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Adtran Q108

Adtran reported surprisingly good numbers and made specific comments that indicate the Great North American capex freeze of 2007 is thawing in a few areas. The company also had interesting things to say relative to access market growth and trends in the Enterprise portion of their business.

It is important to know our internal bias up front: we are owners of ADTN and believe it to be one of the best managed companies in the telecom equipment space. Andrew has worked with engineers at Adtran in the past and believes the company gets Silicon Valley R&D quality for Huntsville, AL prices. We have referred to it in the past as the “American Huawei” for it’s low cost focus and fast-follower strategies. The company never reported a loss during the Telecom crash, and is the only company in the Nyquist index that pays a dividend (something commonly when looking at P/E ratios).

Adtran is in the midst of a transition away from it’s legacy T1/HDSL access business and towards several new areas – optical transport, next-gen fiber & Ethernet based access, and Enterprise products. The company provides historical detail on business segments (see Adtran IR page).

The company indicated that their Broadband access business was “very good”. The company has design wins with their TA-5000 platform at three North American tier 1’s. Only one of the three is deploying product at this time. The company expects AT&T, it’s second TA-5000 tier 1 to begin deployment in mid-08 as part of their legacy ATM to Ethernet aggregation service (This must be replacing the Ciena/Wavesmith product). A third customer (Quest?) with a much more significant deployment planned should turn on in around 12 months. As usual, the timing of these deployments is up in the air but the TA-5000 accounts for only 5% of revenue today.

Optical access saw revenue from all tier 1 customers grow. Adtran has 2 RBOC wins here (and working to close a third). More demand for higher speed versions of the platform (OC-48) and for Ethernet interfaces (Transwitch supplies some of the chips here, and possibly Bay Micro). This product has yet to see significant revenue.

The Enterprise portion of its business (Netvanta SMB access routers and VoIP equipment) was “weak”, a situation the company does not expect to reverse next quarter. They felt this was attributable to macro conditions.

AT&T was fingered by many companies (including Adtran – the news of which triggered a decline in the stock) last quarter as a source of equipment maker revenue weakness. Adtran indicated that in Q1 this began to reverse, with the company buying more legacy HDSL equipment. Tier 2/3 companies exhibited the same spending trends as the past few years – the company used the words “Lockdown Mode” – though Adtran indicated they were growing revenue through new products (unknown if this is true, all companies use this line)

The company has announced a G-PON product and had interesting commentary about Tellabs intention to exit the access business. Adtran felt the Tellabs decision was more about getting out of the Verizon business than it was about exiting FTTH and PON. They expected to continue to see Tellabs in the access marketplace for FTTH, and also see Calix and assorted tier 2/3s. Listening to this, in addition to the comments about tier 2/3 carriers, one might conclude that the company felt it could take share from the legacy Tellabs/AFC business as those customers transition to more modern platforms.

Adtran doesn’t typically provide guidance. The company indicated they should do better than $123M in Q2, and that they expected the company to grow at a greater than 7% annual rate this year. Analysts expected the company to continue along a path of 7% long term revenue growth, we won’t be surprised to see these numbers changed as a result of today’s results.

Summary

Adtran remains one of our favorite companies in the sector. They are well positioned at the customers that matter (68% of their revenue is from four tier one North American vendors) to transition them from legacy T1 infrastructure (Adtran has the largest installed base of T1’s) to Ethernet access. We feel the carrier Capex cycle will move away from residential to enterprise access and Adtran is the incumbent there.

We also continue to cling to the belief that Adtran is the best acquisition target for Cisco in the Telecom area.

There was a dichotomy in the Enterprise vs. Carrier results, one that could be taking shape in the general market. While Enterprise spending is clearly pulling back, Carrier wireline spending has yet to show any such trend. If this is the case for the Carrier equipment/component industry in general, this would be very positive from a investment money flow perspective. The Nyquist Index is at a cyclical low and due for a reversal.

Author has position in Adtran

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