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Executives

Thomas Stanton – Chairman and CEO

Jim Matthews – SVP, Finance and CFO

Analysts

Vivek Arya – Merrill Lynch

Paul Silverstein – Credit Suisse

Ken Luth [ph] – Robert Baird

Ehud Gelblum – J.P. Morgan

Scott Coleman – Morgan Stanley

George Notter – Jefferies

Blair King – Avondale Partners

Nikos Theodosopoulos – UBS

Simon Leopold – Morgan Keegan

Harry Bassinger [ph] – Standard and Poor's

Manny Recarry [ph] – Kaufman Brothers

Larry Harris – CL King

Bill Ellen [ph] – Trident Capital

Todd Koffman – Raymond James

ADTRAN, Inc. (ADTN) Q4 2008 Earnings Call Transcript January 21, 2009 10:30 AM ET

Operator

Good morning. My name is Tamma and I will be your conference operator today. At this time I like to welcome everyone to the ADTRAN fourth quarter 2008 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 marketing, acceptance of new products, the degree of competition in the market for such products, the products in channel mix, component costs, manufacturing efficiencies, and other risks detailed in our annual report on Form 10-K of the year ended December 31, 2007 and Form 10-Q for the quarter ended September 30, 2008.

These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements, which may be made during this call. Thank you Mr. Stanton you may begin your conference.

Thomas Stanton

Thank you Tamma and good morning everyone. Thank you for joining us for our fourth quarter 2008 conference call. With me this morning is Jim Matthews, Senior Vice-President and Chief Financial Officer.

I like to start out this morning by discussing the environment we experienced in the fourth quarter that led to revenues of $112.4 million. As you will recall the latter part of the third quarter experienced a decrease in order flow across most customer segments and across most product segments. Although we experienced a stabilization of order rates in early October, order rates declined further in November to a level that continued through the end of the year as we continued to feel the effects of the economy along with typical seasonality.

On a more granular level although optical access was up 17% year-over-year for the quarter, this category was sequentially down greater than which can be attributed to normal seasonality. This decrease was fairly broad-based across multiple customers. Similarly although internetworking was up 10% year-over-year for the quarter this product segment saw a sequential decline, greater than normal seasonality along with our traditional (inaudible) segment both of which are targeted for the SMB market. The sequential revenue decline we experienced in broadband access category was primarily the result of an expected decline in the 1100 series fiber to the node revenues. This decline was partially offset by an increase in TA 5000 system revenues. As mentioned previously, we anticipate reacceleration of fiber to the node shipments beginning in early 2009 and as expected HDSL was down sequentially. This followed a very strong third quarter. Year-over-year for the fourth quarter HDSL actually grew 15% and for the full year HDSL was up 4%.

Our TA 5000 category continued to grow through the quarter but more importantly we continued to move forward with our customer initiatives, securing our third RBOC approval in December. The momentum in the TA 5000 product remains very strong as we enter 2009.

Looking back on 2008, the environment was difficult as many of our customers and competitors adjusted to the changing circumstances created by the economic condition. Our growth areas combined grew 23% year-over-year each achieving new record revenue levels and all poised for long-term growth.

Broadband access experienced 22% revenue growth for the year. Our fiber to the node products continued to show strong growth as carriers continue to invest and upgrade services to their subscribers. The activity around our fiber to the node products both from a bidding [ph] and land perspective continued to be strong in the U.S. and abroad.

Strategically the TA 5000 system had a phenomenal year. This system is now approved at over 60 carriers in the U.S. including all of the top eight, the majority of which are in the very early stages of deployment. We continue to anticipate that expanded deployment and the addition of new deployments will contribute meaningfully to the growth of this platform for many years to come.

For the year our optical access category also showed good progress growing 25% over the prior year as we can began to see the effects of tier one approvals. We continue to believe despite our gains to date that we’re in the early phases of optical access conversion. And that the increasing demand for bandwidth both wireline and wireless pose great promise for this product area.

In our enterprise segment for the year, internetworking revenues grew 23% over the prior year. This growth although muted by economic condition continue to reflect the broad based support we’re seeing as we continue to utilize our carrier distribution channels and aggressively grow our broad dealer base. For the year, this growth area now represents approximately 60% of our total enterprise revenue.

Finally considering the slowing effects of SMB, HDSL our largest legacy product area showed a strong result for the year growing 4%. Our leading market share position in this category continues to benefit from increased demand for wireless backhaul. We believe the results of continuing share gains in our new product categories will enable us to mute the effects of the environment we are experiencing. Although the continuing economic uncertainty and the resulting volatility in order rates forced us to enter 2009 with some level of caution.

Overall the economic environment has had both positive and negative impacts on our company. There is little doubt that growth in 2008 was slowed due to cautious spending and declining capital budget. However, our heightened focus on improving operational efficiencies across the board will lead to a company with greater flexibility and increased capacity.

In addition, this environment is one where companies with strong operating models can aggressively pursue market share and continue to fund R&D efforts to open up future opportunities.

We believe the company enters 2009 -- the 2009 better positioned for long-term growth than in any time in its history. Although we will continue to be impacted by macroeconomic headwinds, we are positioned well to weather this environment and over the long term prevail as the preeminent access supplier.

I would now like Jim Matthews to review our results for the fourth quarter 2008 and our comments on 2009 first quarter and full year. We will then open the conference call up for questions. Jim.

Jim Matthews

Thank you Tom and good morning to everyone. Revenue for the fourth quarter was $112.4 billion compared to $119 million in Q4 of ’07. For the total year of 2008 revenues grew 5% to $500.7 million compared to $476.8 million for the year 2007. Broadband access product revenues for Q4’08 were $19.5 million compared to $27.3 million in Q4 of ’07. Comparing Q4 of 2008 to Q4 of 2007, the decrease in broadband access product revenues is primarily attributable to a decline in sales of fiber to the node systems partially offset by a significant increase in sales of total access 5000 systems. For the total year 2008, broadband access revenues grew 22% to $102.3 million compared to $84 million for the year 2007.

Optical access revenues increased 17% to $12.6 million for the fourth quarter of 2008, compared to $10.8 million in Q4 of ’07. Comparing Q4 of ’08 to Q4 of ’07, the increase in optical access revenues was the result of continuing market share gains across numerous customers, including tier one carriers. For the year 2008, optical access revenues grew 25% to $53.8 million compared to $43.1 million for the year 2007.

Internetworking product revenues increased 10% to $15.7 million in the fourth quarter of 2008 compared to $14.2 million in Q4 of ’07. For the year 2008, internetworking product revenues grew 23% to $65.8 million compared to $53.4 million for the year 2007.

For the total year 2008, our growth products grew 23% to $222 million from $180.4 million for the year 2007. Carrier systems revenues were at $43.5 million for Q4 of ’08 compared to $49.1 million in Q4 of ’07. Comparing Q4 of ’08 to Q4 of ’07, the decrease in carrier systems revenues was primarily attributable to a decrease in broadband access product revenues partially offset by an increase in optical access product revenues.

For the year 2008 carrier system revenues grew 15% to $206.2 million compared to $179.8 million for the year 2007. The growth in carrier systems revenue for the year was primarily attributable to continuing share gains in our broadband access and optical access categories.

Businesses networking revenues for Q4 of ‘08 were $21.4 million compared to $23.7 million in Q4 of ‘07. Comparing Q4 of ‘08 to Q4 of ’07 the decrease in business networking revenues was primarily attributable to a decrease in traditional integrated access device revenues, partially offset by an increase in internetworking product revenues.

For the year 2008 business networking revenues were $89.6 million compared to $88.3 million for the year 2007. Loop access revenues were $47.5 million for the fourth quarter of ‘08 compared to $46.1 million for Q4 of 2007. Comparing Q4 of ‘08 to Q4 of ‘07 the increase in loop access revenues was attributable to an increase in ACSO revenues partially offset by a decrease in enterprise T1 revenues.

For the year 2008 loop access revenues were $204.9 million compared to $208.7 million for the year 2007. The decrease in loop access revenues for the year was attributable to a decrease in enterprise T1 revenues partially offset by an increase in HDSL revenues. HDSL product revenues grew 15% to $41.7 million in Q4 of ‘08 compared to $36.3 million for Q4 of ’07.

For the year 2008, HDSL product revenues grew to $179.8 million compared to $173.6 million for the year 2007. As a result of the above, carrier networks division revenues were $86.8 million and enterprise networks division revenues were $25.7 million for Q4 of ’08.

For the year 2008 carrier network division revenues were $392.2 million and enterprise network division revenues were $108.5 million. International revenue was $8.1 million for the fourth quarter of 2008 compared to $15.7 million in the fourth quarter of 2007. Comparing Q4 of ’08 to Q4 of ’07 the decrease in international revenues is primarily attributable to a decline in sales of fiber to the node systems to a large Latin American carrier.

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 60.1% of revenue for the fourth quarter of 2008 compared to 58.4% for the fourth quarter of 2007. The increase in gross margin is primarily attributable to lower transportation, expediting, and unit costs per sales dollar.

Research and development expenses were $20.4 million in Q4 of ’08 compared to

$18.7 million in Q4 of ’07 and he increase in research and development expenses was primarily attributable to an increase in activities related to customer specific development efforts.

Selling, general, and administrative expenses were $25.7 million for Q4 of ’08 compared to $25.4 million for Q4 of ’07 and stock based compensation expense net of tax was $1.3 million in the fourth quarter of ’08 compared to $1.1 million for the fourth quarter of ’07.

Interest income was $2 million for the fourth quarter of ’08 compared to $2.8 million for the fourth quarter of ’07. The decline in interest income was attributable to lower interest rates.

During the fourth quarter of 2008 the company recorded net realized investment losses of $2.3 million in this marketable -- marketable equity securities portfolio as a result of a significant decline in the equity markets. That effect reduced diluted earnings per share by $0.02 for the quarter.

The company’s income tax provision rate was 19.1% for the fourth quarter of ’08 compared to 34.4% for the fourth quarter of ’07. The tax provision rate for the fourth quarter of ’08 was lower primarily as a result of recognition of research tax credits for the full year as legislation was enacted in the fourth quarter of 2008. The amount of research credits recognized in the quarter was $2.3 million. Additionally, during the fourth quarter the company completed a review of its estimated tax deduction for the year 2008 relating to section 199 of the internal revenue goal.

This review resulted in an increase in the company’s estimated tax deductions for the year 2008 which reduced the quarter’s tax provision by $900,000.

The increase in tax deductions was attributable to an increase in domestic content of products we manufacture. We anticipate the company will continue to benefit from this deduction in future years.

Earnings per share assuming dilution for Q4 of ’08 were $0.27 compared to $0.27 for Q4 of ’07. Inventories were $47.4 million at quarter end. Net trade accounts receivable were $52.7 million at quarter end resulting in DSOs of 43 days for the fourth quarter compared to 55 days for the fourth quarter of 2007.

Net cash provided by operating activities for the fourth quarter of 2008 was a strong $23.5 million compared to $19.4 million for the same period the prior year. Unrestricted cash and marketable securities totaled $226 million at quarter end after paying $5.6 million in dividends during the fourth quarter and after repurchasing 399,000 shares of common stock for $5.6 million.

We like to remind you that we typically do not give specific guidance on revenues. However, given the environment we feel compelled to assist you in developing your opinions on future revenues. We want to remind you that we are a book and ship business and timing of near term revenues associated with large products we are engaged in, combined with the impact of the economic environment on carrier and SMB spending make it difficult to predict revenue levels.

Assuming economic activity levels remain constant with the current environment for the first quarter of 2009 we anticipate that revenues will be flat to slightly down from fourth quarter 2008 levels. For the first quarter, we believe we will execute in a range consistent with our historic operating level and the achieved revenue level.

On a yearly perspective, we expect total revenues for growth products will be up, HDSL to be slightly down and other legacy products to be down. For the total year 2009, we anticipate profitability will be in a range consistent with our historic operating model.

We believe the larger factors impacting the revenue we realize in the first quarter and full year 2009 will be the following; spending levels at our tier one and tier two carrier customers, the adoption rate of our total access 5000 and 1100 series platforms, the adoption rate of the Opti 6100 for tier one carriers, continued growth of internetworking revenues, the continuing negative impact of the economy on our traditional product revenues and order trends and traction and fewer international customers.

Tom, back to you.

Thomas Stanton

Thanks Jim. Okay Tamma, at this point we are ready to open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Vivek Arya with Merrill Lynch.

Vivek Arya – Merrill Lynch

Hi, thank you. Hello Tom. Hello Jim. A couple of questions, first is Tom can you give us a sense for the drivers of your HDSL business, I mean that has been a pleasant surprise last year. And I think for ’09 you’re guiding it to be down. Can you give us a sense for what the drivers are there? How much of it is tied to wireless, much of it is tied to small medium sized business? Any color around that would be great.

Thomas Stanton

Well Vivek I can basically just give you the color that we have because just to remind everybody we actually ship most of our HDSL equipment to the large carriers and they don’t then distinguish for us whether or not it is going for wireline capacity, wireless capacity or what the actual usage might be. Our sense and I think just from a sense from the current conditions and what we’re kind of seeing in general in the business environment that the majority of -- or definitely the uptick or let us say the positive surprise are really the uptick for the year 2008 where revenue has been driven by wireless and we have continued to hear and we had heard really since the beginning or since the middle of last year about backhaul increases and bandwidth upgrades and we are expecting that same type of activity to probably drive some of the numbers going forward into 2009.

Vivek Arya – Merrill Lynch

And then on the broadband access business, the TA 5000 is expected to grow in ‘09 but how much of that growth could be offset by declines in either the 1100 or the TA 3000?

Thomas Stanton

I think -- I think the real the potential decline was much more centered around the 3000 series platform than the 1100 or 1200 series platforms. The 1100 or 1200 you know are -- were very active in getting these products today. We have some fairly large customers who have projected usages for these things. So we are thinking the 1100 and 1200 series to be fairly stable and you know, would not at all be surprised to see some good growth out of those product lines this year. The 3000 will probably decline but of our DSLAM area it is by far the smallest. So and that is our traditional ATM DSLAM.

Vivek Arya – Merrill Lynch

And then on the optical access side very sharp drop in the fourth quarter, was there any one-time factors associated with that or is it just general weakness and carrier spending and how should we think about that businesses especially when you have someone like Nortel who is having -- who is finding it hard to sell that piece of its business, how should we think about the optical market in general?

Thomas Stanton

I mean I think I don’t know if I would use the inability for Nortel to sell that piece of business. It is necessarily reflective on the business that we are in but yes it was down in the fourth quarter and some of that was seasonality but we did see a more pronounced slowdown in that and very well could be that is to a large extent a CapEx item and we may have seen some additional contraction because of that. We’re very hopeful for the optical access product line in general in 2009 because it is also participating in this wireless upgrade cycle. So that is one where we haven’t given more specific color than that. We don’t expect -- I can tell you we don’t expect significant declines and if anything we would expect an increase in sales but if the visibility on that product line is just less than what we can say on something like the 5000.

Vivek Arya – Merrill Lynch

Got it and one final question, Jim gross margins have actually had left very well, and there is been good improvement on the OpEx side also, can you give us a sense of how the trajectory of those two items will be in ’09?

Jim Matthews

Well, you know as far as growth -- gross margins ‘09 for the total year you know we’re still anticipating in the high 50s there, and in terms of operating income or pretax income for that matter again in 2008 we ended up with 23.6%. We would anticipate that 2009-year would end up in that same range in terms of pretax income.

Vivek Arya – Merrill Lynch

Okay, thank you gentlemen.

Jim Matthews

Okay.

Operator

Your next question comes from the line of Paul Silverstein with Credit Suisse.

Paul Silverstein – Credit Suisse

Jim can you tell us the 10% customers?

Jim Matthews

Sure Paul. AT&T 22% for the quarter, Verizon 14% for the quarter, and Inbar 10% for the quarter.

Paul Silverstein – Credit Suisse

Okay, you know I know you mentioned that it was broad based in terms of the downtick. In terms of the big customers AT&T and Verizon on these roll outs, have they given you any insight in terms of ‘09 plans?

Jim Matthews

No, they have not given us any specific insight.

Paul Silverstein – Credit Suisse

Okay, I will pass it on. Thanks Tom.

Operator

The next question comes from the line of Ken Luth [ph] with Robert Baird.

Ken Luth - Robert Baird

Hi just -- kind of on the kind of CapEx landscape again here, would you expect any additional slowdown in kind of the tier two, tier three customers just because lack of access to capital or do you see them wanting to try to invest in this kind of down environment as well?

Thomas Stanton

I think it is a mixed bag. I think we have some that are wanting to invest and then we have some that have been slow. I don’t know if I would -- I really would be somewhat surprised to see additional slowdown in the tier two space because the ones that had been slow I would expect to continue to be slow and the ones that have been slow have been contracting for some time. It could happen though but I would say there are some out there that are actively planning to grow their network and some of them have started to.

Ken Luth - Robert Baird

Then on the kind of the new presidential administration here, clearly looking at broadband and IT as kind of ways to jumpstart our economy here. International marketplace had a kind of similar things to try to jumpstart their economies. What is your kind of take on all these new kind of political changes and what they want to do with infrastructure?

Thomas Stanton

Needless to say we’re all for it. The -- we have not factored those type of impacts into our thinking at this point. One because of course we’re dealing with carriers, which have a life cycle of their own on purchases and then when you serve a government on top of that I don’t know anybody that can forecast that. So those are all positive things that the customer base that I think the government is currently looking and targeting is that one that I think we are well positioned in and I think we have very good products for that space. So, it would be a nice surprise but it is something we wouldn’t bet on.

Ken Luth - Robert Baird

Okay, and kind of lastly here with the kind of the guidance being about flat for this quarter here, how would you kind of expect that to roll out through the year then, typical seasonality has that increased a little bit throughout the year but do you see it just being more of a flat from the kind of Q1 level?

Thomas Stanton

Well, you know, seasonality in the first quarter it’s always a mixed bag but what we tried to guide for is something that is flat to slightly down. We would expect that our seasonal ramp in our first quarter is slow, then the second quarter goes up, third quarter is typically the highest and we would -- we would definitely expect that to be the case this year also. I don’t know if I answered your question or not.

Ken Luth - Robert Baird

Yes. That is great. I will pass it along. Thank you very much.

Thomas Stanton

Okay.

Operator

Your next question comes from the line of Ehud Gelblum with J.P. Morgan.

Ehud Gelblum – J.P. Morgan

Hi, thank you very much. Couple of questions, first of all on your comment Jim that the operating model for Q1 would be as normal for that revenue line of the flat to down (inaudible). Does that mean that the pretax EBIT margin goes back into the mid 20’s or do you mean that kind of replicates roughly the 20% number that you have in Q4.

Thomas Stanton

Paul, I think it was indicated roughly the 20% number we had in Q4, you know, obviously we were impacted by the impairments. But if we look at it on an operating level, operating income level in Q4 we are at about 19% and you know, if we come in at that revenue level in the first quarter we would expect operating income around that same level.

Ehud Gelblum – J.P. Morgan

Okay. So it is the matching up of the margin with the revenue level by the operating margin model target?

Thomas Stanton

I think that is correct.

Ehud Gelblum – J.P. Morgan

Okay.

Thomas Stanton

I think the other thing too -- our target which is kind of mid 20s is typically for the full year. So we do see a swing towards the positive as revenue increases through the year.

Ehud Gelblum – J.P. Morgan

Okay. It is associated with the (inaudible). Okay. I appreciate that. Linearity for the quarter, it sounded like October was stable and actually fairly good at least in your conference call in October. In the November fell off. Did December get worse than November?

Thomas Stanton

No actually it didn’t and that is -- we usually do see an additional slowdown in December but November and December were fairly flat.

Ehud Gelblum – J.P. Morgan

And when you make those comments is that primarily an HDSL comment or is that a comment on the growth products as well?

Thomas Stanton

That was a comment on everything.

Ehud Gelblum – J.P. Morgan

On everything, okay. And now can you give us a sense as to now through the first two weeks of January the way you had this last time in October, had that continued at the same?

Thomas Stanton

Yes, we have to break out of the cycle, because it is always the scary thing to do but one of the reasons if you recall we did that is, these are difficult times and we are really just trying to give as much information as we can. I will tell you that at this point in time in January it is a -- we got a fairly strong order rate right now. So, I cannot tell you it is going to hang through the rest of the quarter, I can tell you it will hang through the rest of January because we’re pretty much a book and ship business and things are volatile but at this point in time in January we are feeling pretty good.

Ehud Gelblum – J.P. Morgan

Okay. So, it sounds like it has actually picked up from December.

Thomas Stanton

I would say it has picked up from December.

Ehud Gelblum – J.P. Morgan

Okay. Interesting. Now, the fiber to the node, 1100 that fell off in the U.S. from your tier one customer over there. You mentioned again like you did in the last conference call that you expect it to pick up early in 2009. Have they indicated to you what their timing -- what their timing is contingent upon. Are they waiting to see when their own margins come back a little bit? Are they ready to spend earlier in the year but they said sometime over the summer is when they’re planning on spending and how recently did they reassure you that they will continue with their fiber to the node rollout.

Thomas Stanton

I would rather not talk specifically about that customer because it is really up to that customer to speak for themselves and fortunately or unfortunately there are a lot of choice to who that customer is and I don’t want to speak for them. So let me speak about the 1100 product platform. We expected the 1100 order rate to pick up early this year, early this year meaning definitely in the first quarter and we continue to believe that to be the case.

Ehud Gelblum – J.P. Morgan

But that is not part of the pickup you say in January yet, so that could be an incremental pickup from this point?

Thomas Stanton

I think I mentioned that the January pickup was across the board.

Ehud Gelblum – J.P. Morgan

So that could already subsume some of that and therefore will be your confidence level on that 1100? Okay. I will take that as a yes. I appreciate it. Now just one last thing as you look at the optical access business at the end of the quarter, it probably tailed off with some of the other things what level of certain --are there certain projects you are waiting for? Is there certain level of confidence that you get for that to pick back up again in 2009 after the end of 2008 with certain customers that either promised to pick back up with spending that or certain projects you are expecting to see come through. How do you gauge the success of the optical access in particular?

Thomas Stanton

Well, the 6100 product is one that is the most prominent there.

Ehud Gelblum – J.P. Morgan

Right.

Thomas Stanton

And those really aren’t at this point in time with the customer base that is doing the majority of the spending aren’t project oriented, they are just ongoing as they go and upgrade this particular area or go and support this new customer. So, there is no trigger like that. I think we just look at the -- just the order activity.

Ehud Gelblum – J.P. Morgan

Okay. I appreciate it. Thank you.

Operator

Your next question comes from the line of Scott Coleman with Morgan Stanley.

Scott Coleman – Morgan Stanley

Hi, good morning and thanks guys. I’m hearing a lot of feedback on. I’m not sure if you can hear me okay.

Thomas Stanton

Yes, we can hear you fine.

Scott Coleman – Morgan Stanley

Okay. So Tom in your opening remarks you talked about how the company was using the downturn and would lead to increased capacity and greater flexibility, I am wondering if you would expand on that particularly on the capacity side and how you think you will be able to maybe flex your muscles a little bit through a soft 2009.

Thomas Stanton

Well, at any time -- this is one of the things I think as a company our employees do a very good job of which is trying to continually improve particular functions that they may be involved in. But anytime that -- that you enter some type of rough patch in the economy, which is definitely what I would characterize where we have been over the last couple of quarters or so. I mean there is an additional focus on where you spend money, how can you actually improve efficiency in a particular area and as we have seen in the past when we exit those areas there is just the general increase in the level of productivity for the dollar spent. And that is really what I was kind of alluding to in my comment.

Scott Coleman – Morgan Stanley

Are you actively working to cut cost. Now I think Jim correct me if I’m wrong but your guidance for 2009 the full year 2009 is that you think revenue will be down a little bit if I heard correctly?

Jim Matthews

We actually did not say that.

Scott Coleman – Morgan Stanley

Okay. I am sorry. That is what I put in my notes. Are you working to take costs out of the system right now and is that necessary to get back to those mid 20 pretax margins by the middle of the year?

Jim Matthews

You know, I think there is a mid 20, to answer your question on mid 20s the end of the year. We of course, haven’t guided that far out but I don’t think we would need to take cost out in order to do that. The thing that we do need to be you know consistently and constantly mindful of is the fact that we’re in a recession and although you may have great plans for the next six months those plans may change materially and not because of your own doing. So we are at this point in time, no the answer is no. We have a very strong model that we think would carry us through this year and give us the same type of performance we have seen historically but that doesn’t mean that we shouldn’t be looking and planning for things if they turn out differently.

Scott Coleman – Morgan Stanley

Okay and maybe one last question from me. If my math is right, growth products dropped about 9% year over year in Q4 versus the fourth quarter of last year? I am just curious how that compares to what your expectations were coming into the quarter. You clearly were very cautious coming into the quarter given the guidance you provided but it seems like the growth products fell off even a little more than certainly I would have thought and I guess to me the big question is how does that carry through into the beginning part of the year, was it just some push outs in terms of orders or there is obviously good demand out there but the confidence that it comes back I guess stays at this level, slightly better in Q1. I’m just curious where that comes from.

Jim Matthews

Okay, there is little mixed bag when you’re talking about the quarter, the year-over-year comparisons. Let me just try to step you through. One is, you on the broadband access piece, which in the fourth quarter of last year was predominantly 1100 series fiber to the node products that was Telmax [ph]. So we had a fairly large component there that was Telmax and that did not repeat itself this year. So we expected a decline in fiber to the node because of just current customer situations and as I mentioned before we expected it to come back early in 2009. As far as the rest of the growth product areas, I would say optical was a little bit slower than we had hoped. I don’t think it was dramatically slower but it was slower. And internetworking was a little slower in the fourth quarter than we would have expected. And that is kind of in my notes although it probably wasn’t as apparent as we had hoped. I pointed those two products out initially because those were areas where they were a little softer than we would have expected. Fiber to the node I think it is pretty much where we would have expected it to be.

Scott Coleman – Morgan Stanley

Right. Thanks for the color guys.

Operator

The next question comes from the line of George Notter with Jefferies.

George Notter – Jefferies

Hi, thanks very much guys. I wanted to was about the HDSL business and you know, I guess I’m mentally trying to reconcile sort of where that business grows longer term and obviously you’ve got operators trying to pull fiber out to base stations. We are hearing more and more about specific projects to do that and certainly your company plays in areas there but you know, as we see that transition occur more fiber fed base stations versus copper fed can you sort of think about how does that net out for ADTRAN in terms of HDSL versus maybe others as we play with the Optic 6100 and so on? Thanks?

Thomas Stanton

Well, there are two areas that are going on and you are specifically talking about the fiber transition. We also think that over time there will be a copper transition to Ethernet technology versus TDM [ph] technology and our opinion really hasn’t changed that. I think most forecast if you look at the fiber to copper transition you know, it is a fairly long term process and although we see it impact our HDSL business it has been impacting our HDSL business probably for the last five to ten years. And we just don’t see that dramatic of an impact in the near term and I would say the near term being one to two years. And I think the numbers of kind of showed that so over time it will convert and over time the reason for us being in the optical access was we think that that conversion can be very lucrative to a vendor and we want to make sure that we are in there and positioned properly, fairly early in that cycle. So that is a transition that we’re trying to cover both sides. We have the legacy business there and it seems to be doing well and holding its own. Over time that will convert to both Ethernet over copper or fiber and we hope to the positioned well and I think we have come a along way towards that.

George Notter – Jefferies

I guess one of the obvious pieces here though is that the HDSL business you have gigantic market share whereas in optical transport, certainly the market share is improving, but you have not more competitors there. I mean how do you sort of reconcile that when you think about the net effect of the transition happening?

Thomas Stanton

Absolutely without a doubt that is true. There are different set of competitors in the optical business. I think one mitigating factor towards that though know is that the ASPs are substantially different. So I wouldn’t trade a handful of HDSL circuits for one Optic 6100 any day. So we think we will do well in the transition but it is not that it isn’t without risk.

George Notter – Jefferies

All right. Thanks.

Thomas Stanton

Okay.

Operator

Your next question comes from the line of Blair King with Avondale Partners.

Blair King – Avondale Partners

Hi guys. Thanks for taking my question. Just a couple of quick ones, one follow-up on the last question with regard to Ethernet over copper. Is that a market that you believe is going to remain strategic initiatives from your customer base over 2009 or do you see -- do you see them actually milking more of their legacy networks as spending tightens in 2009?

Thomas Stanton

That’s a good question. First of all Ethernet over copper hasn’t really been adopted widespread in the US yet, or definitely not outside of the U.S. So there are few kind of leading companies that are pushing that technology forward. One of them happens to be a very, very large carrier in North America. I think that that is definitely willingness and a continued push for driving Ethernet over copper out. I think that there is a -- several things that have to happen in the overall infrastructure they’re working on and I think also that the end user, you know, whether that is a wireless customer or a wireline customer or let us say a business customer will have to pull that product. So if the wireless companies aren’t pulling Ethernet native services yet, then that won’t happen until that transition does happen. I do think that it is a strategic push for them. I do think they want that to happen in an expeditious manner but I do think that at this point in time they were aligned on adding capacity to their TDM network.

Blair King – Avondale Partners

Okay, interesting. Maybe just a couple of quick -- maybe a couple of quick subjects on sort of spread out. On the CenturyTel [ph] acquisition, have you gotten any clarity out of CenturyTel, whether they would plan to pursue a video based strategy on the Embark [ph] footprint upon that deal?

Thomas Stanton

And that is one where I would definitely been speaking for the customer and I don’t want to do that. I think there has been something some things that have made been made public about their plans. We’re very glad they have CenturyTel as a customer for our product lines as well as Embark. So we will do whatever they need us to do.

Blair King – Avondale Partners

All right, one last question, if there’s any possibility that you can give some update on the international trial activity that you have been involved in that will be very helpful?

Thomas Stanton

Sure. Of course our biggest opportunity continues to be the (inaudible) piece because they have adopted the fiber to the node products and I would say that we -- there is some regulatory issues that have been very slow to clear up and I would say they are still slow to clear up. So that continues to be one that we work with the customer and continue to position ourselves well but there is some timing issues that they have to work through. There will be some additional I believe there will be additional capacity edition’s this year into their network and we just need to make sure we’re positioned well for that.

Blair King – Avondale Partners

Okay.

Thomas Stanton

I will also say just one other point that the 1100 is playing and other areas we really haven’t specifically outlined those and I would like to get some of those under our belt before we are talking about those.

Blair King – Avondale Partners

But there is substantial international activity outside of (inaudible) going on, is that correct?

Thomas Stanton

Absolutely yes, both on the 1100 and on the 5000.

Blair King – Avondale Partners

Okay great. Thank you very much.

Operator

Your next question is from the line of Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos – UBS

Hi, can you hear me.

Thomas Stanton

Yes, Nikos.

Nikos Theodosopoulos – UBS

Okay. I just had a couple of quick questions. First of all on the tax rate for 2009, you know the tax rate was quite volatile quarter-to-quarter in ’08, can you give us a sense of what you are thinking about for the full year ’09 or the first quarter?

Jim Matthews

Sure Nikos. For the full year 09 we think something consistent with the full year ’08 rate would be probably appropriate for planning purposes. So ‘08 the tax rate was 33.6%. So again we think that that would be a fair estimate for the ’09 year.

Nikos Theodosopoulos – UBS

Okay. And the second question was on the impairment charge, what investment incurred the impairment and do you feel that there is some additional risk or this is kind of a one-time impairment?

Jim Matthews

We have a we have about $12 million of marketable equity securities as of the end of December and it is consistent with our portfolio of about 350 marketable equity securities and due to the market declines we though it appropriate to take the impairments. Now, if we have additional impairments in Q1, we believe that that it will be substantially less than what we saw in Q4. However, if the market goes down significantly again that is another issue. Does that answer your question?

Nikos Theodosopoulos – UBS

Yes, perfect. And then just one last question on the PA 5000, you gave a lot of metrics around what happened with the 1100, year-over-year and sequentially. Can you give me a feel what the sequential growth rate and year-over-year growth rates were for the PA 5000 in the quarter?

Jim Matthews

Well, the sequential growth rate could be phenomenal but it is off of a very low base in Q4 of ’07, excuse me, the year-over-year growth rate would have been phenomenal. A sequential growth rate was definitely double digit and I would like to kind of leave it at that.

Nikos Theodosopoulos – UBS

Double digit, okay. And you mentioned that you got additional tier one carrier from that business. I mean, if you look at is that the product that you have the most confidence in ‘09 in terms of growth and guts there to say?

Jim Matthews

Without a doubt.

Nikos Theodosopoulos – UBS

Without a doubt. Okay, and I am sorry. Just one last question, your comments earlier about quarters being a little bit better in January than December is that across enterprise and carrier or was that specific to carrier?

Jim Matthews

It was, and I am going to throw this caution out, but I know, a lot of people’s ears will turn off. It is very early in the quarter. So, I -- we don’t forecast a quarter based off of 2 or 2.5 weeks into it but it was across carrier and enterprise, pretty much the entire product segment.

Nikos Theodosopoulos – UBS

Okay, great. Thanks a lot.

Operator

Your next question comes from the line of Simon Leopold with Morgan Keegan.

Simon Leopold - Morgan Keegan

Great. Thanks a lot. First I want to follow up on the TA 5000 line of questioning, since that seems to be where a lot of the opportunity lies, what kind of time frame and pattern due you expect for the year in terms of maybe getting to let us say 10% of sales and let me express what I am imaging is that there is probably a step function kind of pattern but I want to see how you’re thinking about the rollout?

Thomas Stanton

Well we’re in three different RBOCs and then a multitude of smaller carriers. And the reality is that some of these smaller carriers can in and out of themselves significant amount of volume when they turn on, but they are very lumpy in a way that they do that. You know I would expect it just ramp really from Q1 through the end of the year. There may be a step function in there as one of the bigger carriers starts a project or whatever, but you know we are not really trying to forecast to that level. You know it is probably sometime midyear but I can’t tell you exactly that will be a second quarter or third quarter event and you know a lot of these smaller carriers can actually impact that prior to that or after that.

Simon Leopold - Morgan Keegan

And am I correct in imagining that the product is currently still less than 10% of overall sales today?

Thomas Stanton

I think that would be correct, yes.

Simon Leopold - Morgan Keegan

Okay, if you could give us an update on the competitive landscape. One of the things we’re trying to get a sense of is how much emphasis your customers may be putting on your balance sheet and your position and how that is affecting the competitive environment for you, whether you are gaining or losing share. If you can give us more color on that?

Jim Matthews

You know, I think -- I don’t think we have lost any share definitely because of our balance sheet. I think that we have had as we get into -- got into some competitive situations more so in 2008 than probably in the previous year’s. People ask questions about company’s current financial stability. I don’t think it is really ours. I think other companies that have driven those questions and then we ended up having to check the same boxes. We haven’t lost any share of course because of that metric and I think in fact it has helped us. Where we have seen the more direct impact though is where companies have exited businesses or have said that they are going to stop investing in businesses and that has led to fairly direct businesses to us.

Simon Leopold - Morgan Keegan

Right. Okay, thank you very much. That was all I had.

Operator

Your next question comes from the line of Harry Bassinger [ph] with Standard and Poor's.

Harry Bassinger - Standard and Poor's

Yes, thank you. Do you expect R&D and SG&A expenses in absolute dollars to be down in ’09 year-over-year and related to this, what was the implied headcount in Q4 versus Q3 and your hiring policy going forward?

Jim Matthews

You know, as far as the OpEx trend Harry, we really haven’t given any color on that other than again, we are targeting a pre-tax operating model consistent to what we saw in 2008. Okay? In terms of the employee count, we are around 1650 employee, okay, we will have specific numbers obviously in the 10-K.

Harry Bassinger - Standard and Poor's

And was that up from Q3?

Jim Matthews

No.

Harry Bassinger - Standard and Poor's

Okay, and then last question, can you give a sense of the growth prospects you see in 09 split between the carrier and enterprise segments?

Jim Matthews

Well, you know the color that we give basically is that for ’09 is that our growth areas will grow and that HDSL will be slightly down. Now HDSL does have a component of SMP as well but again we think that any pressure there might be offset with wireless spending, and our other traditional products again outside of HDSL, we would expect to continue to decline, probably at a rate around what we saw over the last couple of years I would imagine. Okay, but that portion of our traditional products has grown to a much smaller level than it was say two or three years ago. Now again I think that is about all the color that we can give at this point.

Harry Bassinger - Standard and Poor's

All right, thank you.

Operator

Your next question comes from the line of Manny Recarry [ph] – Kaufman Brothers.

Manny Recarry– Kaufman Brothers

Good morning, thanks for taking my questions. I have to. One you just mentioned your growth products you expect them to be up a year over year is that across all three of them. Are there any like large deals as they were in the December ’07 quarter that kind of make it a difficult component of the quarters?

Thomas Stanton

Well that is something that stands out I think on a quarterly basis, like we saw in ’07, fourth quarter of ’07. So, I mean, I think we have some customers that kind of ramped through the year in’08 on some of these products and we would expect the same type of thing. So there is nothing that really stands out there.

Manny Recarry– Kaufman Brothers

Okay, and then the second question is would Nortel filing for bankruptcy, you see any opportunities there to target some of their distribution channel on the internetworking side for you?

Thomas Stanton

I think that there are actually several opportunities that have opened up where we can target distribution channels and customers directly. I think Nortel is just one of those. It is probably not the one that we will have the biggest near-term impact but it is definitely one that we would look at.

Manny Recarry– Kaufman Brothers

Okay, thanks.

Operator

Your next question comes from the line of Larry Harris with CL King.

Larry Harris - CL King

Yes. Thank you. Was Qwest a 10% customer in the quarter? I missed that?

Thomas Stanton

They were not Larry.

Larry Harris - CL King

They were not. Okay, thank you and within the internetworking category did you make any comments regarding the 7100 series IP PBX and where that stands right now?

Thomas Stanton

We didn’t specifically (inaudible) 7100. Certainly 1100, we relaunched that 7100 last year with additional features that we felt would continue to push that product forward and I would say we are still in very early days there. So it is not something that I would expect to get 10% of revenue or anything like that in the near term.

Larry Harris - CL King

Understood. Okay, thank you.

Thomas Stanton

Okay.

Operator

Your next question comes from the line of Bill Ellen [ph] with Trident Capital.

Bill Ellen - Trident Capital

Thank you. Relative to your R&D, the percentage increase as a percentage of sales is that largely or solely due to you to the sales drop or do you have some important projects that you are just not willing to pull the spending back on even in the tough economic environment?

Thomas Stanton

It is a function of course the revenue which can swing from quarter to quarter in our business. Having said that. We have over the last year and a half or so increased the R&D line and that was conscious decision on our part to meet some of the customer commitments that we have in some of these commitments are contracted to deliver as late as 2010. So, we made a conscious effort to do that. At the same time we are cognizant of the environment that we are in. So, I think that the rate of increase has definitely slowed down and I would not expect to see that type of rate if any increase going into 2009.

Bill Ellen - Trident Capital

Would you please repeat that last part again, I wasn’t able to hear it.

Thomas Stanton

I wouldn’t expect to see the same type of increase and in fact if there is an increase it would be very small in 2009 or I think at this point in time, fairly right sized with our engineering or R&D expense versus the opportunities that we have and the things that we have committed to.

Bill Ellen - Trident Capital

And then that would be at roughly $20 million per quarter?

Jim Matthews

Yes, that is where we were in the fourth quarter.

Bill Ellen - Trident Capital

Right. Great, thank you.

Thomas Stanton

Okay.

Operator

(Operator instructions) Your next question comes from the line of Todd Koffman with Raymond James.

Todd Koffman – Raymond James

Yes, just a follow up on the TA 5000 performance in the December quarter, I just want to make sure I am getting (inaudible), you have been given a little bit of historically qualitative sense where that business is. It is north of 5% of revenue or not quite?

Thomas Stanton

It is north of 5% of revenues.

Todd Koffman – Raymond James

Okay, and then I don’t know who said it, but I thought I heard you say that you though the TA 5000 would sort of ramp consistently, historically in telecom there has not been a lot of consistency. Are you getting better visibility about the TA 5000 ramp over the next two or three quarters, or was that really just sort of more of a guess?

Thomas Stanton

That was more of a guess, but I will say the difference here is that this has had a broader base acceptance than any product I can recall that we have actually come to market with. So there are a lot more inputs into it than just one customer that can substantially change the order flow and that is probably one of the differences also.

Todd Koffman – Raymond James

But it wouldn’t be unexpected it in one of these quarters over the next two or three quarter you had an outsized performance or an undersized performance in TA 5000, or I mean it right?

Thomas Stanton

Yes, it wouldn’t -- yes, it wouldn’t surprise us. Yes, that is true.

Todd Koffman – Raymond James

Thank you very much.

Thomas Stanton

Okay. Tamma, I think at this point we are pretty at the end. So, I want to thank everybody for joining us on our conference call and we look forward to talking to you next quarter. Thanks very much.

Operator

This concludes today’s ADTRAN fourth quarter 2008 earnings release conference call. You may now disconnect.

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Source: ADTRAN, Inc. Q4 2008 Earnings Call Transcript
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