Tellabs, Inc. Q1 2006 Earnings Conference Call Transcript (TLAB)

Apr.26.06 | About: Tellabs, Inc. (TLAB)

Tellabs, Inc., (NASDAQ:TLAB)

Q1 2006 Earnings Conference Call

April 26, 2006, 8:30 a.m. EST

Executives:

Krish A. Prabhu, President and CEO

Timothy J. Wiggins, Executive Vice President and CFO

Analysts:

Vivek Arya, Merrill Lynch

John Anthony, Cowen & Co

George Notter, Jefferies & Co

Simon Leopold, Morgan, Keegan & Co

Tim Long, Banc of America

Tim Daubenspeck, Pacific Crest Solutions

Brant Thompson, Goldman Sachs

Joe Chiasson, Susquehanna Financial Group

Nikos Theodosopoulos, UBS

Cobb Sadler, Deutsche Bank

Operator

Good morning, my name is Marsha and I will be you conference operator today. At this time, I would like to welcome everyone to the Tellabs Investor Relations Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press “*” then the number “1” on you telephone keypad. If you would like to withdraw your question, press the “#” key. Thank you. Mr. Scottino you may begin your conference.

Tom Scottino, Investor Relations

Thank you very much Marsha and good morning everyone. With me today are Tellabs’ President and CEO, Krish Prabhu, and our Executive Vice President and CFO, Tim Wiggins. If you haven’t seen the news release we issued this morning, you can access it at Tellabs.com.

Before we begin, I will remind you that certain statements made on the call today maybe considered forward-looking. I direct you to the risk factors contained in today’s news release and in the reports filed by Tellabs with the Securities and Exchange Commission. That being said, I’ll turn the call over to Krish.

Krish A. Prabhu, President and CEO

Thanks Tom. Good morning everyone. As you can probably tell, I’m recovering from a bad cold, my voice does not have its usual tone and quality and I’m probably going to be more of laconic than usual, so hopefully you’ll bear with me and we’ll get to all your questions, and Tim and I will make sure we have them answered. Let me just make few opening comments and then I’ll hand it over to Tim.

Firstly, we had a very strong first quarter, 18% year-on-year revenue growth. It reflects the continued momentum from fourth quarter and we see this continuing into the second quarter of 2006. Our gross margins at 47.3% reflect the progress we’ve made. This time last year it was 41.8%, to a large extent cost reductions across several product lines but also more importantly it’s getting the ONTs from a loss-making business to a break-even business. We’ve held the OPEX flat at $155 million. We don’t anticipate any OPEX increases over the next few quarters as some of our R&D investments continue to taper the OPEX and may actually come down; it’s too early to tell.

Our earnings were very good at $52 million GAAP, significant improvement year over year. Most satisfying was the operating profit, which improved from $28 million to $89 million. Some changes, we do have a higher tax rate. In effect, we are expensing options approximately $11 million per quarter. We will be reporting by segments, so we’ve identified those segments in our earnings release. We’ll continue to show you profit line revenue within a segment that we have in today’s release. Let me address a couple of questions that might be on your mind.

Firstly, how sustainable is the revenue momentum, can we translate increased revenue to increased earnings? I’ll come to revenue in a bit, but our OPEX as I mentioned is in check and will continue to stay so. On the gross margin side, we have significant cost reduction efforts underway on the ONT, specifically, we have an initiative in China to optimize design to manufacturing, to sourcing, and we expect to get as good a margin as we can on the ONT. Part of the problem is as our customer continues the transition from BPON to GPON, some of the ONT feature sets are in flux. As you may appreciate, in a high volume business until and unless the features and the designs are pretty much in a stable condition, it’s very difficult to extract all the margins you can.

On the revenue momentum, we do have a growth strategy that has three legs. We have continued to make select enhancements to our cross-connects to optimize opportunities as part of the wireless optimized set, Ethernet back call and DSL back call. We have seen significant improvement in the shipment of T1 equivalents. Tim will give you more detail in the breakdown, but this past quarter we shipped 2.8 million T1 equivalent lines. If you can recall in 2004, we were averaging $1.4 million to $1.7 million a quarter, and in 2005 we were averaging $1.7 million to $1.9 million a quarter. So, this is indeed a very significant good start to 2006.

Our Access sales year on year were up 28%, this on the yield of a strong fourth quarter. Fiber continues to roll. We have an IPTV compatible FTTC which will support an FTPN version. We are offering a full-fledged Multi-Service Access Platform today and we think this will be very competitive in accounts outside of our current FTTP effort.

On the data front, products saw a strong growth year on year, nearly 230%. We have several new customers now, but the applications that are gaining most traction are around fixed mobile integration, wireless back call, and ATN-to-IP migration.

Lastly, on the ROADM, we have launched field trials and FOAs with a large U.S. operator. We are finalizing our contract discussions almost at the end year. We do not expect significant revenue in the first half of this year, but beginning in the second half and into 2007 I think we’ll see revenue coming in from this effort. I will stop at that point and I’ll pass it on to Tim, and once again I apologize for my voice, but Tim and I will get to all your questions.

Timothy J. Wiggins, Executive Vice President and CFO

Great Krish, I’ll let you rest here for a minute, and good morning everyone. As Krish mentioned at the top of the call, broad customer demands rolled double digit revenue growth across our transport, broadband, and service businesses. Total revenue for the quarter is $515 million, was up a robust 18% compared to $436 million in the first quarter of 2005. Continuing revenue momentum together with flat operating expenses and improved gross profit margin produced $89 million in non-GAAP operating income. That’s more than a three-fold increase from $28 million in the first quarter of 2005. Non-GAAP EPS of $0.14 per share more than doubled from $0.06 per share in the first quarter of 2005.

As announced in this morning’s press release, we are beginning with this quarter to report the company’s results in three segments instead of one. This change reflects the way we are managing the business now. It also provides you with incremental profitability measures per segment basis, which we define as gross profit margin minus R&D expense and the impact of stock option expense, amortization of purchase intangibles, deferred stock compensation and restructuring and other changes. The first segment, transport products, is identical to transport revenue category we’ve provided throughout 2005 with one exception. As we mentioned on previous calls, we are beginning with this quarter to include the results from our voice quality enhancement products within the transport product segment.

For the first quarter of 2006, revenue for the transport products segment amounted to $214 million. On an apples-to-apples basis that’s up 24% from $173 million in the first quarter of 2005. Within the transport product segment, wireless continues to be the prominent driver. For the quarter, North American wireless customers accounted for approximately 66% of all transport product segment revenue, up from 58% in the first quarter of 2005.

Looking at the Tellabs 5500 Wideband Cross-Connect business specifically, we shipped approximately 2.8 million T1 equivalents, as Krish mentioned, which is more than any quarter since the first quarter of 2001. We also recorded revenue for the integrated VQE narrow band grooming features we added to the 5500 system last year. About 70% of this quarter’s 5500 system revenue came from port card growth on our install base with the balance consisting of new systems, systems expansions, and software upgrades. That compares with 62% in the first quarter of 2005, but it doesn’t tell the whole story. We sold more new systems and performed more system core expansions in the first quarter 2006 than we did in the first quarter 2005. In fact, the percentage of open port card slots on our install base is essentially the same as it was a year ago. That’s encouraging to us because it means our customers continue to deploy new systems and expand existing systems.

Transport product segment profit was $123 million in the first quarter, up from $80 million in the first quarter of 2005. The increase is primarily due to higher sales of our Tellabs’ 5500 system and right control over R&D expenses.

Our second segment, which we call broadband products, consists of Managed Access and Broadband Data revenue categories from 2005. Overall, broadband product segment revenue for the first quarter of 2006 was $260 million, up 14% from $228 million in the first quarter of 2005. Within the broadband product segment, revenue from our Access products amounted to $164 million, which is up 28% when compared with $128 million we recorded in the first quarter of 2005.

The continuing growth in Access reflects our strategic position in the Fiber-To-The Premise and Fiber-To-The-Curb applications. Excluding $5 million of passthrough revenues associated with video build, we estimate the sales of fiber platforms, both FTTP and FTTC amounted to 56% of Access product revenue in the first quarter, with the balance being copper access platforms. This compares with 43% in the first quarter of 2005 and 53% in the fourth quarter of 2005. We continue to ramp sales of single-family ONTs.

Revenue from Managed Access products, the second part of the broadband product segment, came in at $74 million versus $94 million in the first quarter of 2005. The decline here is related to reduced demand for the 8100 product revenue.

Broadband data products including the Tellabs’ 8800 Multi-Service Router Series and the Tellabs’ 8600 Managed Edge System make up the balance of the broadband product segment. For the quarter revenue from broadband data was $22 million, that’s up from $7 million in the first quarter of 2005. Broadband product segment profit increased to $21 million in the first quarter from $8 million in the first quarter of 2005, driven by increased revenue levels and higher gross profit margin.

The third segment, services, is identical to the service revenue category we reported in 2005. For the first quarter of 2006, services segment revenue was $41 million, up 18% from the first quarter of 2005. Services segment profit was $11 million in the first quarter versus $7 million in the first quarter of 2005, driven largely by increase in services revenue. On a geographic basis, the first quarter revenue from customers in North America amounted to 80% of the total versus 74% in the first quarter of 2005.

Now turning to overall profitability, net earnings for the first quarter amounted to $52 million or $0.11 per share on a GAAP basis. That’s up significantly from GAAP net earnings of $700,000 or $0.00 per share in the first quarter of 2005. Non-GAAP net income amounted to $65 million or $0.14 per share on a fully diluted basis. This compares with non-GAAP net income of $26 million or $0.06 per share in the first quarter of last year.

Our non-GAAP income tax expense for the first quarter of 2006 reflects a normalized rate of 35.5%. This compares with an effective tax rate of 14% in the first quarter of 2005 when we were able to use net operating loss carry forwards to largely cover tax on income from domestic operations. As usual, you’ll find a complete reconciliation of our GAAP and non-GAAP results in this morning’s press release.

Non-GAAP gross margin was 47.3% compared with 47.6% in the fourth quarter of 2005 and 41.8% in the first quarter of 2005. As you know, our gross profit margin is dependent on product and customer mix, which was responsible for the slight shift in the first quarter. Contributing to the shift was a rise in ONT sales. Going into the second quarter, we expect that sales of single-family ONTs will continue to accelerate and that the aggregate gross margin will be between 46% and 47% depending of course on product and customer mix including the volume of single-family ONTs.

Turning to operating expenses, non-GAAP operating expenses excluding amortization of deal-related intangibles and deferred stock compensation and stock option expenses came in at $155 million right on 30% of revenue. That’s flat in real dollars with the first quarter of 2005 when operating expenses amounted to 35% of revenue.

For the quarter, R&D expenses came in at $88 million and SG&A expenses were $66 million. At $88 million, R&D equals 17% of revenue. For the second quarter of 2006, we are looking for non-GAAP OPEX to remain flat to slightly down consistent with our targets to have quarterly operating expenses trend modestly down through the course of 2006. In the second quarter, we expect that the effect of expensing stock options will be approximately $11 million, split between operating expenses and cost to goods sold. Non-GAAP operating income was $89 million in the quarter or 17% of revenue. That compares with $28 million or 6% of revenue in the first quarter of 2005.

Other income on a non-GAAP basis amounted to $12 million versus $6 million in the fourth quarter of 2005 due to larger invested balances and higher interest rates. As mentioned above, our tax provision, our non-GAAP pretax income from the quarter was $36 million for effective tax rate of 35.5. We do expect that our tax rate for 2006 will be approximately the same as it was in the first quarter.

Turning to the balance sheet quickly, day sales outstanding stood at 64 days compared with 56 days in the fourth quarter due to the timing of revenues during the quarter. Inventory terms were 9.4 times versus 9.8 in the fourth quarter 2005. Inventory in terms of dollars increased to $124 million from $109 million in the fourth quarter of 2005. CAPEX amounted to $13 million compared with $9 million in the first quarter of 2005.

During the quarter, we purchased $118 million worth of our stock and received $64 million in cash from stock option exercises. At quarter’s end, the actual number of shares outstanding was $448 million; that compares with $449 million at the end of the fourth quarter. At the end of the quarter, our cash and investment balance stood at $1.145 billion, down $45 million from the fourth quarter of 2005, largely as a result of the stock repurchase activity.

Head count at the end of the quarter stood at approximately 3700. Our book to bill was over 1, taking backlog into consideration along with other internal indicators. We expect the momentum reflected in our strong first quarter results to carry forward into the second quarter of 2006. Factoring in the kind of seasonality we’ve historically seen in the second quarter, we’re looking for second quarter 2006 revenue to show a strong increase between 16% and 18% over the second quarter of 2005. That would put second quarter revenue in the range between $535 million and $545 million. At this point, we’ll open the floor to your questions. Marsha, we’re ready for the first question.

Question-and-Answer Session

Operator

Thank you sir. At this time, I would like to remind everyone, in order to ask a question, pleas press “*” then the number “1” on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Todd Leone with Merrill Lynch.

Vivek Arya, Merrill Lynch

Good morning this is Vivek Arya on Todd’s behalf. My two questions are, first is the growth in cross-connect for wireless deployment seems extremely strong this quarter. Krish, can you give us a sense for whether this is a big bump from one particular customer similar to the big increases you saw in previous years from Verizon and Sprint, and really how sustainable is this kind of growth, now that you had already done with Verizon, Sprint, and perhaps Singular, just the sustainability on that? Thanks.

Krish A. Prabhu, President and CEO

Thanks Vivek. I’m not sure I would agree with your assessment that we are already done with the three you mentioned. I would not be very specific about customers, but one another point I’d like to make is that of the four wireless carriers in North America, two of them are particularly well defined that on 2G to 3G migration, and they are the two big ones, and in both we have a strong play. We saw very good sales in the first half of 2005, the first half of 2006, with those two continues to follow a similar pattern. So, that’s part of the question you had asked. So, I’m not sure if you say we’re done with those two. But let me also mention that two of the others had held back their expenses last year; one was going through a merger acquisition. We saw some strength in orders in that particular account. This year, Tim mentioned about core expansions and new systems, and the combination of core expansions, new systems, and port cards conveys to us that we do have good sustained growth. I have to mention on the wireline side, not the wireless that you referred to, we are seeing the second wind when it comes to DSL back call, especially in light of our T1 IMA and Ethernet multiplexing feature that we introduced in 10.2. I know many have written off that this is the 9 pinning of this particular game. I’m telling we’re sending batters to the play and that doesn’t concern me too much right now. We have good visibility into orders into second quarter, we’ll see as the year progresses.

Vivek Arya, Merrill Lynch

And a quick followup question. You mentioned BPON to GPON transition, can you please give us a sense for what the impact will be on margin, what do you expect your market share to be? Also, I assume that you will place some margin compression not just in ONTs, but is it possible that there could be margin progression in OLT also since this is a new product?

Krish A. Prabhu, President and CEO

On the OLT side margin compression is manageable. In fact, what happens in products that go into the network, either at the edge or at the core, as the initial product rollout is launched and the early startup phase is behind us, we see significant improvements in margin just because of manufacturing efficiencies, optimized cost reduction, and we have a good effort. A good portion of our R&D and manufacturing cost is directed towards that just to make sure that we get these benefits. On the ONT side, the transition from BPON to GPON is likely a 2007 event. Well for now, I think there’s only one customer in the US who is really doing any kind of sizable PON rollout, and that particular customer is probably going to do a transition somewhere in the second half of 2007. I can’t speak for that customer, but I’m just kind of giving you my sense when the volume impacts kick in and where it’s likely to affect our margin, whether it’s margin compression or margin erosion. The GPON pricing we believe will be competitive. We believe that that will open another window for the customer to get price concessions. We are working very aggressively on a GPON design that attempts to hit that pricing window; still a bit too early to tell what impact that will have, but the real volume impact on BPON to GPON is a 2007 event.

Vivek Arya, Merrill Lynch

And one last question; if you look towards the end of this year, would you expect gross margins to be closer to 49%-50% or around this 46%-47% that you’ve got it to?

Krish A. Prabhu, President and CEO

We have never claimed it’s going to be 49%-50%. We had said that our business model was to try and get our gross margins to 50%. I think over the last two or three quarters we’ve stabilized around 47%, and I think Tim mentioned that if ONT volumes continue to rise as we saw in the first quarter, potentially we’ll see in the second quarter, then our margins will be at or around 47% or between 46% and 47%.

Vivek Arya, Merrill Lynch

Thank you.

Operator

Your next question comes from the line of John Anthony with Cowen & Co.

John Anthony, Cowen & Co

Good morning guys. I have a few questions. Krish, I’d like to get a clarification. When you say that you have a Multi-Service Access Platform that is being offered today, is that a GPON enabled platform? I just want to be clear that where exactly you guys are on offering a GPON OLT.

Krish A. Prabhu, President and CEO

Well, you know we have a Multi-Service Access Platform which is a followup or an evolution from the Fiber-To-The-Curb offering that we’ve had. Where the world is going is actually bifurcating along two lines. Customers prefer to do a fiber overbuild, which is one customer who has been most aggressive in PON rollouts, and this particular GPON platform doesn’t need to be multi-serviced. The whole aspect of multi-service is that you would terminate copper and fiber extensions onto that platform so that you could support low-rate things like POTs, T1 specials, as well as fiber extensions that could be PON or Fiber-To-The-Curb. So, the Multi-Service Access Platform is really intended for those customers who feel that their economics need an FTTC or an FTTN or even an FTTP gradient, but not an overbuild scenario, because in an overbuild scenario what you do is you rollout fiber out to every home and then all you’re interested is in making sure that you can get as much bandwidth as possible to that home. So, yeah, the answer your question, our Multi-Service Access Platform does have a GPON as one of the service among the multi-service spectrum that we support, but for those customers that have exclusive overbuilds we have a better offering for fiber terminations only, because we have an integrated router capability which gives them much better network economics.

John Anthony, Cowen & Co

So, then as a followup to that, with regards to the 8865, when will that be available to customers?

Krish A. Prabhu, President and CEO

We are targeting second half of this year.

John Anthony, Cowen & Co

Okay, and when would a GPON ONT be available to customers?

Krish A. Prabhu, President and CEO

I’d say about this winter. We do have preliminary versions of the ONT for lab evaluation, but when you say to customers, are you implying field trials?

John Anthony, Cowen & Co

Yes.

Krish A. Prabhu, President and CEO

That would be more in the second half of this year.

John Anthony, Cowen & Co

Okay great, and how’s the success of the 6325? And my last question on the ROADM, what is component environment like especially on tuneables as it relates to getting the ROADMs out in the second half of this year?

Krish A. Prabhu, President and CEO

The 6325 has a lot of interest. For those who don’t know, this is our micro-MSPP product. It’s a one-rack increment, fully protected MSPP, a very powerful complement to any existing next-generation SDH network. There’s a lot of interest, but the product also is a low price point product. So, in terms of what kind of revenue impact it has to our base business, that is now well over $500 million a quarter. It’s going to have a moderate or a minimal impact initially. But to answer your question, very good interest and we are picking up new customers, both in existing channels as well as new channels. On the ROADM, the issue about tuneable lasers, I’m not particularly aware of any issue with tuneable lasers. We had talked about the ability to do 6-degree and 8-degree ROADMs with suppliers of basic ROADM technology, and as that is usually a small set of startup companies, we have to be watchful that we are not putting too much pressure on them. I do not expect any impact to our plan in this second half, deployment scenarios of 7100, but the fact that the optical component manufacturers for this particular ROADM component, especially for 4-degree and 6-degree and 8-degree, more 6-degree and 8-degree ROADMs, comes from a small set of startup companies, it’s something that we are very watchful about at this time.

John Anthony, Cowen & Co

Terrific, thanks guys, and congratulations.

Operator

Your next question comes from the line of George Natter with Jefferies.

George Notter, Jefferies & Co

Hi, thanks very much guys, a couple of questions. First, you mentioned the Multi-Service Access Platform; just to be clear, is that another variant of the AccessMAX platform, is it the Acom product that you’re reselling, or is there a new incremental platform that guys have been developing? And then also, the second question, on Fiber-To-The-Curb at BellSouth, we know there were a number of milestones that Tellabs had to hit in going after that business as part of the original RFP there. Where are you guys relative to the technology milestones, and at what point would you anticipate starting to retrofit the install base of Fiber-To-The-Curb platforms there? Thanks very much.

Krish A. Prabhu, President and CEO

George, I love it when two questions have one answer. Well, let me see if I can help you there. As part of the commitment we make to BellSouth, we had our platform which we have enhanced, and in fact we have incorporated some Acom technology for an IPTV engine in this platform, but this is our new product, the 1150. The 1150 is our Multi-Service Access Platform. It supports an FTTC, an FTTN, and an FTTP configuration. Again, as I mentioned earlier, if the customer is only interested in overbuild, there really is a different offering, which is our 8865. So for the first question is, neither of these two products is based on the AccessMAX. The 1150 has had a couple of releases that have hit the milestones that we had committed to BellSouth. In fact, I can speak for the customer, but it is an integral part of some of their IPTV trials that they have said they would be conducting this year. We do expect that product to be taken to other markets, not just in this country but overseas. George, I don’t know, did I get to all your questions?

George Notter, Jefferies & Co

What point would you be retrofitting the install base in?

Krish A. Prabhu, President and CEO

The retrofit is a slightly different issue. They did have some older products that they wanted; in one case more data capability, in another case more data plus full IPTV capability. We have a roadmap for that. I’m not precise in terms of whether it was completed at the end of 2005 or whether it spills into 2006. But in terms of actual retrofit, to some extent that’s driven by the customer’s program, to the extent that the customer wants to evolve their existing base from just broadband to competitive broadband to full IPTV; they set the timetable on that.

George Notter, Jefferies & Co

Thanks.

Operator

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

Simon Leopold, Morgan, Keegan & Co

Thank you. Although you did have a very good quarter, I wanted to drill down a little bit on where you guys were a little weaker than we expected, particularly the broadband data networking products in the 8800 series, sequentially that was down. If you could talk a little bit to the trends there, both in the quarter and looking out to the future. And also the Managed Access business, if you could talk a little bit about what the forces were that led to the decline in that business, how much of it is competitive, how much of it is simply purchasing pattern seasonality, and what your outlook is to that group of products? Thank you.

Krish A. Prabhu, President and CEO

Thanks Simon. The 8800 product is also seasonal, so I guess it’s a bit…from the fourth quarter 2005 to the first quarter 2006 we were down, I think it was $30 million or so in the fourth quarter 2005 and we did $22 million in the first quarter of 2006. But, if you really compare the first quarter 2006 with the first quarter of 2005, we went from $3-$4 million in the first quarter of 2005 to $22 million in the first quarter 2006. We are seeing the scaling up of the networks where the product has gone through the initial acceptance phase, initial application phase, and now the applications are being rolled out network wide. I think the momentum will build in the second, third, and fourth quarters. I’m not too concerned about the rate of momentum on this particular product. Of course, it always helps to do more, but I would not classify this as something of a concern to us. We are hitting fixed mobile integration applications overseas, especially in tier 1 operators. We are also hitting wireless back call applications in the US with at least one major wireless provider, and of course we have the converged package applications for enterprise networks with one big tier 1 carrier in the US and big tier 1 carrier outside the US. And then of course, one of our customers, Telstra, announced that they have selected us. So, we have several big networks that will start ramping up here this year. On the Managed Access, we did have a decline in shipments of one particular product. Is that a particular buying pattern or is that something that’s here to stay, it’s too early to tell. We do have the other issue with the other product, I’m referring to the 8100, year on year the sales were down, but on the 6300 which is another element in this product line, we have the issue that one of our channel partners, Ericsson, is now inclined to shift their own products to the Marconi product line. But what we have done is managed to replace the loss of Ericsson products with business from other customers, so you can see year on year we’ve had no decline in the revenue.

Simon Leopold, Morgan, Keegan & Co

Just a quick followup then on the 8800 product; a number of equipment vendors have noted some weakness out of Japan in NTT, which has been a past customer for you, was that an element in the relative sequential weakness here or are there any other factors?

Krish A. Prabhu, President and CEO

Well, the relative sequential weakness is largely related to the fact that we did one major deal, one operator in Europe through a partner in the fourth quarter, and that project will be in fits and starts. The first part of that project in fourth quarter, the second part of the project is to turn it up and bring on the customer on to this network on first quarter. We do expect them to come back and start ordering more and deploying more in the second quarter and beyond. The NTT specific thing did not have anything to do with the sequential decline.

Timothy J. Wiggins, Executive Vice President and CFO

I would add, Simon, that the numbers that came in were above our internal planned targets and it wouldn’t characterize it as weakness at all. If we continue at this pace and have the increasing momentum that puts us on target to see a significant increase in revenue going forward this calendar year.

Simon Leopold, Morgan, Keegan & Co

Great, thank you very much.

Operator

Your next question comes from the line of Tim Long with Banc of America.

Tim Long, Banc of America

Thank you, two questions if I could. First, on the wireless side, you talked a little bit about the U.S. operators. I just want to take that to another level if I could, could you just update us on the kind of capacity for base station that you’ve been deploying, and if in any of your discussions with these operators are there thoughts that if capacity or usage reaches certain levels that you’ll need to come back at incremental capacity at some point? So, I kind want to look out more than the next two quarters and now the year as to what’s the capacity there? Then secondly on to the ONT side, I’m not sure you went over the timing of the ONT 612 and what the potential margin benefit could be there?

Krish A. Prabhu, President and CEO

Okay, on the wireless side, as they go from 2G to 3G and as they add more base stations, there is a continual increase in back call capacity that they need, and what we have seen over the last several quarters is that there is a trend of demand or an underlying force that seems to be exerting pressure on network capacity, and countering this force is really budget cycles or directors driven either by a merger scenario or other major projects that seem to be holding up investments. There was one wireless operator that went through a merger last year, but revenue from that operator did very well in the first quarter of this year. So, I think this will continue to play out over the next several quarters. I won’t be surprised if it goes through all of 2007. Because remember, as they go through not just consolidating the 2G making sure that spectrum plans are in alignment, especially if they’ve gone through a merger, that 3G revenue does indeed call for more back call capacities, so they certainly push hard on that. All this will play out all through 2006 and 2007. So, I know a lot of people are concerned about wireless. Believe me, we are more concerned than anyone of you out there. We watch this very, very carefully. Our account teams are very closely tied to the customers who are most responsible for placing orders, very much in alignment. We feel very good about where we are at least as we look at the next six to eight quarters. There maybe some seasonality driven to budget cycles, so quarter over quarter you’re not going to see the kind of growth we’ve seen, but I’m very encouraged that some of the feature enhancements that we had made in our products are playing out and our customers are validating that. On the ONT front, the 612 was an improvement on the 611. Remember, the 611 was the Vinci ONT that brought us to a break even point compared to the AFC ONT. The 612 had two initiatives; one it introduced a capability called Moca which the customer wanted, mainly because they wanted to ease their installation time in the home, and secondly it had cost reductions that would improve the margins. The 612 is going through final acceptance right now and should start rolling out here very soon. Now, the biggest impact in terms of margin compression or margin erosion in my mind will be driven more by the timing of the BPON-to-GPON transition.

Tim Long, Banc of America

Thank you.

Operator

Question from Tim Daubenspeck with Pacific Crest Securities.

Tim Daubenspeck, Pacific Crest Securities

Thank you, two questions. The first is on the international side, international revenue was down a bit. Can you talk about what you might be able to do either from a partnership standpoint or a product standpoint, where you could kind of re-accelerate what’s going on in the international side? Then the second question is kind of a big picture question; you know, the recent Lucent-Alcatel announcement, has that changed your internal discussions on your M&A strategy, either from accelerating what you might do in terms of acquisitions or being more open to being part of a larger organization?

Krish A. Prabhu, President and CEO

International was basically down…I think as a percentage of totals it was slightly lower but…

Timothy J. Wiggins, Executive Vice President and CFO

I think what’s happening is the North American business was growing at a faster rate…potentially flat down just slightly.

Krish A. Prabhu, President and CEO

Okay, most of it was in that Managed Access around one product, the 8100, and we’re really trying to understand if it was seasonality or whether it was just an ordering cycle. This product is about 10 years old. We’ve continued to enhance it and we’re not sure if this is really the beginning of the end for the product. So, it’s too early to tell right now, we’ll wait and see for the next two or three quarters. The bigger question that you asked is could we do something more internationally through partnerships? Yes, we are exploring that. A significant portion of the 8800 shipment that we did in the fourth quarter was through an international channel partner and we are exploring ways to do more with that partner. Coming to the question about Lucent and Alcatel, we have never said that we are not open to being part of a bigger player. So, I just want to say that for the record, because our board I’m sure will do whatever is right for the shareholders and the landscape is changing in the consolidating world, the board will make the right call. I just want to be clear that we have never said we don’t want to be part of a bigger player. But, at the same time, I must say, we have a great team, we have 3700 employees, we have a good gameplan and we’re putting points on the scoreboard right now, and thankfully that’s our focus as we look at what we need to do day to day.

Tim Daubenspeck, Pacific Crest Securities

So, in terms of the cash that you have on the balance sheet, what would be the expectation and the primary use of that cash?

Krish A. Prabhu, President and CEO

Tim Wiggins can give you an answer to that.

Timothy J. Wiggins, Executive Vice President and CFO

We certainly, as you could see, we’re very aggressive in share repurchase in the first quarter. That’s certainly one of the things on our list and we continue to evaluate what will be our acquisitions or additional share repurchase or maintaining some cushion just based on the changing landscape. I think those are all the things that we have in mind in the short run for the cash.

Tim Daubenspeck, Pacific Crest Securities

Great, thank you very much.

Operator

Your next question comes from the line of Brant Thompson with Goldman Sachs.

Natalie on behalf of Brant Thompson, Goldman Sachs

Good morning it’s Natalie on behalf of Brant. I was wondering if you could just talk about what portion of revenues in the quarter were related to the Katrina rebuild and how should we think about that progression throughout the year? Thanks.

Krish A. Prabhu, President and CEO

We really don’t know what portion of our sales actually goes to Katrina rebuild. Part of the reason is the customer orders equipment, then we have a third party that essentially does the warehousing on behalf of the customer, and then the customer pulls orders from warehouse as and when their field operations calls for equipment. So, I’m sorry I just don’t have the specifics as to what portion of that was Katrina rebuild. I think a lot has been said about spikes in our business because of Katrina. My own sense is that this business, if I look at the last four or five quarters, it’s a very steady business. The customer has ambitious plans for broadband rollout Fiber-To-The-Curb IPTV; of course the customer itself is going through a major acquisition with another operator. So, I think in the grand scheme of things my own sense os over the next several quarters the impact of Katrina would be just a blip on what happens here.

Natalie on behalf of Brant Thompson, Goldman Sachs

Thank you.

Operator

Your next question comes from the line of Joe Chiasson with Susquehanna Financial.

Joe Chiasson, Susquehanna Financial Group

Thanks, good morning guys. Krish, I was wondering if your could comment a little bit perhaps about the shipments of the Digital Cross-Connect into the wireless service providers, and specifically do you have any sense as to how much of that demand is being driven by 2G voice subscriber growth versus 3G back call requirements specifically?

Krish A. Prabhu, President and CEO

Yeah, I think Tim mentioned that 66% of our revenue went to wireless operators for the Digital Cross-Connect.

Joe Chiasson, Susquehanna Financial Group

Of the 66% percentage, I guess, my question is do you have any sense as to how much of that is being driven specifically by voice subscribers, and what I’m referring to is the fact that the past two years have really been unprecedented in terms of the number of new wireless subscriber ads across the big four here in the US? But, if you’ll look at the arithmetic, so to speak, behind the additional capacity they needed at the cell site for 3G service, it sort of pales in comparison to the numbers that you’re having for shipments there. So, there’s a little bit of a disconnect at least from our perception here as to what’s truly driving the high-level demand that you’re having on the wireless side for the Digital Cross-Connect.

Krish A. Prabhu, President and CEO

Yeah, the demand went from $1.9 million T1 equivalents shipped in the fourth quarter, which was the strongest quarter even in comparison to the big Verizon Wireless build out that happened in the second quarter of 2004 to $2.8 million T1 equivalents shipped. So, I’ve got to believe a lot of that was demand, because remember last year there were at least two operators, one of them was going through a major merger and the second one had some constraints on budget spending. So, I’m not inclined here that this $2.8 million T1 equivalent is sustainable for several quarters, but at the same time I also believe that since we have shipped a lot of new systems, we have done a lot of core expansion, we have a lot of empty slots there that can be filled with port cards, I can feel and say this confidently that throughout 2006 and going in 2007 we will see a fair amount of T1 equivalents shipped every quarter, whether it’s a combination of plugs or whether it’s a combination of expansions or whether it’s a combination of new systems. So, how much of it is voice related and how much of it is voice going to 3G, there’s no way we can tell. All we know is customers, as they continue to look at their network and look at their traffic patterns, look at their sites, give us orders based on what they would like to see at each site, and we give you as much information as any of our competitors would, we give you the breakdown in terms of T1 equivalents, in terms of port core expansions in new systems, and I think that should tell you that there’s still a lot of life in this business.

Joe Chiasson, Susquehanna Financial Group

Great, thank you.

Operator

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

Nikos Theodosopoulos, UBS

I have a couple of questions. On the new classification of transport, the business grew 24%. Can you give a flavor of how the 5500 and the traditional Echo Canceller product did versus this 24% growth, did they both grow about the same? I’m just trying to get a sense of how those two products did there, and then I had a followup question.

Krish A. Prabhu, President and CEO

Thanks Nikos. We’re going to dig that information up; Tim you want to look into that…

Timothy J. Wiggins, Executive Vice President and CFO

Give me a second Nikos, why don’t you ask your second question?

Nikos Theodosopoulos, UBS

Okay, my second question is, Krish, you gave us your insight as to when you think the BPON-GPON transition will take place, I guess my question is when do you think the formal decision process by the three RBOCs involved in this big RFP will actually complete, is this something that is going to complete in the first half of this year, do you see it being more in the second half, can you give us a sense of the process and the timing of their decision, not so much the transition of the deployment but the decision process?

Krish A. Prabhu, President and CEO

I really don’t know, Nikos, I wish I had more knowledge on that, and part of the problem is the tri-RBOC is becoming a bi-RBOC because two of the three are merging, and as I mentioned earlier, the architectural preferences are clearly crystallizing into two strategies. One is a clear overbuild strategy, which means you send the fiber all the way to the home and then you want the fiber to be an intelligent broad pipe and you want to make sure that you have Smart Scale to manage that packets coming into the fiber. The other is a multi-service strategy because you roll out the same platform but you want to have the option of terminating at the node, at the curb or at the home, and these two strategies to some extent call for a slightly different platform, especially if you want to look at network economics, and that’s why we have the offering of an 8865 and the 1150. So, will the RBOC make a decision and does that decision say some of us are in and others are out, and is that going to happen in the first half, second half? I really don’t know.

Timothy J. Wiggins, Executive Vice President and CFO

Nikos back to you first question. My first answer is it depends. Were you asking me on a sequential basis or on a year-on-year?

Nikos Theodosopoulos, UBS

You pick, I guess I was looking at the year-over-year, but if you want to give sequential, I’m just trying to get a sense of the respective growth rates.

Timothy J. Wiggins, Executive Vice President and CFO

Year over year, largely the 5500 contributed to the growth.

Nikos Theodosopoulos, UBS

Okay, it’s fair to say that the 5500 grew at least 24% year over year if not more?

Timothy J. Wiggins, Executive Vice President and CFO

It was a pretty significant part of the growth.

Nikos Theodosopoulos, UBS

And when you look at that business going forward, last year your 5500 business was also up sequentially in the first quarter and it kept kind of growing, it ended the year higher than it did in the first quarter. Do you see that pattern again this year? I mean if you look at the second quarter, third and fourth quarter, does this business continue to grow sequentially within the year or is this just a kind of a peak quarter and it’s stabilizing at this level, because that level of growth is very, very significant?

Timothy J. Wiggins, Executive Vice President and CFO

We’d love for that to happen, and I think our visibility to the fourth quarter is not particularly good at this point. I think we feel pretty good about continued solid trends in the second quarter. I mean we’ll take it at a quarter at a time. But I think, as Krish is mentioned, there’s a lot of underlying factors that are driving this, not the least of which is the continued upgrades to the products. In fact, essentially it’s a new product and this new redesign feature pack 11 with the switch core is another life-extending feature for the product. So, I think we’ve done a very good job of positioning this product and continuing to evolve it to meet both the demands for the wireless customer but also, as Krish mentioned, on the wireline side.

Krish A. Prabhu, President and CEO

And once again, I would like to add, there are three primary applications especially in a deployed 5500 network that makes sense today because of these enhancements that Tim mentioned. There is the DSL back call for fixed line operators, there is the wireless back call, especially as you go from 2G to 3G because of our Ethernet capability, and then there is the Ethernet back call, especially as customers look at transitioning from T1 to Ethernet services. In each case, the 5500 becomes a very attractive solution based on the economics.

Nikos Theodosopoulos, UBS

Okay, just one final comment. So, it sounds that at least for the second quarter you don’t expect this business to be down, you’re looking at it to be either flat or up given the guidance you’ve given?

Krish A. Prabhu, President and CEO

Absolutely, and in terms of guidance we look at orders on hand, we look at what we expect by means of booked shipped in the quarter, we look at the runrate at which orders have been coming in, at least for the three weeks that we’ve been in the quarter; we feel very good about this business in the near term.

Nikos Theodosopoulos, UBS

Okay great, thank you.

Krish A. Prabhu, President and CEO

We got time for maybe one more question.

Operator

Your next question comes from the line of Cobb Sadler with Deutsche Bank.

Cobb Sadler, Deutsche Bank

Thanks a lot. I had a quick question on the traditional DLC business, so the AccessMAX ASC, older DLC product, it sounds like the IOC customer base is still kind of under pressure from guys like Calps has got a new product out, but what might you be doing on the RBOC side to offset any weakness? Are you taking any marketshare on large line-sized applications that’s in the RBOC in North America for those traditional AccessMAX DLC products? Thanks a lot.

Krish A. Prabhu, President and CEO

We have a two-pronged attack on the AccessMAX DLC side, and I mean the AccessMAX copper side as opposed to fiber. Firstly, we have a pretty ambitious program to upgrade existing AccessMAX with DSL capability, and we’re seeing good results on that front. So year-on-year that Access business grew 28%, but if you really look at the decline that was forecast for this part of the business because of competition that you had mentioned, last year at this time many analysts had written that this particular part of the business would be in free fall. But when we do a comparison between the first quarter of 2005 and the first quarter of 2006, that decline is minimal and really part of that is because we are selling a lot of DSL capability and upgrades. But our real plan in this particular market, especially with independents, is to offer the 1150 as the platform of choice. The 1150 gives the independent operator a really superior Multi-Service Access capability, allows them to choose, have some architectural flexibility in terms of Fiber-To-The-Premises, Fiber-To-The-Curb, or Fiber-To-The-Node, or even a broadband loop carrier configuration, and we feel fairly confident that we will be in a position to have a very competitive offering in the non-RBOC market with the 1150.

Cobb Sadler, Deutsche Bank

Okay great, and then on the RBOC side, are you seeing any marketshare picks for large line-sized applications?

Krish A. Prabhu, President and CEO

For DLCs?

Cobb Sadler, Deutsche Bank

For copper-based DLCs.

Krish A. Prabhu, President and CEO

That’s a market that’s predominantly dominated by Alcatel and Lightspan. It’s not a market in which we’ve competed with the AccessMAX.

Cobb Sadler, Deutsche Bank

Great, thanks a lot.

Krish A. Prabhu, President and CEO

Thank you everyone. Hopefully on the next earnings call my voice would be much better. We appreciate your support and your efforts to understand our business, and we’ll continue to do a good job on behalf of our shareholders. Thanks again.

Operator

This concludes today’s conference all, you may now disconnect.

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