Ladies and gentlemen, thank you for standing by and welcome to ADTRAN’s First Quarter 2016 Earnings Release Conference Call. [Operator Instructions] Please note this call maybe recorded. I will be standing by if you should need any assistance. 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 cost, manufacturing efficiencies and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2015. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements, which maybe 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, Tanisha. Good morning, everyone. Thank you for joining us for our first quarter 2016 conference call. With me this morning is Roger Shannon, Senior Vice President and Chief Financial Officer. I would like to begin this morning by discussing the details behind our Q1 results and I will end with some comments on what we see for the future. Roger will then discuss our Q1 performance in more detail on our financial reporting segmentation that we announced on April 8. As we stated in our earnings press release, revenues for the quarter were $142.2 million, slightly higher than expected, driven by a 7% increase quarter-over-quarter in our network solutions business partially offset by seasonal decline in our service and support revenue. Our total network solutions revenues, including both international and domestic markets, came in at $123.9 million and total services and support revenue came in at $18.3 million. Revenues from our domestic markets came in at $116.3 million or 82% of the total and international revenues were $25.9 million for the quarter or 18% of the total. We continue to see a shift towards North American revenues on a year-over-year basis predominantly due to the growing momentum in the U.S. broadband market and the return to more normal buying patterns in Europe. On a sequential basis, strength in our U.S. customer base was able to overcome the typical seasonal decline we see in this market. International revenue was slightly down sequentially with the expected growth in Europe offset by seasonal decline in the Middle East and Latin America. Looking at our previous reporting segments, carrier network sales were up slightly year-over-year, coming in at $118.4 million, with U.S. sales up 62% over the same period last year. The year-over-year growth in this area came from increased sales in…

Thank you, Tom and good morning. Before covering our financial results for the quarter, I want to touch on the financial reporting segment and product category changes we announced last week. Consistent with SEC regulations, requiring financial disclosure of services revenues when they are consistently expected to exceed 10% of total revenues, beginning with the publication of our earnings from March 31, 2016 quarter. We are reporting our financial performance based on two new reportable segments: Network Solutions, which includes our network hardware and software solutions and Services and Support. In addition to these new reporting segments, we will also report revenue for three new categories: access and aggregation; customer devices; and traditional and other products. These three categories include both network solutions and services and support revenues as applicable. The performance of our new operating segments will be reported based on gross profit. We will continue to report our selling, general and administrative expenses, research and development expenses, interest and dividend income, interest expense, net realized investment gains and losses, other income expenses and provision for income taxes on a consolidated companywide basis. Last week, we provided a revised financial reporting structure to give visibility into the new reporting model. And earlier today, we provided our recast 2014 and 2015 quarterly and full year results in the new reporting format on our ADTRAN Investor Relations website and 8-K filing. For this quarter only and our earnings release and for this call, we will present our current quarter results in both the new and the previous reporting formats. Revenue for ADTRAN’s first quarter was $142.2 million, which is relatively flat compared to the $142.8 million for Q1 of 2015, but up 2.3% from the $139 million we reported for Q4 of 2015. First, for our new segments, network solutions revenues…

Thanks very much, Roger. I appreciate that comprehensive report and it’s a little bit longer this time just so listeners know because we had to cover both our old way of presenting numbers and our new way of presenting numbers. With that, Tanisha I think we are ready to open up for any call – questions that people may have.

[Operator Instructions] We will take your first question from Rod Hall with JPMorgan. Please go ahead. Your line is open.

Yes. Good morning guys. Thanks for taking my question. Nice job on the numbers, nice to see the numbers moving ahead of expectations in the year. So I guess a couple of things. One, I was curious what you guys – the international numbers were a little bit weak, curious what you guys are thinking embedded in your Q2 guidance on international? And then just if you could give us any color on how that plays out through the year? Secondly, the services gross margins have continued to slip a little bit. I just wonder do you guys expect stability on that gross margin line for services sometime soon? Could you give us any idea where that stabilizes? And then I guess the third question I have got to go on CAF related spending? I know you called out, Tom – Roger, the risks, the timing of this, but what sort of visibility have you got there on CAF? How do you expect that to trend and where do you think it peaks? I mean, do we – do we have any idea whether CAF spending peaks the second half of the year or where you are expecting that would be helpful to us? Thanks.

Sure. So, we will cover these in order that you presented them. The first one, which is just our international business in general. So, we – do we expected a stronger U.S. content this year than international content? Our outlook for the entire year really has baked in at this point in time kind of a flattish international business this year with what’s going on with our large Latin American customers and what’s going on in Europe. Actually – hopefully, we will do better than that, but that’s kind of where we are looking at the entire year at this point. And so the growth really for the business is coming from the U.S. side. And that will be consistent throughout pretty much every quarter. We don’t have a lot of visibility in the fourth quarter, but that’s what we are looking at, at this point in time. Second question was on services gross margins. Do you want to touch on that?

Sure. So, consistent with the expanding the double-digit growth that you see in services that has transitioned towards more NNI as opposed to maintenance – more maintenance in the past. So, as that mix has increased NNI that the margins on NNI obviously are lower than the maintenance margins, which have much lower cost of goods to earn. So, as the services continue to grow, we do more NI turnkey limitations, that’s kind of getting to more of a normalized level.

I think if you look at the Q1 percentage basis on gross margins, I think if we look at it at least for this year, we don’t know what’s going to happen next year. But for this year, we would probably see expected – we would expect similar, because we saw the NNI business actually start picking up second quarter of last year. And at this point, it is a large piece of our business, right? I hope that answered that question. And then on CAF, so the peak, it’s a good question. I will tell you not all of the CAF players are – not all the people with CAF for, let’s say, the larger carriers, the Tier 2 carriers, are really in full deployment yet. So, I would say we still – we are still fairly early into that process. In the CAF, the new CAF for the rate of return carriers, really have yet to be seen. So, whether or not we kind of hit a run-rate this year, that’s the peak run-rate or next year. My sense would be we probably won’t hit that peak this year especially because half the money really isn’t even online yet, but we will just have to wait and see how that plays out.

Great. Alright, thanks guys.

Okay.

Thank you. And we will go ahead and take our next question from Simon Leopold with Raymond James. Please go ahead. Your line is open.

Great, thank you for taking the question. First, a very quick clarification, subtle change in the language in your press release when you are talking about the outlook, we note that in your second paragraph, you have added longer term at the beginning of the sentence, we expect further improvement of carrier environment as compared to the prior quarter, your fourth quarter report. So, I know it’s a subtle change, but I wanted to get a sense of what was the thinking behind adding that phrase, longer term in terms of what’s changed versus the prior quarter. The other thing I was hoping to ask about it is an update on the G.fast trials in Europe you noted more than 60 carrier trials. I am most interested in the progress of the BT trial if there is any update you can offer in terms of timing or outlook. And then the last thing is in terms of the rate of return carriers. I wanted to see if you could give us a little bit of perspective on your competitive position with this group. And I am asking, because typically we think of your strength with more of the Tier 2 carriers and we tend to think of you as being basically holding a lower share of those smaller rate of return carriers and I don’t want to see if that’s a fair assessment or not? Thank you.

Sure. So first of all, the longer term comment was not meant to depict anything on the shorter term. When – and I will be honest with you, when these things are derived, we don’t necessarily look and see exactly how they reflect it back on the exact comments we gave in the previous quarter maybe we should. The intention there was to say we really do think we are in a longer term upgrade cycle. So, I mentioned in my comments, we are very much focused on CAF. And I think many of the people that follow us are focused on what’s going to happen with CAF funding here in the U.S., but I think we are in a backdrop where we really think that the infrastructure is, in general, going to go through an update cycle because of what’s happening in the MSO space and what’s happening with alternative carriers. And I think – so the longer term was just meant to say that we are assuming it to be a longer term cycle. As far as what’s going on in Europe with the G.fast trials, that’s still open. So, we continue to work with the large carrier over there that’s going through the trial. I think we think we are positioned fairly well. We have a really good product set. I think we are – from everything that we see outwardly, we are just going through the process, but we have no real word on exactly there has been no decision at this point in time. And then your last one was on the rate of return carriers and the answer to your question is kind of yes and no. So, we tend to deal with larger carriers, so the larger Tier 2s, the Tier 1s and then the larger Tier 3s. So, if you look at it from a pure customer account basis, then we do not have the leading market share. If you look at it from a number – the number of access lines that are out there in the Tier 3 space or the number of actual lines and customers that, that base – that market is actually serving, then we actually do have the leading market share. So, it’s depending on how you slice it up. So, I would say it’s going to be beneficial to us as to which base of carriers end up accepting and implementing plans on their particular customer. I think we don’t know yet. I don’t think anybody knows that yet. I do think that our penetration into that base is meaningful and that we would see a benefit from it, but I can’t really tell you who is going to benefit more.

And can you just remind us of the timing of the rate of return decision process? And that’s it for me.

Sure. Well, Roger I think has got that.

Sure. So, the FCC released the regulations actually just a couple of weeks ago. So, what they came out with was as expected the two-prong or the two-model approach. So, the rate of return carriers are going to have to go through an exercise to where they evaluate their funding based on both of these approaches and see which is most beneficial to them. So, the first one is what they are calling the alternative Connect America model or AKM and that model is similar to price cap CAF, with funding based on the number of locations the carrier commits to building out broadband over 10 years and that does have a 40% completion requirement within 4 years and 10% per year for each year after that. So, that’s one model. The other is the existing rate of return support model. And in that model the returns being reduced from today’s 11.25% to a 9.7% rate of return over 6 years, but the new wrinkle to this is that the FCC is also requiring some targets for build-out into the 10.1 megabits per second broadband. So, they are going to go through those exercises and obviously determine which is most beneficial to them. One new twist in the regulations that came out that had not been expected or talked about much before we saw them was some additional sweetener that the FCC had put in. We had expected the $10 billion over 10 years. But there was an additional $150 million to $200 million per year added to support additional broadband build out. And then the other thing just to kind of add on what Tom mentioned, this is in some ways, this rate of return carrier funding is not necessarily incremental to these carriers because it’s a transition of the USF to CAF2. This $150 billion per year is incremental. But also what this $150 million per year, apologies is incremental. But what is obvious and this is that there is a transition from more of a voice-related to a broadband-related.

Thank you.

Thanks very much.

Just is there a date for when that process of review was completed?

Yes. So we expect – from what we are hearing, the money will start flowing in the back half of this year. Okay.

Thank you.

Thank you. [Operator Instructions] Our next question comes from Doug Clark with Goldman Sachs. Please go ahead. Your line is open.

Hi. Thanks for taking my question. And my first one is actually on the 10% customers for the quarter, assuming that those were the same U.S. customer, 10% customers from 2015, your revenues with them have been up nicely, kind of year-on-year, I am wondering what’s driving that, is that market share gains, project related spend, is the competitive environment changing within those customers?

Whether or not it’s changing, so some of it is CAF-related spend and we do have a good position with our CAF product line. But our market share – I would say our market share has been pretty stable at those accounts in general. In Tier 2s, we have a dominant market share. And we are just seeing more spending. And some of that is CAF-related expense. Some of that is specific project, bandwidth increase-related spend. So we are just seeing them just doing more.

Okay, got it. And then my follow-up question is one of the Tier 2s Frontier acquired or completed the asset acquisition from Verizon, I am wondering if kind of what the timeline of investment that you would expect from them on that would be and if you actually see that as kind of a positive uplift in terms of your opportunity to sell into the customer?

Yes. So without getting too specific on any customer, typically we see benefit whenever there are acquisitions – property acquisitions by the carriers, because many times those properties have not been invested to the level that you would want to see and you would also see some commitments to the PEC. And I would just say that that is a good customer of ours. These type of build-outs usually have timetables that are published to the extent that there are PEC commitments, but in general, it’s a positive thing that plays itself out over several quarters. Are you still there?

Yes. And then maybe one additional follow-up, you have mentioned in terms of the international activity of the division between Europe and Latin America, can you give a little bit more detail on expectations for Latin America throughout the year for 2016?

Yes. I am really and the thing is that I am really trying to buy myself some lead way there because we have multiple projects in both Latin America and in Europe with the specific customers that tend to lead those regions. So some of those include PON deployment, some of those include copper based vectoring deployments. So I am just giving my selves some latitude. To the extent that we see – that we expect one to be up and we are giving ourselves latitude for the other to be down and vice versa. And if we are lucky, both of them will up. But I will tell you in both of those regions we have multiple projects that we are getting through different phases of lab implementation, either lab trials or in some cases OS implementation.

Great. Thanks a lot.

Okay.

Thank you. And our next question comes from Rich Valera with Needham & Company. Please go ahead. Your line is open.

Thank you. Good morning. Tom, you mentioned a new 10 gig PON win with the Tier 1 carrier, I think in your prepared remarks, can you give anymore color on that in terms of potential magnitude or timing of ramp on that win?

I doubt it’s going to be this year just as it’s a Tier 1 and it takes a while to get through the integration cycle. So I wouldn’t expect any revenue this year. And I don’t know – the reason for the comment was more about the fact that our 10 gig product development is actually started to bear fruit and we are starting to see the movement of that at. And as you probably know, we have 10 gig developments that are targeted after the carrier market as well as 10 gig developments that are targeted after the MSO market. But having said that, I really don’t have a lot more color to give you until this thing starts to rollout, I know that there are some specific plans for the rollout, but they will not happen this year.

That’s helpful. And then I know you won’t be reporting on this category specifically going forward, but Internetworking was pretty solid this quarter, I think better than probably most people expected it to be, can you give any color on the kind of ebbs and flows in that business and how you see – I know you can’t – you won’t really guide for the rest of the year, but how do you sort of feel about generally speaking that enterprise piece of your business as you look out at the rest of 2016?

Sure. So the Internetworking has quite a few different products in it, typically driven by IP gateways. The strength that we saw this year was more – excuse me, that we saw this quarter was on the carrier side, on our carrier this distribution channels and whether they are using it in bundled products. And it was kind of expected – to be honest with you, it’s been expected for a long time. So as you know we – that market was slow pretty much all of last year. And we were just glad to see it start to pick up. I am not envisioning that as being a trend. I think we need to wait a couple of more quarters to see what it does. We have introduced quite a few different products in that area. And as we are probably aware, we are also starting to introduce enhanced SBC functionality and our E&F product line into that marketplace. But we are seeing – on the RFP front, we are doing better than we probably would have expected where we won some additional business within the MSO space for that product category, but that’s yet to be deployed. So right now, we are on the legacy – actually, let’s call them legacy, let’s say our incumbent customer base and we are just doing better.

Okay, that’s it for me. Thank you, gentlemen.

Okay, alright. Thank you.

Thank you. And we will go ahead and take our next question from Fahad Najam with Cowen. Please go ahead. Your line is open.

Thank you for taking my call. Kind of going back to the International segment piece, if I go back a few quarters ago you had highlighted the business Internetworking product and specifically with the German telecom operator, when should we expect that project to start driving non-U.S. revenue?

Good question and you are absolutely right. That project is over 1 year late. The project is still very much a funded project. It is – the overall forecast for that project is still very much intact. We did start shipping a little bit of it. Like I think we started shipping a little bit of actually towards the tail end of last year. We shipped a little bit more this year, but it really hasn’t launched. Our expectation is we would see the launch of that project either at the tail end now. At this point of time, at the tail end or early next year. And we would see it start ramping forward at this point. I will say that the forecast from the customer has not changed. It’s just that it’s just been incredibly delayed due to technical difficulties, which by the way were not ours. So we are still hopeful. But I do think we are at this point in time not forecasting a lot for the project this year. You will see that showing up in our forecasting for next year.

Got it. And just kind of staying with the international team, in terms of – if you can give us some color on the competitive dynamics, any pricing changes that you have noticed, competitive platform, the Huawei’s and other competitors, any change in the outlook on the competitive front?

No. It’s been – understanding that there has been that there is always pressure in international markets, especially where our two larger competitors are in there competing. There is always pressure, but I would say that, that pressure hasn’t significantly changed. Our Chinese competitor tends to be very aggressive. We tend to understand where they are going to come in at and then our European competitor is also aggressive, but typically not at the same level.

Got it. Thank you.

Thank you. And we will take our next question from Matt Dane with Titan Capital. Please go ahead. Your line is open.

Great, thank you. I was curious, so the CAF spend that started slowing, is it ramping faster or slower than you expected rolling the clock back to the beginning of the year?

I would say, in general, it’s about where we expect. I mean, there is always – for us, $5 million one way or the other maybe material in the quarter, but it’s not material in the overall picture. I would say pretty much it’s where we expected it to be. And the outlook for the rest of the year is pretty much where we expect.

Okay. And my second question is around G.fast and the 50 or so trials that you have going on right now, when would you expect some major wins to start flowing through in real revenues to be generated from all those trials?

Okay. So, it depends on the size. And G.fast is a little different than maybe some of the other technologies – maybe not so much different, but the larger carriers tend to jump out first when it’s a new technology and then the small carriers follow suit. So, it was, in most cases that we are dealing with larger carriers and they tend to have OS integration cycle that’s anywhere from 12 months to 18 months. Having said that, we expect our first G.fast revenue with larger carriers to begin really kind of in the first half of 2017, we may see a little bit this year but we really expect it to be material in the first half of next year.

Okay, great. Thank you.

Did that cover? Okay.

Yes. No, that’s helpful. Thanks, Tom.

Alright, okay.

Thank you. [Operator Instructions] Our next question comes from Tim Savageaux with Northland Capital. Please go ahead. Your line is open.

Good morning. First a quick clarification reading kind of around the guidance, low to mid-teens sequential for some reason. I thought I heard mid to high teens sequential, can we clarify what kind of revenue guidance you gave for Q2?

So, it was low to mid-teens.

Low to mids, okay. You turned all analysts over optimism, I suppose. Okay. Well, given that either way, let’s call it, mid-teens, let’s stay with the optimistic bend, I think you also guided gross margins flat sequentially. And given that degree or flattish – given that degree of revenue increase I might expect some degree of leverage there. I wonder if you could talk a little bit more about this sort of levers driving gross margins given the strength of the sequential revenue increase?

Well, if you take that factor into that, that would do very – let’s say we have three or four major factors. One of course is international versus U.S. content. We talked about that a little bit earlier. You would surmise to say that we don’t see a material change although we expect to the rest of this year that the U.S. is going to grow at a faster rate. That kind of bodes to your comment. There is the service mix, which changes from quarter-to-quarter. We do think that we are in the range as far as gross margin for the services business were kind of in the range where it may fluctuate, but we don’t see dramatic fluctuations going forward, but that percentage maybe a higher percentage in any one quarter than any other quarter. And then there is still something that we cannot maybe talk so much about, but there is product mix. And I think we mentioned that. So, it ain’t coming into any quarter, we are trying to forecast what the chassis mix, what type of chassis and line card mix that’s going into any particular customer at any particular time during that period of time. So, it is not all known, but those are the things that we actually deal with. So, you can take from that which you will, but it’s just what our current view is.

Okay, great. I will pass it on. Thank you.

Okay.

Thank you. And we will take our next question from George Notter with Jefferies. Please go ahead. Your line is open.

Hi, thanks very much guys. I guess I wanted to come back to a prior question about the new subsidy program for rate of return carriers. So, when exactly do you guys expect them to decide which of the two subsidy models will go forward with? I guess the larger question here is simply do you expect to see any potential risk in spending here as you guys managed through this transition could be a slowdown ahead of the decision point, would they speed up afterwards or how do you think the tender of spend would play out with these rate of return carriers before, during and after the transition? Thanks.

Yes. George, that’s a really good question. And I am sure that there is multiple answers depending on who the carrier is. That particular market has not been – that has not – that the Tier 3 market has not driven a lot of our upside. We have been very much focused more on the Tier 2. So, I guess from where our revenue level is right now and our expectations through this year on the Tier 3 market, we don’t see a lot of downside, because it hasn’t been – we haven’t seen the uptick that we saw in the Tier 2. So but you are right, there is a decision factor. There could be a delay in that market. I don’t see that delay being material to us at this point in time. And as to when – how they are going to make those decisions, each carrier is different as you know. I mean, some of these are fairly small, family-operated organizations and some of these are fairly large, diverse organizations that will look at things completely differently. So, I don’t have a lot more inside to be honest with you than you probably already had yourself there.

Got it. Okay, thank you.

So, at this point in time, I see – I think we are pretty much done with our question queue. So I appreciate everybody for joining us on our call and look forward to talking to you next quarter.

And that does conclude today’s program. We would like to thank you for your participation. Have a wonderful day and you may now disconnect.