ADTRAN, Inc. Q1 2010 Earnings Call Transcript

Apr.14.10 | About: ADTRAN, Inc. (ADTN)

ADTRAN, Inc. (NASDAQ:ADTN)

Q1 2010 Earnings Call

April 14, 2010 10:30 am ET

Executives

Tom Stanton – CEO

Jim Matthews – SVP & CFO

Analysts

Unspecified Analyst

Blair King – Avondale Partners

Ari Bensinger – Standard & Poor’s

Michael Genovese - Soleil Securities

Sanjiv Wadhwani - Stifel Nicolaus

Todd Koffman - Raymond James

Rich Valera – Needham & Company

Nikos Theodosopoulos - UBS

Steve Ferranti – Stevens Incorporated

Vivek Arya – BofA/Merrill Lynch

Simon Leopold - Morgan, Keegan

Amir Rozwadowski - Barclays Capital

Jim Suva - Citi

Lawrence Harris - CL King

Hasan Imam - Thomas Weisel Partners

Operator

Good morning, at this time I would like to welcome everyone to the ADTRAN first quarter earnings release conference call. (Operator Instructions) During the course of the conference call, ADTRAN representatives expect to make forward-looking statements which reflect management’s best judgment based on factors currently known.

However, these statements involve risks, and uncertainties including the successful development and market acceptance of new products, the degree of competition in the market for such products, sub products, and channel mix, component costs, manufacturing efficiencies, and other risks detailed in our Annual Report on Form 10-K for the year ended December 31, 2009.

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. At this time I would like to turn the call over to Mr. Tom Stanton, CEO; Mr. Stanton you may begin your conference.

Tom Stanton

It is my pleasure to welcome you to ADTRAN’s first quarter 2010 conference call. Joining me on the call is Senior Vice President, and Chief Financial Officer, Jim Matthews. I will start today’s call by providing some insight into the company’s first quarter performance as well as our outlook for the second quarter.

Following this, Jim will provide the financial results for the first quarter. We will then open the floor up to answer any questions that you may have.

Let me begin by saying I am pleased to report that we had a solid first quarter for 2010 with strong performances by both our carrier and enterprise divisions. The carrier networks division reported a 14% increase in revenue over the same period last year due to a number of factors, including increased deployments of products for broadband connectivity, increased deployments of products for business Ethernet connectivity driven by network convergence and the accelerating need for higher bandwidth, an increased demand for network aggregation products as carriers scale their infrastructure to increase network capacity, and a general improvement of the telecom spending environment.

Our enterprise networks division reported a strong performance in its internetworking category. This was aided by growth in both its carrier and VAR channels and as a result we reported an 18% increase in revenues for the division over the same period last year.

During the first quarter our combined growth areas, broadband access, internetworking, and optical access, delivered yet again, growing an impressive 45% year over year. Taking a closer look at these areas, broadband access revenue grew 64% over the prior year, led by the Total Access 5000. The company benefited from continued share gains from Tier 2 and Tier 3 customers as well as an increase in shipments to our Tier 1 accounts.

Also of note during the quarter were strong contributions by our Total Access 1100 and 1200 series, fiber to the node products. We are pleased that both the Total Access 5000 and our fiber to the node products continued to gain momentum across all carrier classes and application sets.

As previously mentioned in internetworking led growth in the enterprise segment with a 45% increase in revenue over the same quarter in 2009. This increase was a result of good product strength throughout the internetworking portfolio, and meaningful market share gains within the competitive carrier space, as well as a benefit of the recovery in the IT sector.

During the quarter we achieved carrier certification for new applications and continued to add new resellers to our VAR channel base. Overall the demand of our internetworking products was driven by continued conversion towards Ethernet services and gains in market share from incumbent suppliers.

Optical access reported a 6% increase over the same period last year as results were impacted by typical seasonality in the baseline business. However customer activity around wireless backhauls increased through the quarter.

As expected HDSL declined 7% when compared to the first quarter of 2009. Now moving on to a broader discussion of the second quarter, in general we expect the momentum of the first quarter to continue, marked by strong performances from all of our growth categories.

In broadband access we anticipate our Total Access 5000 platform will make meaningful progress in new deployments in addition to market share gains in existing customers. We anticipate increased shipments of Total Access 5000 and our fiber to the node products accelerated by market share wins in Tier 2 and Tier 3 accounts and new application deployments within Tier 1 markets.

In internetworking momentum will be driven by incremental application wins in both Tier 1 and competitive carrier accounts, as well as a continual increase in our VAR presence with the addition of new channel partners.

In optical access as previously mentioned an increase in customer activity leads us to expect an increase in revenues for this category in the second quarter. Moving on to our traditional product lines, although we expect HDSL to decline for the year in the high single to low teens percentage range, activity around wireless backhaul suggests the first half of the year will not see that level of decline.

We will continue to review our outlook on this product line as the year unfolds. As mentioned on our previous conference call the broadband stimulus package holds the potential of having a material impact on the company’s revenue, although the timing and magnitude of this impact remains uncertain.

During the quarter we were awarded several projects aligned with this program and we believe orders will be forthcoming as stimulus funding is released. Looking forward in our industry and what we expect for the future, we anticipate an accelerated shift from TDM to Ethernet architectures fueled by the growing need for bandwidth that is resulting from the rapid adoption of applications such as VoIP, IP TV, and internet enabled mobile devices.

In addition carriers will increasingly deploy fiber deeper into their access networks and deploy newer technologies to leverage their current infrastructure in order to accelerate broad based deployment and alleviate access bottlenecks.

We show that ADTRAN is well positioned to address this transition with a broad portfolio of solutions that meet both carrier and enterprise customer needs. We believe we are uniquely positioned with a full portfolio of fiber and copper technologies with long standing channels to market for these [barrier] customer classes.

At this time I would like to turn things over to Jim Matthews to provide you with the financial details for the quarter. Following Jim’s comments we will open the floor for questions.

Jim Matthews

Thank you Tom, and good morning to everyone. Revenue for the first quarter increased 15% to $127 million compared to $110.4 million in Q1 of 2009. Broadband access product revenues for Q1 2010 increased 64% to a record level of $36.4 million compared to $22.2 million for the Q1 of 2009.

Internetworking product revenues for Q1 of 2010 increased 45% to $22.2 million compared to $15.3 million for Q1 of 2009. Optical access product revenues for Q1 of 2010 increased to $11.3 million compared to $10.7 million for Q1 of 2009.

Carrier systems revenues for Q1 of 2010 increased 36% to $58.1 million compared to $42.7 million for Q1 of 2009. Business networking revenues for Q1 of 2010 increased 32% to $26.5 million compared to $20 million for Q1 of 2009. Lube access revenues were $42.5 million for Q1 of 2010 compared to $47.6 million for Q1 2009.

HDSL product revenues were $39.9 million for Q1 of 2010 compared to $42.9 million for Q1 of 2009. As a result of the above carrier networks division revenues for Q1 of 2010 increased 14% to $99.5 million compared to $87.1 million for Q1 of 2009.

Enterprise networks division revenues for Q1 of 2010 increased 18% to $27.5 million compared to $23.3 million for Q1 2009. International revenue was $6.7 million in Q1 of 2010 compared to $6.9 million in Q1 of 2009.

To provide the reporting of each of these categories we have published them in our Investors Relations webpage at www.adtran.com. Gross margin was 59.3% of revenue for Q1 of 2010 compared to 61.1% for Q1 2009. Research and development expenses were $22.8 million for Q1 of 2010 compared to $20.9 million for Q1 of 2009.

This increase in expense was primarily related to an increase in customer specific projects. Selling, general, and administrative expenses were $27.2 million for Q1 of 2010 compared to $23.7 million for Q1 of 2009, and this increase in expense was primarily related to an increase in selling activities in the US and abroad.

Stock based compensation expense net of tax was $1.5 million for Q1 of 2010 compared to $1.6 million for Q1 of 2009. All other income net of interest expense for Q1 of 2010 was $2.9 million compared to a loss of $2.3 million in Q1 of 2009.

As you will recall during the first quarter of 2009 the company recorded net realized investment losses of $3.2 million and this investment portfolio primarily relating to other than temporary impairments of marketable securities as a result of significant declines in the equity securities markets in that quarter.

The company’s income tax provision rate was 35.7% for the first quarter of 2010 compared to 26.3% for the first quarter of 2009. The tax provision rate for the first quarter of 2010 was higher due to delays in legislation to extend the benefit for research tax credits for the year 2010.

In the first quarter of 2009 the company recognized their usual benefit from research tax credits. Also during the first quarter of 2009 the company completed a review of this estimated tax deduction for the years 2005, 2006, and 2007 related to Section 199 of the Internal Revenue Code. This review resulted in a $1.7 million benefit being recorded in the first quarter of 2009 reducing the company’s income tax provision for that quarter.

The increase in tax deductions was attributable to an increase in the calculated dollar value of domestic content of products we manufactured for those years. Earnings per share assuming dilution for Q1 of 2010 were $0.29 compared to $0.24 for Q1 of 2009. Inventories were $47.8 million at quarter end, and net trade accounts receivables were $74.1 million at quarter end resulting in DSO of 53 days for the first quarter of 2010 compared to 46 days for the first quarter of 2009.

Unrestricted cash and marketable securities totaled $325 million at quarter end after paying $5.6 million in dividends during the first quarter and after repurchasing 478,000 shares of common stock for $10.3 million.

Due to the book and ship nature of our business and the timing of near-term revenues associated with large projects it is our policy not to give specific guidance for the quarter or for the year. We would like to give color to help you formulate your views on our near-term business outlook. We expect second quarter revenues to be up high single-digit percent on a sequential basis.

At this revenue level we expect second quarter operating expenses to be approximately flat on a sequential basis. We believe the larger factors impacting the revenue we realize for the year will be the following: spending levels at our Tier 1 and Tier 2 carrier customers; the adoption rate of our Total Access 5000 platform; upgrades for wireless infrastructure; and the award and timing of broadband stimulus funding to program participants.

For the year we believe we will execute in a range consistent with our historic operating model at the achieved revenue level.

Tom Stanton

Thank you Jim, at this point I think we’re ready to open it up for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Unspecified Analyst

Unspecified Analyst

A couple of quick questions, on the internetworking clearly we’ve seen that grow as you penetrate the carrier VAR channel more and more, can you give us a sense as to where we are on that scale, are we half way through and there’s still more businesses and segments to get through and so from sheer penetration of further VARs especially the carriers, that we can continue to see that grow or are we starting to see, at what point are we going to start seeing the level of VARs level out and then its pure share gains from a perspective of same store sales as opposed to just further penetration. And then some follow-ups as well, if you can just give us the 10% customer.

Tom Stanton

As far as the, I think you mentioned both carrier customers and VARs which are to us are two distinctly different channels, from a carrier perspective we are, we have approvals that are relatively broad based and two of the big [inaudible]] and then one of the [inaudible] we are no where near as far along, so we think there’s a whole lot of potential in that one carrier and really in the other carriers we’re by no means the dominant supplier.

And we continue to get approval. As I mentioned in my notes that we got approvals last quarter. We expect additional approvals for applications this quarter. Some of those approvals are things like for the first time actually being able to sell our IP T products, our communication products, into some of the [inaudible] so we think we’re fairly early on in that phase.

As far as VARs we are definitely at the beginning stages. We have a couple of thousand or so right now, that number will grow over the next two to three years and at the same time we’re also continuing to look at the type of VARs that we have and make sure that the players that are in the program are the ones that are able to produce.

Unspecified Analyst

Can you give year over year as to how the VARs have grown.

Tom Stanton

I don’t have it right off the top of my head, I can give you kind of a sense. Let’s say three years ago we were looking at a very strong, we were looking in excess of 50% and I would say its probably at this point in time moderated to a probably 30% mid 30% range, but there again that’s just my sense. I don’t have the number in front of me.

Jim Matthews

Ten percent customers were AT&T at 18%. Verizon was 11% for the quarter and Quest was 23% for the quarter.

Unspecified Analyst

So there’s a lot of your 1100’s went into, when you look at the, you mentioned share gains in Tier 2 and Tier 3, is that primarily with the 1100’s or the TA 5000, can you go into some details on some of the customers you’re seeing share gains at and is that for order activity or for actual revenue placed and have you gauged that and what types of metrics do you use to measure those share gains.

Tom Stanton

Well for one we can take a look at the 5000 in the Tier 2’s for some spaces is very new so we know for instance in one of the larger Tier 2’s we weren’t selling into the 5000 into an IP T slam or IP T application a year ago and we are now so and there was an incumbent supplier so in those cases we’re definitely picking up share on things that we weren’t even playing in before.

As far as, I really hate to get into names but I will tell you we made significant headway, there’s a finite number of what we call Tier 2, I think our number is up to about five right now. And we made significant gains at at least half of those as far as real incremental movement there. And that has been centered around the 5000.

We fully expect this year to see kind of different movement or additional movement in the fiber to the node space in some of those carriers as we go through the year.

Unspecified Analyst

And do you know if you were brought in as a second carrier to the incumbent in each case or were you given a geography that was yours where you are the primary carrier and can therefore go into the incumbent’s positioning on the rest of those Tier 2’s.

Tom Stanton

I’m not aware of a geographic breakdown in general, I’m not aware of a geographic breakdown so I think our attitude is if we can go and provide value to the entire footprint that’s what we’re trying to do and I haven’t heard that we’re going to be relegated to a particular state or region.

Operator

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

Blair King – Avondale Partners

Just a couple of quick questions here, one I think you had mentioned in your prepared remarks that OpEx might stay, well is at least expected to stay flat for the balance of this year, but we have seen the R&D line trend up a little higher over the past couple of quarters, in fact over the past several quarters, and if there’s any way you could provide a little color around what that entails and particularly is that focused on international opportunities or how should we think about your R&D budget.

Jim Matthews

First of all my comments in regards to OpEx were only in regards to the second quarter. Now in terms of engineering costs, yes they have increased and in, they have related in large part to domestic opportunities, but we are seeing growing activity for international opportunities as well. And as far as R&D going through the rest of the year the way I’d like to talk about that is probably on a level of total OpEx.

We do expect OpEx to increase year over year this year but again we do not expect it to increase as much as revenue. So that’s how we’re managing OpEx overall. We’re probably going to see some level of increase in R&D in latter quarters but again its with the focus to maintain that sort of model that I just mentioned.

Blair King – Avondale Partners

And then obviously with stimulus now becoming a little bit clearer at least in terms of when funds may be released could you give us any sort of backdrop in terms of what needs to happen at ADTRAN logistically to support or fulfill incremental demand and what the supply chain might look like there and also from a CapEx perspective if there’s test equipment that needs to be added to turn up lines or what the plan is to fulfill the demand.

Tom Stanton

In general I would say you’re not going to see a big shift. We have the test equipment in place and although we continue to add to that base of test equipment there’s not a particular application that would drive a significant amount of new test equipment. In fact I think some of our incumbent customers are probably some of the most difficult testers in the world.

So I think we’re set up there. From a supply chain perspective we have a lot of flexibility. We have been able to handle very big jumps in near-term increases in the past and we think that we’re well set up for that. If you see an increase in anything it may be in field level support but at this point in time we’re not envisioning that to be a requirement.

Operator

Your next question comes from the line of Ari Bensinger – Standard & Poor’s

Ari Bensinger – Standard & Poor’s

Looking at the HDSL line its certainly benefiting from backhaul activity and I’m just interested in the comment you made about at least for the first half you shouldn’t see the type of decline that you’d expect for the year for the high single-digits and low teens, what makes you think that this trend would sort of decelerate to see that type of decline at the end of the year given the strong start for the beginning of the year and the trends of wireless backhaul seem to be strengthening.

Tom Stanton

That’s a very legitimate point and I think the reason you’re seeing us cautious about talking about the second half has to be centered for us around the history that we’ve had where we have seen carriers come in very strong in one quarter and then come in very light in the next quarter, so its more centered around the lumpiness of that HDL has exhibited in the past is driving us to really kind of not look too far beyond our headlights.

So we feel very good about the second quarter but we have really not a whole lot of inkling about the third quarter and probably won’t until we get closer to the end of the second and that, if you look at our HDSL numbers in the past and definitely our HDSL numbers on a customer by customer basis you can see a fairly wide variation in order and pattern.

Ari Bensinger – Standard & Poor’s

And then in the optical access segment there was a drop off quarter to quarter, you mentioned seasonality, what type of rebound are you expecting going forward and what’s the outlook for that division, maybe if you could give a little color for the full year.

Tom Stanton

It is to some extent on a similar dynamic as HDSL which is wireless backhaul spend for us has been choppy and we’ve seen that. So its another case where we feel good about the second quarter. We feel good about the momentum at this point in time but we’re going to, here again, try to stay within our headlights and not project too much into the third and fourth quarter until we get closer to those periods of time.

We do expect optical to be up sequentially, we expect optical to be up year over year in the second quarter but that’s about as far out as we want to look at this point.

Operator

Your next question comes from the line of Michael Genovese - Soleil Securities

Michael Genovese - Soleil Securities

Can you tell us, did you recognize stimulus what you would characterize as stimulus revenues in the first quarter.

Jim Matthews

We did not.

Michael Genovese - Soleil Securities

And would you expect any at this point before say the fourth quarter of this year and would that, would you think that the fourth quarter might be an inflection point there.

Jim Matthews

I think a lot of that depends on the timing of funding being released and our latest information is that funding on round one will begin to be released within the next several weeks. Now that’s what we’re hearing and as you know there’s been delays in the past so I think its really dependent on the [inaudible] funding.

Michael Genovese - Soleil Securities

So in terms of round two though would you expect round two funding still in the fourth quarter, is that the right way to think about it.

Tom Stanton

What we’re talking about now is round one funding which is taking longer than many people had forecasted and I’m not sure that we will have gained any efficiency in the way that we’re running the program in round two so I wouldn’t expect a quick turnaround on that.

Operator

Your next question comes from the line of Sanjiv Wadhwani - Stifel Nicolaus

Sanjiv Wadhwani - Stifel Nicolaus

Just to follow-up on that just to confirm the Q2 guidance does not include any broadband stimulus, right.

Jim Matthews

That is correct.

Sanjiv Wadhwani - Stifel Nicolaus

And then just general question on Quest, obviously very strong and looks like they’re using you for multiple applications, I’m just curious if you could talk about for the rest of the year do you expect that strength to continue, any sort of color there would be helpful.

Tom Stanton

I really can’t give you customer specific outlook on Quest. I would rather talk more about the entire products that’s, with the 5000 we are expecting momentum through this year. Now, we have pretty much every large carrier in the US is using it for something or another and what we’re seeing and I think the momentum that makes us bullish on the 5000 is we’re seeing the applications really start to come online and not just in the Tier 3, not just in the Tier 2 where we’re picking up good market share, but also in the Tier 1 where we have been working for a couple of years now on getting these applications brought to market.

And I think you’ll see it in more than one carrier where you’ll actually see, more than one Tier 1 carrier in Q2 where you’re going to actually see some realistic momentum in the 5000. And then the 5000 will typically see seasonality I would guess. Its fairly early for us at the end of the year, but with all of the other things going on in this area, we may surpass that and I think we actually did that in the fourth quarter of last year.

In fiber to the node products which is our 1100 and 1200 series, we absolutely see seasonality in that product and it tends to tail off at some point in the third quarter and then have a lower fourth quarter profile. Here again though, I mentioned earlier that we have some Tier 2 accounts that are very serious about deploying that series of product or variance of that series of products that will hopefully start up some time this year, so that may skew that some.

But the typical profile is that decline in the fourth quarter.

Operator

Your next question comes from the line of Todd Koffman - Raymond James

Todd Koffman - Raymond James

Just on the Total Access 5000 last quarter in December you said it broke through 10% of revenue, can you give us some sense of the contribution in the March quarter, was it up sequentially.

Tom Stanton

I mentioned that it was, that it broke through the 10% level and I think I also mentioned, I didn’t want to talk about that anymore because we had kind of achieved that level and from a competitive perspective I’d rather not talk specifically about that other than to say we had good momentum. There’s no, I will say and I’d rather, I’d like that to be the kind of what final piece is on this is that we were of course above the 10% level in Q1 and we expect it to remain that for quite a long period of time.

Todd Koffman - Raymond James

Just as a follow-up then on that particularly coming off the [inaudible] offering, and the disparity and profitability is the pricing environment today about what its been for that product and product line the last few quarters or have you seen any change in the pricing environment.

Tom Stanton

We haven’t seen really a change in the overall environment, the 5000 is one, because of the truly the underlying design of it, I think that we’ve got a good cost competitive product that gives us a lot of flexibility so for the most part where we’re seeing changes we believe are driving those changes in order to grab market share but I would say fundamentally the pricing environment is the same.

Operator

Your next question comes from the line of Rich Valera – Needham & Company

Rich Valera – Needham & Company

I was wondering if you could clarify where you expect HDSL to go on a sequential basis.

Tom Stanton

Sequentially we expect HDSL, it’s a good question and I guess we didn’t cover that and I’m not going to cover it here. I think we want to leave it at the, what we said, which is it was down year over year 7%. We had implied and in fact I think had stated on previous calls we expected for the year, 9%, I think we said high single, low double-digits.

We would expect on a year over year comparison then in the second quarter that it would be less than 7% down and I think that’s a very safe bet. I think, I wouldn’t be a bit surprised at this point in time to see us actually do better than that 7% range.

Rich Valera – Needham & Company

I was wondering if you would be willing to comment on your position at Century Link, they used to be a 10% customer, I guess when, before [Embark] merged with CenturyTel, and just wondering if you can say how close to a 10% customer Century Link is and how you feel about your competitive position there.

Tom Stanton

We feel very good. I think that there’s probably some confusion as to what happened with Century Link and Embark, we have not lost any momentum in Century Link over some period of time and I’ll step you back to Embark. When we were doing business with Embark and they were buying some of our broadband products and really they were a very good customer and bought just about everything that we sold.

We had two pieces of business with them, we had the Telco business and then we had the distribution business. Coincidence or around the same time as the Century Link merger happened they sold the distribution business to another partner so that business is no longer in our Century Link total number and actually if you look at Century Link as a Telco business, non-distribution has actually been doing very well and kind of our new entry point with the 5000 which is something that we weren’t selling in any numbers to them a year ago.

So kind of this, our ability to actually open this up has actually done very well for us on pretty much any metric. We had a very good quarter with them in the first quarter and we expect the continued growth going forward but I have heard the perception that there was this big downfall and that somehow we had lost market share, that’s absolutely not the case. What had happened is they had sold their distribution base that was no longer factored into our Embark number.

Rich Valera – Needham & Company

Is it fair to say that you think you’re sort of at a relatively early stage with the TA 5000 in terms of penetration of that Telco side of the business.

Tom Stanton

Absolutely its fair to say that.

Operator

Your next question comes from the line of Nikos Theodosopoulos - UBS

Nikos Theodosopoulos - UBS

Just a couple of questions, on the Quest revenues the disclosures you gave last quarter and this quarter, that customer was up about $7 million sequentially. How broad based was that sequential increase. Should we look at as vastly the fiber to the node products or are there other drivers in that sequential increase.

Tom Stanton

Here again, customer specific things are very difficult but let me see if I can give some color and, we sell a broad base of equipment to Quest so we sell fiber to the node products, we have just recently towards tail end of last year started selling 5000’s to them. We of course sell HDSL to them and we sell optical to them.

I think in general trying to see how I can give you more color on that, but I would say the bigger players, the ones that have been driving the revenues over the past, or kind of what’s driving the revenue from Q4 to Q1 which is pretty much what we expected actually. The big incremental piece to us and the one that we’re expecting going forward to continue to drive things we’re very hopeful on the fiber to the node getting into new applications with them but really the 5000 has got an awful lot of potential with them.

Nikos Theodosopoulos - UBS

That’s still in early stage there.

Tom Stanton

Yes.

Nikos Theodosopoulos - UBS

And one other question on I guess I realize its tough answering questions on customers so whatever insight you can give but AT&T was down meaningfully sequentially for you and obviously the opti product was down meaningfully for you, and yet there’s a lot of well public disclosure by AT&T how they’re ramping up significantly their wireless spend and their wireless backhaul spend. So can you comment on why you’re not seeing as much of that. Is there opportunities for you to get a better share in what they’re doing there in wireless backhaul.

Tom Stanton

I think there are near-term opportunities and then there are longer-term opportunities and the near-term opportunities would be centered around our opti product line and then what’s going on with HDSL and if I had to try to characterize Q1 and kind of how we rationalize what’s going on, its, we have seen them be a very targeted on either geographic or demographic or some other rationale that there’s one technology versus another for a period of time.

And we talked about that throughout last year as we were seeing HDSL do what HDSL did and seeing optical do what optical did. And that’s really the only kind of color that I can put around this that makes sense to us. We’re very engaged in trying to help them alleviate whatever problems they may have and we’re very hopeful that we’ll see good momentum this year but its, for us its sporadic.

And yet we do think we’ll play in the near-term position. We have a longer-term thing that we’re trying to get done that hopefully will be successful with but that won’t have an impact this year. The longer-term stuff is farther than that.

Operator

Your next question comes from the line of Steve Ferranti – Stevens Incorporated

Steve Ferranti – Stevens Incorporated

Great job on the quarter, I wanted to zoom out a little bit in terms of the TA 5000 penetration within Tier 1’s, could you give us your sense for where this product is in terms of penetration of that particular customer base. I know thus far Tier 2’s and Tier 3’s you’ve seen fairly significant adoption. It feels like we’re in early stages of Tier 1’s starting to pick it up. Any sort of color you could give around that dynamic would be helpful. And then are these retrofits or are these green field applications where you’re seeing this adoption.

Tom Stanton

Where we are is different upon with the different carrier but I would say in every case we would be early on. With Verizon we’re very early and we’re hoping that we’re going to see some really good things coming out of them this year. With Quest we’re early but they have adopted and one of the things that I have to step back and remind you is that we have in each of these multiple applications and they all have their own timeline.

But even having said that Verizon I would say we’re still very early and we’re hoping to see momentum this year. Quest we’re farther along on let’s say half of the applications and we’ve already seen some good things happen and we expect that to continue on. And AT&T I would say we’re still very early. We came out of the gate with Ethernet over copper. It is still slow going as they continue to work on how their operationalizing and how they’re actually going to deploy it.

I think we saw some good, in general I think everybody saw some good news from them in regards to what their SMB push is. There are two other applications that are yet out of the gate that we are hopeful will be out of the gate some time in the near future which will add to that momentum but I would say they’re not as far along as Quest and I would say even to some extent they may not be as far along in a meaningful momentum push from where they are today as Verizon.

Steve Ferranti – Stevens Incorporated

One quick follow-up, can you give us any sense given the level of discussions you had with customers this year, do you have any thoughts on what your seasonal pattern might look like this year just because we’re coming off of what would be sort of an abnormal year in 2009. Do you think that changes the shape factor or the seasonality that you might see in 2010.

Tom Stanton

There again another good question, our sense right now is no. We had a good Q1 and everything at this point in time points to us that Q2 will follow the kind of traditional path and nothing from what we’re seeing right now would say Q3 would be any different than that, so my initial answer at this point in time would be no.

We would expect it to follow our historical trend.

Operator

Your next question comes from the line of Vivek Arya – BofA/Merrill Lynch

Vivek Arya – BofA/Merrill Lynch

Just to go back to this Tier 1 carrier question, if my math is right the sales to AT&T and Verizon were down sequentially and year on year. I also see the same trend if I add up sales for the last four quarters and compare them to the prior four quarters, so most of the Tier 1 sales growth in the US seems to be coming from just Quest. So the question is why have sales to AT&T and Verizon been weak and how sustainable is the growth at Quest.

Tom Stanton

I didn’t understand the first part of your math so I’ll try to answer what I did understand. I think actually first of all we, all of our customer bases saw a decline, maybe other than Quest although I didn’t go back and look that explicitly as we entered a recession. So, we did see a decline and I would say it probably wasn’t just Verizon and AT&T specific.

And I think as we came out of last year we saw momentum in both AT&T and Quest, less so at Verizon because our predominant sales to Verizon are still HDSL and our kind of forward going plan for Verizon included other products, predominantly the 5000 which I had just spoke about. So that’s the profile that we see. I don’t know if that’s different than what you had said.

Vivek Arya – BofA/Merrill Lynch

If I look at the second half and I realize that second half is some ways away, but if let’s say the fiber to the node applications you mentioned, there could be some seasonality there and AT&T and Verizon at least in the last four quarters have not picked up and I think you gave the reasons why and then I think even HDSL you were saying could go down single-digits to maybe even low double-digits, then is it fair to say that most of the second growth is predicated on maybe broadband stimulus or additional TA 5000 pick up.

Tom Stanton

L1 broadband stimulus, although we haven’t really talked about what the second half pick up would be, but our plans in Q2 and right now when we look at Q3 and I talked about it having the profile of following the typical seasonal pattern that did not include any input of 5000’s. What will drive the growth though if we look at Q2 and Q3 will be broadband access in general which is the 5000 as well as our fiber to the node products which we fully expect to be up and not just up at a particular customer.

As I’ve also mentioned we have additional customers that are buying that and actually coming online. We expect internetworking to be up and we expect optical to be up.

Vivek Arya – BofA/Merrill Lynch

And just last one, OpEx was a little higher than expected and I believe you gave some of the reasons, were there any run offs during the quarter or if there’s a new base and OpEx could be sort of flat to up this year from these levels on a quarterly basis.

Jim Matthews

As I said, we think Q2 will be approximately flat. Q3 and Q4 I think is going to be dependent a bit on the revenue levels but overall OpEx if we look at OpEx overall, we expect it to increase year over year for the total year but at a lesser rate than revenue.

Operator

Your next question comes from the line of Simon Leopold - Morgan, Keegan

Simon Leopold - Morgan, Keegan

I wanted to ask two questions, one on gross margin and one on the TA 5000. First talking about the TA 5000 in the past you’ve talked a little bit about applications for it and understanding that there is a diverse set, could you tell us what the mix was in the March quarter in terms of what applications were driving the strength in the product and maybe back up a little bit and talk about how you see the applications trending.

Tom Stanton

I haven’t really thought about what the trending profile would be because we tend to look at the future quarters in an aggregate basis, but if I look at the March quarter all of the major applications and I characterize a major application as being Ethernet aggregation, just broadband deployment and broadband deployment being IP D slam type deployment, and carrier Ethernet, all three of those segments were up.

So it was fairly broad based.

Simon Leopold - Morgan, Keegan

I guess one of the things that I’m wondering is, is I think there’s been a lot more focus on the role of the product as a mobile backhaul platform and I think on the last earning’s calls you had mentioned seeing applications for providing enterprise Ethernet services, and I think I’m really trying to get a sense of the mix between those two types of deployment where they’re really Ethernet platforms but different application in my mind.

Tom Stanton

I would say, my sense would be at this point in time that mobile backhaul is not driving the 5000 that is it more carrier Ethernet, IP TV delivery, and just increasing for instance backhaul bandwidth and aggregation, you can almost think of it as a middle mile type product. So its more centered around that then mobile.

I would think that’s driving it more than mobile backhaul at this point.

Simon Leopold - Morgan, Keegan

Great that’s what I was thinking and glad I wasn’t too far off. The other topic was around gross margin, I don’t think you commented on expectations for gross margin for the June quarter and I just wanted to revisit this topic from kind of a bigger picture perspective in that I think in the past you’ve suggested that your gross margins among your products are all pretty tight with maybe the exception of the net vanna product line being a little bit better than the group. Could you just delve into that a little bit in terms of talking about how much of a mix shift might effect gross margin.

Jim Matthews

As far as gross margins go we continue to anticipate that they will be in the range of the high 50’s for the foreseeable future. The gross margins between the products are fairly close and are certainly not large enough to drive it meaningfully one way or the other. So the larger thing that drives gross margin really is expediting costs.

And that’s what we try to manage the most as we go through a quarter and as you looked at last year first quarter gross margins were at a record level that you might recall last year the first quarter was very linear in terms of shipments. They were not as linear first quarter this year so and really, are they as linear as what we saw last year.

So that’s why we continue to anticipate high 50’s on gross margin.

Operator

Your next question comes from the line of Amir Rozwadowski - Barclays Capital

Amir Rozwadowski - Barclays Capital

I wondered if we could shift gears towards the enterprise spending environment, certainly it seems as though last year some of the growth that you saw in the enterprise spending environment was particularly notable given the fact that we hadn’t seen sort of enterprise as picking up spending and in fact cutting off spending last year. As we look to this year it seems as though you are seeing bits and pieces of recovery in IT spending and I was wondering if you could comment on sort of your outlook for the spending environment and whether or not you’ll be able to sort of leverage some of the share gains that you had in the prior year.

Tom Stanton

I will tell you its difficult for us to kind of extrapolate what our numbers are on the overall environment so what we can talk most about is our numbers although our sense is, is that we’ve seen an improvement in the IT environment in general. And I will also say its difficult for us to be able to segment market share gains from an overall increase in the pie.

But we think we’ll benefit and why we’re optimistic is because we do think we’ll benefit this year from both of those items. In the enterprise segment internetworking is driven both by carrier direct sales, as well as value added reseller sales. And if you look at our channel mix between the carriers and the VARs we actually saw a good pick up in both of those segments in Q1 which as we entered the downturn last year was not the case.

We saw a decrease actually in both and then we saw the carrier kind of pick up a little bit and the VAR kind of stayed flat to down. That actually has shifted coming into this year. We’re actually seeing some strength on both sides of that equation. The other piece is the market share gains where I had mentioned in my notes and I think its easy to miss but we are not only picking up new applications within the Tier 1 accounts but we think we’re making some meaningful market share gains within the competitive carrier base or the [C lex].

So, there are some carriers out there that can move some numbers in that division because they sell an awful lot of equipment to small and medium business and end up being kind of the entry point for us and we’re seeing some good momentum there.

Amir Rozwadowski - Barclays Capital

So then is it fair to say looking out with some of the share gains and sort of recovery in spending, could you find yourself in a position where your enterprise growth in fact accelerates this year versus 2009.

Tom Stanton

Yes, absolutely.

Operator

Your next question comes from the line of Jim Suva - Citi

Jim Suva - Citi

Congratulations on a great quarter, you gave a lot of commentary around you expecting normal seasonality to benefit the company and in your sales outlook of the high single-digits here that’s clearly manifest, however when I look back historically factually of the past five years, four of those five years have been up double-digit percent and the average of the past five years have been up 11.5%, so I would almost consider and impose to you why isn’t normal seasonality up 11.5% if that’s what it was the past five years.

Tom Stanton

First of all there are variations in those numbers and those variations have to do with momentum in any particular quarter from, and it can be from a particular customer. So the numbers that we post are small enough and we can be influenced by a large order one way or another. So when we look at what it is that we’re guiding for in the next quarter we tend not necessarily to fall back just on what we have done historically on a percentage basis, but really trying to understand from a product, upwards as to what we think we’re going to do.

And then we kind of, for the traditional products and things that we don’t have that same level of visibility then we’ve got to fall back onto what is seasonality. We had a good quarter in Q1 and you may argue that that’s temporary and I’ll look at Q2 a little, I guess we’ll find out in three months, but I understand your point.

Jim Suva - Citi

Second now on a different topic, when the broadband stimulus money starts to be deployed and you start to get orders from that, do you think you’ll be able to receive and ship and produce those orders under normal shipping terms or do you think that you’ll have to incur additional expediting of shipping and what I’m trying to get at is do you expect those monetary funds and orders to be similar to the company’s high 59% gross margins, or do you think that they’d be a little bit lower because of expediting.

Tom Stanton

My sense is that they would be in the high 50’s range. Its not that we haven’t been doing some expediting over the last three quarters, so first of all we’re getting better at that and I don’t see this being substantially different then that. So I would expect it to fall in the same framework.

Jim Matthews

I would agree.

Operator

Your next question comes from the line of Lawrence Harris - CL King

Lawrence Harris - CL King

If I could add my congratulations relative to the results for the quarter, looking at the historical performance over the last few years in the optical segment it looks like historically your third quarter has been the best performance for this segment and I was thinking is there a specific reason for that, perhaps related to outdoor construction in the summer months, providing connections at the sell sites, and if so could we see that again happen this year.

Tom Stanton

That is true for the 6100, our optical product set in general, but I think that you’ll also see if you look at pretty much any other segment that we have that’s also the case so, and I do think there are a lot of environmental factors that play into that. I think its easier for them to actually do that. There are times that that will be slightly different from one big initiative or another. But at this point in time we would expect the 6100, our optical product line and all of our products, we don’t have any reason to say that that wouldn’t be the profile going forward.

With the exception that we are still cautious on HDSL because we do expect a stronger first half than we initially thought. So we’re going to kind of wait and see and kind of revise that view as we get into, towards the tail end of next quarter.

Lawrence Harris - CL King

So stronger first half and then you’ll have a wait and see attitude I guess in terms of the second half on HDSL and then take another look at the guidance at that point, is that a fair assessment.

Tom Stanton

Yes, I think what we will try to be more, as explicit as we can on the HDSL products this time next quarter and the reality is is we don’t know what third quarter is going to be and the thing that has got us maybe a little conservative on the way we’re looking at it is we have seen fairly wild swings that would not necessarily line up with normal seasonal patterns in the past.

Because customers can do a lot with that product in a short period of time. They can deploy very quickly. The turn time on that product is very quick so its just a real easy hammer to swing. If they decide to swing at one point in time and not another then that would wipe out the typical seasonal pattern.

But what you had mentioned about seasonality is absolutely true for most of our businesses.

Operator

Your final question comes from the line of Hasan Imam - Thomas Weisel Partners

Hasan Imam - Thomas Weisel Partners

Just curious about the Tier 2 and Tier 3 customer spending, did see an uptick this quarter but how do you explain that in terms of the actual broadband stimulus, do you see Tier 2 and Tier 3 customers holding back a piece of that spending waiting for broadband stimulus to kind of come in and spend part of that. How do you really define that uptick in spending.

Tom Stanton

Good question, and I think the way that we view it is there’s more clarity in that market as to who’s going to apply for money and who’s not going to apply for money. So the people that have decided not to apply for money have decided to go ahead and move on and I think we’re seeing the benefit of those customers right now going ahead with the plans that they may have been on hold for some period of time as they’ve kind of made that internal decision that its something they don’t want to participate in.

I would say that there’s still some demand out there that is waiting on stimulus funding, but we know that for a fact because we have customers that as I have mentioned have selected us and have not started spending yet. But I would kind of characterize the increase that we saw based off of more predominantly the ones that have decided not to move forward with, they know that they’re definitive about that and they’re starting to place purchase orders because of that.

Hasan Imam - Thomas Weisel Partners

And I have just one more question on market share gains, you had mentioned you saw some of this happen this quarter as well, how do you kind of break out what percentage if you will of the revenue increment you’ve seen this quarter has been from that versus just the overall pie expanding.

Tom Stanton

Its difficult for us to do. Its easy for us to look at market share gains if we look at a customer that we were not in and now we are in. So that’s without a doubt a piece of business that we would not have gotten before. Trying to figure out exactly what that pie was last year versus this year except for very few instances, is impossible for us.

So we feel better about the overall environment and some of that has to do with your previous question what we think customers are kind of gotten off the fence and decided what they’re doing so they’re starting to spend money, but to, that’s why we’re, we think that there’s been kind of an internal change in the mindset of those customers to start spending so the market itself is bigger than it was last year.

But for the most case its impossible for us to quantify what that market was last year because we weren’t playing in that market last year.

Hasan Imam - Thomas Weisel Partners

One confirmation, are you still confirming on the 25% OpInc level for the year.

Jim Matthews

All we said is that again we expect revenue to increase, we do expect OpEx to increase but OpEx not as high of increase as revenue. I think all we said is we expect to be above last year in terms of our margin.

Tom Stanton

I think we’ve exceeded our time a little bit, so I’d like to thank everybody for joining us on the conference call and we look forward to talking to you next quarter.

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