Note 1 — Nature of Business and Summary of Significant Accounting Policies

ADTRAN, Inc. designs, manufactures, markets and services network access solutions for communications networks. Our solutions are widely deployed by providers of communications services (serviced by our Carrier Networks Division), and small and mid-sized enterprises (SMEs) (serviced by our Enterprise Networks Division), and enable voice, data, video and Internet communications across wireline and wireless networks. Many of these solutions are currently in use by every major United States service provider and many global ones, as well as by many public, private and governmental organizations worldwide.

Principles of Consolidation

Our consolidated financial statements include ADTRAN and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

Cash and cash equivalents represent demand deposits, money market funds, and short-term investments classified as available for sale with original maturities of three months or less. We maintain depository investments with certain financial institutions. Although these depository investments may exceed government insured depository limits, we have evaluated the credit worthiness of these applicable financial institutions, and determined the risk of material financial loss due to exposure of such credit risk to be minimal. As of December 31, 2010, $22.0 million of our cash and cash equivalents, primarily certain domestic money market funds and foreign depository accounts, were in excess of government provided insured depository limits.

Financial Instruments

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, and accounts payable approximate fair value due to the immediate or short-term maturity of these financial instruments. The carrying amount reported for bonds payable was $48.0 million compared to an estimated fair value of $42.5 million, based on a debt security with a comparable interest rate and maturity and a Standard & Poor’s credit rating of A+.

Investments with maturities beyond one year, such as our municipal variable rate demand notes, may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. At December 31, 2010, 29% of our municipal variable rate demand notes had a credit rating of AAA, 63% had a credit rating of AA, 8% had a credit rating of A, and all contained put options of seven days. Despite the long-term nature of their stated contractual maturities, we routinely buy and sell these securities and we believe that we have the ability to quickly liquidate them. Our investments in these securities are recorded at fair value, and the interest rates reset every seven days. We believe we have the ability to sell our variable rate demand notes to the remarketing agent, tender agent, or issuer at par value plus accrued interest in the event we decide to liquidate our investment in a particular variable rate demand note. At December 31, 2010, approximately 28% of our variable rate demand notes were supported by letters of credit from banks that we believe to be in good financial condition. The remaining 72% of our variable rate demand notes were supported by standby purchase agreements. As a result of these factors, we had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from these investments at December 31, 2010. All income generated from these investments was recorded as interest income. We have not been required to record any losses relating to municipal variable rate demand notes.

Long-term investments represent a restricted certificate of deposit, municipal fixed-rate bonds, corporate bonds, a fixed income bond fund, marketable equity securities, and other equity investments. Marketable equity securities are reported at fair value as determined by the most recently traded price of the securities at the balance sheet date, although the securities may not be readily marketable due to the size of the available market. Unrealized gains and losses, net of tax, are reported as a separate component of stockholders’ equity. Realized gains and losses on sales of securities are computed under the specific identification method and are included in current income. We periodically review our investment portfolio for investments considered to have sustained an other-than-temporary decline in value. Impairment charges for other-than-temporary declines in value are recorded as realized losses in the accompanying consolidated statements of income. All of our investments at December 31, 2010 and 2009 are classified as available-for-sale (see Note 3).

Accounts Receivable

We record accounts receivable at net realizable value. Prior to issuing payment terms to a new customer, we perform a detailed credit review of the customer. Credit limits are established for each new customer based on the results of this credit review. Payment terms are established for each new customer, and collection experience is reviewed periodically in order to determine if the customer’s payment terms and credit limits need to be revised.

We maintain an allowance for doubtful accounts for losses resulting from the inability of our customers to make required payments. We regularly review the allowance for doubtful accounts and consider factors such as the age of accounts receivable balances, the current economic conditions that may affect a customer’s ability to pay, significant one-time events and our historical experience. If the financial condition of a customer deteriorates, resulting in an impairment of their ability to make payments, we may be required to make additional allowances. If circumstances change with regard to individual receivable balances that have previously been determined to be uncollectible (and for which a specific reserve has been established), a reduction in our allowance for doubtful accounts may be required. Our allowance for doubtful accounts was $162 thousand at December 31, 2010 and $138 thousand at December 31, 2009.

Other Receivables

Other receivables are comprised primarily of amounts due from subcontract manufacturers for product component transfers, accrued interest on a restricted certificate of deposit and amounts due from employee stock option exercises.

Inventory

Inventory is carried at the lower of cost or market, with cost being determined using the first-in, first-out method. Standard costs for material, labor and manufacturing overhead are used to value inventory. Standard costs are updated at least quarterly; therefore, inventory costs approximate actual costs at the end of each reporting period. We establish reserves for estimated excess, obsolete or unmarketable inventory equal to the difference between the cost of the inventory and the estimated fair value of the inventory based upon assumptions about future demand and market conditions. When we dispose of excess and obsolete inventories, the related write-downs are charged against the inventory reserve.

Property, Plant and Equipment

Property, plant and equipment, which are stated at cost, are depreciated using straight-line depreciation over the estimated useful lives of the assets. We depreciate building and land improvements from five to 39 years, office machinery and equipment from three to seven years, engineering machinery and equipment from three to seven years and computer software from three to five years. Expenditures for repairs and maintenance are charged to expense as incurred. Betterments that materially prolong the lives of the assets are capitalized. The cost of assets retired or otherwise disposed of and the related accumulated depreciation are removed from the accounts, and the gain or loss on such disposition is included in other income, net in the accompanying consolidated statements of income.

Liability for Warranty

Our products generally include warranties of one to ten years for product defects. We accrue for warranty returns at the time revenue is recognized based on our estimate of the cost to repair or replace the defective products. We engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers. Our products continue to become more complex in both size and functionality as many of our product offerings migrate from line card applications to systems products. The increasing complexity of our products will cause warranty incidences, when they arise, to be more costly. Our estimates regarding future warranty obligations may change due to product failure rates, material usage, and other rework costs incurred in correcting a product failure. In addition, from time to time, specific warranty accruals may be recorded if unforeseen problems arise. Should our actual experience relative to these factors be worse than our estimates, we will be required to record additional warranty expense. Alternatively, if we provide for more reserves than we require, we will reverse a portion of such provisions in future periods. The liability for warranty obligations totaled $3.3 million and $2.8 million at December 31, 2010 and 2009, respectively. These liabilities are included in accrued expenses in the accompanying consolidated balance sheets.

A summary of warranty expense and write-off activity for the years ended December 31, 2010 and 2009 is as follows:

Year Ended December 31, (In thousands)		2010				2009
Balance at beginning of period		$	2,833			$	2,812
Plus: amounts acquired or charged to cost and expenses			5,309				2,665
Less: deductions			(4,838	)			(2,644	)
Balance at end of period		$	3,304			$	2,833

Stock-Based Compensation

We have two Board and stockholder approved stock option plans from which stock options and other awards are available for grant to employees and directors. All employee and director stock options granted under our stock option plans have an exercise price equal to the fair market value of the award, as defined in the plan, of the underlying common stock on the grant date. There are currently no vesting provisions tied to performance or market conditions for any option awards; vesting for all outstanding option grants is based only on continued service as an employee or director of ADTRAN. All of our outstanding stock option awards are classified as equity awards.

Under the provisions of our approved plans, we made grants of performance-based restricted stock units to five of our executive officers in 2010, 2009 and 2008. The restricted stock units are subject to a market condition based on the relative total shareholder return of ADTRAN against a peer group of companies (2008 and 2009 grant) or against all the companies in the NASDAQ Telecommunications Index (2010 grant) and vest at the end of a three-year performance period. The restricted stock units are converted into shares of common stock upon vesting. Depending on the relative total shareholder return over the performance period, the executive officers may earn from 0% to 150% of the number of restricted stock units granted. The fair value of the award is based on the market price of our common stock on the date of grant, adjusted for the expected outcome of the impact of market conditions using a Monte Carlo Simulation valuation method. The recipients of the restricted stock units also earn dividend credits during the performance period, which will be paid in cash upon the issuance of common stock for the restricted stock units.

Stock-based compensation expense recognized under the Stock Compensation Topic of the Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) in 2010, 2009 and 2008 was approximately $7.7 million, $7.0 million and $7.3 million, respectively. As of December 31, 2010, total compensation cost related to non-vested stock options, restricted stock units and restricted stock not yet recognized was approximately $20.3 million, which is expected to be recognized over an average remaining recognition period of 3.1 years. See Note 2 of Notes to Consolidated Financial Statements for additional information.

Impairment of Long-Lived Assets

We review long-lived assets for impairment under the guidance prescribed by the Property, Plant and Equipment Topic of the FASB ASC. We evaluate long-lived assets used in operations for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable and the undiscounted cash flows estimated to be generated by the asset are less than the asset’s carrying value. An impairment loss would be recognized in the amount by which the recorded value of the asset exceeds the fair value of the asset, measured by the quoted market price of an asset or an estimate based on the best information available in the circumstances. There were no such impairment losses recognized during 2010, 2009 or 2008.

Research and Development Costs

Research and development costs include compensation for engineers and support personnel, outside contracted services, depreciation and material costs associated with new product development, the enhancement of current products, and product cost reductions. We continually evaluate new product opportunities and engage in intensive research and product development efforts. Research and development costs totaled $90.3 million, $83.3 million and $81.8 million for the years ended December 31, 2010, 2009 and 2008, respectively.

Comprehensive Income

Comprehensive income consists of all changes in equity (net assets) during a period from non-owner sources. Items included in comprehensive income include net income, changes in unrealized gains and losses on marketable securities, and foreign currency translation adjustments. Comprehensive income is presented in the Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income.

The components of accumulated comprehensive income (loss) are as follows:

		Change in
		Unrealized Gains				Foreign				Accumulated
		and (Losses) on				Currency				Other
		Marketable				Translation				Comprehensive
(In thousands)		Securities, Net of Tax				Adjustment				Income (Loss)
Balance at December 31, 2007		$	4,646			$	1,058			$	5,704
Activity in 2008			(4,889	)			(1,824	)			(6,713	)
Balance at December 31, 2008			(243	)			(766	)			(1,009	)
Activity in 2009			16,394				2,468				18,862
Balance at December 31, 2009			16,151				1,702				17,853
Activity in 2010			7,701				1,394				9,095
Balance at December 31, 2010		$	23,852			$	3,096			$	26,948

Income Taxes

The provision for income taxes has been determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from the difference between financial and tax bases of our assets and liabilities and are adjusted for changes in tax rates and tax laws when such changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

Foreign Currency

We record transactions denominated in foreign currencies on a monthly basis using exchange rates from throughout the year. Assets and liabilities denominated in foreign currencies are translated at the balance sheet dates using the closing rates of exchange between those foreign currencies and the U.S. dollar with any transaction gains or losses reported in income. Adjustments from translating financial statements of international subsidiaries are recorded as a component of accumulated comprehensive income (loss).

Revenue Recognition

Revenue is generally recognized upon shipment of the product to our customer in accordance with the title transfer terms of the sales agreement, generally FOB shipping point. In the case of consigned inventory, revenue is recognized when the end customer assumes ownership of the product. When contracts contain multiple elements, contract interpretation is sometimes required to determine the appropriate accounting, including whether the deliverables specified in a multiple element contract should be treated as separate units of accounting for revenue recognition purposes, and, if so, how the price should be allocated among the elements and when to recognize the revenue for each element. We record revenue associated with installation services when all contractual obligations are complete. Contracts that include both installation services and product sales are evaluated for revenue recognition in accordance with contract terms. As a result, depending on contract terms, installation services may be considered as a separate deliverable item or may be considered an element of the delivered product. Either the purchaser, ADTRAN, or a third party can perform the installation of our products. Shipping fees are recorded as revenue and the related cost is included in cost of sales. Revenue is recorded net of discounts. Also, revenue is recorded when the product price is fixed or determinable, collection of the resulting receivable is probable, and product returns are reasonably estimable. Sales returns are accrued based on historical sales return experience, which we believe provides a reasonable estimate of future returns.

A portion of Enterprise Networks products are sold to a non-exclusive distribution network of major technology distributors in the United States. These large organizations then distribute to an extensive network of value-added resellers and system integrators. Value-added resellers and system integrators may be affiliated with us as a channel partner, or they may purchase from the distributor in an unaffiliated fashion. Additionally, with certain limitations our distributors may return unused and unopened product for stock-balancing purposes when such returns are accompanied by offsetting orders for products of equal or greater value.

We participate in cooperative advertising and market development programs with certain customers. We use these programs to reimburse customers for certain forms of advertising, and in general, to allow our customers credits up to a specified percentage of their net purchases. Our costs associated with these programs are estimated and included in marketing expenses in our consolidated statements of income. We also participate in rebate programs to provide sales incentives for certain products. Our costs associated with these programs are estimated and accrued at the time of sale, and are recorded as a reduction of sales in our consolidated statements of income.

Unearned Revenue

Unearned revenue primarily represents customer billings on our maintenance service programs and deferred revenues relating to multiple element contracts where we still have contractual obligations to our customers. We currently offer maintenance contracts ranging from one to five years, primarily on Enterprise Networks Division products sold through distribution channels. Revenue attributable to maintenance contracts is recognized on a straight-line basis over the related contract term. In addition, we provide software maintenance and a variety of hardware maintenance services to Carrier Network Division customers under contracts with terms up to ten years. Non-current unearned revenue is included in other non-current liabilities in the accompanying consolidated balance sheets. At December 31, 2010 and 2009, unearned revenue was as follows:

(In thousands)		2010				2009
Current unearned revenue		$	10,138			$	7,138
Non-current unearned revenue			3,801				3,915
Total		$	13,939			$	11,053

Other Income, net

Other income, net, is comprised primarily of miscellaneous income and expense, gains and losses on foreign currency transactions, investment account management fees, and gains or losses on the disposal of property, plant and equipment occurring in the normal course of business.

Earnings per Share

Earnings per common share, and earnings per common share assuming dilution, are based on the weighted average number of common shares and, when dilutive, common equivalent shares outstanding during the year (see Note 11).

Dividends

The Board of Directors presently anticipates that it will declare a regular quarterly dividend as long as the current tax treatment of dividends exists and adequate levels of liquidity are maintained. During the years ended December 31, 2010, 2009 and 2008, we paid $22.5 million, $22.5 million and $22.9 million, respectively, in dividend payments. On January 18, 2011, the Board of Directors declared a quarterly cash dividend of $0.09 per common share to be paid to holders of record at the close of business on February 3, 2011. The ex-dividend date was February 1, 2011 and the payment date was February 17, 2011. The quarterly dividend payment was $5.8 million.

Business Combinations

On September 15, 2009, we acquired all of the outstanding stock of Objectworld Communications Corporation (Objectworld), a provider of unified communication solutions. The purpose of this acquisition was to acquire unified communications technologies. These technologies have been integrated into our NetVanta^® product line. The purchase price was approximately $1.5 million in cash subject to certain post closing adjustments, and was allocated to the individual assets and liabilities acquired. There was no goodwill determined in the final purchase price allocation. Objectworld’s financial statements have been included in our consolidated statements of income and cash flows since the date of the acquisition and our consolidated balance sheets dated December 31, 2010 and 2009.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expense during the reporting period. Our more significant estimates include the allowance for doubtful accounts, obsolete and excess inventory reserves, warranty reserves, customer rebates, allowance for sales returns, determination of the deferred revenue components of multiple element sales agreements, estimated income tax contingencies, the fair value of stock-based compensation, and the evaluation of other-than-temporary declines in the value of investments. Actual amounts could differ significantly from these estimates.

Recently Issued Accounting Standards

In October 2009, the Financial Accounting Standards Board (FASB) issued Update No. 2009-13, which amends the Revenue Recognition topic of the FASB Accounting Standards Codification (ASC). This update provides amendments to the criteria in Subtopic 605-25 of the ASC for separating consideration in multiple-deliverable arrangements. As a result of those amendments, multiple-deliverable arrangements will be separated in more circumstances than under existing U.S. GAAP. The amendments establish a selling price hierarchy for determining the selling price of a deliverable and will replace the term fair value in the revenue allocation guidance with selling price to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendments will also eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method and will require that a vendor determine its best estimate of selling price in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis. These amendments will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this amendment will have a material impact on our consolidated results of operations or financial condition.

In October 2009, the FASB issued Update No. 2009-14, which amends the Software topic of the ASC. The amendments in this update change the accounting model for revenue arrangements that include both tangible products and software elements. Tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality is no longer within the scope of the software revenue guidance in Subtopic 985-605 of the ASC. In addition, the amendments in this update require that hardware components of a tangible product containing software components always be excluded from the software revenue guidance. In that regard, the amendments provide additional guidance on how to determine which software, if any, relating to the tangible product also would be excluded from the scope of the software revenue guidance. The amendments also provide guidance on how a vendor should allocate arrangement consideration to deliverables in an arrangement that includes both tangible products and software. The amendments also provide further guidance on how to allocate arrangement consideration when an arrangement includes deliverables both included and excluded from the scope of the software revenue guidance. These amendments will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this amendment will have a material impact on our consolidated results of operations or financial condition.

During 2010, we adopted the following accounting standards, which had no material effect on our consolidated results of operations or financial condition:

In January 2010, the FASB issued Update No. 2010-06, which amends the Fair Value Measurements and Disclosures topic of the ASC. The amendments in this update require new disclosures about transfers in and out of Level 1 and Level 2 fair value measurements and the activity in Level 3 fair value measurements and, in addition, clarify existing disclosures required for levels of disaggregation and inputs and valuation techniques. These amendments are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about activity in Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We adopted this amendment during the period ended March 31, 2010, and we have provided the disclosures required for the three and twelve months ended December 31, 2010.

In February 2010, the FASB issued Update No. 2010-09, which amends the Subsequent Events topic of the ASC. The amendments in this update require entities that are SEC filers to evaluate subsequent events through the date that the financial statements are issued. Additionally, SEC filers are no longer required to disclose the date through which subsequent events were evaluated. The amendments in this update were effective upon issuance. We adopted this amendment during the period ended March 31, 2010.

Note 2 — Stock Incentive Plans

Stock Incentive Program Descriptions

Our Board of Directors adopted the 1996 Employee Incentive Stock Option Plan (1996 Plan) effective February 14, 1996, as amended, under which 17.0 million shares of common stock were authorized for issuance to certain employees and officers through incentive stock options and non-qualified stock options. Options granted under the 1996 Plan typically become exercisable beginning after one year of continued employment, normally pursuant to a four or five-year vesting schedule beginning on the first anniversary of the grant date, and have a ten-year contractual term. The 1996 Plan expired February 14, 2006, and expiration dates of options outstanding at December 31, 2010 under the 1996 Plan range from 2011 to 2016.

On January 23, 2006, the Board of Directors adopted the 2006 Employee Stock Incentive Plan (2006 Plan), which authorizes 13.0 million shares of common stock for issuance to certain employees and officers through incentive stock options and non-qualified stock options, stock appreciation rights, restricted stock and restricted stock units. The 2006 Plan was adopted by stockholder approval at our annual meeting of stockholders held on May 9, 2006. Options granted under the 2006 Plan typically become exercisable beginning after one year of continued employment, normally pursuant to a four-year vesting schedule beginning on the first anniversary of the grant date, and have a ten-year contractual term. Expiration dates of options outstanding at December 31, 2010 under the 2006 Plan range from 2016 to 2020.

Our stockholders approved the 2010 Directors Stock Plan (2010 Directors Plan) on May 5, 2010, under which 0.5 million shares of common stock have been reserved. This plan replaces the 2005 Directors Stock Option Plan. The 2010 Directors Plan provides that the Company may issue stock options, restricted stock and restricted stock units to our non-employee directors. Stock awards issued under the 2010 Directors Plan normally become vested in full on the first anniversary of the grant date. Options issued under the 2010 Directors Plan have a ten-year contractual term. We currently also have options outstanding under the 1995 Directors Plan, as amended, and the 2005 Directors Plan. Expiration dates of options outstanding under both plans at December 31, 2010 range from 2011 to 2019.

The following table is a summary of our stock options outstanding as of December 31, 2009 and 2010 and the changes that occurred during 2010:

										Weighted Avg.
						Weighted				Remaining
		Number of				Average				Contractual Life				Aggregate
(In thousands, except per share amounts)		Options				Exercise Price				in Years				Intrinsic Value
Options outstanding, December 31, 2009			6,916			$	20.42				6.05			$	25,719
Options granted			888			$	33.55
Options cancelled/forfeited			(87	)		$	23.53
Options exercised			(1,483	)		$	16.88
Options outstanding, December 31, 2010			6,234			$	23.09				6.21			$	81,561
Options exercisable, December 31, 2010			3,964			$	21.56				4.70			$	57,896

The following table further describes our stock options outstanding as of December 31, 2010:

		Options Outstanding												Options Exercisable
		Options				Weighted Avg.				Weighted				Options				Weighted
		Outstanding at				Remaining				Average				Exercisable at				Average
Range of		12/31/10				Contractual Life				Exercise				12/31/10				Exercise
Exercise Prices		(In thousands)				in Years				Price				(In thousands)				Price
$8.70 – $15.28			892				1.55			$	11.58				892			$	11.58
$15.29 – $22.53			1,727				6.29			$	18.91				1,269			$	20.19
$22.54 – $30.03			1,802				7.86			$	23.46				862			$	23.51
$30.04 – $37.18			1,813				6.77			$	32.36				941			$	31.11
			6,234												3,964

All of the options above were issued at exercise prices that approximate fair market value at the date of grant. At December 31, 2010, 9.0 million options were available for grant under the shareholder approved plans.

The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the difference between ADTRAN’s closing stock price on the last trading day of 2010 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2010. The amount of aggregate intrinsic value will change based on the fair market value of ADTRAN’s stock.

The total pre-tax intrinsic value of options exercised during 2010, 2009 and 2008 was $20.3 million, $5.3 million and $3.7 million, respectively. The fair value of options fully vesting during 2010, 2009 and 2008 was $6.9 million, $7.1 million and $7.4 million, respectively.

Restricted Stock Program Description

On November 6, 2008, the Compensation Committee of the Board of Directors approved the Performance Shares Agreement under the 2006 Plan which sets forth the terms and conditions of awards of performance-based restricted stock units (RSUs). Of the 13.0 million shares of common stock authorized for issuance under the 2006 Plan, we may grant up to 5.0 million shares of common stock for issuance to certain employees and officers for awards other than stock options, which would include RSUs. Under a proposal that was approved by the Board of Directors and shareholders at the 2010 annual meeting, the number of shares available for awards other than stock options under all stock plans was reduced to 3.3 million. The number of shares of common stock earned by a recipient pursuant to the RSUs is subject to a market condition based on ADTRAN’s relative total shareholder return against a peer group (2008 and 2009 grants) or against all companies in the NASDAQ Telecommunications Index (2010 grant) at the end of a three-year performance period. Depending on the relative total shareholder return over the performance period, the recipient may earn from 0% to 150% of the shares underlying the RSUs, with the shares earned distributed upon the vesting of the RSUs at the end of the three-year performance period. The fair value of the award is based on the market price of our common stock on the date of grant, adjusted for the expected outcome of the impact of market conditions using a Monte Carlo Simulation valuation method. A portion of the granted RSUs also vest and the underlying shares become deliverable upon the death or disability of the recipient or upon a change of control of ADTRAN, as defined by the 2006 Plan. The recipients of the RSUs receive dividend credits based on the shares of common stock underlying the RSUs. The dividend credits are vested and earned in the same manner as the RSUs and will be paid in cash upon the issuance of common stock for the RSUs.

The following table is a summary of our RSUs and restricted stock outstanding as of December 31, 2009 and 2010 and the changes that occurred during 2010:

						Weighted
		Number of				Average Grant
(In thousands, except per share amounts)		RSUs				Date Fair Value
RSUs and restricted stock outstanding, December 31, 2009			52			$	21.85
RSUs and restricted stock granted			35			$	38.40
RSUs and restricted stock vested			—			$	—
RSUs and restricted stock cancelled/forfeited			—			$	—
Unvested RSUs and restricted stock, December 31, 2010			87			$	28.46

As of December 31, 2010, there was approximately $1.9 million of total unamortized compensation cost related to the non-vested portion of RSUs and restricted stock granted, which will be recognized on a straight-line basis over the remainder of the three-year performance period for RSUs and over the remainder of the one-year vesting period for restricted stock.

Valuation and Expense Information

We use the Black-Scholes option pricing model (Black-Scholes Model) for the purpose of determining the estimated fair value of stock option awards on the date of grant. The Black-Scholes Model requires the input of certain assumptions that involve judgment. Because our stock options have characteristics significantly different from those of traded options, and because changes in the input assumptions can materially affect the fair value estimate, existing models may not provide reliable measures of fair value of our stock options. We use a Monte Carlo Simulation valuation method to value our performance-based RSUs. The fair value of restricted stock issued to our Directors in 2010 is equal to the closing price of our stock on the date of grant. We will continue to assess the assumptions and methodologies used to calculate the estimated fair value of stock-based compensation. If circumstances change, and additional data becomes available over time, we may change our assumptions and methodologies, which may materially impact our fair value determination.

The following table summarizes stock-based compensation expense related to stock options and RSUs under the Stock Compensation Topic of the FASB ASC for the years ended December 31, 2010, 2009 and 2008, which was recognized as follows:

(In thousands)		2010				2009				2008
Stock-based compensation expense included in cost of sales		$	317			$	268			$	253
Selling, general and administrative expense			3,575				3,039				3,263
Research and development expense			3,825				3,680				3,822
Stock-based compensation expense included in operating expenses			7,400				6,719				7,085
Total stock-based compensation expense			7,717				6,987				7,338
Tax benefit for expense associated with non-qualified options			(650	)			(634	)			(669	)
Total stock-based compensation expense, net of tax		$	7,067			$	6,353			$	6,669

At December 31, 2010, total compensation cost related to non-vested stock options, RSUs and restricted stock not yet recognized was approximately $20.3 million, which is expected to be recognized over an average remaining recognition period of 3.1 years.

The stock option pricing model requires the use of several significant assumptions that impact the fair value estimate. These variables include, but are not limited to, the volatility of our stock price and employee exercise behaviors. The assumptions and variables used for the current period grants were developed based on guidance in the Stock Compensation Topic of the FASB ASC. There were no material changes made during 2010 to the methodology used to determine our assumptions.

The weighted-average estimated fair value of stock options granted to employees and directors during the twelve months ended December 31, 2010, 2009 and 2008 was $11.69 per share, $8.11 per share and $4.96 per share, respectively, with the following weighted-average assumptions:

		2010				2009				2008
Expected volatility			39.57	%			41.86	%			41.70	%
Risk-free interest rate			1.35	%			2.29	%			2.43	%
Expected dividend yield			1.08	%			1.55	%			2.33	%
Expected life (in years)			5.78				5.10				4.97

We based our estimate of expected volatility for the 12 months ended December 31, 2010, 2009 and 2008 on the sequential historical daily trading data of our common stock for a period equal to the expected life of the options granted. The selection of the historical volatility method was based on available data indicating our historical volatility is as equally representative of our future stock price trends as is our implied volatility. We have no reason to believe the future volatility of our stock price is likely to differ from its past volatility.

The risk-free interest rate assumption is based upon implied yields of U.S. Treasury zero-coupon bonds on the date of grant having a remaining term equal to the expected life of the options granted. The dividend yield is based on our historical and expected dividend payouts.

The expected life of our stock options is based upon historical exercise and cancellation activity of our previous stock-based grants with a ten-year contractual term.

The RSU pricing model also requires the use of several significant assumptions that impact the fair value estimate. The estimated fair value of the RSUs granted to employees 2010, 2009 and 2008 was $39.21, $26.65 and $17.05, respectively, with the following assumptions:

		2010				2009				2008
Expected volatility			40.82	%			41.41	%			38.61	%
Risk-free interest rate			0.51	%			1.40	%			1.63	%
Expected dividend yield			1.07	%			1.53	%			2.35	%
Fair value of future dividend payments		$	1.07			$	1.06			$	1.06

Stock-based compensation expense recognized in our Consolidated Statements of Income for the 12 months ended December 31, 2010, 2009 and 2008 is based on RSUs and options ultimately expected to vest, and has been reduced for estimated forfeitures. Estimates for forfeiture rates are based upon historical experience and are evaluated quarterly. We expect our forfeiture rate for stock option awards to be approximately 2% annually. We estimated a 0% forfeiture rate for our RSUs and restricted stock due to the limited number of recipients and historical experience for these awards.

Note 3 — Investments

We classify our investments as available-for-sale. At December 31, 2010, we held the following securities and investments, recorded at either fair value or cost.

														Fair Value /
		Amortized				Gross Unrealized								Carrying
(In thousands)		Cost				Gains				Losses				Value
Deferred compensation plan assets		$	3,483			$	770			$	(7	)		$	4,246
Corporate bonds			126,671				630				(229	)			127,072
Municipal fixed-rate bonds			71,212				268				(13	)			71,467
Municipal variable rate demand notes			116,745				—				—				116,745
Fixed income bond fund			526				220				—				746
Marketable equity securities			11,486				36,657				(133	)			48,010
Available-for-sale securities held at fair value		$	330,123			$	38,545			$	(382	)		$	368,286
Restricted investment held at cost															48,250
Other investments held at cost															2,103
Total carrying value of available-for-sale investments														$	418,639

At December 31, 2009, we held the following securities and investments, recorded at either fair value or cost.

														Fair Value /
		Amortized				Gross Unrealized								Carrying
(In thousands)		Cost				Gains				Losses				Value
Deferred compensation plan assets		$	2,904			$	528			$	(8	)		$	3,424
Corporate bonds			20,127				287				—				20,414
Municipal fixed-rate bonds			140,278				1,009				(2	)			141,285
Municipal variable rate demand notes			84,359				—				—				84,359
Fixed income bond fund			867				296				—				1,163
Marketable equity securities			9,805				23,927				(197	)			33,535
Available-for-sale securities held at fair value		$	258,340			$	26,047			$	(207	)		$	284,180
Restricted investment held at cost															48,250
Other investments held at cost															2,208
Total carrying value of available-for-sale investments														$	334,638

At December 31, 2010 and 2009, we held $4.2 million and $3.4 million, respectively, of deferred compensation plan assets, carried at fair value.

At December 31, 2010 and 2009, we held $127.1 million and $20.4 million, respectively, of corporate bonds. These bonds are classified as available-for-sale and had an average duration of 2.0 years at December 31, 2010. At December 31, 2010, approximately 3% of our corporate bond portfolio had a credit rating of AAA, 11% had a credit rating of AA, 51% had a credit rating of A, and 35% had a credit rating of BBB.

At December 31, 2010 and 2009, we held $71.5 million and $141.3 million, respectively, of municipal fixed-rate bonds. These bonds are classified as available-for-sale investments and had an average duration of 1.2 years at December 31, 2010. At December 31, 2010, approximately 15% of our municipal fixed-rate bond portfolio had a credit rating of AAA, 74% had a credit rating of AA, and 11% had a credit rating of A. Because our bond portfolio has a high quality rating and contractual maturities of a short duration, we are able to obtain prices for these bonds derived from observable market inputs, or for similar securities traded in an active market, on a daily basis.

As of December 31, 2010, corporate and municipal fixed-rate bonds had the following contractual maturities:

		Corporate				Municipal
(In thousands)		bonds				fixed-rate bonds
Less than one year		$	11,335			$	29,399
One year to four years			115,737				42,068
Total		$	127,072			$	71,467

At December 31, 2010 and 2009, we held $116.7 million and $84.4 million, respectively, of municipal variable rate demand notes, all of which were classified as available-for-sale short-term investments. At December 31, 2010, 29% of our municipal variable rate demand notes had a credit rating of AAA, 63% had a credit rating of AA, 8% had a credit rating of A, and all contained put options of seven days. Despite the long-term nature of their stated contractual maturities, we routinely buy and sell these securities and we believe that we have the ability to quickly liquidate them. Our investments in these securities are recorded at fair value, and the interest rates reset every seven days. We believe we have the ability to sell our variable rate demand notes to the remarketing agent, tender agent or issuer at par value plus accrued interest in the event we decide to liquidate our investment in a particular variable rate demand note. At December 31, 2010, approximately 28% of our variable rate demand notes were supported by letters of credit from banks that we believe to be in good financial condition. The remaining 72% of our variable rate demand notes were supported by standby purchase agreements. As a result of these factors, we had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from these investments. All income generated from these investments was recorded as interest income. We have not been required to record any losses relating to municipal variable rate demand notes.

At December 31, 2010 and 2009, we held $0.7 million and $1.2 million, respectively, of a fixed income bond fund. This bond fund had unrealized gains of $0.2 million and $0.3 million at December 31, 2010 and 2009, respectively.

At December 31, 2010, we held $48.0 million of marketable equity securities, including a single security, of which we held 1.5 million shares, carried at a fair value of $34.2 million. We sold 0.5 million shares of this security during the 12 months ended December 31, 2010. The sales resulted in proceeds of $8.2 million and a realized gain of $8.1 million. This single security traded approximately 1.0 million shares per day in 2010, in an active market on a European stock exchange. This single security comprises $33.7 million of the gross unrealized gains included in the fair value of our marketable equity securities at December 31, 2010. The remaining $3.0 million of gross unrealized gains and $0.1 million of gross unrealized losses at December 31, 2010 were spread amongst more than 415 equity securities. At December 31, 2009, we held $33.5 million of marketable equity securities, including the single security mentioned above, of which we held 2.1 million shares, carried at a fair value of $22.4 million. This single security comprised $21.7 million of the gross unrealized gains included in the fair value of our marketable equity securities at December 31, 2009. The remaining $2.2 million of unrealized gains and $0.2 million of gross unrealized losses at December 31, 2009 were spread amongst more than 375 equity securities.

At December 31, 2010 and 2009, we held a $48.3 million restricted certificate of deposit, which is carried at cost. This investment serves as a collateral deposit against the principal amount outstanding under loans made to ADTRAN pursuant to an Alabama State Industrial Development Authority revenue bond (the Bond). At December 31, 2010, the estimated fair value of the Bond was approximately $42.5 million, based on a debt security with a comparable interest rate and maturity and a Standard & Poor’s credit rating of A+. We have the right to set-off the balance of the Bond with the collateral deposit in order to reduce the balance of the indebtedness. For more information on the Bond, see Note 6 of Notes to Consolidated Financial Statements.

At December 31, 2010 and 2009, we held $2.1 million of other investments carried at cost, consisting of interests in two private equity funds and an investment in a privately held telecommunications equipment manufacturer. The fair value of these investments was estimated to be approximately $10.0 million at December 31, 2010, based on unobservable inputs including information supplied by the company and the fund managers. We have committed to invest up to an aggregate of $7.9 million in the two private equity funds, and we have contributed $8.0 million as of December 31, 2010, of which $7.4 million has been applied toward these commitments. As of December 31, 2010 we have received distributions related to these two private equity funds of $7.1 million, of which $0.9 million was recorded as investment income. These investments are carried at cost, net of distributions, with distributions in excess of our investment recorded as investment income. The duration of each of these commitments is ten years with $0.1 million expiring in 2013 and $0.4 million expiring in 2012. We have not been required to record any impairment losses related to these investments during the years ended December 31, 2010, 2009 or 2008.

We review our investment portfolio for potential “other-than-temporary” declines in value on an individual investment basis. We assess, on a quarterly basis, significant declines in value which may be considered other-than-temporary and, if necessary, recognize and record the appropriate charge to write-down the carrying value of such investments. In making this assessment, we take into consideration qualitative and quantitative information, including but not limited to the following: the magnitude and duration of historical declines in market prices, credit rating activity, assessments of liquidity, public filings, and statements made by the issuer. We generally begin our identification of potential other-than-temporary impairments by reviewing any security with a fair value that has declined from its original or adjusted cost basis by 25% or more for six or more consecutive months. We then evaluate the individual security based on the previously identified factors to determine the amount of the write-down, if any. As a result of our review, we did not record any other-than-temporary impairment charge during the fourth quarter of 2010. For each of the years ended December 31, 2010, 2009 and 2008 we recorded a charge of $43 thousand, $2.9 million and $2.4 million, respectively, related to the other-than-temporary impairment of certain marketable equity securities, a fixed income bond fund and deferred compensation plan assets.

Realized gains and losses on sales of securities are computed under the specific identification method. The following table presents gross realized gains and losses related to our investments.

Year Ended December 31,
(In thousands)		2010				2009				2008
Gross realized gains		$	12,191			$	1,978			$	1,884
Gross realized losses		$	(1,183	)		$	(3,275	)		$	(4,293	)

The following table presents the breakdown of investments with unrealized losses at December 31, 2010.

		Continuous Unrealized								Continuous Unrealized
		Loss Position for Less								Loss Position for 12
		than 12 Months								Months or Greater								Total
						Unrealized								Unrealized								Unrealized
(In thousands)		Fair Value				Losses				Fair Value				Losses				Fair Value				Losses
Deferred compensation plan assets		$	338			$	(7	)		$	—			$	—			$	338			$	(7	)
Corporate bonds			32,326				(229	)			—				—				32,326				(229	)
Municipal fixed-rate bonds			5,869				(13	)			—				—				5,869				(13	)
Marketable equity securities			2,021				(107	)			176				(26	)			2,197				(133	)
Total		$	40,554			$	(356	)		$	176			$	(26	)		$	40,730			$	(382	)

The increase in unrealized losses during 2010, as reflected in the table above, primarily occurred due to an increase in intermediate term interest rates during the last two months of 2010 primarily impacting our corporate bonds. At December 31, 2010, a total of 160 of our marketable equity securities were in an unrealized loss position.

The following table presents the breakdown of investments with unrealized losses at December 31, 2009.

		Continuous Unrealized								Continuous Unrealized
		Loss Position for Less								Loss Position for 12
		than 12 Months								Months or Greater								Total
						Unrealized								Unrealized								Unrealized
(In thousands)		Fair Value				Losses				Fair Value				Losses				Fair Value				Losses
Deferred compensation plan assets		$	—			$	—			$	160			$	(8	)		$	160			$	(8	)
Municipal fixed-rate bonds			1,481				(2	)			—				—				1,481				(2	)
Marketable equity securities			2,428				(91	)			1,834				(106	)			4,262				(197	)
Total		$	3,909			$	(93	)		$	1,994			$	(114	)		$	5,903			$	(207	)

The decrease in unrealized losses during 2009, as reflected in the table above, primarily occurred due to the improvements in the credit markets and improved equity market conditions. At December 31, 2009, a total of 145 of our marketable equity securities were in an unrealized loss position.

In accordance with the Fair Value Measurements and Disclosures Topic of the FASB ASC, we have categorized our cash equivalents held in money market funds and our investments held at fair value into a three-level fair value hierarchy based on the priority of the inputs to the valuation technique for the cash equivalents and investments as follows: Level 1 — Values based on unadjusted quoted prices for identical assets or liabilities in an active market; Level 2 — Values based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly; Level 3 — Values based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs include information supplied by investees.

		Fair Value Measurements at December 31, 2010 Using
						Quoted Prices				Significant
						in Active				Other				Significant
						Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs
(In thousands)		Fair Value				(Level 1)				(Level 2)				(Level 3)
Cash equivalents
Money market funds		$	14,532			$	14,532			$	—			$	—
Available for sale securities
Deferred compensation plan assets			4,246				4,246				—				—
Available-for-sale debt securities
Corporate bonds			127,072				—				127,072				—
Municipal fixed-rate bonds			71,467				—				71,467				—
Municipal variable rate demand notes			116,745				—				116,745				—
Fixed income bond fund			746				746				—				—
Available-for-sale marketable equity securities
Marketable equity securities — technology industry			35,596				35,596				—				—
Marketable equity securities — other			12,414				12,414				—				—
Available-for-sale securities			368,286				53,002				315,284				—
Total		$	382,818			$	67,534			$	315,284			$	—

		Fair Value Measurements at December 31, 2009 Using
						Quoted Prices				Significant
						in Active				Other				Significant
						Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs
(In thousands)		Fair Value				(Level 1)				(Level 2)				(Level 3)
Cash equivalents
Money market funds		$	18,370			$	18,370			$	—			$	—
Available for sale securities
Deferred compensation plan assets			3,424				3,424				—				—
Available-for-sale debt securities
Corporate bonds			20,414				—				20,414				—
Municipal fixed-rate bonds			141,285				—				141,285				—
Municipal variable rate demand notes			84,359				—				84,359				—
Fixed income bond fund			1,163				1,163				—				—
Available-for-sale marketable equity securities
Marketable equity securities — technology industry			23,491				23,491				—				—
Marketable equity securities — other			10,044				10,044				—				—
Available-for-sale securities			284,180				38,122				246,058				—
Total		$	302,550			$	56,492			$	246,058			$	—

As of December 31, 2010 and 2009, the fair value of the investments in available-for-sale Level 2 corporate bonds and municipal fixed-rate bonds was $198.5 million and $161.7 million, respectively. The fair value of these securities is calculated using a weighted average market price for each security. Market prices are obtained from a variety of industry standard data providers, security master files from large financial institutions, and other third-party sources. These multiple market prices are used as inputs into a distribution-curve-based algorithm to determine the daily market value of each security.

As of December 31, 2010 and 2009, the fair value of the investments in available-for-sale Level 2 municipal variable rate demand notes was $116.7 million and $84.4 million, respectively. These securities have a structure that implies a standard expected market price. The frequent interest rate resets make it reasonable to expect the price to stay at par. These securities are priced at the expected market price.

Note 4 — Inventory

At December 31, 2010 and 2009, inventory was comprised of the following:

(In thousands)		2010				2009
Raw materials		$	43,897			$	27,326
Work in process			2,871				2,662
Finished goods			27,506				15,686
Total		$	74,274			$	45,674

We establish reserves for estimated excess, obsolete, or unmarketable inventory equal to the difference between the cost of the inventory and the estimated fair value of the inventory based upon assumptions about future demand and market conditions. At December 31, 2010 and 2009, raw materials reserves totaled $7.3 million and $6.6 million, respectively, and finished goods inventory reserves totaled $1.6 million and $1.1 million, respectively.

Note 5 — Property, Plant and Equipment

At December 31, 2010 and 2009, property, plant and equipment were comprised of the following:

(In thousands)		2010				2009
Land		$	4,263			$	4,263
Building and land improvements			15,507				14,638
Building			68,479				68,495
Furniture and fixtures			16,130				15,746
Computer hardware and software			61,898				57,218
Engineering and other equipment			83,946				80,289
Total Property, Plant and Equipment			250,223				240,649
Less accumulated depreciation			(176,237	)			(166,340	)
Total Property, Plant and Equipment (net)		$	73,986			$	74,309

Depreciation expense was $10.2 million, $10.0 million and $9.9 million in 2010, 2009 and 2008, respectively.

Note 6 — Alabama State Industrial Development Authority Financing and Economic Incentives

In conjunction with an expansion of our Huntsville, Alabama, facility, we were approved for participation in an incentive program offered by the State of Alabama Industrial Development Authority (the “Authority”). Pursuant to the program, on January 13, 1995, the Authority issued $20.0 million of its taxable revenue bonds and loaned the proceeds from the sale of the bonds to ADTRAN. The bonds were originally purchased by AmSouth Bank of Alabama, Birmingham, Alabama (the “Bank”). Wachovia Bank, N.A., Nashville, Tennessee (formerly First Union National Bank of Tennessee) (the “Bondholder”), which was acquired by Wells Fargo & Company on December 31, 2008, purchased the original bonds from the Bank and made further advances to the Authority, bringing the total amount outstanding to $50.0 million. An Amended and Restated Taxable Revenue Bond (“Amended and Restated Bond”) was issued and the original financing agreement was amended. The Amended and Restated Bond bears interest, payable monthly. The interest rate is 5%. The Amended and Restated Bond matures on January 1, 2020. The estimated fair value of the bond at December 31, 2010 was approximately $42.5 million, based on a debt security with a comparable interest rate and maturity and a Standard & Poor’s credit rating of A+. We are required to make payments to the Authority in amounts necessary to pay the principal of and interest on the Amended and Restated Bond. Included in long-term investments at December 31, 2010 is $48.3 million which is invested in a restricted certificate of deposit. These funds serve as a collateral deposit against the principal of this bond, and we have the right to set-off the balance of the Bond with the collateral deposit in order to reduce the balance of the indebtedness. In conjunction with this program, we are eligible to receive certain economic incentives from the state of Alabama that reduce the amount of payroll withholdings that we are required to remit to the state for those employment positions that qualify under the program. For the years ended December 31, 2010, 2009 and 2008, we realized economic incentives totaling $1.5 million, $1.5 million and $1.4 million, respectively.

We are required to make payments in the amounts necessary to pay the principal and interest on the amounts currently outstanding. Based on positive cash flow from operating activities, we have decided to continue early partial redemptions of the Bond. It is our intent to make annual principal payments in addition to the interest amounts that are due. In connection with this decision, $0.5 million of the Bond debt has been classified as a current liability in the Consolidated Balance Sheets.

Note 7 — Income Taxes

A summary of the components of the provision for income taxes as of December 31, 2010, 2009 and 2008 is as follows:

(In thousands)		2010				2009				2008
Current
Federal		$	49,144			$	30,756			$	37,245
State			6,380				3,615				3,350
Total current			55,524				34,371				40,595
Deferred tax benefit			(1,324	)			(1,024	)			(903	)
Total provision for income taxes		$	54,200			$	33,347			$	39,692