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Executives

Robert Pullen - President & Chief Executive Officer

Timothy Wiggins - Executive Vice President & Chief Financial Officer

Thomas Scottino - Senior Manager of Investor Relations

Analysts

Vivek Arya - Bank of America

Ken Muth - Robert Baird

George Notter - Jefferies & Co.

[Aziya] - Citigroup

Alex Henderson - Miller Tabak

Jeffrey Kvaal - Barclays Capital

Simon Leopold - Morgan, Keegan & Co.

Brett Miller - Dialetic Capital

Jack Monty - UBS

Michael Genovese - Soleil Securities

Brian Coyne - Wedge Partners

Tellabs Inc. (TLAB) Q3 2009 Earnings Call October 26, 2009 8:30 AM ET

Operator

Good morning, my name is Chelsea and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Tellabs investor relations conference call. (Operator Instructions)

Mr. Scottino, you may begin your conference.

Thomas Scottino

Thank you very much Chelsea, 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 www.tellabs.com website.

Before we begin, I’d like 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 its live presentation. If the presentation is reviewed afterwards, it may not contain current or accurate information. Tellabs disclaims any obligation to update or revise any forward-looking statements based on new information, future events or otherwise.

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

Rob Pullen

Thanks Tom and good morning everyone. As you saw, Tellabs just reported our earnings and Tellabs innovative growth products are helping our customers and our companies succeed. We are excited, consistent with this theme Tellabs recently announced the acquisition of WiChorus and that’s going to bring our customers new innovative breakthrough technology for the mobile internet. This is going to extend our mobile backhaul business into an adjacent growth business, and I’ll comment a little bit more after we review the financials.

Revenue was within guidance albeit at the lower end. Gross margins came in at the higher end of guidance and operations generated $66 million in cash. Revenue was within the guidance range, as I mentioned. This was our second consecutive quarter of sequential revenue growth. The business appears to be stabilizing although it’s probably too early to predict a wide scale recovery on a global basis.

Tellab’s third quarter of 2009 revenue was $389 million up 1% sequentially. Our transport revenue was up 17% year over year and up 8% sequentially. In fact, the Tellabs 7100 Optical transport system generated its best revenue in about five quarters, and we also had new enterprise customers in North America and new customers in Latin America and Asia Pacific.

Almost half of our third quarter revenue was from our growth products. It was about 45% and this was up from 40% a year ago. Data revenue was the second best quarter ever. International revenue was around 30% of overall third quarter of 2009 revenue and North America revenue was the highest it has been in six quarters.

International revenue was around 30% versus 38% a year ago. In fact, that was just with customers in Brazil at the Future Comp show, a couple of weeks ago and the economy they are still a little tough, but things seem to be fine in Brazil. In fact, we expect a stronger 2010 in Latin America and in Brazil in particular. Albeit, when I talk to our customers in Western Europe, things are still little slow in Western Europe.

Our gross profit margin came in at the high end of guidance and operating expenses were in line. On a non-GAAP basis, we delivered earnings of around $28 million or $0.07 a share. That’s up 51% from $19 million or $0.05 a share from a year ago quarter.

Our non-GAAP profit margins were about 41.9% or almost 42% versus 38.5% in the year ago quarter. Non-GAAP operating profits were $36 million or 9.2% and this is the second highest in three years. So, our operating margins at 9.2%, they’ve been the second high since the third quarter of 2006. We generated cash and continued investing in research and development.

We generated $66 million in cash from operations and added $12 million in cash, cash equivalents and marketable securities to our balance sheet in the third quarter. We also repurchased approximately 9.5 million shares for a cost of around $62 million.

As you know, Tellabs now holds about $1.25 billion in cash, cash equivalents and marketable securities with no debt. We continue investing for the future to emerge stronger after the downturn. R&D expenses were around 17% as a percent of sales in the third quarter.

Now, let’s turn a little bit to our customers. Customers are choosing our solutions in our growth product area. Tellabs now serves 43 of the top 50 service providers worldwide. At Super Comp last week we introduced Tellabs intelligent network management, which includes improvements to our 8000 Network manager which is in 600 networks as we speak today.

We also introduced a new professional service called Network performance management. This new service helps our service providers isolate, prioritize and resolve hidden network problems so that customers can improve satisfaction, reduce churn and defer capital operating expenses.

We added a mobile customer in Latin America in third quarter of 2009, namely for 8600 and it’s for regional mobile backhaul. We had customers select us in three regions of the world, in North America, Asia Pacific and Latin America for our optical networking products.

In Latin America, we have an existing customer that has been buying our 8100 and 6300 and they are evolving now to our 7100 ROADM technology, trying to reduce their CapEx and OpEx and deliver new services, both in the wavelength space as well as the integrated Ethernet.

All are using our integrated end-to-end network management system. In fact, they are trying to deliver both 10 Gigabit and 40 Gigabit transport, which is one of the reasons they selected Tellabs, with our integrated Ethernet technology.

We also had a North American service provider, started deploying our first 7100 nano nodes, which are the lower entry price 7100 systems. That scale into the equivalent of the 7100. They are using this to deliver mobile backhaul service in a wholesale basis. So to them it looks like it’s an enterprise services delivering to the mobile space.

We also recognized revenue on the 7100 from a North American cable TV operator in the quarter. I mentioned earlier that we’d helped our customers deliver business or enterprise services to end users; we won 18 new enterprise customers through the service provider segment in the quarter.

I mentioned at the top of my talk that we had some exciting news. We announced the acquisition of WiChorus, which shows our commitment and our fervor in the mobile internet base. Both Tellabs employees, WiChorus employees and our customers are excited, in fact I was just out visiting our new employee this past Friday and Saturday of this week.

We are adding the innovative SmartCore mobile packet solutions, which means we can deliver rich differentiated user experiences, such as mobile internet, mobile video and mobile commerce. With smartphone sales up 30% year over year and mobile data traffic growing 30% to 50%, we want to help our customers make the most of this growth opportunity in the mobile internet and we are excited about this space.

We can help service providers improve the mobile internet user experience, deliver new applications to generate revenue or monetize content, and simplify networks to achieve significant savings. This acquisition brings our customers breakthrough technology for the mobile internet. It logically extends our mobile business into an adjacent high growth market and helps ensure our future growth.

With that, I am going to turn the call over to Tim and then we will come back to answer some of your questions.

Tim Wiggins

Thanks Rob, and good morning everyone. What I would do before I dig into the numbers is offer some observations about this quarter. First our total revenue was up for the second quarter in a row. In North America revenue was up sequentially driven by increased sales to both wire line and wireless customers.

Second as expected, revenue from customers outside North America was down sequentially following a very strong second quarter in which these customers accounted for 40% of our total revenue.

Third, while data revenue for quarter was down sequentially as expected, we did record our second highest quarterly revenue from data products in the third quarter. In North America data product sales to wireless customers were up sequentially.

Non-GAAP gross margin for the third quarter was down sequentially as a result of an anticipated shift in product mix. For the first nine months of 2009, non-GAAP gross margin was up 5.8 points compared with the comparable period of 2008.

As we look to the fourth quarter we expect to see sequential improvement in gross margin. We continue to drive down expenses both sequentially and on a year-over-year basis. Non-GAAP operating expenses for the first nine months of 2009 were down $32 million compared with the comparable period in 2008.

With $36 million in non-GAAP operating profit, operating margin came in at 9.2% one of the highest levels in recent years. Again, if we look at the first nine months of 2009, non-GAAP operating margin is up 63% compared with a year ago.

Cash generated from operations was strong at $66 million, and year to date we generated a $174 million in cash from operations, and we were active in the stock buyback in the third quarter. Year-to-date we repurchased 9.5 million shares of our common stock at a cost of $62 million.

We believe year over year revenue performance reflects the global recession and lower overall spending by carriers worldwide. Improvements in non-GAAP gross margin operating expenses and operating profit primarily reflect the new strategy we’ve been executing over the last year and a half.

With that, let’s take a look at the numbers. Total revenue for the third quarter of 2009 amounted to $389 million compared with $385 million in 2Q, ‘09 when revenue was positively impacted by customer acceptance of two data deployments for which the equipment was shipped in prior quarters.

Sequential growth in the transport segment was offset by lower overall broadband segment revenue which I’ll discuss shortly. GAAP net income for the third quarter of 2009 amounted to $29 million, nearly doubled the $16 million we recorded in the second quarter of this year. That equates to EPS of $0.07 per share, up from $0.04 per share in the second quarter.

That’s quite a difference from last year’s third quarter when we recorded a GAAP net loss driven by goodwill impairment. On a non-GAAP basis, net income excluding pre-tax charges for special items was $28 million or $0.07 per share in the third quarter of ‘09. If you take that $28 million and subtract $4.5 million or eight tenths of a penny for equity based comp, and that’s to be consistent with first call, the result of $0.06 per share in non-GAAP EPS.

As usual, you’ll find complete year over year comparisons and a reconciliation of our GAAP and non-GAAP results in this morning’s news release. On a sequential basis, revenue from customers outside North America increased to $273 million in the third quarter. Revenue from customers outside North America decreased to a $116 million compared with the second quarter of this year. Revenue from customers outside North America accounted for 30% of total sales.

Let’s take a look at the segment data for the third quarter. Broadband segment revenue in the third quarter this year was $206 million compared with $210 million in the prior quarter. On a sequential basis, growth in access and managed access products revenue was offset by expected decline in data revenue. Specifically data revenue for the third quarter came in at $82 million.

On a sequential basis, that compares with a $107 million in 2Q ‘09 when revenue was impacted by the two deployments I talked about earlier. At $82 million in revenue the third quarter marks our second highest level of data revenue only lower than the prior quarter. In all, data continues to be our fastest growing product category, for the first nine months of 2009, data revenue totaled $252 million, that’s up 62% from the $156 million we recorded in the comparable period of ‘08.

Access revenue was $86 million in the third quarter up from $68 million in the prior quarter. The sequential increase was largely driven by higher sales of single family ONTs. Improving ONT profitability has been a priority for Tellabs and we’ve done so in eight of the last ten quarters.

Looking at the managed access category, revenue in the third quarter of 2009 came in at $38 million up from $35 million in the prior quarter. We continue to see slow demand for managed access products, particularly in Europe and Latin America. Taking all that into account, broadband segment profit for the third quarter of 2009 was $50 million compared with $57 million in the second quarter this year.

Segment profit declined primarily on lower level of revenue from data products which carry gross margins above corporate average. Transport segment revenue was a $128 million in 3Q, up 8% from the prior quarter increased revenue from Digital Cross-Connect and Optical Networking systems.

Optical networking is another area where we have been diligently working to improve profitability and have done so in seven of the last ten quarters. Transport segment profits driven primarily by the higher level of revenue from Digital Cross-Connect systems was $29 million in the third quarter of this year and that compares with $26 million in the second quarter.

Like data products, our Digital Cross-Connect systems carry gross margins better than the corporate average. Services segment revenue was $55.5 million in 3Q, up slightly from the second quarter this year. Services segment profit amounted to $20 million consistent with 2Q levels.

Non-GAAP gross margin for the third quarter of 2009 was 41.9% and that compares with 43.7% in the second quarter of 2009. Gross margin declined as expected primarily as a result of lower quarterly level of revenue from data products. By having said that, we came in at the high end of our gross margin guidance and interestingly that was the result of it actually selling more data products in the quarter than we expected.

For the first nine months of 2009, non-GAAP gross margins improved to 43.3% up 5.8 points from the comparable period last year. Turning to operating expenses, for the quarter non-GAAP R&D expenses came in at $65 million, almost 70% of revenue. SG&A expenses for the quarter were $63 million. On a nine month basis, non-GAAP operating expenses were down $32 million in 2009, compared with the comparable period of 2008.

Other income amounted to $5 million in the third quarter of ‘09 compared with $6 million in the prior quarter. Our tax provision on non-GAAP pre-tax income for the quarter was $13 million for an effective tax rate of 31.5%. We expect our effective non-GAAP tax rate for the balance of 2009 to be about 32% plus or minus. At one million our GAAP tax expense for the quarter reflects evaluation allowance that shields our domestic earnings and $6.8 million benefits for the reversal of tax reserves which were no longer required.

Let’s turn to the balance sheet now. During the quarter we generated $66 million in positive cash flow from operations and grew the cash, cash equivalents and marketable securities and investment balance by $12 million. CapEx was about a $11 million and DSO dropped to 63 days from 65 in 2Q. Inventory returns were 6.2 times versus 5.4 in the second quarter, that’s the best returns performances we have seen since the fourth quarter of 2007.

At the end of the third quarter inventory in terms of dollars improved to a $127 million compared with a $148 million at the end of Q2. During the quarter, we purchased about 9.5 million shares of our stock at the cost of $62 million. The actual number of shares outstanding at quarter’s end was about $387 million.

Headcount at the end of the quarter stood at about 3200 and book to bill for the quarter was less than one. Turning to the outlook for the fourth quarter of this year, while we expect a few of our customers to spend soundly in the fourth quarter by and large we continue to see signs of caution in our customers spending plans for the fourth quarter.

Based on the orders received in 3Q and given the overall market conditions we are guiding for fourth quarter revenue to be flat to the third quarter of this year plus or minus three percentage points. We told you last quarter, we expected to see some recovery in gross margins during the fourth quarter we are going to see that, we expect to see gross margins in the fourth to be about 43% plus or minus it’s a point or too again depending on product mix.

We expect non-GAAP OpEx in the fourth quarter to be flat to slightly down. In addition, we expect the effective expensing equity based compensation in the fourth quarter will be about $5 million, split between operating expense and cost of goods sold.

To recap, we have made some good progress so far this year. On a nine month basis we made significant improvements in non-GAAP gross margins, operating expenses and operating income. We continue to generate cash and give it back to our shareholders via buybacks, and what is perhaps the most exciting development to me, we are expending our presence in the mobile internet markets with our recently announced acquisition of WiChorus.

Having said that, we’ll open floor to your questions. Chelsea we are ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Pal Levoni - Bank of America.

Vivek Arya - Bank of America

It’s Vivek Arya on Pal’s behalf. Rob for a long time you were somewhat hesitant to make acquisitions, but you recently acquired WiChorus for a significant premium. Has your view of organic growth of Tellabs changed in the last few weeks?

Rob Pullen

Well, first of all we think we paid a fair price for WiChorus and we hope to show our shareholders that we give them a very positive return on invested capital.

Next, no I’m optimistic about Tellabs’ future. This is just us being aggressive and expanding into an adjacency. Since I’ve taken over we’ve focused on re-owning our strategy which is focusing on mobile backhaul, optical networking, business service delivery and pro services. We as the management team wanted to stabilize our base as well as improve our fundamental operations, improve our profitability and return to shareholders, and we’ve told you what we are going to do, and we have done what we have said.

Having said that, I expect our growth portfolio is sound. In fact we are doing new extensions which could evolve into additional growth in 2010 to that growth portfolio. We are looking for growth out of the WiChorus SmartCore products and acquisitions, and we are hoping for better spend by our customers in next year as well; but no, I’m optimistic about Tellabs. This is us expanding into a normal adjacency that customers have been talking to us about over the past year or so anyway.

Vivek Arya - Bank of America

Secondly, if you look at one of the major Telco’s and the US AT&T, they expect to ramp their CapEx significantly in the fourth quarter, probably related to wireless and backhaul, but you are not seeing that in your fourth quarter expectations. I know it’s not a one-to-one correlation, but we would love to see how you think about wireless CapEx trends in the fourth quarter, and how they might impact your fourth quarter sales?

Rob Pullen

Well first of all, AT&T is a great customer and I don’t comment on specific customers CapEx trends. What I will share with you Vivek, is that AT&T’s spend is in our fourth quarter forecast, and as Tim said, we are guiding flat plus or minus two or three points. We see some very positive spend in certain customers, but in general we still see some caution when we look at our global base.

Tim and I mentioned that we are seeing some caution still in Western Europe, the North of Latin America is still cautious. I shared with you that I was just down in Brazil this past week. They look like verifying, are going to spend next year in 2010, and as we mentioned, we have had our best spend in North America here in recent quarters. So we are seeing some buying in North America as well.

Vivek Arya - Bank of America

One final question; what is the trough in some of your legacy segments like Access and Managed Access, at what point do you see them sort of coming to trough levels. Thank you.

Rob Pullen

It’s hard to tell Vivek. Even this quarter our spend was up in Access quarter-over-quarter. So it’s going to vary. I think the best answer is we’ll have long tails to them, but they are probably in decline in the short term.

We are hoping for some broad band stimulus funding, that looks like it’s delayed. In fact I was just recently at a show and I heard three different responses from customers on broadband stimulus. The first was “hey Rob, I actually put in 13 bids, seven of them have been approved, and they are doing site surveys and I am going start spending, and hopefully I’m going to spend my money and then get second half of 2010 reimbursement as a grant from the government.”

The second kind of group of customers that I visited said, “Rob, I put in these bids. I don’t know the current situation, so I have slowed down my spending until I can wait and see what the government is going to do.” The third group of customer said, “Hey, there is too many strings attached to this thing that I am not even putting in bids.”

Now having said all that, one of my Chorus’s customer is a current recipient of broadband spending, and so we should be able to get some positive outcome out of that as well as broadband stimulus flows, probably toward the second half of 2010.

Operator

Your next question comes from Ken Muth - Robert Baird.

Ken Muth - Robert Baird

Could you just give us a little bit of update of where you see kind of your bundling opportunities occurring Rob and Tim on the 8800 and 8600. A lot of the systems may be sold separately, but how do you see you going to the customers now and selling more of that bundled solution.

Rob Pullen

Well Ken, we sell them both independently and together, depending on the customer needs, and in the short-term, high scale and multi service, we would promote both the 8800 and 8600. At the same time we are now transitioning all those systems to optimize for Ethernet and IP and so, as the world transitions to Ethernet and IP, we are developing higher density, lower cost interfaces, to extend those products into the Y-Max and long term evolution, next generation 4G market place.

Lastly, that was part of our announcement recently here, which is leveraging our 120 mobile backhaul customers and our 600,8000 network management systems. We are leveraging our 8000 network manager to sell not only our 8800 and 8600, but other portfolio products including optical networking, optical enterprise through our access systems as well, and eventually the integration of WiChorus.

Ken Muth - Robert Baird

Then just a little bit more on the enterprise, because it seems to be getting a little bit more traction for you, can you just kind of tell us how do you get to those customers? Is it all through a Var channel or is this kind of the place where Nortel used to have a pretty good seat at the table with their strong optical enterprise.

Rob Pullen

Yes, it’s a good question Ken. First of all, it’s multifaceted as you could imagine. One example is we sell through our customers, including help our customers sell to enterprises, where we’ll go to a big service provider who offers wholesale service and help them sell both wavelength of light, as well as high speed Ethernet, all integrated over one platform.

Next we will do the same thing to help them deliver virtual private network, VPLS Ethernet LAN service off of our 8800 or 8600 services, and so that’s kind of helping our customers through their enterprise group sell to big fortune 500 in the world, and by the way Ken, that’s an example where we are actually going with the sales and marketing people of the service providers, and helping them sell to those enterprises, that’s kind of one extreme.

The other extreme is, we are distributing through value added resellers for example to the government. You saw that most recently we went through general dynamics to win some business in the federal government, and so we are selling that both directly through the service providers as well as through Vars. The other example is, is that our optical enterprise where we are doing Ethernet over optics to the desktop. That’s an area where we are selling through Vars to the federal government as well.

Operator

Your next question comes from George Notter - Jefferies.

George Notter - Jefferies & Co.

I wanted to ask about M&A post to recourse acquisition. Can you talk about how you think about the balance sheet, the cash generation and the company, what you would do with that cash, is it likely that we could see another M&A deal or more M&A deals down the road. We focus on repurchasing stock with the buy back authorization, what’s the though process now? Thanks.

Tim Wiggins

Well, first of all George, our competitors would love to know what we are going to do with that cash, so for competitive reasons I am not going to spend much time on that, but you can see us is investing in Tellabs organically and it’s proving out. Look at our improvement, even though like most companies our revenue is down year-over-year, look at our gross margin and the growth from our new products. We are falling back 17% as a percent of sales back into the platforms, and we are coming out with a bunch of new extensions.

Additionally, we are generating cash, putting it on the balance sheet, and we are being aggressive. Our customers have been talking to us about WiChorus’s technology and our mobile backhaul applications, both 8800 as well as 8600, and so these right folks are going to help us enable that.

Then lastly, look at us. We are being aggressive and figuring out how we use that balance sheet and grow the business, and while we expected to be slightly dilutive in 2010, we expect this whole acquisition to be accretive in 2011 and beyond.

George Notter - Jefferies & Co.

Then shifting gears a little bit, I want to ask about the Access business as well. It was up sequentially a fair amount this quarter. Was that driven more by traditional copper products or was that ONTs, and then can you tell us how much of this business came from traditional stuff in access?

Rob Pullen

Well, actually we are up slightly in just the new system sale for the Access, whether that was both fiber to the node or fiber to the prim. At the same time we are up sequentially from 2Q to 3Q in the ONT business as well.

Tim Wiggins

We’re looking up a percent for you George, hang on one second. Okay George, when you look at the fiber part of the business, it was 76% of the sales in the third quarter of ’09; that includes fiber to the prim and fiber to the curb, any one keys would be in there.

Operator

Your next question comes from [Aziya] - Citigroup.

Aziya - Citigroup

This is [Aziya] here on Jim’s behalf. Any updates that you guys have from AT&T regarding their vendor consolidation strategy. I know they have announced some partnership. We haven’t heard anything from Tellabs. I’m wondering if you could give us an update on that.

Rob Pullen

Well, we haven’t made any announcements about any of that subject area, but what I can’t share with you is AT&T is a very good customer of ours and we aspire to continue that format.

Aziya - Citigroup

Have you heard AT&T at all or you are just not commenting right now?

Rob Pullen

Sure, I hear from AT&T all of time. I talk to them often; in fact we were just talking to an executive last Thursday and Friday. We think it’s really AT&T’s job to comment on their vendor selection process. We’ll take our lead from them.

Aziya - Citigroup

Any comments on the top three customers or the top ten customers this quarter?

Rob Pullen

We had two greater than 10% customer this quarter.

Operator

Your next question comes from Alex Henderson - Miller Tabak.

Alex Henderson - Miller Tabak

So if I look at the ONT/access business, and I look at the Cross-Connect business, and I look at the margins of the two segments, given the rate of decline that you are thinking is likely to happen in those two segments. If I match the margins off against each other, does it net increase your margins or net reduce your margin based on your internal thinking.

Rob Pullen

Well Alex, first of all those aren’t segments that we report on, but as you can imagine, that we have already mentioned the Cross-Connects are higher than corporate average margins, and the Access products have been lower than corporate average margins.

Alex Henderson - Miller Tabak

Yes, I think everybody on these lines know that. I guess what I am trying to determine is, there is a perception that the decline in some of these older business, particularly the high margin business would negatively impact your business, but looking at the access business, it looks like the margins are further from corporate average, and I guess the question is, does the rate of decline in the Access business offset the decline in 5500 overtime as you see it?

Tim Wiggins

Well Alex, it’s Tim. Of course, the question that we don’t know answer too, is what is the rate of decline of the products. We know though that in the transport segment we have the 5500 which has solid margins. We also have these 7100 in there, which we have been working hard to improve its performance.

We also know in the access part of our business we have the ONTs, which again we have been working hard to improve it. So certainly what we have been able to accomplish over the last 12 months is based on the mix we’ve been able to significantly improve our margins. So with the significant growth of the data products which have solid margins, and the rates of decline and the improvements and profitability of the 7100 while it wasn’t declining, but the transport in general, we’ve been able to improve our margins.

So, it’s a problem of what are the growth trajectories of the products, but we’ve been able to do exactly what you are saying in the last 12 months, and we are hopeful that we’ll be able to continue to do that; which is to say that we are able to replace the margins from the 5500 with the data products and some of our growth products, while we also managed down the ONTs which has been particularly a low margin product for us, even though we continue to make it better as time progresses.

Rob Pullen

Alex just looks at our margins form last year 1Q above 8, until Tim and I just forecasted, the 43%, plus or minus a point or two. That should give you the answer, which is we are improving our gross margins year-over-year, and in this case quarter-over-quarter. It’s hard to predict any given products for a given quarter, the product mix, but even with the 5500 we are expecting it could be flat quarter-over-quarter, maybe even a slight up-tick from 3Q to 4Q.

Alex Henderson - Miller Tabak

Looking at the comments from your customers as you have been going into the fourth quarter, are you seeing any trajectory change starting to develop in North America. It seems like the spending was little bit anomalous, at least one of your large customer in 3Q, and therefore may have caught some people by surprise here, but the fourth quarter should obviously be stronger. How do we reconcile those facts with the fairly tepid guidance?

Rob Pullen

Well first of all, what you maybe alluding to is the fact that we had a fair amount of revenue recognized this past quarter from a couple of customers, one in Latin America, one in Asia, but we actually see a few of our customer with fairly positive spending, but as I mentioned at the top of the call, we see a fair amount of them cautious too.

Now as I also mentioned, I was just down in Brazil I guess a couple of weeks ago now; the past few weeks have been like a blur for me. In Brazil we are winning new customers down there and they are optimistic of our GDP from ‘09 to ’10, and we are trying to give you that consideration in our forecast.

We’ve gotten customer saying “hey Rob, I have budget money I am going to spend.” I have customer saying, “I need to spend, but I don’t know if I have budget money” and I have customers saying “I think we are going to be cautious in the fourth quarter,” and so it’s a mix, that’s why we gave you our best guess of our guidance here flat, plus or minus 2% or 3%.

Tim Wiggins

I would add Alex that we also expect that the ONT volumes which were relatively high in 3Q would abate somewhat in 4Q. So it’s something you need to take into account as you model our 4Q. That also drives some of the margin improvement that we are forecasting as well.

Operator

Your next question comes from Jeff Kvaal - Barclays Capital.

Jeffrey Kvaal - Barclays Capital

You have a fairly big guidance range for the fourth quarter. I am wondering if you could help us think about why the range of the guidance, particularly compared with recent quarters, and then some of the variables that echo into the high or the low end, thanks.

Rob Pullen

It’s a fair amount of moving parts Jeff. It’s product mix issues, it’s what I was sharing with you earlier that I am simplifying a complex situation, but customers are saying “I need to spend and I am going to spend.” Others are saying, “I need to spend and I don’t know whether I may get budget money or not yet” and the third group that are saying “Hey, I am cautious, because I am still coming out of economic recovery,” and it’s a confluence of all those which has probably given us, to give you that guidance range that we currently have.

Jeffrey Kvaal - Barclays Capital

Is it fair to say that it’s a wider guidance range than you had in the recent quarters?

Rob Pullen

I think it’s slightly wider, but I didn’t go back and do that analysis.

Tim Wiggins

I think we did make the range wider than we initially thought for this quarter, just to reflect some of the uncertainties that we are talking about. We are seeing some of that caution in some fronts, and other places we see some strength.

I think the sense of the management team was that we worked very hard to deliver inside these ranges that we give you, and these key elements, we are not given the EPS guidance, but the whole view of our guidance here is really to give you a sense of, or put you in the seat of management in terms of how we see the business.

What we are saying is we could see some things all lining up and it being a strong quarter where we’d show growth, but we also see some factors that could line up and cause us to be at the lower end, we are just not certain. So we are trying to get you a sense of based on what we are seeing, what the range of outcomes are, and then we work really hard to make sure we are inside those.

Jeffrey Kvaal - Barclays Capital

Okay, and then any thoughts for us on the deferred revenue trajectory?

Tim Wiggins

I think kind of more of the same, nothing major. We don’t expect any major changes as we go into the next quarter.

Operator

Your next question comes from Simon Leopold - Morgan, Keegan.

Simon Leopold - Morgan, Keegan & Co.

I just wanted to follow on a little bit on the trending. May be it’s more specifically the Managed Access business, which I guess good European exposure typically is up sequentially in the fourth quarter, and the broadband access, just seasonal factors typically have that down in the fourth quarter. Just want to see if you can confirm that that’s the kind of seasonal patterns we should expect to continue this year.

Tim Wiggins

Yes, you are right. We expect hopefully Managed Access to be up slightly from 3Q to 4Q, and access will be down slightly, based on typical seasonality that you alluded to.

Simon Leopold - Morgan, Keegan & Co.

Okay, and then on the data network and platforms you’ve talked about a large number of customers for both the 86, 8800. I’d like to see if you could present that in a little bit different light, and help us understand the customer concentration. Really what I am trying to get a sense of is, do you have a good diverse base of customers or one or two that are, 20% of the business and then a large spectrum beyond that. Someway you can give us some color on that.

Tim Wiggins

Well Simons, its Tim. I think it’s interesting to look at what happened in Q2 and Q3. We do from time-to-time have customers who will make up a big percent, but I was particularly encouraged even after sizable revenue recognition in 2Q to come back with a very solid quarter, almost $82 million.

So I think what we are beginning to see, even though some quarters will have a big impact from particular customers, we have enough customers and we see kind of some momentum in the business, that we are able to continue to produce revenues in these ranges. If you look back over the last couple of quarters, back to 3Q of ’08, it was $68 million, 4Q ‘08 it was $60 million, 1Q ‘09 it was $63 million, then of course in 2Q ‘09 we had 107, including some sizable rev rec, and then this quarter $82 million.

I think if things go well, we should have that business hopefully up again in 4Q, and in fact if you look at our fourth quarter internal estimates, each of the segments has a possibility to be up sequentially depending on how things play out. Really the big change in 4Q with the exception of access, and the big change would be around the ONTs, where we expect to see some meaningful reduction in revenues, and it’s certainly shading the overall guidance that we are giving for the business.

Rob Pullen

I would also add Tim, some for your benefit, the top 10 or 15 customers make up, 75% to 80% of our business, and then it’s evenly distributed after that. We have over 120 customers now in that spread. Hopefully, we will get the lower tier spending a little bit more, while the higher tiers continue to spend, but that’s hopeful thinking based on economic turn around and so on.

Simon Leopold - Morgan, Keegan & Co.

If you were to just step back and kind of take a first pass impression of longer term trends, let’s say going out four quarters rather than one, obviously the expectation is growth products grow. What’s your feeling of kind of the mix shift of when you see growth products sustainably more than half your sales, and how do you think about the balance between your mature products declining and your growth products growing. How does that equation work out in your mind? Thanks.

Rob Pullen

Well, we are probably about 50-50 growth versus core going forward, and then hopefully that transition occurs where more of the percentage is growth in 2010. We told you this year Simon that, our growth products may exceed our core in one each quarter, may be in a quarter, but all-in-all we’d be about 50-50 for the year, and that’s probably still a decent guess, and then next year we hope to transition that number for a higher percent in growth products.

Simon Leopold - Morgan, Keegan & Co.

And the growth products just to remind us, give us a list of those again please?

Rob Pullen

8800, 8600, 7100, 6300 professional services and now WiChorus.

Operator

Your next question comes from Brett Miller - Dialetic.

Brett Miller - Dialetic Capital

I had a question about order linear arrangement for the quarter. What did you see as the quarter trended on?

Rob Pullen

First of all our book to bill was just slightly under 1, it was 0.95, and I didn’t see data on the linearity, but I assume it was consistent with other quarters.

Tim Wiggins

That’s right Rob. It’s been fairly consistent Brett.

Brett Miller - Dialetic Capital

So meaning, that things got better as the quarter went on?

Tim Wiggins

No, I think we see the orders pretty evenly distributed throughout the quarter. You are talking about orders or our revenue?

Brett Miller - Dialetic Capital

Orders.

Tim Wiggins

Yes the orders came in I think fairly consistent with what we’ve seen in the prior quarters.

Brett Miller - Dialetic Capital

How about customer visibility? Did that change at all throughout the quarter?

Rob Pullen

Like I told you Brett, there are a few customers that gave us a fair amount more visibility in there and kind of the left hand of the spectrum which was, they need to spend money and they have money. Then we didn’t have as much visibility in kind of the other extreme part of the customer base which was, either we need to spend money and we don’t know if we have it or we are being cautious. So we didn’t get as much visibility there, so it’s been a mix.

Operator

Your next question comes from Jack Monty - UBS.

Jack Monty - UBS

I am curious, as you look at gross margins trending in the fourth quarter, is most of the improvement coming from product mix, and we have the 5500 possibly up, the OMTs down I think was mentioned or is it from cost cuts. I just want to make sure I’m thinking about it the right way?

Tim Wiggins

Jack, it’s largely mix and we expect less OMT’s in 4Q and also more Managed Access, those are really the two big things. There is of course probably eight or 10 things that are moving the number, but those would be the two big categories that would help us lift the margins going into 4Q.

Jack Monty - UBS

Okay excellent, and as far as OpEx, I mean it’s been trending down versus last year, versus last quarter. Should we think about most of the OpEx cuts behind the company now and at more of a stable level going forward or are there maybe more cost cutting actions that are going to happen in the fourth quarter of this year?

Tim Wiggins

Well, I think one of the things that is important to notice that will go into 2010, in this $125 million, $6 million, $7 million range. So we are going in with a run rate with $500 million range give or take, as opposed to the 520 plus or minus that we’re likely posed this year. So I think we enter into next year with that lower run rate.

I think it’s a question that we are constantly evaluating based on our mix, and the need for investment in R&D and also in our channel. So I think we are feeling comfortable at the moment, but it’s really a function of constantly working every lever we can to drive more cost out and we’ll take this lower run rate into next year.

Jack Monty - UBS

Okay, and I guess one more on customers if I could; North America was a little stronger, it sounds like the tier ones are spending a little bit more, and it sounds like more of the cautions around tier two’s and international customers, is that the right way to think about it?

Tim Wiggins

Yes, I believe so.

Operator

Your next question comes from Michael Genovese - Soleil Securities.

Michael Genovese - Soleil Securities

I wanted to follow-up on the comments about the broadband stimulus; I thought that was an interesting discussion. If you could maybe help us put the tiers of carriers into those buckets, so I imagine the tier one carriers are basically saying, “We don’t want to get involved with the government money and the government restriction.” So what I’m most interested is the tier two carriers, the publicly traded IOC’s which I would say are the tier two’s and then the tier three.

If you can talk about each of them, do the tier two fit more into, we don’t want the money or we are uncertain of funding; and then tier threes are they more of a, let’s go ahead and spend the money or are they also uncertain about whether they will be getting the money from the government.

Rob Pullen

Okay, that’s a lot of questions. Okay the first part to your question is, is it correct to assume that the tier ones are saying, “I don’t want the strings attached,” and yes, that’s true.

Then the second part is, is that the tier two’s, is the publicly traded IOCs that are either getting money or uncertain. It’s actually a mix. There is a tier two IOC that’s publicly traded. One of them told me for example, they are uncertain about whether they are getting funding or not, and the other one told me a more interesting story, which was, this was the one that said, “I submitted 13 projects, I’m going to get seven out of 13, I don’t know the remaining six.”

The interesting anecdotal feedback was, the tier two that was going to get spending for the seven projects, the anecdotal information was they had a whole list of projects, one through N, and they proposed to bottom 13 of the one through N. The feedback to me was “Rob, I most likely never would have spent money on the bottom 13,” and as it turned out I’m likely to get money for the seven of 13, and I’m going to spend my money this year, and then the reminder this year and first half of next year, and then I will get reimbursed with a grant in the second half of next year.

I thought to myself, “that’s great, this is what this broadband stimulus funding was all about, which was to get a rural community high speed internet,” and I see it working versus get involved up in the politics. The head of engineering told me, says “hey Rob, it’s ironic that this rural environment now is going to have some of the best broadband internet in the world,” so that’s kind of one area.

Then there is others that were looking for middle mild to kind of fund their existing infrastructure. The middle mild is going to get a lot of money, but those haven’t been the projects that have been approved yet. Then lastly, even with our pending acquisition of WiChorus, there is a bunch of groups building out broadband. I mean today dominantly Y-Max for municipal networks and they are getting funding already for that, and they expect to get more funding as this roll out.

So, it’s really been highly variable, and the feedback we have gotten from customers, I think that’s the best characterization I can give you at this stage.

Michael Genovese - Soleil Securities

Okay, I appreciate that. Have you heard it from any tier two’s that you would put in the cap of hearing comments along the lines if we don’t want the strings attached or is that limited only to tier one?

Rob Pullen

No, I heard it from a tier two as well, so then I’d have to share with you that I did hear it from a tier two, that we don’t want the strings attached.

Michael Genovese - Soleil Securities

Then my last question is, just following up on some of the comments about seasonality. I would have expected that we would think the access business, as you said would have negative seasonality in the fourth quarter, but I would also have thought that the 5500 sales would as well, as we have seen that pattern in wireless backhaul the last few years, kind of weaker spending at the end of the year in wireless backhaul, but you are saying that the 5500 could be up.

When I look at your growth products, optical and data, I would think those should also be up in the fourth quarter, just along with normal carrier spending pattern. So the 5500, if you are not sort of budgeting that to be down in the fourth quarter, how do you not come in at the high end of your guidance or above. I mean it seems pretty conservative guidance if you think the 5500 is not going to be down.

Tim Wiggins

Well first of all, I believe the 5500 will be flat to slightly up, but think about it flat to slightly up. Next is, you are right, we share which is that Access should be slightly down, and we also share which is that we have great visibility from a few of our customers and murky visibility from many, and so that’s why we gave you the range that we did.

Rob Pullen

Don’t underestimate the impact of ONTs for the fourth quarter.

Operator

Your next question comes from Brian Coyne - Wedge Partners.

Brian Coyne - Wedge Partners

If you could just put stress for the final point on, the sort of I guess better than expected strength you saw in the data product. I guess first of all, if you could also remind me just about the fair sequential comparison, net of the rev rec last quarter? Then, did you see some of the strength come from I guess the wireless backhaul type applications, or was it more evenly split among wire line as well?

Rob Pullen

Okay, a couple of thoughts. We last quarter Brian described the increase of data, which went from $63 million in Q1 to a $107 in Q2. We described that most of that was a result of revenue recognition for some key customer. So if you think about the $81 million or $82 million that we just reported was pretty solid, and a nice growth trajectory if you adjust for that, we did see strength in North American wireless spending that impacted our data product revenue in Q3. Hopefully in Q4 we will continue to have a good, solid quarter there.

Brian Coyne - Wedge Partners

Then in terms of customers again, it just looks like Verizon is saying it’s more to like its CapEx is coming at the low end of yearly guidance, and I know obviously you all don’t comment on specific customers, but is that kind of the tone of your conversations that you are having generally across the board.

Are a lot of customers perhaps looking to spend a little bit more and are sort of now pulling back. Just in terms of visibility have things, did you say over the past quarter, been about what you would expect for the fourth quarter or you think deteriorate a little bit?

Rob Pullen

No, I believe it’s been about what we expected for the fourth quarter, which was a mix of up and down. I mean remember, we are still recovering from a global economic melt down. And so every part of the world is in different shape, the emerging countries.

Well, first of all we shared with you North America rebounded, here in the previous quarter, emerging countries continue to spend, we are seeing positive stuff from India and China. I mentioned to you that Latin America was very cool over the past nine months and is showing some buying.

I was down at a Future Comp tradeshow meeting with our customers and employees. I got a purchase order from a new customer; it’s the first time it has happened in 15 years, and so that’s an interesting anomaly I will say, but it’s consistent with what we expected.

Brian Coyne - Wedge Partners

Then finally, I guess if you could comment a little bit maybe on the incremental business opportunities you talked about with WiChorus. Maybe what they are just in your mind at this point really necessarily, but beyond say what we already know about the clear wire deployment? What do you have to do here to be successful? I mean, it’s just kind of displacing incumbents at this point, or perhaps just participating in a growing overall market?

Rob Pullen

Well, first of all we shared with you on last weeks call that we have roughly four customers today, and were about 10 trials. Converting those 10 trials to revenue and success is obviously key and very important to us, but that’s not going to be sufficient, we are going to have to scale well beyond that. As you saw the and heard, the clear wire is a Y-Max deployment, but this architecture is a purpose built 4G technology for both long term evolution and Y-Max that can also do third generation, and it’s purpose built for both the hardware and the software.

Now obviously us winning new customers and new applications is of key importance, and that’s going to be new application on our embedded base, as well as new standalone applications with SmartCore platform. As for, is it a big and growing market? The answer is yes. We anticipate that just the mobile packet course standalone business on itself is going to grow at 22% compound annual growth rate over the next several years. We believe we are in our infancy of this internet Tsunami for mobile internet, mobile video and mobile commerce.

I expect one day that your handheld computer will be your wallet, your keys to your car and your transactions, and furthermore, one model that we are pursuing is how we help the service providers monetize content or monetize the internet that today is over the top, which bypasses their network for all profit transactions, and we are going to use this technology overtime to help our customers monetize the traffic and the content that goes over their network.

Let me give you an example; Banks in Kenya are using the Smartphone or the handheld computer for banking transactions. There is an opportunity where I am traveling in a remote city. I am in downtown Rome. I know I want to eat 9 or 8 o’clock. The network knows where I am and it says, “Hey Rob, here’s all the menus of great Italian restaurants, throughout downtown Rome.” It’s that personalized web that we believe is going to be a huge growth phenomena over the next 20 to 30 years and ideas that we haven’t even contemplated today.

Now I see my children use their handheld devices and they are very fortunate children I might add, but I am sitting in my family room and there’s a 52-inch flat screen TV and my son is watching video on his handheld device. It’s a phenomena that’s going to happen, that I certainly would never do, but my kids are going to do and probably your children are going to do for a long time to come.

So we believe it’s massive macro economic trend, not withstanding leveraging our embedded base of 120 mobile backhaul customers, the 8,000 integrated management system and our strong relationships with our customers growing worldwide.

Operator

Your next question comes from Alex Henderson - Miller Tabak.

Alex Henderson - Miller Tabak

So, I just wanted to go back to WiChorus for a second. If I were to think about the OpEx costs associated with that business, and using a non-GAAP of cost structures. So I am not taking into account the compensation per stock. Is it reasonable to think that that’s adding $25 million to $50 million or 5% to 10% to your OpEx cost?

Tim Wiggins

Well Alex, it’s Tim. I think the way to think about it is we gave you some data points around what our valuation was, 6.5 times our net cash price on their forecasted shipments for next year, so you can run the math on that. Then we also said we expect it to be dilutive a couple of pennies, and we also told you that we thought the margins were similar to other companies in this space. So I think you got enough data there to figure out what the spend is going to be give or take, okay?

Alex Henderson - Miller Tabak

Okay, would it be significantly different if you were to take into account the stock compensation

Tim Wiggins

Yes, we don’t know how the purchase accounting is going to play out. There will likely be amortization of intangibles, in process R&D, we’ve got some new roles on how to do this accounting and there haven’t been a lot of deals. So we were on the process of working through those things. There would also be the impact of retention programs to keep this valuable team in place and driving, all those things will impact the results; some on the GAAP basis, some on a GAAP and a non GAAP, particularly the latter retention costs that would impact the non GAAP to the extent it wasn’t an equity.

Alex Henderson - Miller Tabak

Well, there could be some increase in the number of shares outstanding for compensation purposes.

Tim Wiggins

Over time.

Rob Pullen

Okay, everyone thanks a lot for your good questions and your support of Tellabs. We are obviously excited about improving our gross margins, generating cash. We are up sequentially quarter-or-quarter. We hope to have the fourth quarter positive one as well, and we are feverishly trying to get through the hardest cap to close WiChrous and make them part of our fully integrated team.

It shows not only our commitment to turning around and transforming the current business, but also be seeing aggressive and entering new adjacent businesses for this mobile internet tsunami. Thanks a lot for your time and we will talk to you soon.

Operator

This concludes today’s conference call. You may now disconnect.

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