Ladies and gentlemen, thank you for standing by and welcome to ADTRAN's Fourth Quarter 2016 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period [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 cost, manufacturing efficiencies and other risks detailed in our Annual Report on Form 10-K for the year ended December 31, 2015 and Form 10-Q for the quarter ended September 30, 2016. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements, which may be made during the call. It is now my pleasure to turn the call over to Mr. Tom Stanton, Chief Executive Officer of ADTRAN. Sir, please go ahead.

Thank you, Roxanne [ph]. Good morning, everyone. Thank you for joining us for our fourth quarter 2016 conference call. With me this morning is Roger Shannon, Senior Vice President and Chief Financial Officer. I'd like to begin this morning by discussing the details behind our Q4 results, and I will end with some comments on what we see for the future. Roger will then discuss our Q4 performance in more detail, and we will then open the call up for any questions, any questions that you may have. As we stated in our earlier press release, revenues for the quarter were 163 million, coming in ahead of expectations, seasonally down 3% but sequentially up 17% year-over-year. Our total network solutions revenues including both international and domestic markets came in at 126.8 million, and total services and support revenue came in at 36.2 million, another new record for the Company. Revenues from our domestic markets came in at a 123.7 million or 76% of the total and international revenues at 39.3 million for the quarter, representing 24% of the total. On a year-over-year basis, our domestic revenues increased 10% as Tier 1 U.S. spending continues to accelerate, driven by an increase in demand for our higher bandwidth vectoring solutions, CAF II and a record performance by our U.S. services team. Our last two items continue to have a positive effect on our Tier II performance and our Tier III business also saw material pickup in both the year-over-year and sequential basis. For the full year 2016, our domestic business was up a very solid 20% over 2015, driven by healthy increases in both Tier I and Tier II customers. Moving onto our international business, here we also had a solid quarter growing 46% over the same period last year as we…

Thank you, Tom, and good morning. I will speak about our fourth quarter results and discuss what we see for the next quarter. During my report, I will be referencing both GAAP and non-GAAP results. ADTRAN's fourth quarter revenue was $163 million, which is up 17% compared to the 139 million for quarter four, 2015 and down 3% from the 168.9 million we reported last quarter. Our network solutions revenues for Q4 were 126.8 million, up 10% from 115.7 million for quarter four of last year, led by our continued rebound and our European Tier 1 business and seasonally down from the 136.3 million reported for Q3 of 2016. Our services and support segment continued a strong growth, as Q4 2016 revenues were 36.2 million, up 55% compared to the 23.3 million earned in quarter four, 2015 and 11% ahead of the 32.6 million reported for quarter three of 2016. Across our revenue categories, access and aggregation revenues for Q4 2016 were 119.7 million, up 24% compared to 96.7 million for quarter four of 2015, as we saw a growth in our U.S. broadband products and services and internationally in our European access business, and down slightly compared to the 120.6 million for quarter three of 2016. Customer devices revenues for quarter were 31.4 million, up 11% compared to 28.3 million for quarter four of 2015, and down 5% compared to 33 million for quarter three, 2016. Finally, traditional and other product revenues for quarter four 2016 were 11.9 million, down 15% compared to 14.1 million for quarter four of 2015, and down 22% compared to 15.3 million for quarter three of 2016. Domestic revenues for Q4 of 2016 were 123.7 million, up 11.7 million or 10% from 112 million we reported in Q4 of last year, and down 4…

Thanks, Roger. Roxanne, at this point, we're ready to open up to any questions people may have.

[Operator Instructions] And we will take our first question from Rod Hall with JPMorgan. Please go ahead.

So I wanted to kick off, I guess, and ask about the gross margins to dig into that a little bit. You guys talked about I guess mixed international services and weak euro. I wonder, could you breakout that how much the euro change affected the gross margin just so we can understand the sensitivity there? And then, I also wanted to see, if you could talk a little about the pricing environment. Are you seeing any changes there? Are we strictly here looking at euro impacts and mix impacts? And then I had a follow-up to that.

Sure. First of all, I think you've ordered that for Roger and correct me if I am wrong that you spoken is the order that they actually impacted the business. So, the biggest one was international mix followed by services and then followed by the euro. So, the euro impact was the least of the three and just we do pick a little bit of that backup on in other income. As far as the pricing environment is concerned, it's actually I would say normal. The U.S. product gross margins were actually pretty good, pretty much in line with what they have been over the last couple of years. Without a doubt the biggest impact is internationally.

And I wanted to just follow up on the big G.fast project in the U.S., and I think you guys are participating in. Could you just comment just an M&A activity around that was may or may not happened depending on which tweet you read which day? I just wonder. Could you just comment on whether you see M&A affecting that project from a timing point of view or sizing point of view or at the moment, if it seems like it's just going ahead regardless?

Definitely, it seems like it's just going ahead regardless. As you know, we had started a field trial for the outer region deployment of that. We still fully expect to be starting shipments for that, for that customer in the first half of this year.

Okay. And then just one last one from me as you know, I got you, you've got an update on this, but the administration change coming in. There has been a lot of talk, a lot of focus on infrastructure, obviously broadband infrastructure one of the critical parts of that for the U.S. given that we miss in our infrastructure. Could you just comment on whether you've seen any movement in the direction or mentioned as people talk about infrastructure investment in projects and additional broadband funding from the government beyond the CAF I and II projects?

Not a whole not more, especially, if you say not beyond the CAF II projects. I mean CAF II they're trying to move forward. There was a milestone towards the tail end of last year that I think was positive for the Tier 3 carriers. But the direct answer to your question is, no. I mean, we agree with you that on the general senses is that the incoming administration is going to be more friendly to infrastructure investment, but nothing that's really tend to grow at this point.

And we will take our next question from Doug Clark with Goldman Sachs. Please go ahead.

My first one is on the first quarter guidance. Can you talk a little bit about expectations between the U.S. versus international business and sequential growth there?

Yes, without a doubt the international business is strong, and one of the benefits we have for that with that business is, we typically have greater visibility because of the dominant customer in that segment. So, I can speak to some specificity on that, but that is, we are expecting a strong year out of that customer, and it's going to start. There typical seasonality have been, if you look historically have been kind of front half loaded where you see really kind of more back or backend loaded, let's say Q1, Q2 versus Q2 and Q3 in the U.S. And that’s kind of what we are expected, although we got a lot of momentum coming into this year of course with our domestic business as well so. But I have very strong visibility to what's happening in the with our European customer base. Is that answered your question?

That does and I am wondering, if you can give a kind of that granularity on the U.S. business in the first quarter as well, so is that going to be down sequentially kind of offsetting some of the growth in the international business?

The reality is, I don’t know yet. I have order flow coming out of the year was very strong. We typically -- in Q4, we typically see a downtick in the second half with accordance both in the European business and our domestic business, and I’ll just say the order flow for the entire quarter was very strong both U.S. and internationally.

Okay that’s helpful. And then my other question is on the services mix. Obviously, rose as a percentage of revenues this year and in the fourth quarter as well. Does that continue to tick up higher throughout 2017? Or do we start to face some more challenging comps for that might stabilize as a percentage of revenues?

That’s a good question. I would expect it to tick up on a percentage basis. I think the unknown there is the G.fast ramp up both in the U.S. and outside of U.S. So, a lot of the tick up in services is vectoring in cap related. We sell more products, but we also sell more services and on a project-by-project basis one may be more higher percentage than the other. So, you will see both of those grow this year. Our G.fast revenue typically doesn’t have the same level of service component. So to the extent we actually see that, that come on more material in the second half and I think that would be an offset to the mix shift.

And we will take our next question from Michael Genovese with MKM Partners. Please go ahead.

So, it sounds like the gross margins are where they are and where they're headed in the first quarter because you're winning a lot of new footprint, putting out a lot of new chassis. So, I guess that probably implies that there will be a mix towards cards later and that gross margins will go back up. I want to ask what can they go back up to? The high 40s seem awfully far away from here. But is this high 40s is still something we should be thinking about, and what kind of timeframe to get there?

If you were to come in mid to high 40s, I would say yes. The high 40s themselves with -- some of that has been depended on does the euro weaken or strengthen. Because that, as you’ve seen historically has had an impact on us, but what you've said at the very beginning of the question is absolutely correct. There is a material difference between chassis shipments and line card shipments. And which you’re seeing right now is also really feeding the footprint, the new footprint that having an impact not on the European gross margin, so you’re actually seeing a more depressed than typical European gross margin contribution. And you're also correct in that as those things get installed, you'll start seeing line cards installed then you'll start see that full backup.

And then, still on the gross margin, was there any warranty expense? Was that a fourth issue in the quarter? Was there any warranty expense in the gross margin? And I think you were asked this earlier, but I just want to ask again, price competition has anything changed in terms of price competition in the market?

Nothing has changed in terms of price competition. If I look at the gross margin of U.S. as I mentioned before has been fairly consistent. So, we did have the services growing, but here again that’s an accretive to our operating income, so no change in the competition. What was the first part of the question again?

Was there any warranty expense?

There was of course -- there was a warranty expense that Roger mentioned in his notes. We expect that will probably -- it will materially tail down is our hope from here now. We only have some visibility to that, but we got a chunk of that out of the way in the fourth quarter.

Just a couple of more quick one. Tier I G.fast timing, what part of 2017 should we think about that ramping up?

I wish I knew the answer of that. I don’t know the answer of that. So, we will start shipments exactly, how quickly they ramp up is somewhat out of our control. So, I can’t tell you, if we'll see a big ramp. More than likely which you typically see is as they start marketing the service, you start seeing a take hold and then they kind of hit an inflection point and really happened. So, I can’t tell you exactly when that material pickup will happen. All we'll try to do is making sure that we have the products integrated into their network and up and running, and that we have the service available.

Right. And last one before I pass the mic. Tier III improvement in the fourth quarter was that CAF II related or was any of that outside the CAF II? And just any kind of comments on the overall rate of return carrier program for CAF II would be helpful? Thank you.

Sure, I don’t believe there was really CAF II impact. You were correct and I mentioned it that we did see a pickup, both the year-over-year and sequential, and actually a pretty good pickup, if I look on a year-over-year basis, the material pickup in the Tier III business. But I don't -- it doesn’t feel like its CAF II related. And the rationale for that is, in November that was kind of the trigger point where the carriers had to denote whether or not they were going to following to the price CAF carrier kind of rules or the older rate of return rules. That program was oversubscribed which is good. That program denotes them actually committing to building an underserved or non-served areas and having to show proof points along that way that they're actually building in those areas. Many of the largest carriers actually signed up for that program, that kind of get finalized I think the next go-around Roger is where they --

So, they will be submitting a plan this week and then accepting at the end of March.

Okay, so the real impact for that group of carriers which are typically your largest Tier 3 won't happen until probably towards the end of this year.

And will take our next question form Simon Leopold with Raymond James. Please go ahead.

This is Victor Chiu in for Simon Leopold. I just wanted to ask on the international growth. It seems you're expecting results of the heavily driven by that specific Tier 1 European carrier, but can you just speak some about the opportunities outside of Europe? And what probability you have the growth in another regions and what the prospects are for other regions that might be you looking out for?

Yes, sure. First of all, there are multiple carriers in Europe. The largest one being the one that is during the major vectoring rollout with us in and we have the expanded footprint. As the last count, we had 108 G.fast trials, so our hope key there is converting those G.fast trials to revenue and that's a big part of our plan. Our largest traditional customer outside of Europe is in Latin America. There was effectively a freeze on capital spending with that customer in the second half of last year. That freeze has now been lifted. So more comfortable, well, we are feeling much more comfortable about seeing the meaningful contribution of their customer, but not comfortable in that derivative putting in our numbers. And that's one where we had been working on GPON approvals. We've been working on Ethernet over copper approvals. We have been working on G.fast trials which are still going on. So, there are a lot of things going on with that customer that we think will be very beneficial. There of course also a larger G.fast opportunity that's fairly well known. In Australia, that is still an ongoing thing that haven’t quite landed yet, but we are feeling pretty good about it at this point. Other than that is really that's kind of 108 trials. We do expect by the way that both in the U.S. and Europe, and probably even quicker in the U.S. that there will be other customers coming on board for vectoring. So, if you think about I've mentioned in my notes that we had shipped 10 million vectoring capable VDSL ports. That's effectively driven by two major carriers. So, there is an awful large percentage of the carrier base that can now deliver 50 to 100 meg service. And most of the -- there aren't really any large carriers or Tier 2 carriers that aren't looking at figuring on how they can utilize that technology in the same ways these carriers have.

And will take our next question from George Notter with Jefferies. Please go ahead.

I know there was a significant North American telco that was looking at an NG-PON2 deployment in a particular city. I guess I was just wondering, if there was any update there. I know you guys were in evaluations there, and I saw the press release also about interoperability of NG-PON2 products from the other day. I was just kind of wondering, if there is something we can read into that from you guys? Thanks.

I don’t think I would read anything more towards than what it says, which is this is just part of that customers' evaluation process. We feel we are doing well. We think we still a lot of away from decision point. As you know there were -- you probably know there are two competitors us and one other competitor in that RFP. So, it's definitely a less crowded field where both, I think both parties are in there developing as quick as they can and trying to make sure they are positioned well for whatever they would outcome would be. We feel our technology is now on by estimates of course. But we saw our technology is a best technology and we have some proof point is to why that is. But it's still an active going RFP where we have deliverables and we have calls pretty much every week.

And then also just on the timing of that. Does it still feel like that could be revenue opportunity towards the end of this year in terms of when it could become material or how's we think about that?

Yes, George, I've always been -- I would always be nervous. I am hopefully that I haven't said that. I would not expect that this year, I mean our -- I think an award will be made this year where you may see some trial systems. But I think really to get integrated up and running, I just think it will be difficult with where we are in the award process today. Now, I think when it was started off, the award was -- and I don’t know how much later the award is actually coming from what it was initially expected to be. But it's materially different. So, I think it would be tough just because it's a big carrier.

And we will take our next question from Rich Valera with Needham & Company. Please go ahead.

I wanted to revisit the question of mix with your large German customer. You said currently you have I think a lot of greenfield footprint you're populating with chassis. Presumably at some point this year that switches more towards when upgrade and a line card mix, do you have any visibility to how that might trend through the year between chassis and line card with this big German customer?

A little bit, not as much as you probably like. But and the visibility we have is really reaching end of the second quarter. So, we see that mix actually starting to ship in the second quarter. So, we would expect setting exchange rate aside. We would expect to see those margins improve kind of sequentially throughout the year.

Got it. And then, as well with the warranty expense side, do we expect sequentially less impact from that? I don’t know how was from 3Q to 4Q, I think it was a less than impact, but can you talk about how you expect that to trend as we head into the first quarter and beyond on the gross margin?

Yes, it will be less, if any in Q1. So, hopefully, we won't be talking about it in Q1, but the way that we are modeling right now, there is a little bit of impact to that. But hopefully, we won't be talking about that in Q1. So, it was less in Q4 than Q3, and our current projection is very little impact in Q1 and then no impact when we pass that.

Got it. And then with respect to OpEx, you gave a baseline for Q1 that sounds like it’s a bit down sequentially from Q4. Any other thoughts on how that OpEx level should trend as we move through the year?

There is always up and down based off of revenue and commission mix and things like that. Other than that, I would expect OpEx to hold fairly flat. We are running a little harder honestly than we want to be because of the opportunities that was mentioned on NG-PON2 and that's kind of accelerating some of the development programs for that opportunity. Other than that and that’s the biggest impact or operating expense, right now, that we see next year that would, and I don’t expect it to materially tick up by the way next year. And that is I think we are at a comfortable level, so other than the variability and revenue, not a whole lot of change.

Again just final one from me. You've had a vectoring program with the domestic Tier I customer that got off the ground, I guess in 2016 and I think went out to a few cities and it's expected to expand pretty significantly, as we head in the 2017. Have you started to see that ramp already in that domestic factoring program?

Let me just think about what I can talk about. We had good momentum coming out of the year with that program. And we want to keep that momentum, and we’re feeling pretty good about it right now. So, I guess the answer to question is, yes. Yes, we feel good about where that program is going and the contribution for the full year as well as some contribution in Q1.

And I gather that program has a significant service component to it. But in aggregate, can you say if that business is sort of corporate average gross margin or perhaps better then the European business?

So, the problem is I am getting into a little bit of competitive situation here to the extent I talk about this. With where we’re without a doubt, it is better than our European business. We're very -- we're happy with where we go right now in the U.S. business.

And we will take our next question from Tim Savageaux with Northland Capital. Please go ahead.

Couple of quick questions, first you've commented I think on both Tier II and Tier III spending trend. I guess Tier II in part influenced CAF. I wonder if you have any sort of similar high level commentary on U.S. Tier I capital spending trends and whether indeed you saw anything in terms of a budget flush here in Q4, as I think some others have seen in the quarter? And secondly and somewhat related I guess. Given that you've mentioned Q2, I did not, with regard to Deutsche, I wonder given what seems to be a stronger than seasonal pattern coming into your Q1, given the order strength you've mentioned. Is there any reason to believe that your normal double digit sequential increase plus actually that you’ve seen in Q2 these last few years, if not several would be different this year?

Yes, you’re right, I did mention. It’s early to talk about. Right now, though, I don’t see anything that would be, that will make us feel different about seasonal pattern for the year. We’re coming into the year stronger, but if I look at the strength into Q1, it’s very understandable and it’s just where we are and where the customer base is. And their mindset towards delivering the solutions that we happen to have, so I don’t see anything that would make me so different about seasonality at this point in time, before I pull in, we -- I don’t know if anything that was explicit, that was a pull in. I do know that there are some -- we saw an uptick in our European business which was kind of unexpected, and I don’t think that was pull in. I think that was just a real need that they had. And so, I wouldn't characterize it that ways. What happened in the U.S. is very much planned. So, I don’t know if anything I would explicitly call a pull in, although, I will tell you like I said the order flow coming, and allow to that order flow turn into backlog. So, the order flow that will come into Q1 and really exiting Q4 was just strong.

And will take our next question from Bill Dezellem with Tieton Capital. Please go ahead.

Couple of questions, first of all on a super simplistic level, do you expect your geographic footprint expansion project in Europe to be at risk at all in the first quarter associated with weather or is that really not an issue? And then the second question is, I believe you mentioned that vectoring is your fastest growing product in the history of the Company. And curious if you can discuss why you had that success relative to your competitive position? And how we can think about that positioning going forward?

Sure. Weather typically does not affect our shipments into that customer, so some of this is, they tend to preposition material and kind of get ready. So, I don’t expect any impact because whether borrowing something kind of material different, but I don’t expect it. As far as the vectoring -- first of all, you're right, and I think what happened is one of things we did is, we kept the focus on that product area. So, I do think what we try to do as vectoring capabilities were starting to fruition within the semiconductor area was to make sure that we allocate enough resource to really get ahead of that curve and which was difficult. But I think that leave us to a point where we say, we have the most diversified portfolio of access products and I think that's correct. So, I think we just kept our eye on it. I think there are lot of people that thought copper technologies were dead and everything was going to go fiber quicker than it happened or is happening or will happen is probably where we are. And I think there was a whole group of customers either because of capital budgets or because of their competitive situation or because of their geographic situation in relation to their network architecture that would be very very much willing customers for the technology. And I think it's just happened to be where our R&D alignment was in relation to what they actually did.

What's your current view of competitors' ability to catch up?

Right now, we still feel pretty good. We have a broad product set and it's not easy to do especially when you start getting into the outside plant category of products. So, we're comfortable with where we are than there are kind of two offshoots to that, right. So, super vectoring is coming right down the line. We'll start shipping next year and you're going to have a whole group of customers that are going to be looking at and having super vectoring capability, if they are going to go ahead and roll into vectoring. And that kind of give us that we think another leg up from a technology basis. And then to some extent, we'll see G.Fast kind of be the next leg after that. So, we are feeling good about that. I think the other piece and if you look at the solutions set, there is more and more people are looking at when they acquire the products. On Mosaic cloud based architecture is really going to big push -- big benefit for us. Not so much in the initial vectoring shipments that didn’t get us to the 10 million, but that will get us to the 20 million. So, I think you got to look at it as the entire set of solutions that we are actually offering in. Right now, we feel very good where we're situated.

And we will take our next question from Greg Mesniaeff with Drexel Hamilton. Please go ahead.

Yes, Tom, as you look at your revenue mix clearly services and support is becoming center stage. What kind of cost levers do you have at your disposal to opportunistically improve gross margin in that revenue segment going forward?

That’s a good question. The best thing we can do for gross margins right now is work on mix. So, there is mix within the gross margin segment. There are some areas in the services area that are fairly good gross margin. And then when you get into the actual installation and things, it's not as good. Last year was a building year for us. So, I didn’t expect our efficiency on either one of the areas to really be up to maximum or maybe -- I mean when you are in the building area, you tend to put catch a lot. And without a doubt, we did that in 2016. It was more important for us to make sure that we met the customers' requirement than whether or not we could save of couple of points of gross margin. And we will always make that trade-off towards meeting the requirement. But once you get your feet underneath, it's much easier to do both. So, I think we will be more efficient, we will definitely have more scale this year. We will have more scale both in personnel and more scale in revenue. So, I think that efficiencies will come from that. But the biggest thing is mix, and I do want to make sure that understanding of the picture that which is, it is very accretive to our operating income. So albeit the gross margin is low and that’s one of the thing that you will see us shifting towards this year, which is really talking more about operating income. We'll still talk about gross margin, but the gross margin on our service business, I don’t want people to think; we don’t want that to grow because we do. It is going to be negative on a gross margin line, but it's a very good business for us. But the best thing we can do right now is actually work on the mix, which mean sell more of our higher end services, which we'll be actively working on this year.

And we have a follow-up question from Rich Valera with Needham & Company. Please go ahead.

Just want to clarify on the revenue guidance. The low-single digit to mid-single digit that was on a year-over-year basis, is that correct Roger?

For guidance for Q1?

Yes.

No, it's sequential.

Sequential. Okay. Thank you, appreciate that clarification.

At this point, I think we’re out of question. So, I appreciate everybody for joining us on our call. And we look forward to talking to you next quarter.

And this concludes today’s call. You may disconnect at any time. And have a wonderful day.