Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Thomas Scottino - Senior Manager of IR

Rob Pullen - CEO

Tim Wiggins - EVP and CFO

Analysts

Vivek Arya - Bank of America

Ehud Gelblum - JPMorgan

George Notter - Jefferies & Co.

Nikos Theodosopoulos - UBS

Simon Leopold - Morgan Keegan

Jim Suva - Citi

Jeff Kvaal - Barclays Capital

Todd Koffman - Raymond James

Larry Harris - C.L. King & Associates

Ted Moreau - Cardinal Research

Ken Muth - Robert W. Baird

Tellabs Inc. (TLAB) Q1 2009 Earnings Call April 28, 2009 8:30 AM ET

Operator

Good morning. My name is Richard, and I will be your conference operator today. At this time, I would like to welcome everyone to the Tellabs Investor Relations Conference Call. (Operator Instructions).

I would now like to turn the call over to Mr. Thomas Scottino, Senior Manager of Investor Relations. Sir, you may begin.

Thomas Scottino

Thank you, Richard, and good morning, everyone. With me today are Tellabs' CEO, Rob Pullen and our Executive Vice President and CFO, Tim Wiggins. If you haven't seen the news release we issued this morning, you can access it at our tellabs.com website.

Before we begin, I'd like you to remind you that this presentation contains forward-looking statements about future results, performance or achievements, financial and otherwise. These statements reflect management's current expectations, estimates and assumptions. These forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and other factors that may cause Tellabs' actual results, performance or achievements to be materially different.

A discussion of the factors that may affect future results is contained in Tellabs' most recent SEC filings. The forward-looking statements made in this presentation are being made as of the time and date of the slide presentation. If this presentation is reviewed after the time and date of the slide presentation, it may not contain current or accurate information. Tellabs disclaims any obligation to update and revise any forward-looking statements based on new information, future events or otherwise.

This presentation may also include non-GAAP financial measures. Reconciliations between non-GAAP financial measures and GAAP financial measures can be found at our tellabs.com website and in our SEC filings.

Having said all that, I will turn the call over to Rob.

Rob Pullen

Thanks, Tom, and good morning, everyone. Thanks for joining us today. As you can see by the results, I'm pleased with Tellabs' performance in this tough economic time. Tellabs is focused on improving profitability, both for our customers and our company. Tellabs is transitioning innovative growth products, improving gross margins, generating cash, and investing in our future.

During the first quarter of 2009, Tellabs is focused on generating operating income and cash, as customers curtailed spending in light of a fairly tough global economy. In the first quarter of '09, revenue was consistent with what we said, and gross margins were better than what we said. We continue to improve Tellabs' gross margins and generate cash.

Non-GAAP gross profit margins improved to 44.5% from 38.7% a year ago, marking Tellabs' highest gross profit margins in the past 10 quarters. This is the highest gross margin since third quarter of 2006. This resulted from higher data revenue, our multiservice router in the 8800 and 8600, improved margins on access and optical networking products, and higher margins on services.

On a related note, non-GAAP operating expense fell as forecasted to $134 million in the first quarter of 2009, from $135 million in fourth quarter of '08 sequentially. That's also Tellabs' lowest operating expense in more than four years, and that's been since third quarter of 2004. Our non-GAAP operating earnings were $27 million. We delivered non-GAAP earnings per share of $0.06.

At the same time, we invested in research and development and generated cash. We are investing for the future to emerge stronger after the downturn. Our solid cash flow enabled us to invest 19% of revenue in research and development during the first quarter.

We generated $44 million in cash from operations in the first quarter, and we added $32 million in cash to our balance sheet in the first quarter. We now hold approximately $1.18 billion in cash, cash equivalents, and highly liquid financial instruments. And as you know, we have no debt.

Tellabs is helping customers succeed by improving their profitability. We are helping them generate new service revenue, reduce their capital expense, and we cut their operational expense. We are helping them generate new services by delivering new business services whether it's wavelength of light through Ethernet services on our 7100, delivering wholesale mobile backhaul as a business service, or delivering everything from Internet virtual private networks to distributed land networks.

We continue to implement our strategy to focus on our investments in growth products, innovate in these growth markets, and aspire to execute flawlessly. Our strategy is working. We are winning new customers.

In the first quarter, we received orders and revenue from our first 7100 customer in Brazil. We also received orders from a new 7100 customer in Asia Pacific, actually specifically India. We recognized our first revenue from Tellabs' 8600 on the BT mobile backhaul project that we announced last quarter that we had won, and we received our first order from a major 8600 customer here in North America.

We generated revenue from three new Tellabs' 8800 customers, one in the United States, one in China, and one in Latin America. We won our first three customers for our new Tellabs' 7300 series. We are also positioning Tellabs to serve the needs of the US federal government. We had mentioned that we are positioning some of our sales resources on the US federal government. We have sold Tellabs' 7100 to one of the premier intelligence agencies and the 1150 GPON access system for the Department of Justice for monitorization project.

A Department of Defense Agency has embraced Tellabs' new enterprise GPON and optical networking solution, which really combines our 1150 and 7100 into joining our operability testing, which has started this month.

We expect second quarter revenue to be flat to up by a high single-digit percentage in the second quarter. And in general, I'm pleased with our performance in that in this tougher economic time, our company has improved the gross margins, generated cash, and is investing in the future.

With that, I'm going to turn the call over to Tim Wiggins, our Chief Financial Officer and he will give you a little bit more insight and detail on the quarter.

Tim Wiggins

Thanks, Rob. Good morning, everyone. To begin with, I'd like to make a few observations about the quarter. The top line is down, partially because of a decision we made last year to consolidate two GPON platforms into one and exit on profitable business, and partially as a result of current market conditions.

Within that backdrop, we continue to improve gross margin and reduce OpEx, two key components for improving the bottom line. And we generated $44 million of cash from operations in a tough environment, where our DSO increased.

Given all the changes we have made to the business over the last year, and the changes we have seen in the overall environment, we think that looking at the business on a sequential basis is probably more relevant than year-over-year comparisons at this time. Of course, complete year-over-year comps are contained in the news release we issued this morning.

With that in mind, let's take a look at the numbers. At $362 million, total revenue for the first quarter of 2009 was down by $47 million compared with 4Q '08, as sequential growth in Transport segment was offset by declines in Broadband, Services segment.

GAAP net income for the quarter amounted to $6.5 million or $0.02 a share. On a non-GAAP basis, net income excluding pre-tax charges for special items was $22 million or $0.06 a share. Subtract $5 million or $0.09 of a penny for equity-based comp to be consistent with first call and the result is $0.05 a share in non-GAAP EPS. As usual, you will find a complete reconciliation of our GAAP and non-GAAP result in this morning's news release.

Revenue from customers in North America amounted to $247 million, and revenue from customers outside North America was $115 million. While both are down in real dollars on a sequential basis, North American revenue increased by 2 percentage points to account for 68% of the total in Q1.

Let's look at the segment data for the first quarter. Broadband segment revenue declined by $49 million compared with the fourth quarter. On a sequential basis, growth and data product revenue was offset by lower access and managed access revenue. Specifically, data revenue totaled $63 million, up 6% from the prior quarter.

On a year-over-year basis, data is our fastest growing revenue category with Q1 '09 revenue climbing 45% compared with Q1 '08. Managed access revenue for the quarter was $51 million, compared with $69 million in the fourth quarter of last year. Access revenue was $64 million in the first quarter, compared with $98 million in the prior quarter.

The sequential decline is primarily result of lower sales of single family ONTs. We are now pursuing more profitable activities in the access area with products like our GPON capable 1150 platform as Rob discussed at the top of the call. This quarter, Broadband segment profit at $34 million was essentially flat with the fourth quarter, despite a 21% sequential decline in revenue. On the profitability side, we benefited from a more favorable product mix and reduced R&D expense.

In the Transport segment, revenue was $130 million, up 5% from the fourth quarter. The improvement here comes from higher sales of the optical networking and digital cross-connect systems, which were offset by lower echo canceller revenue. Transport segment profit was $40 million compared with $46 million in 4Q '08, as a result of product mix shifts and higher R&D expense.

North American wireline carriers represent 61% of total transport revenue in Q1, up from 51% in the fourth quarter. On the wireless side, we are seeing increasing revenue from North American customers for our data products. And as Rob mentioned, we have added a new North American carrier to the 8600 customer roster during the quarter.

Looking at the Tellabs 5500 cross-connect specifically, we shipped approximately 1.6 million T-1 equivalents in the quarter, up from 1.4 million in the fourth quarter. About 19% of this quarter's 5500 system revenue came from new system expansions and system upgrades compared with 48% in the fourth quarter. At the end of the quarter, 19% of the card slots in our installed base were open, consistent with the fourth quarter.

Services segment revenue was $54 million compared with $57 million in the fourth quarter. Service segment profit amounted to $19 million consistent with the fourth quarter '08 level, despite the 6% decline in service revenue as we benefited from margin improvements and deployment services.

Non-GAAP gross margin for the first quarter of 2009 was 44.5%, up from 41.9% in the fourth quarter of 2008. As you know, our gross profit margin is dependent on product and customer mix. Contributing to the shift, this quarter was about three points of improvement related to higher level of 5500 and data product revenue, which was offset by about a 0.5 point of decline from other factors including other product mix and lower manufacturing costs.

Turning to operating expenses; for the quarter, non-GAAP R&D expenses came in at $68 million or nearly 19% of revenue. SG&A expenses for the quarter were $66 million. Other income on a non-GAAP basis amounted to almost $5 million in the first quarter of 2009, which is up from $3 million in the prior quarter.

Our tax provision on non-GAAP pre-tax income from the quarter was $9.3 million for an effective tax rate of $29.5 million. We expect our effective non-GAAP tax rate for the balance of 2009 to be about 30% plus or minus. At nearly 52%, our GAAP tax rate for Q1 reflects the impact of the valuation allowance maintained against our domestic deferred tax assets.

We expect our GAAP tax rate and cash tax percent to be similar to or slightly higher than our non-GAAP rate for the full year. During the quarter, we generated $44 million in positive cash flow from operations and grew the cash and investment balance by $32 million.

CapEx was about $8 million during the quarter, DSO increased to 69 days in Q1, while the overall level of receivables declined by $13 million to $320 million. DSO went up as a result of higher revenue and receivables within the Asia Pacific region, where we have historically seen longer payment terms.

Inventory turns were 4.4 times versus 5.1 in Q4 '08. At the end of the first quarter, inventory in terms of dollars improved to $171 million compared with $177 million at the end of 4Q. We will continue to focus on driving down inventory in the second quarter.

During the quarter we purchased about 4,000 shares of our stock at a cost of about $17,000 under our 10b5-1 plan. The actual number of shares outstanding at quarter's end was about $396 million, consistent with the end of the fourth quarter. Headcount at the end of the quarter stood at approximately $3,150, and book-to-bill for the quarter was slightly below one.

Turning to our outlook for the second quarter of the year; based on everything we see in backlog and given the overall market uncertainty, we are guiding for the second quarter revenue to be in a range from flat to up by a high single-digit percent compared with Q1. Where we land in the range will depend on overall market conditions, order flow during the quarter, and specific customer projects. We have achieved sequential gross margin improvement this quarter as we benefited from cost reduction activities and a favorable product mix.

Looking ahead, we expect gross margin in the second quarter will be flat, plus or minus a point or two. While the third quarter is a long way off, our current view is for a less favorable product mix and therefore potentially lower gross margins in Q3. We expect non-GAAP OpEx for the second quarter to be down in the low 130's range. Our goal for 2009 is $520 million in total non-GAAP OpEx. And over the course of the year, OpEx will continue to trend down.

In addition, we expect the effect of expensing equity-based compensation in 2Q will be about $6 million split between operating expense and cost of goods sold. We have made a good start to 2009 by winning new customers, growing data revenue, improving gross margins, reducing expenses, and generating cash. That momentum and the financial strength and flexibility we get from our solid balance sheet should enable us to meet the challenges and opportunities that 2009 presents.

At this point, we will open the floor to your questions. Richard, we are ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Tal Liani with Bank of America.

Vivek Arya - Bank of America

Good morning. It's Vivek Arya on Tal's behalf. Rob, a couple of questions. As I look at the last year, your SG&A spending has stayed relatively flat, but the R&D has gone down by almost $12 million or by 15%. My question is that are you investing enough in new areas, so that top line can grow as the carrier spending grows?

Rob Pullen

Good question, Vivek. You're right, R&D has been reduced. And as Tim mentioned and as I've talked about in the past, we consolidated two GPON platforms into one and exited on profitable business and, therefore, cut our R&D expense, while still having the 1150 GPON access platform.

Next is, as I mentioned, we are investing 19% as a percent of sales in research and development in plowing back a lot of new money into innovative development. So, you will hear more about those as we roll that out over the coming months.

And lastly, you're right, SG&A is flat. And we're investigating that. But we consciously made a decision to invest more in our sales functions in developing countries like Latin America, specifically Brazil, to name one, and invest our way in sales through the downturn.

Vivek, if you take a look at Tellabs, we are a small percent of the overall CapEx spent in the world. And if we can sell our way through this downturn, we are going to increase our market share. And that's what we aspire to do.

Vivek Arya - Bank of America

And then secondly, the cross-connect sales are generally seasonally strong in the first half. But then, I think the suddenly decline in the second half, so if that pattern holds, should we expect the gross margins to go down to the low 40s as we get into the second half of the year?

Rob Pullen

Well, as Tim mentioned, while we are not given guidance for the second half of the year, we will have some variability of gross margins based on mix. And you're right, Vivek, the 5500 typically does well in the fourth quarter, in the first quarter, and this year is no exception from that.

We exceeded fourth quarter of '08 revenue with the 5500 in the first quarter of '09. And I would expect revenue to go down in subsequent quarters. And I don't have a crystal ball for the fourth quarter of '09, but I would expect it to uptick in 4Q '09, as well.

Vivek Arya - Bank of America

And just a final one, Rob. Your second quarter guidance is fairly wide, flat to up the high single digit. Can you give us a sense of the puts and takes, and mainly what are your expectations about the domestic CapEx environment? Is your high end of the guidance based on carrier spending growing sequentially, like what are your main assumptions when you look at the flat versus the high end of your guidance? Thank you.

Rob Pullen

Well, first of all, let me start from the top, Vivek, which is our CapEx. First of all, let me talk on a global basis, we expect CapEx to be flat to single digit down across the world. At the same time, it varies in region of the world. For example, North America, Western Europe, Japan, Australia to name a few countries, are going to be down by the high single digits in CapEx.

At the same time, while the global economy is negatively impacted developing countries, an emerging country, China, Brazil, India, CapEx and GDP should be up slightly. And so, I'm expecting that same trend in the second quarter. Additionally, we have both, our best visibility into the second quarter, plus we have some projects being completed in Asia where we expect that we should probably be toward the higher end of that guidance I hope.

Vivek Arya - Bank of America

And one last question before I close. The operating model, as you progress through the year, what kind of operating models do you have in mind as the business environment normalizes? Is it fair to assume that it could be like a 45% gross margin, 10% operating margin type model, or do you have something else in mind? Thank you.

Rob Pullen

Well, certainly I'd like the 45% in 10, but as I said, Vivek, we don't have great visibility in the second half of the year and, hence, didn't give guidance for it. But Tim gave you some insight that I wouldn't model 44% or 45% gross margin throughout the whole year. We will see some variability on mix probably in the third quarter, which is seasonally a soft quarter for us.

Operator

Your next question comes from the line of Ehud Gelblum with JPMorgan.

Ehud Gelblum - JPMorgan

A couple of questions, mainly around gross margin. First of all, can you just quickly go over the puts and takes of gross margin this quarter? I caught part of it, but I don't think all of it. And I wanted to dig a little bit into, you said some of the gross margin improvement came from better margins in the optical, in access, which I imagine has more to do with the mix away from fiber-to-the-prem GPONS. And some of it may have had to do with improvement on the 7100.

Can you quantify how much improvement came from just less GPON and how much actually 7100 improved? And give us a sense as to where the 7100 might be in gross margin right now?

Tim Wiggins

So the step down that we gave you and the step up from Q4 to Q1, we described as three points of improvement related to higher level of 5500 and data product revenue. And that was offset by a half a point of decline from all the other factors together, which included all the other product mix and lower manufacturing costs in the quarter.

In terms of some of the things that are going on in that mix, you're right that the decline in access certainly was impacted by lower ONT revenues and those are below our corporate average. So that was one of the positive things. But, there are a lot of moving pieces in there, Ehud. So we thought that was the easiest or best ways to summarize what the key things that were moving were.

Ehud Gelblum - JPMorgan

You've got break apart your access revenues into fiber and copper the way you used to?

Tim Wiggins

Yes. I'm going to look that number up.

Ehud Gelblum - JPMorgan

And if you can give us a send as to where the 7100 gross margin is right now if we start modeling that out, how should we look at how the total company gross margin changes with the 7100?

Tim Wiggins

The 7100 was consistent with the prior quarter and is below our corporate average. But, our target is to improve that and continue to improve it over time. I think we have something like seven quarters of improvement on that margin.

Rob Pullen

Ehud, when you look at the access business, the fiber-to-the-prem piece and fiber-to-the-curb piece, which we ganged together was 64% of the revenue in 1Q '09.

Ehud Gelblum - JPMorgan

That's actually very helpful. It looks like you're still selling GPON and you are pushing 7100 further. Interesting, you saw both them into the government, silly question, but does the government pay better margins than Verizon does?

Rob Pullen

Yes, this is short answer. Ehud, first of all, it's only a modest amount of sales into the federal government. We start the push about nine months ago, six to nine month ago. We expect the government to be updating and modernizing some of its bases over the coming years. And we believe that some spending will occur there.

As a result, we went to that past. We're aspiring to hire corporate margins in the federal government. But they're not buying hammers for $1,100 a piece.

Ehud Gelblum - JPMorgan

On exact same products that you were way below corporate average to Verizon?

Rob Pullen

Yes, precisely.

Tim Wiggins

With one caveat. It's a different GPON system entirely. The 7100, it would be a similar system, but we're also down in the cost curves compared to where we started with Verizon.

Ehud Gelblum - JPMorgan

I appreciate that. So finally, as you look at just regular spending trends, can you give us a sense of the linearity was the three months in the quarter and how this quarter looks in terms of just April, whatever trend you see in the first three months of the year, did that continue?

And most CapEx kind of models as well as comments from major carriers in North America showed that CapEx started light and then getting better as the year goes on and you are sort of guiding the 5500 to probably decline as the year goes on. Why wouldn't you be guiding it either at least flat, if not up, and just correlate that with whatever linearity you saw in this quarter, and the trend that you're seeing now in terms of order strength?

Tim Wiggins

The linearity is pretty similar to what we saw in the fourth quarter. I think in terms of overall CapEx spend, I think given Tellabs' size and our product mix, it's hard for us to draw any conclusions over the overall spend, what we're seeing. I think it's unique to our product and where we are in our customer build cycles.

Having said that, we've given a broad range in the guidance, flat to up high single digits, I think, which would be if we were toward the high end of reasonably good performance and, if we're at the mid-point, still reasonably good in my view considering what's going on in the overall economy.

So I think it is showing improvements, what you'd expect in Q2. We also mentioned at the top of the call that there are some projects that are a little hard to forecast. This is based on customer hitting milestones and us. So that will impact our variability and tie the guidance depending on how we accomplish that and how our customers do in those network builds.

Rob Pullen

But Ehud, I mean, I would just add, I'm driving the company to do mid to high single-digit percentage growth. And our guidance to you is flat to that high single-digit percentage growth. So, we are taking that into consideration.

Ehud Gelblum - JPMorgan

Mid to high single-digit growth year over year?

Rob Pullen

No. Sequentially.

Ehud Gelblum - JPMorgan

And that's each quarter?

Tim Wiggins

No. We're talking about Q2 guidance.

Ehud Gelblum - JPMorgan

Just Q2?

Tim Wiggins

Yes.

Ehud Gelblum - JPMorgan

Sorry. That sounded like a general kind of overall thing.

Tim Wiggins

Not so fast, Ehud.

Ehud Gelblum - JPMorgan

I just wanted to make sure that I didn't want to put the cart before the horse.

Tim Wiggins

Thank you.

Ehud Gelblum - JPMorgan

Mid to high single digit for the quarter.

Operator

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

George Notter - Jefferies & Co.

I just wanted to ask about the variability in the access business. Sounded like you had a really strong ONT quarter, a quarter ago and two quarters ago, and now it feels like it's fallen off. What explains the variability in the business with Verizon?

Tim Wiggins

You're right, by the way. Your presumption is correct. We did have strong ONT revenues in the back half of last year. I think certainly there's less new housing start. There's less churn in terms of people moving from one house to another. And I think there was a lot of concern and maybe still be a lot of concern in the consumer side of the business in terms of what people are doing in Q1.

My sense is over time that we will see that pick up again as people get a little more stable in terms of where they see the economy and potentially our customers may do some promotional activity, as well.

Rob Pullen

Tim, I believe you're right. And I would also add, George, that there is inventory build-up in 4Q, as well. So I think they're eating off some of their inventory, as well.

George Notter - Jefferies & Co.

Got it. Separately, I wanted to ask about the 5500. Do you guys have any new perspectives on the longer-term outlook for that product line? And I bring up the question because you were getting new visibility on two projects that major customers like AT&T to drive more toward gigabit Ethernet aggregation.

AT&T obviously has their IP aggregation build going on. The presumption obviously is that negative for the 5500. But have you changed your longer-term views on that product line at all?

Rob Pullen

No. First of all, George, in the transition in the world to Ethernet and IP, we are playing an active role in that, both with our IP enhancements on our 1150 GPON platform, our Ethernet application abilities on our 7100 optical networking platform and on our multiservice routers with the 8800 and 8600, that are all Ethernet and IP.

So having said that, that's kind of one thing. At the same time, going to the direct point of your question, our perspective on the 5500 hasn't changed. It's a product that is later in its lifecycle. It will likely decline over time. But it gives meaningful revenue to the corporation, and of course higher than corporate average margins.

But it's going to be around for some time. Last year, we did in excess of $300 million on the 5500, and it will decline over time. I think at our peak, don't hold me accountable today, but let me just say our peak, we did close to $2 billion on sales on the 5500. It will decline over time. T-1 is still very relevant, but it's decreasing its relevancy in the world.

Operator

Your next question comes from the line of Nikos Theodosopoulos. Nikos, please state your company name.

Nikos Theodosopoulos - UBS

It's UBS. Thank you. I had a question, Rob, on the future plans in terms of beyond 2009. So, as you go to 2010 and '11, obviously, I'm sure you want Tellabs to be a growth company. With the access business and the cross-connect business potentially being in a longer time decline phase, what's your position on how you get the whole company to grow?

And as part of that, there's private companies that are running out of cash. You've got Nortel that are selling businesses. Are you looking at adding products potentially through low cost acquisitions for growth, or do you think the portfolio you have now can do it, given the mix of the access in the 5500 businesses as you look out to 2010-2011?

Rob Pullen

Sure, Nikos. Well, first of all, we believe that we can turn the company growth organically with our current portfolio, but we're always examining other alternatives. And we examine other alternatives as we speak. So let me start out at the top.

As you know, part of our strategy is to invest in the dynamic optical network which is converging layer zero wavelengths through layer two Ethernet. We are also focusing on carrier Ethernet and IP functionality with the 8800 and 8600 families and professional services.

I also believe that we're innovating in growth markets where customers are spending in the mobile backhaul space and the optical networking space and business services delivery. And we're trying to reduce our costs to improve profitability.

Having said all that, as you also notice, we minimize some of our stock purchases after spending close to $800 million on stock buybacks, and we have improved our cash on our balance sheet to $1.18 billion. And we are examining low cost investments as potential acquisitions, but only if it makes sense for our customers and our shareholders.

We have nothing imminent right now, and we are full steam ahead on investing in our current portfolio. My last comment is, and I alluded to this in my initial comments, we're investing in our sales channel, as well in different parts in the world, India, China, Brazil to name a few countries that are developing and growing in their CapEx and GDP. And that's been paying off, as well.

So we're pursuing a three-pronged investment both organic investment, both in our products, organic investment in our channel as well as our partners. And lastly, we're, evaluating acquisitions going forward, but nothing is imminent right now.

Nikos Theodosopoulos - UBS

I appreciate that answer. Just quickly on a couple of other items. Federal government, you mentioned them. I mean, can you just quantify how big that is for Tellabs now, is it sub-5%, just trying to get a sense of where you're starting in that business?

Rob Pullen

Nikos, we're initially starting, it's very small. We believe the opportunity is large. As you know, it's a long bureaucratic sell cycle, but we're giving you some early insight as to where we're putting our bets.

Nikos Theodosopoulos - UBS

And just lastly, on the broadband stimulus plan, realizing it's really going to be more smaller telecos and so forth, do you view that as something that could be incremental in the second half, or is not going to move anything for you guys?

Rob Pullen

Well, I believe it could be helpful to us and the industry as a whole. For those of you who have been following it, there is a broadband stimulus plan and I expect it to benefit the tier-two wireless and wireline service providers. As you know, the goal is to fund broadband for rural and underserved areas. By the way, the government is spending your money right now defining what those terms really are.

But I expect probably $7 billion of funding to occur, probably slightly over $4 billion through NTIA and slightly over $2 billion through RUS. Now the notice of funding availability is supposed to happen by June of this year. And I would expect the initial spending to occur maybe two to three months after the initial applications.

Then there's going to be a second tranche of notice of funding availability in the October to December timeframe is what the current word is. And again, I expect some funding to occur maybe two-plus months after that, as well.

And lastly, the last tranche of funding should occur, the notice of funding availability will occur as currently planned, Nikos, around April to June of 2010. And all the money should be spent by that September or October in this space. And I do expect that in wireline space for the tier-two service providers, that could benefit our optical access and multiservice routing technology, and the same could occur in wireless, but that would likely benefit our multiservice router and mobile backhauls equipment.

Nikos Theodosopoulos - UBS

Thanks for the detailed answers. Thank you.

Operator

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

Simon Leopold - Morgan Keegan

I wanted to see if you could talk a little bit about your customer concentration in the quarter, and particularly drill down on the data networking products, the 8800, 8600. Obviously, what I'm trying to figure out here is how much of the upside and strength from data is coming from the BT project, and how diverse the rollout is? Or, if you can give us any color overall as well as on the data?

Rob Pullen

Well, as Tim mentioned, Simon, our data was up year-over-year by over 45%. We are up sequentially, as well. All the revenue, Simon, was from a diverse customer list. It was while we had two customers, that were 10% customers in the quarter, the 8600 and 8800 was a wide customer base.

We approximated we have probably 100 customers now in the 8600 and over 50 in the 8800. And specifically BT was a small percent. Of the total 8600 and 8800 revenue, they are about 10% of the total mix.

Simon Leopold - Morgan Keegan

That's very helpful. And then shifting, you've made some comments about trends around the 5500 and the 7100 within the quarter, if you could just sort of review where these products are in terms of contributions. It seems as if I interpreted the body language correctly, the 5500 was up sequentially, and the 7100 was flattish. Did I get that right?

Rob Pullen

No. Both the 5500 was up sequentially, and the 7100 was up sequentially, as well. The 7100 was up sequentially more than the 5500, Simon.

Simon Leopold - Morgan Keegan

Great. That's also helpful. And then when we look at the 7100, it seems that it's getting pretty material at this point. You've given us commentary on the 5500 in the past with chassis versus line cards. Be help so that get some sense of the mix on the 7100.

Rob Pullen

Simon, we're not giving out that information, and candidly, I don't have it at my fingertips here anyway.

Simon Leopold - Morgan Keegan

Do you have a feel for at least trend-wise which way it's going?

Rob Pullen

Well, it's up in general. And we're diversifying a customer base so the new chassis are up, and we have growth on a bigger and better base of transponders and gigabit Ethernet cards. And we just released the Ethernet functionality on the 7100. And so, we expect that to be an add-on, as well, Simon.

Operator

Your next question comes from the line of Jim Suva with Citi.

Jim Suva - Citi

Thank you and congratulations. Can you give a little bit of commentary on, it seems like the carriers are talking about a little bit more visibility or second half spending a little bit stronger than the first half.

The question is, is Tellabs kind of seeing and envisioning that because you definitely gave commentary on Q3 gross margins? And it appears to be true that potentially your visibility has improved versus, say, maybe three or five months ago.

Rob Pullen

Yes, Jim. Thanks for the congratulations. We don't have great visibility into second half spending, while we're hopeful that second half spending will increase. And I expect it, by the way, there's a higher likelihood that it will increase in the wireless part of the network versus wireline, secondarily, in business services, and then, lastly, in wireline and access build-outs. But we don't have great visibility. We are guiding up in the second quarter as we shared with you. And we're hopeful for spending, but it's not clear to us at this stage.

Tim Wiggins

Let me add, Jim, that one of the things that we were concerned about is that the streak would pick up the solid margin performance in Q1, and guidance in Q2 of flat plus or minus a point or two and potentially run that out for the balance of the year. So while we're hesitant given the lack of visibility, we did see some things in Q3, potentially increased ONT activity and somewhat lower 5500, which is customary for that period of the year.

We didn't want the 44% plus margins to be rolled out for the balance of the year and end up in a disappointment. So, outside of our normal practice we want to at least caution folks and say Q1 was solid. We expect Q2 with up data and somewhat lower 5500 to be solid, but as we look into Q3, we see some potential for lower margin. We didn't want that to be a problem later in the year for us.

Rob Pullen

And as you know, Jim, we guided even on 2Q gross margin of flat, plus or minus a point or two. And we'll give you more insight into 3Q in the 2Q announcement. We're just trying to give you as best visibility as we have.

Jim Suva - Citi

And as a quick follow-up on the very impressive gross margins that you gave, printed as well as your guidance. I believe your outlook for the year was a general guidance of around 39% gross margins, which based upon Q1 results and Q2 outlook even with a little bit less favorable mix for Q3 seems like that that year guidance of around 39% may be a little bit obsolete. Do you care to update us on that so we can keep expectations relatively reined in to reasonable then?

Rob Pullen

Yes. Jim, it's our practice only to provide the guidance out one quarter. So I'm not sure where the 39% came from. But my hope is given the performance of Q1 and if we track to Q2, we should be above that, just using the math.

Operator

Your next question comes from the line of Jeff Kvaal with Barclays Capital.

Jeff Kvaal - Barclays Capital

I was wondering if you would be able to share with us the percentage of the products that you categorized as growth these days? You've done that in the past. I was wondering if that would be something we could have again.

Rob Pullen

Yes, Jeff. Our growth products are continuing to gain traction. When you look at the first quarter of 2009, 39% of our revenue came from our growth products and services which is up, by the way, from 33% in the fourth quarter of '08.

Jeff Kvaal - Barclays Capital

Do you have a sense when that might be more than half of the overall revenue?

Rob Pullen

We don't have great visibility. We believe that best case that could be in the fourth quarter of this year and more likely in 2010.

Jeff Kvaal - Barclays Capital

But, we're thinking about it qualitatively, then 2010 could be an up year in revenues for you guys if all goes according to plan.

Rob Pullen

If we keep on our current organic pace, yes.

Jeff Kvaal - Barclays Capital

And then specifically on the 7100, you're adding the Ethernet element to that. Should that addition help the margin profile for the product?

Rob Pullen

Yes, it will. It's going to help our customers save money, and so it's likely that we'll improve our percent margin as well with that particular feature. What we're doing is we're doing Ethernet edge aggregation.

So we're either delivering new business services with wavelength of light or Ethernet out to a university or business or we're optimizing the transport of Ethernet services toward the core routers, whether that's a Tellabs router, Cisco, or Juniper router is irrelevant.

What we're trying to do is save the customer money on router ports, and we estimate depending on what the service provider is, we can say 25% to 40% on the cost of router ports by doing Ethernet edge aggregation. And so while having said all that, we expect that we would participate in that profit pool, as well.

Jeff Kvaal - Barclays Capital

Then, Tim, you've given us some thoughts on the margin trajectory in the third quarter, anything that you would like us to be careful with on the revenue side, as well?

Tim Wiggins

Well, I think I'd look at just our historic performance. 3Q, we don't know how that's going to stack up as typically fairly quiet in terms of what's going on in our various product lines. So it's not our strongest quarter.

And as Rob mentioned, historically we've seen an uptick in the fourth quarter. So I'd just have you look at some of the historic data, we don't have enough visibility to give you much more granularity than that.

Operator

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

Todd Koffman - Raymond James

Just a clarification as you look out through the year. Clearly, as the number of questioners have already pointed out, the larger carriers have signaled a pretty consistent improvement in spending. And you keep going back to this sort of historical seasonality but the carriers sort of signaling something different. And I'm wondering why you're not picking up on that from your customers?

Rob Pullen

Well, first of all, we don't have great visibility into the second half of the year. We aren't giving guidance even though Tim gave you a little bit of the gross margin sensitivity. But if the economy improves and our customers' CapEx improves, we'll improve with it.

Todd Koffman - Raymond James

Just a follow up, some of the larger carriers have been quite vocal about their spending plans improving. And yet it sounds as though you haven't heard that from them yet. Is that accurate?

Rob Pullen

I've heard a lot of talk through previous decades as well as this year both up and down. And I'll believe it when I come close to seeing it. And I'll share it with you when we see it.

Operator

Your next question comes from the line of Larry Harris with C.L. King.

Larry Harris - C.L. King & Associates

Looking I guess from a bigger picture point of view, 5500 was up sequentially this quarter and looks like it will do well in the second quarter. From a longer-term perspective as that drops off, the plan I guess would be for the 8600 and 8800 which are also high margin projects sort of offset it in the portfolio?

And is that a correct assumption? And the customer base for the 8600 and 8800, is it fairly well line up with those who have purchased the 5500, or is it a different customer base?

Rob Pullen

Let me take a shot at it first, Tim, then I'll pass it over to you, okay?

Tim Wiggins

Yes.

Rob Pullen

So first of all, everything you alluded to is correct. But I would also say that in addition to the 8800 and 8600, we're trying to fill the decline of the 5500 over its lifecycle with our other growth products, which are 7300, 7100, 6300, and our optical networking and our professional services. So that's kind of the first point I would mention to you.

The next part of the question which is our 8800 and 8600 customers similar to the 5500, I'd say no, it's much broader. The 5500 was North America period. And we did business with the tier-one and tier-two carriers in North America. 8600 and 8800 is our global products. And we're doing business with the tier-one and tier-two global customers.

We have already announced that we're doing business with the biggest carriers in North America. We also are doing business with 8800 and 8600 with likes of big tier ones like British Telecom, Nippon Telephone and Telegraph, Telstra in Australia, to name a few. We mentioned that we just won a big contract with 8600 with Vodafone, and so the 7100 with Telekom South Africa. And so those 8600 and 8800 customer base are global customers. Both tier one and tier two. And the 5500 was only North America.

Operator

(Operator Instructions). Your next question is a follow-up from Ehud Gelblum with JPMorgan.

Ehud Gelblum - JPMorgan

Hi, Rob. Thanks for the opportunity for follow-up. Don't take this wrong way, but I'm just curious in answer to a previous question as to the strategic direction of what you're looking at with respect to possible acquisitions. It sounds like nothing on the horizon.

And as far as the ability to see growth, where you're taking the company, where you're going, is there a good reason to keep the company public versus making it a private company of some sort, there is some LBO?

It appears that the strategy and the growth trajectory is similar to the hardware store down the street. Does incredibly well and brings a lot of cash flow in? And to the owners that can be happy and successful, but doesn't seem to be as much of a need to keep it as a public company. Is that something that has even entered the strategic conversation?

Rob Pullen

Tim, I'll let you take that first and I'll add I'll add color to it.

Tim Wiggins

Certainly we thought about it. I think one of the paradoxes, Ehud, is that we have a solid been sheet today which we think is very important for our customers in terms of when they look around this landscape and are deciding who to put and which network here to put and their networks that are going to be there for a decade or more. We think that's very important.

So being public and having that kind of solid balance sheet is important to our customers. If we were private, maybe we could invest significantly in a new platform that would have less impact on our current earnings, but the paradox is you don't have the cash anymore because you've used most of it to buy out your shareholder.

So there are trade-offs obviously. We think as Rob mentioned that we have good, solid prospects for growth organically. We have a solid balance sheet. We think that the market has some interesting structural changes going on that makes us more important to our customers and potentially other providers in the space.

So I think we look at it, I think I guess in some ways there's a question of just because you can do something, should you do something? At this point, we like where we are. In the terms of structure, we think it's beneficial.

We think we can create shareholder value for our shareholders by driving significant improvements in our operating performance, what you're seeing us do through margins and continue to lower our OpEx throughout the year. We'll keep all the options on the table in terms of what makes most sense for creating value, both for our customers and our shareholders.

Rob Pullen

Yes, Tim. I agree. Ehud, it's a fair question. We don't take offense by it because we've contemplated it ourselves. But it would be a distraction. I've asked, and Tim and I have asked the corporation, our leaders to keep focused on customers and emerge stronger after this downturn.

Next, my number one job is to figure out how to get Tellabs back to profitable revenue growth. We know that. I know that. Over the past year, however, you've seen that we've taken quick and decisive actions, and some fairly tough decisions. We had to set Tellabs up for success to emerge stronger.

We had to exit duplicate and non-profitable business. We had to improve our gross margins. We cleaned up our balance sheet by writing off goodwill. And so, we had to do those things first. But I know my number one job is profitable revenue growth. And we are pursuing that vigorously. And we'll do it whether it's organic or inorganic.

Ehud Gelblum - JPMorgan

I appreciate the answer. Just wondering.

Rob Pullen

No, it's fair, Ehud.

Operator

Your next question comes from the line of Ted Moreau with Cardinal Research.

Ted Moreau - Cardinal Research

Question that I have would be in light of the gross margin improvement, OpEx reduction, some cutbacks on product lines and R&D, Tim, where are you on the $100 million cost-cutting initiative? Are you where you need to be? Is more coming to achieve these goals? Do you need to do any more or where are you on that sort of initiative?

Tim Wiggins

We have met our objective there. And in fact, have found some additional savings, where we are now is executing. We expect that our operating expense will trend down during the year. We've talked in my comments about a 520 goal, which would be meeting the objective as you recall, the $100 million. About $25 million of that was above the line to improve gross margins, and you're seeing the benefit of that. $75million was below the line to reduce our OpEx.

And you'll see that continue to play out throughout the year. We'll continue to monitor this. One of the benefits that Tellabs has in this difficult economic environment is. One, products that are getting traction, that are meeting customer needs. Two, we're seeing improvements in our margin as a result of some of the decisive actions we've taken. And three, we have a balance sheet that allows us to invest as we go through this downturn. And we do see significant opportunity on the back side.

So if the market opportunities or conditions change, there are other things that we can do. We've not had to go through some of the draconian measures that other companies in and around our space have had to do, which we think is important to keep our team members focused on growing the business. So, I think we still have a number of options there. We are comfortable with where we are. We see our program rolling out. And if market condition change, we're able to flex that way.

Rob Pullen

Ted, I would also add to Tim's appropriate comments. We are going to be relentless about cost reductions. We asked our employees to aspire to flawless execution. And that was removing complexities in our business, minimizing the number of stock keeping units we have. And so, we're going to be relentless in continuous improvement on OpEx reductions, as well.

Ted Moreau - Cardinal Research

Well, and in light of that, like halfway through the program, do you expect all the cost initiatives to have been reflected in your operating results by the end of 2009, for example, or?

Rob Pullen

Yes. Absolutely.

Ted Moreau - Cardinal Research

So that's sort of the time schedule that you're on.

Rob Pullen

We expect to deliver the -- one way we gave folks to measure this was to compare our 2007 OpEx spend with our 2009 OpEx spend. And the 2007 was $595 million. And so if we deliver the $75 million reduction, that would put you at the 520, which we've committed to this year or less.

Operator

Your final question comes from the line of Ken Muth with Robert Baird.

Ken Muth - Robert W. Baird

I am trying to elaborate a little on the China and your opportunities there. It's kind of caught me off guard that you had opportunities in one business there. Was that as a matter of kind of direct sales, or is that through partnerships that you've been trying to expand your channel? And then a follow-up is, how many of the carriers do you have at this point in China that you're operating with? And I'd presume they're for the 3G build-out?

Rob Pullen

Yes, Ken. First of all, it was a direct sale. We do have a direct presence in China. Furthermore, we have development that we now do in China as well, augmenting our current development. Additionally, we did sell through channels as well into China, through one of our big systems integrator partners.

Ken Muth - Robert W. Baird

Is it for the 3G build-out that's going on there?

Rob Pullen

It actually is for mobile backhaul for 3G.

Ken Muth - Robert W. Baird

So, is it more of a multiple products or is it just one product like the 8600?

Rob Pullen

Actually, it was two separate products. It was the 8800 in one case and the 8600 in the other.

Ken Muth - Robert W. Baird

And do you see other opportunities going in China, or is this kind of sole opportunity that's kind of in front of you at this point?

Rob Pullen

No. We expect other opportunities. And we aspire to grow that business.

Ken Muth - Robert W. Baird

Could you just give any more comments and your international business seems like it's taking off and doing well and gaining momentum there. I mean, how do you see the mix going forward? Is that a direct sales force touch, or is that going to be again more through kind of some of your channel partners?

Rob Pullen

It will be both, Ken, on a global basis. We've told customers that we'll do business the way they want to do business, whether it's direct or through a big systems integrator. Additionally, when you look at our mix in the first quarter of 2009, about 68% of our revenue was North America, 32% was outside of North America. And I would expect over time, it to move more toward an even balance of international and North America for the foreseeable future.

Ken Muth - Robert W. Baird

Then last comments just on kind of the 8100, any insights there as that business is due for a refresh, or is it kind of like the 5500 that you have over here and just kind of looking to kind of work that mature product to the pipeline?

Rob Pullen

Well, it's like the 5500 in that, it's later in its life cycle and it's in decline year-over-year. But we actually because of parts obsolescence issues and because customers count on it, we just reinvented the 8188 version of it to extend the tail and profitability of its lifecycle.

Operator

There are no further questions. Do you have any closing remarks?

Rob Pullen

No. Thank you, everyone, for your attendance and support of Tellabs. We appreciate your good questions. And as you can tell, Tellabs is focused on improving profitability, both for our customers and our company. Thanks again for listening in, and we'll talk to you soon.

Operator

Ladies and gentlemen, that concludes today's Tellabs' investor relations conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Tellabs Inc. Q1 2009 Earnings Call Transcript
This Transcript
All Transcripts