Tom Stanton - CEO Mike Foliano - SVP and CFO.

Ashwin Kesireddy - JPMorgan Amitabh Passi - UBS Doug Clark - Goldman Sachs Simon Leopold - Raymond James Rich Valera - Needham & Company Michael Genovese - MKM Partners Sanjiv Wadhwani - Stifel George Notter - Jefferies Bill Dezellem - Tieton Capital Roger Chuchen - J. Goldman.

Ladies and gentlemen, thank you for standing by and welcome to ADTRAN’s Second Quarter 2015 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period.

[Operator Instructions] During the course of this conference call, ADTRAN representatives expect to make forward-looking statements, which reflect management’s best judgment, based on factors currently known.

However, these statements involve risks and uncertainties, including the successful development and market acceptance of core products, the degree of competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies, currency exchange rate fluctuations and other risks detailed in our Annual Report on Form 10-K for the year ended December 31, 2014 and Form 10-Q for the quarter ended March 31st, 2015.

These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements, which may be made during the call. It’s now my pleasure to turn the call over to Mr. Tom Stanton, Chief Executive Officer of ADTRAN. Please go ahead, sir..

Thank you, Keith. Good morning, everyone. Thank you for joining us for our second quarter 2015 conference call. With me this morning is Mike Foliano, Senior Vice President and Interim Chief Financial Officer. I’d like to begin this morning by discussing the details behind our Q2 results and I will end with some comments on what we see for the future.

As stated in our press release, revenues for the quarter were $160.1 million, slightly higher than expected, mainly due to strength in our domestic broadband sales. Our total carrier networks division revenues, including both international and domestic, came in at $135.4 million and total enterprise networks revenues came in at $24.7 million.

Revenues from our domestic markets came in at $104.4 million or 65% of the total. International revenues came in at $55.7 million for the quarter or 35% of the total.

On a product basis, our core product areas, which include broadband access, internetworking and optical, came in at $150.3 million, up 14% sequentially with strong increases in both our broadband and optical product areas.

More specifically, total broadband access revenues came in at $100.7 million, up from $84.4 million in the first quarter, with solid performances in both our Fiber to the Node and GPON product areas. Our internetworking product category came in at $33.2 million, essentially flat from Q1.

We saw a continued strength in GPON ONTs and conversely continued weakness in our IP Gateway products segment, primarily in our CLEC customer base. Our optical product category came in at $16.4 million compared to $12.5 million for Q1.

On a geographic basis, as I mentioned, total international sales came in at $55.7 million, with EMEA essentially flat from a strong Q1 and Latin America down sequentially due to project-related timing. Our European business of course continued to be impacted by negative sequential currency exchange rates. In the U.S.

market, we saw continued momentum in carrier sales space, driven by Tier 2 CAF spending and a general improvement in the Tier 3 market. This increase positively impacted both product and services revenues.

Moving forward, we expect a positive momentum in Tier 2 accounts to continue as CAF Phase I is replaced by broader and more substantial deployments with CAF Phase II.

Additionally, our progress with securing additional awards with Tier 3s and non-traditional carriers and the continuing incrementally positive movements we expect to see in the Tier 1 space in the second half lead us to believe the U.S. will see solid growth for the year.

Outside the U.S., our European customer base remains solid, and our G.fast trials and Fiber to the Node initiatives are progressing well. I mentioned in our last call that we would be moderating our operating expenses and in the second quarter, we recorded incremental expenses necessary to move forward with that goal.

I'd now like Mike Foliano to review our results for the second quarter of 2015, and provide comments on our third quarter view as well. We'll then open the question -- the conference up for questions.

Mike?.

Thanks Tom. Revenue for the second quarter was $160.1 million compared to $176.1 million for Q2 2014 and $142.8 million for Q1 2015. Broadband access product revenues for Q2 2015 were $100.7 million compared to $108.3 million for Q2 2014 and $84.8 million for Q1 2015.

Internetworking product revenues for Q2 2015 were $33.2 million compared to $41.0 million for Q2 2014 and $34.2 million in Q1 2015. Optical product revenues for Q2 2015 were $16.4 million compared to $15.8 million for Q2 2014 and $12.5 million in Q1 2015.

Carrier systems revenues for Q2 2015 were $119 million compared to $128.8 million for Q2 2014 and $100.4 million for Q1 2015. Business networking revenues for Q2 2015 were $34.2 million compared to $42 million for Q2 2014 and $35.4 million for Q1 2015.

Loop access revenues for Q2 2015 were $6.9 million compared to $5.3 million in Q2 2014 and $7 million even for Q1 2015. HDSL product revenues for Q2 2015 were $6.4 million compared to $4.8 million for Q2 2014 and $6.7 million for Q1 2015.

Carrier networks division revenues for Q2 2015 were $135.4 million compared to $143.5 million for Q2 2014 and up from $116.0 million for Q1 2015. Enterprise networks division revenues for Q2 2015 were $24.7 million compared to $32.7 million for Q2 2014 and $26.8 million in Q1 2015.

International revenues for Q2 2015 were $55.7 million compared to $79.1 million for Q2 2014 and $59.4 million in Q1 2015. The reduction year-over-year and quarter-over-quarter includes the effects of the decline in the euro/dollar exchange rate.

To provide the reporting of each of these categories, we have published them on our Investor Relations webpage at adtran.com. Gross margin was 42.6% for Q2 2015 compared to 49.3% for Q2 2014 and 45.9% for Q1 2015.

The decline in gross margin for the quarter compared to Q2 2014 and Q1 2015 was primarily driven by the FX impact on our euro-based sales and growth in service-related material sales in our U.S. market.

Total operating expenses were $67.6 million for Q2 2015 or $65.6 million for the same quarter, net of the $2 million one-time restructuring charge compared to $67.5 million for Q2 2014 and $63.6 million in Q1 2015. The increase in operating expenses compared to Q1 2015 was attributable to increases in R&D and SG&A.

The R&D increase was primarily due to Telcordia-related development costs associated with a particular customer. The SG&A increase was due to higher than anticipated selling expenses associated with a higher revenue level. Acquisition related amortizations totaled $0.6 million for the quarter.

Stock-based compensation expense, net of tax, was $1.3 million for Q2 2015 compared to $1.8 million for Q2 2014.

Supplemental information for one-time restructuring charges, acquisition-related expenses, amortizations and adjustments in connection with the most recent acquisitions and the stock-based compensation expenses are provided in our operating results disclosure.

All other income, net of interest expense for Q2 2015, was $3.5 million compared to $2.5 million for Q2 2014 and $3.5 million for Q1 2015. The Company’s income tax provision for Q2 2015 was at a rate of 38.12% compared to a tax provision rate of 34.00% for Q2 2014 and a tax provision rate of 39.80% for Q1 2015.

Earnings per share on a GAAP basis, assuming dilution, for Q2 2015 were $0.05 compared to $0.26 for Q2 2014 and $0.06 for Q1 2015. Non-GAAP earnings per share for Q2 2015 were $0.10 compared to $0.30 for Q2 2014 and $0.10 for Q1 2015.

Non-GAAP earnings per share exclude the effect of the one-time restructuring charges that I mentioned earlier, acquisition-related expenses, amortizations and adjustments related to acquisitions and stock compensation expense.

The reconciliation between GAAP earnings per share diluted and non-GAAP earnings per share is provided in our operating results disclosure. Inventories were at $100 million at quarter-end compared to $93.1 million at Q1 2015.

Net trade accounts receivable were $89.1 million at quarter end, resulting in 51 DSOs compared to 60 DSOs at the end of Q2 2014 and 57 DSOs at the end of Q1 2015.

Unrestricted cash and marketable securities, net of debt, totaled $310 million at quarter-end after paying $4.7 million in dividends and repurchasing 2,782,287 common shares for $46.3 million.

The book and ship nature of our business, the timing of revenues associated with large projects, and the variability of order patterns of the customer base into which we sell and the fluctuation in currency exchange rates may cause material differences between our expectations and actual results.

However, our current expectations are that Q3 revenues will be essentially flat on a sequential quarter basis. Taking into account euro exchange rates and anticipated mix, we expect that gross margins will be in the mid-40s.

We expect that operating expenses for the third quarter will be slightly below our Q1 expense level, net of any additional restructuring charges. We anticipate a consolidated tax rate for Q3 to be in the high-30s percentage point range for pre-tax income.

We believe the larger factors impacting the revenue and earnings realized in 2015 will be the following.

The macro spending environment for carriers and enterprises, currency exchange rate movements, the variability of mix in revenues associated with project rollouts, professional services activity levels, both domestic and international, timing of revenue related to Connect America fund and the adoption rate of our broadband access platforms and inventory fluctuations at our distribution channels.

With that I would like to turn it back over to Tom..

Okay, thanks, Mike. Keith, at this point we are ready to open up for any questions people may have..

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

Yeah. Hi, Tom, this is Ashwin on behalf of Rod. Thanks from taking my question. I was looking you could comment on timing for CAF-2 related revenue or at least give us your expectation of revenue recognition from CAF-2 products.

Also can you comment on your expectations from DD in the second half of this year?.

Okay, sure. So on CAF-2, there are nearly -- many of the carriers, not all of them, at this point in time have signed up for whatever CAF-2 funding that they're going to be receiving and many of them have already started in the planning process.

It's still variable, but my sense is we will start to see kind of initial pieces of that probably in Q4, but kind of more accelerated ramp into next year. We're still at this point still shipping of course some CAF-1 projects that will be shipping out through the end of this year. As far as our European customer base, no new news there.

Basically they had a very fairly very strong first half and then we expect them to be seasonally down in the third and then seasonally down again in the fourth quarter. So you will see a pickup in our US business and a downturn in our European business..

Okay, thank you. I saw that you mentioned LatAm projects were down in Q2 because of timing related issues..

Yeah..

Are they coming back in Q3 or when can--?.

For that project, I mentioned it was down, but I will tell you, it was not substantially down. I think it's actually going to be up a little in Q3, but I don't think it's the materiality one way or the other is small compared to what's happening in the US and of course what's going on in Europe right now..

I have one last question. On the Enterprise segment, it looks like it continues to be in a decline mode.

Can you comment on how sort of the enterprise demand is looking like and your expectations there will be really helpful?.

Yeah, there are two things that are impacting it and then the rest of the product basis is, I will say, fairly flat. So the downturn that we are seeing in enterprise is due to two reasons. One the IP gateway business has been down now for a few quarters.

The tick down some again from first to second quarter, I will tell you, market share-wise we are fine. There has been some shift from our IP gateway business to routing business, but that's not the predominant issue. The predominant issue there is the larger tier-2 CLECs that are in that space have just slowed down. So that's one of the impact.

The other impact is we did shift a lot of the GPON ONT business, which was traditionally an enterprise business.

The Carrier Networks division started developing those products, and so we saw a shift that was – so the biggest growth area that would have been in enterprise today actually is now probably in the Carrier Networks division with the ONT business.

So both of those things kind of impacted, which is one of the reasons I would ask you to take a look our internetworking number, that’s kind of more of a bellwether on how that total business is doing because it includes both carrier and network kind of termination points..

All right. Thank you..

Our next question comes from Amitabh Passi with UBS. Please go ahead..

Hi, thank you. Tom, I just wanted to ask a couple of questions.

First, just on the CAF Phase II related funds, I mean, operator starting to spend, have they received the funds, are they spending already or do they still have till August I think to accept the funds? I am just trying to get sense of the cadence and how the spending is actually manifesting itself? Are you starting to see the benefit or do you think it’s yet to come?.

It’s yet to come. I am not aware of any type of business that we have received for CAF-2. Everything that we have received at this point has been CAF-1 related.

And you’re right, it is August for the final dates, I think a lot of them made their decisions on what they are going to do and I would tell you some of them right now do have plans to start deployment of that in Q4, but I would say it would be too early to count on that, I think that’s still kind of influxes to what [indiscernible] a lot of that will depend on the weather of course in Q4 as well.

So I would put more onus on that starting next year..

And do you think the level of overall spend envelop will actually expand or will they substitute what they were going to spend anyways or do you think this is actually net incremental to their spend?.

I have no doubt that’s net incremental, or at least to us, there is no doubt about it..

Okay. And then just a quick follow-up on Europe. You know I thought, previously you had said you would expect momentum to continue to 2Q and then 3Q, 4Q being seasonally down. 2Q came in slightly down, I don’t think we saw significant FX movements quarter-to-quarter.

So I am just wondering, did Europe and your largest customer there come in maybe a little weaker than you had anticipated? Maybe just some incremental insight in terms of what happened?.

Sure, and it’s probably harder for you see without knowing exactly what we use for exchange rates, which we set at a particular time during the month and during the quarter and so the fluctuation you may see in the market may be different from what we actually see here.

I would tell you, once down, it was – and it was down enough, it was materially down from Q1 to Q2. But the total revenue, if you look at – the best way to look at Europe is first half versus second half, so we had a very strong Q1, the strongest Q1 with them in our history. Q1 was substantially stronger than last year’s Q1.

And then we saw basically maybe a slight uptick or flat from Q1 to Q2 and if I look at the half it is definitely on a non-euro impacted number substantially up. So we think it’s – that’s just kind of the way that they are building out this year..

Okay..

And Q3 and Q4 had no change from what we would have thought..

Okay.

And finally, how many 10% customers did you have?.

Mike?.

We had three 10% customers. One in our international business and two in our domestic business..

Interesting. Okay, thank you..

And our next question comes from Doug Clark with Goldman Sachs. Please go ahead..

Great, thanks a lot. One quick clarification, you mentioned OpEx to be down slightly, wondering if that was off of the restructuring numbers, the $65.5 million or the actual reported GAAP number.

And then second question is more on the gross margin front, I mean, continuing to take a step down and kind of assuming that FX isn’t going to [ph] deteriorate that much from second quarter to first quarter, which it sounds like it may have, is all of that gross margin pressure being driven by the services component of CAF?.

Yes, well, -- the first question, which was Mike?.

It was OpEx right?.

Right. So that was on a – that was what we had talked about is for the – it will be down on a – off of the 65.

Mike, correct?.

I think what our guidance was for this quarter was that we would be at or slightly below the Q1 level. So if you look back to that Q1 number, which I believe was $63.6 million that’s our target for Q3..

That make sense?.

Yes, so down – flat or down slightly versus the 1Q level?.

Yes..

Okay..

And the second question was around gross margin..

Yes.

Just the sequential decline, is that predominantly due to CAF related projects?.

So, there were two impacts. One which you’re correct, it was the -- an FX impact, depending on what your number is, our number that we saw may be higher than what your number, I don’t know what your number was. And then the other is CAF related projects and really there is two components to that.

There is the actual service piece itself, which did grow and then there is material associated with that service, for instance, cabinets and a lot of cabinets when you’re talking about projects like this that typically come in at lower gross margins than products that you actually develop yourself..

Okay, that makes sense.

And then one quick follow-up as well, you had mentioned G.fast in the prepared remarks, wondering if you can give an update on kind of interest levels, activities and potential timing of deployments associated with those?.

Yes. Timing of deployment of course is always suspect to change, because several of these cases, we’re talking about Tier 1 carriers, we have a couple of Tier 1 carriers in Europe that are right now in a trial phase with the product as well as couple of Tier 1 carriers in North America.

You won’t see -- we won't see revenue from that this year, because it will take a while to get integrated. But we would expect to see something next year..

Great, thank you very much..

Okay..

Our next question comes from Simon Leopold with Raymond James. Please go ahead..

Great, thank you. I just want to get a quick clarification. In the press release, you talk about strength driven by CAF and in your prepared remarks and in your answers, you’ve talked about CAF-2 really coming in 2016, so really the strength in the reported quarter is the CAF 1 whereas the CAF-2 funds are really more of a 2016 event.

And I think you've said that, just want to make that clear, is that true?.

That is true..

Great.

And then in terms of kind of gross margin, you did give us some guidance for the following quarter and we’ve talked a bit about the June quarter, can you give us your perspective on how you think about the longer-term gross margin trends? It seems as if you had somewhat of a reset from your sort of long-term history of kind of high-40s to low-50s.

I'd like to get your thoughts on what you think your gross margins should be like beyond the next quarter?.

Right. So there are two components to that and if you let me -- let me just throw away currency and assume that whatever we end up at currency as at the end of the year is where we end up with for a longer period of time.

The gross margins that we’re looking at right now with the strength that we see in the US business, if I look at the total mix, I would expect to be in the – somewhere in the mid to high-40s..

Great.

And you mentioned -- this is my last question, you mentioned GPON improving, when I look at some of the third-party market research, it looks as if you have relatively low share in GPON and I'm just wondering if you could give us a little bit more color in terms of the trends in your GPON product business, how you see that within the mix and how that affects the overall business model? Thank you..

I would say, well, GPON is probably and has been over the last two to three quarters, it's not our fastest growing products, it was always number two. And I would eventually guess that this quarter, I'm looking at Mike, but I would eventually guess it’s probably our fastest on a percentage basis.

So -- and we picked up more GPON customers last year than any other carriers, so I'm not sure what specific numbers you are looking at?.

No, I guess I'm trying to put it in context.

So within the broadband access business, what percentage of revenues, so it could be $1 million in growing super-fast…?.

Yes. It was more than that. I will tell you it is very material, but if you think about when – like when does it actually get to impact, it’s on part with, let’s say, our Fiber to the Node business, maybe it is one way to look at it. Right. And I would say it is still some time away.

We have -- the biggest customers of course are Tier 1s for GPON and then you aggregate a bunch of Tier 3s in order to be able to build meaningful presence and Tier 3s are where we’ve seen the most success, we've had a slow start in a large US carrier here on GPON as you’re very much aware of.

That business has been picking up, but I’ll tell you all the carriers seem to be in a mix as to where do they use Fiber to the Node and where do they use GPON and so that variability changes over time and I would tell you right now, we see there is more opportunity right now with Fiber to the Node in the U.S.

that I would have told you than what we would have seen, let’s say, year ago on both in the larger carrier space and of course in the CAF space. So, those two often are always playing off each other. So, I would say it’s going to be some period of time before it eclipses Fiber to the Node..

And your European customers use a combination of VDSL2 and G.fast I think, is that correct?.

There is no really G.fast shipping at all right now. So, all of these trials are very early in their deployment phases. They’re just trials. So, nobody is shipping any G.fast in production at this point. So, European is predominantly VDSL2 and vectored VDSL2..

Right, thank you very much..

Okay..

The next question comes from Rich Valera with Needham & Company. Please go ahead..

Thank you. First the clarification on your comments on CAF-2 funds, Tom. I think you said you were confident that the incremental. So, is that incremental to what you’re receiving in CAF-1 right now or is there some substitution between CAF-1 and CAF-2 and then there is something incremental above that? Just wanted to sort of get the magnitude..

Yeah, that’s a good question. So, I would tell you for the ones that are doing CAF-1, that will at some point in time, let’s say, either end of this year or definitely before the half of next year, my sense would be CAF-1 will be done. So, in those carriers, CAF-2 will replace CAF-1, absolutely correct.

[00:01:52] When I was talking of incremental, I was really kind of reflecting back on like broadband stimulus, where what we figured out was, there were some carriers that actually it wasn’t so incremental, it was actually replacement.

And I would tell you, in the carriers that we’re dealing with on CAF-2, all of these are incremental to their base business cases and kind of operating activity.

Did that clear that?.

So, these are ones that you’re saying that didn’t do CAF-1?.

Yeah, there is a quite a few that didn’t..

Okay.

So, there are a lot of new carriers participating in CAF-2 and that’s incremental?.

Right, yes..

Is there any way for you to roughly size up the opportunity for you in CAF-2 versus CAF-1?.

It’s substantially bigger, I can tell you that. I mean it’s -- there are many more carriers and that aggregate dollars in each of those carriers is substantially larger..

Great. Next question related to CenturyLink. They’ve been publicly out there talking about pretty aggressive vectoring upgrade program. I think much more aggressive than they’ve been in the past potentially upgrading I think 8 million lines over the next couple of years. This would seem to be something that you’d be well suited to participate in.

Is there anything you can say about your potential to participate in that program and what that might mean for ADTRAN?.

I think we have a very strong potential to participate. I don’t want to speak for them. I think we have the best most well rounded and highest performance vectored VDSL solution out there. And I think that we’re very much attuned with CenturyLink in general, but I don’t want to speak for them.

So, but the answer to your question goes out do we have a strong potential there, yes, we do..

And I -- you might not want to comment on this, but could you get a sense of how incremental that might be? You’ve obviously had historically a significant amount of business with CenturyLink with variety of products.

I mean, any sense of how incremental this might be or would this be I think more substituting for other products, maybe fiber-based products that you wouldn’t be doing now that they’re doing more vectoring?.

I view it predominantly to the extent that we’re successful there as incremental. That is we do both Fiber to the Node and GPON business with their customer.

This is to my knowledge the very first vectored VDSL and they’re trying to hit specific service rates that although you could argue that same capital would go to -- could go to PON, I think the mix of capital that ends up being equipment versus engineering and installation when it’s PON [ph] versus Fiber to the Node is substantially different that's why it looks better to carriers and so I think that the equipment spend will be higher and I think our percentage is likely to be higher than what we're seeing on GPON..

Got it that's helpful and just one more if I could.

I'm not sure how fine you're willing to cut this but can you say roughly what you think slightly is in terms of OpEx being slightly down in 3Q versus Q1 is that, are we talking $1 million to $2 million, would that be a good sort of number to think about there?.

Rich, you are --.

Cutting it too fine?.

I would like to have some little, yes, but actually look [ph] too fine..

Okay, fair enough, thank you..

Our next question will come from Michael Genovese with MKM Partners, please go ahead..

Great, thanks a lot. And I apologize if this is a repeat question because a lot of things going on this morning, I'm not sure if this was asked but you mentioned on the comments about an improvement in the U.S.

Tier 1 market, and I was wondering if you could give us more color on that customer and that project, and what you're talking about there?.

Sure.

So I think, I mentioned three things, one was of course about the Tier 3 market, we did see some strength in Q2 and we expect that to continue, which is good, I mean, so that's kind of a baseline, there is some CAF effect but in general, I think that the USF to CAF regulation is getting figured out and you're seeing Tier 3s kind of come out of a whole a little bit at least for us.

The bigger strength of course was Tier 2 accounts with CAF funding and we spent a lot of time talking about that.

In the Tier 1 accounts and there are, depending on who you talk to, there is either two or three Tier 1s, we tend to think about it as three Tier 1s here in the U.S., and there has been some discussion already about potential projects that are going on with one of those Tier 1s early on this call, which is, as I mentioned during that question that we view some of that as, in fact a large portion of that as incremental to us, which we think could bode well for us over the longer term.

And then on the other Tier 1, we have and we discussed this on the last call, we had other opportunities with that customer some rewards that we have won which we expect it to be operationalized at the end of this year and start deployment at the end of this year and that just remains on track..

So with the number three Tier 1, where it seems like maybe there are some incremental opportunity, is that opportunity that you would see now in this season before the winter gets here or is that something that's more of a next year opportunity?.

So, I think the answer, I would be, let me be cautious here, which I need to be here.

So there maybe some benefit that we would see this year but the real benefit is, if we have a carrier out there talking about upgrading, and I use the number that was mentioned on the call, 8 million lines, personally that's a long-term opportunity, you can't do that in one season and its very material to us.

So, the real upside to that is, would be when they would start to roll out of that magnitude which you would not see in a short period of time..

And then if I get one more in just on gross margins, which I think is also been discussed but you're guiding -- so when we think about mid-40s, is 45 a fair number to think about and does that imply that the service and product mix is going to change going forward or is that just really the benefit of not locking in a negative currency view for the next quarter, I mean, how does -- how do we get such a big one quarter change with the major driver there?.

European versus U.S.

business, so we would expect the service revenue still to be fairly high in Q3 because these are CAF-related projects and many of these projects, if not the majority at this point for CAF Phase I, we're doing it pretty much turnkey, so we're doing an awful lot of the work that's being done that's going to continue on into Q3 and into Q4, so the big change is you'll see a stronger U.S.

component and a weaker European component..

Okay, great thanks a lot..

Our next question comes from Sanjiv Wadhwani with Stifel, please go ahead..

Thank, hey Tom, just wanted to clarify one comment you made about as it relates to mix of capital and equipment is different in GPON and Vectoring, I was wondering if you could just give it a little more details around that. And then in the prepared comments, you also mentioned Telcordia Certification.

Just wanted to clarify if that's related to the vectoring project or is that something completely different. Thanks..

Sure.

So the first one, on the capital, if you look at PON, PON is a great technology, it continues to be the highest R&D component of our development as far as from an expense perspective and purpose perspective, because we do believe that longer-term, the world is going to move to GPON, but that long term may take an awful long time to get there and the reason is the installation cost associated with pulling fiber and digging up streets and all the things you have to do when copper is typically already in the ground and already run to most of these locations.

So if you think about the total cost, both expense and capital in order to be able to pull fiber versus connect up to an existing copper line, I think it's kind of self-evident there is a huge difference there. So that's what I was speaking to.

And so if you look at the incremental cost from an equipment perspective for GPON versus DSL, there is not that big of a difference..

Got it. That's helpful.

And then Telcordia?.

Telcordia, it was a -- I don't -- as you know Telcordia is used in the US by tier-1s and it was one of those customers and I probably don't want to give into really more than that..

Alright, that's helpful. Thanks..

Okay..

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

Hi, thanks very much. Hey, I wanted to go back to the discussion of CAF-1 versus CAF-2, you said it's I guess significantly more incremental or positive for your business, but help me understand the logic behind that.

I mean, I certainly understand that on a per line basis, the subsidy is larger for CAF-1 -- or CAF-2 versus large CAF-1, but I guess I am trying to understand why this is incremental.

I guess the logic if we go back to the broadband stimulus days, even though the operators had more capital to work with, it didn't have more people, bodies, professional services, it was a pig through a python problem in a sense and I guess I am wondering why that wouldn't be an issue right now as well?.

Well, it could be an issue as to – I do think that there is a different approach right now to outsourcing. If you look at even our CAF-1 project, I mentioned we are doing a lot of that turnkey now. Our expectation is that CAF-2 will follow that same model. So I think there is a lot more outsourcing going on than there was in broadband stimulus.

So as to whether or not there is still going to be some type of constraint and just manpower could -- there very well could be.

What I was speaking more to, though, is if I look at broadband stimulus, my sense is at least with some of the careers that what you ended up doing is replacing – upgrading the networks in areas that needed to be upgraded anyways and so what you ended up doing is after that broadband stimulus subsided, you ended up in effect with a hole in the capital spending in some of the market because they had moved forward projects that were going to happen over the next couple of years.

In CAF, definitely in CAF-2 and I would say -- let me just say CAF in general, when we are talking to careers, they are absolutely looking at areas and markets that they were not going to build into, that they are now planning on building and covering and these are areas that would not in my opinion have been touched other than for CAF-2 funding.

So I think it's doing exactly what it was supposed to do, which is target areas that are underserved, that are underserved for economic reasons and bolstering the economic picture on those in order to be able to serve those customers..

Got it. Okay. And then, I also wanted to ask about the linearity in the business this quarter, the DSO calculation I got was 50 days. It was pretty low relative to what you guys have put out there historically.

Is there something that changed this quarter? Is it more front-end loaded? Is there something going on with collections? Is it something regarding the mix? Help us understand that better. Thanks..

Linearity, it was like it's fairly linear quarter, so Mike I don’t know if there is anything -- any color you have on that?.

I think the quarter was fairly linear compared to what we usually do, so I think that's pretty much the story there..

Great. Thank you..

Our next question comes from Bill Dezellem with Tieton Capital. Please go ahead..

Thank you. I have a group of questions. And starting with inventory, the sequential inventory growth was, I believe, the highest in three years or so.

Would you talk to us of the implications of that especially in light of thinking about revenues being flat sequentially?.

Yeah. I think, this is Mike, I think some of that has to do with some of the project work that’s going on in services. So we had talked about large project work happening and Tom talked about services in cabinet placements and those types of things.

Those are much longer to the revenue recognition cycle and as that happens, all that stuff sits in inventory until you reach the end. So I think, the bigger uptick that's happening there, the lion’s share of that is the effect of this increased build-out..

So most of that uptick in inventory is actually in the field right now at some level of turn up and that will, once we get the turn up, it turns into revenue and the inventory goes back down..

The way I think about that is, it’s really more of an accounting issue than it is a practical inventory growth?.

Yes. But literally majority of that uptick was sitting in the field right now, ready to be turned up at a customer site..

That's helpful. And then I don't think anywhere in this call that you have yet discussed the restructuring that you did do and the restructuring that you might do going forward.

Would you provide some commentary on that please?.

Sure. I mentioned on our last call that we were looking at different areas of the organization to see where we can be more focused on longer-term developments and to kind of right size after the acquisition we had during the BBA time and the incremental engineers that we brought on there and just took another look at the entire operation.

That would then include some site closures. We have somewhere near 40 total sites that includes sales office sites as well as R&D sites. R&Ds are typically the larger of those.

So we’re going through all of that and looking at how we can be more efficient and that's really what you saw in the second quarter with us just executing on that plan and our intent is to be able to drop our operating expense, exiting the fourth quarter somewhere in, I think we said mid-single-digits versus Q1 and that’s still where our plan is..

Thank you. And then finally the Latin America, you mentioned that that region was soft here this quarter, simply due to timing.

Would you talk to us about your view of the timing of revenues going forward there please?.

Sure, that customer is always a challenge to forecast and there are multiple reasons. One is, we do turnkey services with them and those turnkey services, many times, have contingencies that are not within our control.

So the problem that we have in the US like we just talked about with inventory being in the field, we had the same issue in Latin America as well. And -- but I would tell you that the dependencies in Latin America are typically more complicated and there are more parties involved in being able to unblock those.

So it just makes that difficult to forecast.

They are in the midst, also right now, of rolling out a new product of ours and getting that through the lab and all of that also adds to the mix of this confusion and then they have a tendency of ordering product at the last minute with very little notifications that you could say they are very flexible in the way that they operate their business and we have to match that.

So all of that just leads us to be kind of cautious on how we forecast that and we always view it better to have an upside surprise there than a downside surprise..

Thank you. I appreciate the commentary..

Okay..

We’ll go next to Roger Chuchen with J. Goldman. Please go ahead..

Thanks, guys. I look to start off with a big picture question, could you maybe compare the similarities and differences of the current period to maybe October 2012. If I recall, October 2012, your stocks were up to $16 per share after a couple of quarters of setback.

After putting up a couple of quarters of okay numbers and discussion of some -- couple of Tier 1 opportunities, stock ultimately went up 50% in the next three to six months.

Now, we fast forward to today, and your stock is hovering at 16% again and you just reported a good quarter and on guide and as I think about opportunities assuming from this call today, we’re talking about being incremental, suspending opportunity related to CAF-2 that should kick in late ‘15, early ‘16 and then your Tier 1, U.S.

Tier 1 customers talking about Vectoring rolling out to 60% [ph] of footprint.

The question I have is, did I get my facts and opportunities right and what am I missing, and can you fill in gaps from it?.

Yeah, there is a few gaps in that, but I will say essentially I understand your question and the bigger picture comment that you’re trying to make. The gap is being that we had an international business that came in line to and grew substantially, and then we had gross margin impact on that at some point just relatively recently.

And then the other big thing is I think there was a Tier 1 opportunity there that was very much single threaded that in hindsight we got ahead of our headlights on, and it didn’t prove out to be the case. And I’m not -- and if I have intimated to you that I expect CAF-2 revenue to be anything meaningful this year, then that is a mistake, all right.

I believe that we will see – there was a potential for some CAF-2 revenue this year, but I am not expecting it in any material way this year.

I have talked about the Tier 1 opportunity, in fact the one that I myself brought up is talked about the one that is with the larger Tier 1 here in US and I view that as kind of modestly incremental, if we see some upside next year that would be nice.

There was another opportunity that was brought up on the call today that, yes, we are participating with, yes, we think it could be incremental have we won all of the market share or had we seen POs for millions of lines being converted, to answer that is no. So let me make sure that we are communicating properly here.

I do think that where we are right now is we have a multi-threaded potential that we just need to manage, so we have in CAF-2, it’s not one customer, it’s somewhere on the order of five or so, all of which are looking at incrementally spending. Will I get a 100% of that market share? Probably not.

But if you think, if you go and look at that list of customers and our relationships and our market share and some of these are stated market share contractual awards with these customers, we should do well.

I am not proposing that it’s the size of our Tier 1 customer that we had teed up and went away at the beginning of this year, but it’s incrementally very nice and should the Tier 1 market go up in the US from where we are positioned right now, absolutely. So that’s just the basis of where the business is right now.

I would tell you that in 2012, when we were talking about the Tier 1 incremental piece, although I don’t think it actually happened in 2012, it’s probably 2013 or so where it started coming out.

That was – we were cautious, arguably not cautious enough, but we were cautious in saying that that Tier 1 carrier has a history of changing their mind, that’s exactly what happened.

I would say, the environment today and the number of carriers and then just the general uplift in the Tier 2 and Tier 3 market is more positive and it’s more widespread..

And so it’s fair to say that the difference in this cycle maybe versus the last is, there are – the individual opportunities are smaller, but they are more spread out and so that should reduce kind of concentration risk if you will?.

Yeah, but let me just try to recall just some of the comments that I believe we made during the call back then. I mean, there was a general sense after 2012 that at least for us, and I would say in general that there was a pullback in carrier spending in Tier 2s and Tier 3s and in general, even Tier 1s, but definitely 2s and 3s.

And so our communication was to the fact, yes, at some point the market in general will recover and – but we could not put the timing on when that recovery would be, but we also had an incremental Tier 1 opportunity that was positive enough to where we were dependent on that recovery to the extent that Tier 1 opportunity came to fruition, it did not.

And I would say, the thing that at least we are hopeful of right now, we are seeing that general recovery and capital spending at least in the Tier 2 and Tier 3 space, some of the catalyst driven with CAF getting better..

Right. And then my next question is, I just want to go back to that domestic Tier 1 that’s been discussed earlier in the call, it seems like they are talking about this change in their network architecture from all fiber to Vectoring, I am sorry, if this was previously covered, but I just want to make sure I understand it correctly.

So I guess how do we think about kind of the -- with this change in architecture, how do we think about the access equipment TAM [ph] versus maybe what they’ve been doing before and then number two, what does your -- what do you think is your market position given your track record in vectoring and then number three, how do we think about the gross margin profile of vectoring given that my understanding is that this is primarily a line card swap out?.

Not a line card swap out. I mean, not with -- it’s just not. There are areas where that maybe the case but I would say that that’s not predominantly the case. And even to the extent that it is the case, it’s more than -- you’re really upgrading the capability of that box, which includes backhaul and everything else.

So, it includes switching and other things. I would tell you it’s no more of a line card swap out and saying I want to put GPON in a VDSL cabinet. I mean, it’s a little more too within that.

As far as change in PAM, my sense -- and I don’t want to be biased in presenting because I think fiber to the prem is a very strong technology case in and of itself. I mean, it’s just harder to prove in and takes a lot more time to pay that and takes a lot more time for installation, because pulling fiber is difficult.

But as far as the TAM, my sense is that you can cover a lot more customers with a lot less capital.

So, to the extent that you want to cover the exact same number of customers in the exact same number of time, I don’t know if there’d been a substantial incremental change, but the reason to do that is to be able to cover more customers than you would have been if you deploy fiber everywhere.

And from our perspective, the revenue is not incrementally as far as -- on a per port basis, I would say, on a per port basis, it’s probably stronger, because if you think about GPON, where you have an OLT that feeds 64 set of customers for each port, VDSL does not, it’s one customer per quarter.

Makes sense to you?.

Yes. And just maybe staying on this topic, just running through kind of the public filings of your disclosure of 10% customers, I’m not sure if I got this right, but with respect to that Tier-1 customer, I think in 2012 maybe it was the Tier-1 US that is, it represented maybe 23% of revenues and if I’m looking at right, it went down to 14% in 2014.

So, that’s a decline of call it $50 million to $60 million in that period.

And is it fair for us to assume that with the shift in architecture, I mean, is there an opportunity for regain share and maybe recruit some of that?.

Yeah. I mean there is definitely an opportunity for that. We have to see how it all falls out. So, what happened and this is why I said there is some new answers to the 2012 story. Of course, what happened in 2012 as well is there was an acquisition of carriers in the U.S.

and one of those acquisitions included kind of mandate to drive for a dual source situation and a large property in the U.S. that had not been dual sourced before. And that -- hence the decline that you’re actually talking about as well as where the market -- there was a market shift in where lots were actually happening.

So, the answer to your question is we think we have the best product line. We think we have the best price points and our sense is that the head start that we have in VDSL vectoring, we’ve shipped more VDSL vector portion than anybody in the world and we are the primary deployment of the largest VDSL vectored roll out in the world.

And so we think we’re well positioned, but that will have to prove itself out..

Okay. And then on CAF-2.

Could you maybe help us -- give us some color in terms of how to think about kind of the annual revenue opportunity there?.

I don’t -- the reality is I don’t know. I know it is public as to what the dollar amount that these carriers are getting on an annual basis in order to supplement the deployment of this technology into their footprint.

The thing is and I do believe it is predominantly incremental and notwithstanding the CAF-1 versus CAF-2 discussion that was alluded in the call. But as far as them laying out, we have some customers that are fairly aggressively in their plans and we have some customers that have not shared with us the timing of their plans.

And there is some period of time for them to be able to build this out.

So, in aggregate, it's very easy to see the dollar amount that whether or not you want to take 15% of that dollar amount or 10% or 20% of that dollar amount and equate it back to access equipment, I'll leave that up to you because that's here again very carrier dependent and then you have to then just back into what you think a realistic timeframe for that deployment is..

Got it. Couple more questions if I may. And as we look out to 2016, I think on this call you talked about CAF-2 ramp, U.S. Tier 1, and then Germany, the German customer maybe ramping enterprise award and ramp from what 2.0 customer rolling out 1 Gig service, just major Tier 2 buying DC properties..

I did not mention that, you're putting color in the way that you're presenting that, it is much stronger than the color I was trying to present, so, but okay..

So, is there a way to think about kind of rank order kind of these magnitude opportunities here?.

Yeah, yeah, okay, so, but I don't want to be in the position that your earlier comment on 2012 reflects, all right. So, CAF-2 is the most solid piece out there, because there are carriers that are signing up for commitments to deploy something, right.

So, that feels in the carrier space, and these carriers tend to be more dependable and then when they say something, they typically do it, alright. So, of all of those you just mentioned, that's the one that is pretty solid, we have to execute on product plan, we have execute in making sure that we maintain market share, but it feels pretty solid.

The Tier 1 space in the U.S., would we love there to be a shift towards vectored technology, yes, because the differentiation we think we have a better GPON product than our competitor but the differentiation that I see in vector to be cell technology versus GPON is substantially more.

So, just from a competitive position I'm better positioned there, but I'm not going to sit here and bet that 8 million lines are going to be converted next year nor am I going to intimate to you that 8 million lines are going to be converted next year, it would be nice to see but I haven't seen any POs [ph] yet that reflect 8 million lines. E.N.G.

will start next year in Europe and I have a tentative forecast from them, but I'm not sharing that forecast, because until I see POs from it and the start date on that actually coming in any meaningful volume, I'm not going to discuss it.

So I want to make sure, yes, are there opportunities out there that we have won, yes, but I'm not trying to paint a scenario here that all of this stuff going to happen like clockwork, because it won't..

Got it, all right, thanks guys..

Okay. At this point Keith, I think we're out of time, so I appreciate everybody joining us for the call and I look forward to taking to you next quarter..

And this does conclude today's program, thanks for your participation, you may now disconnect, have a great day..