tier 1 carriers are starting to deploy.

And then, I guess, finally, were there any 10% customers in the quarter? And can you tell us if they were domestic or international?

Yes, there were 2 10% customers and both of those were domestic.

Our next question comes from the side of Michael Genovese with MKM Partners.

First of all, I think you guys have said in the past that both AT&T and Deutsche Telekom are 9-figure opportunities, so I'm wondering, can you help us -- is it closer to the $100 million or the $900 million numbers? And what is the timing of this? I mean, are these things going to happen in 4 to 6 quarters? Or are these going to be spread out over 3 to 4 years?

So I don't think we've ever mentioned any customers specifically by name because that would get us into issues with those customers. The large opportunities we're talking about are, in our view, are multi-hundred million dollar customers and that's probably about as much color as we want to give on that because there is some variability in what they will do. This is over approximately roughly 3 years and they go a little bit longer than that. So that's the way that we think about it. One, of course, one has a greater potential to be meaningfully higher than the other one, but both of them are multi-hundred million dollars opportunities for us. As far as the timing, one of them, as I mentioned previously, is starting to ship this quarter and we don't see any real lull on that other than what we would see at normal seasonal -- things tend to slow down in the fourth quarter, then you'll see it pick back up next quarter. So that one is very, needless to say, very four wall [ph]. Products approved and being deployed as we speak. Then the second one is a 2014 event and that's where the large U.S. carrier who the schedules tend to fluctuate some with rollouts with that carrier, at least for us. So that one we're just a little more cautious about. So I'd tend to think about it more middle of next year. I think current plans would have it accelerated from that. But I'm always cautious about trying to give a specific quarter on that just because of the -- our history there.

Okay. That's helpful color. Now, when you talk about multi-hundred million opportunity, is that purely for equipment? I mean, is that the overall project that would include Carrier spending on labor or is that also -- what I mean, is that purely on your equipment and services?

That's ADTRAN equipment and services. And when I say if you just give me the latitude of multi-hundred million, it's ADTRAN equipment and services. There are some upside service opportunities at one of the carriers but it would still keep us in that range.

Should we think about this as being a fairly normal split between product and services as your typical business?

Yes, I would think so. That's the right way to think about it. There are longer term maintenance agreements with both of these customers. So I think if you think about what our split has been over the last 3 years or so, I think that's the right way to think about it.

Okay, and then just finally. Could you just -- what happened with the DSOs? Why did those go up so much? And what's behind that? And then just -- if you could talk about you're thinking about buying back so much stock in the quarter, what you're thinking there?

Sure. On DSOs, Michael, they did go up sequentially to 58, but below last year second quarter of 59, driven in large part by, really, the increased activity that we've seen from the acquired business, which those customers have traditionally, many of them, longer payment terms. I mean, there's a mix of payment terms amongst them all, but this quarter or Q2, the mix was higher towards the longer payment terms. So we do expect it to moderate, DSOs to moderate as we go through this year as that mix, we expect, will shift a bit as we go through Q3 and Q4.

And the buybacks?

Oh, the buybacks. So yes, I mean, we certainly had healthy activity in buybacks in Q2. We do continue to just consider the best use of excess cash would be buybacks going forward. We would continue to do that on an opportunistic basis.

Yes, and I'll tell you because there have been questions about this before. One of the things that -- from our view, the environment last year was very -- was a challenging environment for a lot of people on our space and we were hurt by that, too. And one of the things that -- it's good to have cash on the balance sheet when you're going through an environment like that. But we continue to think that's the best use of cash. And as, kind of, things clear up and you get better visibility, we tend to get a little bit more aggressive.

Our next question comes from the side of Simona Jankowski with Goldman Sachs.

You talked a little bit about improving activity in terms of orders from Europe towards quarter end. Was that specific to that one large customer that is beginning to ramp this quarter or was it broader than that?

It was broader than that but that one customer definitely contributed in a meaningful way towards that, but it was more than one customer.

Okay. And can you just paint the picture a little bit? You also, I think, commented on kind of seeing a multi-year axis infrastructure upgrade opportunity ahead of you that is only just beginning and there's 2 sizeable opportunities you've been engaged in. But can you just give us a little bit more detail of, do you think there might be other carriers like behind that, that might have similar opportunities that currently in the process of bidding for?

Yes, there are actually several. And the way I'd characterize it is up until, really, very recently, carriers were somewhat frozen in their ability to really compete with DOCSIS 3.0 and definitely DOCSIS 3.1, so they really want [ph] good alternatives. And 2 things have happened. One is fiber deployment has gotten substantially cheaper, so we have some carriers that are looking at increasing fiber deployments in order to kind of get to a more competitive network. And the other one that's probably impacting us more near-term is vectoring technology which, really, for the first time, allows carriers to deploy an 80 to 100 megabit service and truly be competitive and actually, in many cases, be a step ahead of where their competition is. The economics of deploying vectoring completely changed the landscape of how they view that business and I think most of them are very much aware of it, and they're just basically at different levels of engagement at this point in time as to when they will actually deploy it. So we really do view it as kind of a third phase of DSO deployment for vectoring and then I think GPON, the economics' just continue to get better.

Got it. Do you see any discernible impact on the spending environment in response to Google Fiber's actions?

I would say there's activity that's generated by Google Fiber's actions. And I do think that it does help kind of drive this whole sense that a 15-megabit service is going to be challenging to sell into the future. So I think it does actually help kind of carriers focus on what their plans are with their residential network. So I would say yes, but I wouldn't say that there's a lot of direct -- I think it is helping shape the architectures in the future but I don't know if I would say that there's direct movement yet. In spot cases there is, but in general, I think it's more architectural and longer-term planning.

Yes. And then just lastly, the 2 opportunities you've been highlighting at the multi-hundred dollar opportunities, can you just give us a sense roughly of what your share is of the total award? My understanding is in each of those cases, there's about typically 2 vendors in that buildout. So are you the majority or the minority share vendor?

Well, there are different applications within these awards. And for instance, in one of the awards, we will be a -- there is already an incumbent and we brought in the second vendor. We think our share there will be very meaningful. But in that exact same customer, there is a portion of the network which is very large, which we will be primary and in fact, single source. So in general, I take a look at the aggregate spend. I would say we're the majority in both of those carriers.

Our next question comes from the side of Ehud Gelblum with Morgan Stanley.

Just quickly on your 2 10% customers. One of them, I would imagine, is your traditional 10% customer that you had for some time. The second one, because you didn't have 2 last quarter, I'm trying to see, was that second one pushed over the 10% hurdle by the Optical Access build that you were talking about to a Tier 1?

No. No, it was not.

It was not, okay. And was that a -- the 10% customer someone you've had in the past, recent past, over the last couple of years or is it a brand new one?

Jim, I think they pop up from time to time.

Yes.

Okay, that's actually helpful. If we look -- if we try and parse your international business, can you give us a sense as to what the, as we know, that Telmex was strong last quarter. Can you give us a sense as to what your legacy or, let's say, your core ADTRAN, x the BBA, how that performed this quarter versus last quarter. Give us a sense if that was flat or up?

The core BBA -- the core ADTRAN business was actually down quarter-to-quarter and then it was made up by the BBA business, but that down was driven -- if I look at it on a regional basis, it was really driven by one customer and that has to do with just the fluctuations within that customer.

Right. Do you expect that customer to come back next quarter or is it more like they finished for now and then come back for Q4? Or...

Well, no, there's ongoing projects going on. So it has to do, as much as anything, with that customer's ability to deploy. So the products -- many of the products are there and just waiting and it's just matter of that carrier actually getting the deployment out of the door. So that -- the fluctuations that you see with that customer to which we've talked about in the past have to do with more of the deployment of and how quickly they can actually get the equipment out in the field and up and running.

So they have equipment and they have to still -- this is still part of the same phase of their buildout, kind of their multi-phased buildout?

It is part of the same phase of their buildout. And a lot of what we're doing, we talked before about that customer, we're having services and TA5000 equipment. All of that is actually being sold as they deploy. Did that make sense to you?

Yes, so -- but then I'm trying to understand, did they finish a phase here or they're still in mid-phase and so there's still more shipments that you have?

They're still in the mid-phase and we're still shipping equipment. It's just -- it's different types of equipment in many cases, but it's -- we're still shipping equipment.

Okay. So we should expect them, if not next quarter, in Q4 or Q1, although maybe Q4 not because of seasonality. Maybe Q1, we should start seeing that come back again?

Yes, there's just variability in how quickly they do it so the answer to your question is yes, though. I mean, there's -- there are absolutely plans to go out there and get this equipment installed and there's a need to get the equipment installed. So there's just variability in that customer.

Okay. And as far as the BBA business, it sounds that that's just going to keep going up now that you have 1 of your 2 Tier 1s, your Tier 1 projects starting real shipments in Q3, one of them kind of flowing through your BBA business. That sounds like that BBA business just goes up.

Yes. With the exception of the seasonal factor that we talked about, we feel very strong about that customer. I would say the BBA business itself, that's not the only customer that is doing well and that we really think will accelerate. But without a doubt, that customer should accelerate through next year.

Okay. So we should be modeling a down season on Q4 for that just as well and then back up again next year?

Even though we really don't want to give Q4 guidance. I mean I don't see any reason. We came into the last Q4 not really sure because it was a very new situation to us. But the reaction that we saw pretty much around the world with the BBA business was what we saw here in the U.S., which is we definitely saw a pullback.

Okay, that makes sense. Now digging a little bit deeper into the gross margin guidance that you gave. Two questions, one about the gross margin guidance and second about the gross margin for this quarter. I'd imagine that the Q3 gross margin dip is entirely related to the shipments. So is revenue going to ramp up that much that it brings gross margin down by 200, 300, 400 basis points?

It is directly related to the shipments. So -- but now there are several factors to that shipments, which Jim didn't go into. One is, so you will see a shift. I mean, just the European business is going to be strong in the third quarter. The other is the volume has come at us in a fairly quick manner. And so we are expediting quite a lot to keep up with the accelerated schedule. And then the third piece is, is on the new projects. As you would expect that there is more chassis shipments and in fact, that's heavily chassis-based. And as we talked about before, chassis shipments tend to have a lower gross margin profile.

Absolutely. And you got it back, I mean, on the back end. But how long do this chassis phase last? That's what I'm trying to just understand what the pace of gross margin over the next 1.5 years.

The chassis phase will actually last through next year, but I will tell you that we have cost improvements that are continuing to come online. So I think you'll see -- Jim have talked about an improving fourth quarter. And I mean, I would expect to see improvement through next year as well.

Okay, but you do expect -- sorry for taking too much time, but you do expect that these dip in gross margin to only be a 1-quarter long even though it was still doing chassis after that?

I would expect our gross margins -- so 2 things I think will happen. You'll see an acceleration there, but as we talked about before, next year, you'll also see an acceleration in some other pieces of our U.S. business. So you'll see an offset there just in the mix. And we will have cost improvements that are continuing to come online through this year and through next year. So I think both of those will mitigate that.

The next question comes from the side of Rich Valera with Needham & Co. Richard Valera - Needham & Company, LLC, Research Division: Another question on gross margin. Can you give us an update on where the gross margins are on the BBA, the NSN BBA business and where you see them going over the next year?

Jim?

Well, the margins have improved. We do expect that the gross margins, as Tom said, that as we go through next year and see further cost reductions improve from what we saw in Q2 even from what we expect to see in Q3. The gross margin levels for the acquired business is not something that we disclose other than saying that they are lower than what we experienced in our organic business. But again, over time, we expected those gross margins will continue to improve. Richard Valera - Needham & Company, LLC, Research Division: I think you've recently talked about them as being sort of in the high 30% range. I just wanted to see if that was accurate. And I wondered where you were because I know when you acquired that business, you had a pretty specific roadmap in terms of the margin improvement. The first phase being to outsource the supply chain to a lower cost, then engage in supply chain and then the next phase being cost reduction. So just kind of wondering how you are relative to the roadmap and where you see that getting those margins to?

You're right and Jim can kick me here if I say something I shouldn't say. But we did start in the kind of 30-ish percentage range. And we had talked about getting it into kind of the mid-40-ish percentage range. And to be honest with you, we're right on track with that. But the thing that we had talked about on previous calls is the thing that, when we say that, you have to look at it over a broader window because chassis shipments, if we have a strong quarter in chassis shipments, then we're below that number. If we have a strong quarter in line cards shipments, to be honest with you, we're substantially above that number. So you have to look at it over a bigger window. So we see some -- we have seen some improvements from quarter-to-quarter depending on what that mix shift ends up being. And one of the things that's hurting us right now in the third quarter is the fact there is a higher chassis shipment piece. And because of the quick nature by which this business has come online, we are not using all of the low-cost things that we would typically use. For instance, chassis, you can -- there are higher-cost areas we can get chassis and there's lower cost. And if volume comes up quickly, then you tend to have to resort to the higher-cost areas. And that's one of the things that's hitting us also in the third quarter. As far as your roadmap is concerned, on a normalized basis, I would say we're still close to where we want to be and it's pretty much on track. Richard Valera - Needham & Company, LLC, Research Division: Great. And then I'll ask this, but I'm not sure if you'll be willing to go here. But when you look at the business sort of medium to longer term, can you say how you think about the gross margin? I mean, do you see it being 50% plus gross margin type of business? Or do you think it's sort of structurally ends up below that because of this mix shift towards the European business? Any color there would be helpful.

So I think some of that is going to be dependent -- there are several variables on that. Do I see it in the 50s? I really do. But there are a lot of variables that are very difficult to forecast. Our Enterprise business is well above that. Our U.S. Carrier business tends to be above that. We had talked about some aggressive pricing we did for the Broadband Stimulus piece. And we have caught up or catching up on the cost reductions associated with that Broadband Stimulus piece so I fully expect that to be above that. So it's going to depend on what's the Enterprise mix, what's the U.S. mix and how aggressive we can roll out additional cost reductions. I had mentioned before that -- or I believe I have mentioned before that we have a major cost reduction, for instance, in our European business that's centered around the middle of next year. And that will help boost the overall corporate average, too, especially when we expect that customer to be taking a significant amount of volume. And then we have this second carrier in the U.S., the Tier 1 carrier in the U.S., that will come online sometime in 2014 as well, which, when compared to the overall European business, will be a positive margin contributor. Richard Valera - Needham & Company, LLC, Research Division: Just one final one for me. Will that -- the Tier 1 coming on mid- next year, will that have margins sort of comparable to your current domestic BBA business?

Domestic... Richard Valera - Needham & Company, LLC, Research Division: Broadband Access business?

I probably don't want to get much more into that. I would say it reflects more the U.S. business than the European business, but I don't want to -- for probably obvious reasons, I don't want to touch too much more on that. But we think that in aggregate it'll be a contributor. There's also, of course, within that customer, there are multiple applications, fiber to the prem versus vector VDSL, fiber to the node, fiber to the curb, and the mix of that will affect what that gross margin profile will end up being as well.

The next question comes from the side of Simon Leopold with Raymond James.

This is Victor Chiu in for Simon. I just wanted to ask you about your Internetworking business a little bit. You mentioned a major Tier 1 carrier customer for your Internetworking products this quarter. Was this new business and was this an incremental driver for the Internetworking strength this quarter?

It wasn't a driver for the strength this quarter because it's really -- what I'd say as we were awarded the business, which means we haven't started shipping it yet. We would expect to really that to start shipping probably in the first half of next year. And it is a significant piece of business, especially for the Enterprise division. I mean, it is a -- I take a look at what we believe the volumes will be. They will ramp up fairly substantially over the next 3 years or so and really be able to help move the needle there. But it is not in our numbers today.

Okay. So I guess, kind of how should we think about the strength going forward? I mean, should we expect it to kind of continue at this rate, I mean, given that you've got this new business coming?

Yes. The good thing about what we have seen and we really started seeing a little bit of a pickup really even as early as Q1 is that it's really broad. So it's not like I have one customer that's driving the Enterprise number up. It's really pretty much across the board, which makes us feel good that it's something that's really sustainable. So I don't know if there was somewhat of a -- I'd characterize it as a rebound so I don't know if we saw a little bit of a rebound effect and that you'd the same type of growth that we saw from Q1 to Q2. But we fully expect it to continue to grow.

Okay. So it's fair to say that the macro trends are kind of...

Yes, that's really how it feels right now.

Okay, great. And relating -- just regarding the Optical business this quarter, with the exception of this quarter, it seems that the transition from SONET to WDM systems has impacted the Optical results over the last several quarters and it's actually been declining for 2 quarters now. So kind of what is your strategy to kind of address this? And were the results this quarter exceptional? Because I think you mentioned earlier that you didn't have a specific driver for that this quarter...

Yes. So that's why I said we had to pick up a Tier 1 carrier and they started deploying a little bit broader. But I will tell you that, that some of the uptick that you're seeing and to be honest with you, I don't have that quantification in front of me, but some of the uptick you're seeing is the fact that we have another platform, the 5000, which is also used in Optical deployment with the ONE, in Optical Networking Edge. So without a doubt, we saw a broader base pickup. And although I don't have it in front of me, I would venture to say that that was probably driven more by the 5000 and by the SONET gear.

Okay, okay. And looking forward, how do we look at it going forward?

I think that you'll see -- continue to see the 5000 portion of Optical go up and that will be a positive piece for the number. But I think the only -- the mitigating piece, as you had mentioned, SONET has been declined so there is a drag on the Optical piece that you'll -- that has driven by the 6100 SONET piece. So even though Verizon's a positive note towards that, I would still expect overall for that to be much more challenging than what we've seen in the 5000.

Next question comes from the side of George Notter with Jefferies. George C. Notter - Jefferies & Company, Inc., Research Division: I just wanted to ask you about the unearned revenue on the balance sheet. It was down a bit sequentially. I assume it was related to the NSN BBA business, but I just want some clarification there?

George, this is Jim. It actually relates to the acquired business and organic activity as well, okay, as it relates to our services business, okay?

So a little color on that. So there's 2 pieces. One is we have customer service contracts in our -- predominantly in our BBA business that there's just timing associated to when those contracts get signed. So I don't think that business is going down. I just think that we happen to be in a period of time where we have contract negotiations going on with several customers at the same time and we have not yet re-upped that. Those will get re-upped though. One other piece that's happening and I think is impacting that number is the BBS business, the Broadband Stimulus business, was very much a rough contract-type scenario, where we would ship equipment and we would have to wait for customer acceptance to -- before we'd recognize that revenue. And as those systems get accepted, you'll see that number go down. But I will tell you, as I mentioned in my comments, that the order flow from that area has actually picked up. So it is actually being replaced by things that just aren't reserved because our normal terms with almost all of our customers is, we wreck and we ship it, they receive it, they get tied on and we recognize it. So the lost [ph] contract BBS kind of portion actually shifted that some.

Got it. Okay, that's helpful. And then the other question I had was just on the position you guys have in dialogue semiconductor. Can you remind me how many shares you still own there? And what pace have you guys been peeling out of that position? And how much longer do you think you can continue selling those shares?

George, that's a fact that I don't have before me at this point in terms of number of shares of that particular security, but...

We typically don't...to be honest with you, we don't break down on security that we own anyways.

Next, we will go to the side of Sanjiv Wadhwan with Stifel. Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division: Tom, I was wondering if you could give us an update on Tier 1 carrier spending in the U.S. How do you think it trended in Q2 and what do you think is going to happen for the rest of the year?

Well, the Tier 1 carrier spend we have in the U.S. is -- with the 3 Tier 1s, we have one that's predominantly broadband. That customer did well. It is one of our 10% customers. And then we have 2 that, as of today, are kind of HDSL, SONET and a little bit of broadband. I would say the portion -- the broadband portion of those customers was stable and we're really kind of waiting for this next phase that I talked about for that really did meaningful pick up and we do think of the meaningful pick up. The HDSL portion was down. Again, I think it's now down to about 8% of the company's revenue so it's quite relatively immaterial at this point. And then the Optical piece we already spoke about. But I guess... Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division: Do you think the sort of trends continue as this broadband's sort of being stable to doing better and sort of Optical's being volatile with HDSL going down for the rest of the year?

Yes. HDSL is, I mean, if you look at the HDSL number, it's kind of on a -- and I hate to call it a 4%, but I'm sure I'll get hurt if I do call it a 4%. I would say -- but it's 8% of the number. So it kind of just bounces around there. Broadband will probably continue to pick up a little bit and then the real driver will be the next year and then it will substantially pick up.

The next question comes from the side of Bill Dezellem with Tieton Capital.

Two questions. Would you please remind us when you anticipate the cost reduction plan for the NSN acquisition to be complete? And then secondarily, we actually just missed your comments as to why the margins are going to rebound in the fourth quarter from Q3. Would you please go over that? And if you could have additional details and you add -- versus what you had before, that would be great too.

First of all, the cost reduction plan for BBA, the kind of stated plan that we had for BBA is pretty well done with the caveat that when we are expediting to the extent that we're expediting right now, we are not using necessarily the lowest cost providers. But that has also happened in the U.S. business. I think the delta is probably larger in our European business. So you're seeing that impact that happens in the -- that happened in the third quarter. In the fourth quarter, with that much of visibility and that much time, I think you'll see that mitigates some. And you'll see that's why we're talking about a margin improvement. I also think that due to the seasonal factors that we'll probably see a more favorable mix of U.S. to International. But having said all that, the net -- next big leg of cost reduction is about middle of next year and that has to do with the introduction of new products. And I don't -- that is a stated very much focus of ours. But I will also say that cost reduction is something that we continually do. So I mean we'll continue to try to improve gross margins on that. Typically, as we bring on a new customer of this size, which you'll see has a gross margin impact upfront and then you'll see us as we continue to cost improve things that, over time, that area will get substantially better. And we think that's exactly what will happen here. Did that answer your question?

I believe so, but it does raise another. You've mentioned the mid-2014 or mid-next year when -- that's the next big leg of cost reduction. That also happens to tie in with the time frame you mentioned for the large U.S. opportunity to begin to ramp. Is that pure coincidence or how is that tied together?

No, that's absolutely pure coincidence. They're completely different product sets. Now to be honest with you, we will benefit from the volume associated because the components are similar. So there's no doubt it puts us in a much better negotiating position from a component perspective. But they're really just different products.

The next question comes from the side of Michael Genovese with MKM Partners.

I just wanted to get more color on these Tier 2 market share gains that you're talking about. I mean I believe you said earlier in the call that the organic Broadband Access business, or the U.S. Broadband Access business, was down sequentially. So I'm trying to square that with market share gains. Like what gives you the confidence that you are making these market share gains?

Well, it's really has to do with the fact that we're getting approvals for applications that other people were approved for before. So in 2 of the Tier 2s, we know for a fact that we weren't selling into these applications a year ago and we're selling into them now. And that's -- so that's an easy thing to figure out. The other piece is on the largest one. We have a stated agreement with them. And as they started to pick up their sales this year kind of coming out of Q1, they're living up to the agreement that we have, and that's a substantial increase in market share. To be honest with you, it's probably 40% or 50% increase in market share than what we were guaranteed last year or what we were getting last year.

Okay. Can you make any comments on the -- I know you don't want to talk specifically about customers too much. But I guess the Tier 1 we haven't talked so much about. That's traditionally your largest customer where there's been some market share questions. Any market share comments in that account?

I would say that we're -- why I've mentioned before that account did well for us. The area, I mean, the rollout of IPT services in that customer, I think, is very positive for us. So we're doing a good job of keeping up. And then that is one customer that is, right now, looking at longer-term plans and how fiber will play into their network and how vectoring will play into their network. And so I think in general, I feel good about that. I think we're doing well. We've talked before about the fact that the west portion of that customer was predominantly less. We feel very strongly and we still have a very good installed base and we are still growing our footprint there as they continue to do the IPTV service. And I think we're hitting it on the east. So really, no big change.

And our next question comes from the side of Paul Silverstein with Cowen and Company.

Josh, I think this'll be the last one because I think we're just about out of time. Go ahead, Paul?

So Jim, can you remind us, the TA5000, the ramp, if I remember correctly, it was in the 2008, 2009, where we really ramped big time? There's a question attached to this.

It was probably more -- it was really more -- it was probably more '09, '10.

All right. So here's the question. This is what I'm trying to understand. When I look back at your ramp on the TA5000, when I look at the gross margin numbers, there doesn't appear to have a been an adverse impact that was chassis- and line card-related. And I assume the platform is not very different from the hiX with respect to VDSL vectoring rollout and the other stuff you're doing with the European carrier. So I'm trying to understand what's different.

Literally, the difference is the mentality and the price points of that business in that region are just different than the mentality and the price points in this region. So we have, in the U.S., at least to my knowledge in any significant way, we have not really played well for the other. We haven't given chassis away in any big way in order to secure line card business. And when I say give them away, sell them at a substantially reduced price. That is just not the case in the acquired business. There's a history there. We've been doing that for some number of years and that is just -- and the competitive environment does the same thing. So it's got more to do with what the customer expects in those particular regions.

So the chassis line card concept in terms of differential, put aside dramatic difference in margins, but you're telling me within North America, there really is a negligible impact in terms of chassis and line card ratios?

Yes, I would say -- I mean, that's why you just didn't see the impact on our gross margins that you just -- it just -- historically, it's never been that way.

One other quick question if I may, and I apologize because I know you all were asked this before. But in terms of the split right now between Ethernet and legacy SONET within Optical Access, I heard you say you didn't have the number in terms of the growth rate, but do you have the split between the 2?

No -- no, to be honest with you, that growth rate would be on that same sheet of paper. And I don't really want to venture a guess. It's not 90-10. It's probably closer to 50-50 or something like that, which is I'm venturing a guess, but I don't know that for a fact -- Okay, all right. Thank you very much. Thank you, Josh, for hosting us here. And we look forward to talking to everybody next quarter.

This does conclude today's conference. Thank you for your participation. You may now disconnect.