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Tellabs, Inc. (NASDAQ:TLAB)

Q4 2009 Earnings Call

January 26, 2010 8:30 am ET

Executives

Thomas Scottino - Senior Manager of Investor Relations

Robert Pullen - President & Chief Executive Officer

Timothy Wiggins - Executive Vice President & Chief Financial Officer

Analysts

Alex Henderson - Miller Tabak

Jason Gersky (ph) - Unidentified Company

Ehud Jablaum (ph) - Unidentified Company

Michael Genovese - Soleil Securities

Vivek Arya - Bank of America

Simon Leopold - Morgan, Keegan & Co.

Jeffrey Kvaal - Barclays Capital

Andy Schopick - Nutmeg Securities

Jack Monty - UBS

Todd Koffman - Raymond James

Brian Coyne - Wedge Partners

Shendin Sarkar - Unidentified Company

Operator

Good morning. My name is Tania, and I will be your conference operator. At this time I would like to welcome everyone to the Tellabs Investor Relations conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator’s instructions).

Thank you, Mr. Scottino. You may begin your conference.

Tom Scottino

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

Before we begin the call, I would like to remind you that this presentation contains forward-looking statements about future results, performance, or achievements, financial and otherwise. These statements represent 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 after the time and date of this live presentation, it may not contain current or accurate information. Tellabs disclaims any obligation to update or revise any forward-looking statement based on new information, future events, or otherwise.

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

Robert W. Pullen

Thanks, Tom. Good morning everyone. Despite tough economic times, Tellabs has performed well, both in the fourth quarter and in 2009. As we sit here and we begin 2010, we see that our innovations are helping customers and our company succeed. As we visit customers, they are giving us positive responses as to how we improved their networks, increased their revenue, lowered their expenses, and improve profitability.

Today, I will provide a high level look at both the fourth quarter and our 2009 results. Then I will summarize our progress in advancing Tellabs strategy towards profitable revenue growth. Then I will pass over to Tim, and Tim is going to give you more detailed results.

First of all, in the fourth quarter, Tellabs landed squarely in the middle of our guidance that $389 million in revenue, and on a GAAP basis, $0.16 a share, and on a non-GAAP basis, $0.09 a share. Tellabs is growing our Ethernet and Internet Protocol data space. It has done this greater (ph) by our fourth quarter data revenue, which was up 10% sequentially and 52% year-over-year. It was our second best data quarter ever.

Fourth quarter transport revenue was up 4% sequentially and 7% year-over-year. It was driven by the strength of the Tellabs© 7100 system, which customers are deploying around the world, as I will comment in a moment. We also had a slight up shake in our Tellabs© 5500 system, which also contributed to our fourth quarter transport revenue being up.

Our services business was up as well. Fourth quarter services revenue was up 17% sequentially and 13% year-over-year — could be a leading indicator of some positive trends moving forward. Our growth products generated almost half of our overall fourth quarter revenue, or roughly 48%. This is an ongoing trend, where we believe over time our growth products, including this year, will eclipse our core products.

Our fourth quarter non-GAAP gross profit margin rose to 45.5%, up from roughly 42%, or 41.9%, in the third quarter. These were Tellabs’ highest gross margins in over three years. This is consistent with our strategy, the management team, to improve our profitability over time, and this is a strong indicator of trends to come here in 2010.

Our fourth quarter non-GAAP operating income was $49 million. This was also one of our highest, at 12.6% of revenue as a percent of revenue (ph), our fourth quarter non-GAAP operating margins were the highest since the third quarter of 2006. At 9% of revenue, our fourth quarter GAAP operating margins were the highest since the third quarter of 2006 as well. This is our best profitability in over 3 years, and we are proud of the trends that (inaudible).

On a GAAP basis, our fourth quarter earnings, as I mentioned, were $0.16 a share, compared with $0.03 per share in fourth quarter of ’08. Our fourth quarter GAAP earnings, of course, include a tax benefit that Tim is going to talk about here in a moment, of roughly $0.06 a share. On a non-GAAP basis, we earned a solid $0.09 per share.

Now, let’s look at our 2009 annual results. We have made tremendous progress in improving profitability during 2009. We control the things within our control. Although our annual revenue was down by over $200 million, or 12%, our non-GAAP operating income increased by $43 million, or 39%. Our decision to reduce investments in unprofitable businesses paid off. Our operating income in 2008 was $109 million and in 2009 was roughly $152 million. It manifested itself in both positive GAAP and non-GAAP comparisons of 2008 versus 2009. On a GAAP basis in 2009 we earned $0.29 a share, versus 2008, which was a loss of $2.32 a share dominantly by a one-time write-off of good will. Our (ph) non-GAAP 2009, we earned $0.30 a share versus $0.26 a share in 2008.

We increased our annual non-GAAP gross profit margins from 38.5% in 2008 to 43.9% in 2009. And we reduced our annual operating expenses on a non-GAAP basis, from $556 million in 2008 to $517 million last year. All are positive trends.

We also did a good job of managing our inventories down. Total inventories decreased by $49 million year-over-year. We went from $177 million at the end of ’08 to $128 million at the end of ’09. These are also positive trends increasing turns ratios and so on.

We generated $234 million in cash from operations during 2009. This enabled us to pay $165 million net of cash for our new merger and acquisition with WiChorus, and spend roughly $83 million, or $82.9 million, to purchase 12.9 million Tellabs shares.

All in all, and most important, we advanced our strategy for profitable revenue growth. Now, we are relentless about profitable revenue growth. We are turning the tides here at Tellabs. We are more focused on wireless and mobile markets. We expanded in the mobile packet core market with the WiChorus acquisition. This is the intelligence linking subscribers to the public Internet in the mobile market. And we see tremendous opportunity to lead in the mobile Internet. When we say mobile Internet, we are talking about the confluence of events of the smart phone, 2G to 3G, 3G to 4G, and the trend toward mobility and the personalized web. We believe over time the personalized web is going to create big demand, both in bandwidth and new services and revenue opportunities for our customers.

During the fourth quarter, Tellabs recognized our WiChorus revenue from the platform we are now marketing as the Tellabs© 9000 SmartCore platform. The Tellabs 9000 SmartCore platform now has five service provider customers, and while I mentioned last time we had ten trials, we are now in 15 customer trials, including our U.S. customer.

We are more focused on growth products as we have shared with you in the previous earnings calls. We focused and shifted our investment from our core products to our growth products in research and development, and growth products were 46% of 2009 revenue. That was up from 36% in 2008. In 2010 we expect growth products to generate more than half of our revenue. And of course in the fourth quarter, our growth products were roughly 48% of our total revenue. We are more focused on Ethernet and IP products. We achieved record data revenue in 2009, and we expect further growth in 2010.

Today, we are also announcing a restructuring. It is going to affect about 200 employees over the next 5 quarters. The restructuring shifts more investment from Time Division Technology to Ethernet and Internet Protocol products. We are also shifting our skills head (ph). It is improving our Ethernet and Internet Protocol and mobile packet core skills sets companywide. We are also moving our supply chain closer to our suppliers. And we are reducing general and administrative expenses. These are all necessary changes that will continue on the transformation of Tellabs, even though this is one of the smallest we have announced in previous years.

That said, even though we are reducing the headcount, we expect Tellabs overall headcount to increase during 2010 as we invest in our growth areas, namely markets outside the United States, as well as in Ethernet and IP products in our optical networking (ph), in our data networking, in our business services delivery, and in our professional services.

In 2009, we are more successful with our Optical products. We achieve record revenue for the Tellabs© 7100 system by winning customers in all of our regions around the world. And I am happy to say growth profit margins on the Tellabs© 7100 improved in each quarter of 2009 quarter-over-quarter.

We are more international. We continue to invest in international markets, and our percentage from international revenue has grown to 34% of our overall revenue, which is up from 32% in 2008. We are winning new customers. Our book-to-bill ratio is above 1. During the fourth quarter, we won new customers for the Tellabs© 7100 system, both in the Asia-Pacific and in North America. We also won two new customers for the 8600 in Latin America. We recognized our first revenue from three new Tellabs© 7100 in Latin America and Asia-Pacific. We recognized revenue from three new 8600 customers in both Latin America and our region in Europe, the Middle East, and Africa. We also recognized revenue from two new customers on the Tellabs© 8800 system, both in North America and in Europe, the Middle East, and Africa region, and our Latin America region — all positive trends in Tellabs transformation.

We are more profitable. Our annual gross profit margins are the highest since 2006. Our non-GAAP operating expenses are the lowest since 2004. We are proud of that. The management is focused on the things we can control in our business. Our non-GAAP annual operating income increased, as I said, $43 million or 39% in 2009, and at 10% our non-GAAP annual operating margin was the highest since 2006. Now, we are laser beam focused on top line revenue growth — and I underline profitable revenue growth.

As you have heard from us before, we are financially strong. Our balance sheet includes more than $1.1 billion cash and equivalents, including after paying $165 million in net cash for WiChorus and repurchasing about $83 million in Tellabs shares during 2009. And as all of you know, we have zero debt.

I also have some exciting news to announce to all of you. This is all with a goal of looking out for another way of looking out for our shareholders. Tellabs is announcing a new quarterly dividend of $0.02 per share, which yields about 1.3% in our recent stock price of around $6.00 a share. We believe that dividends are a good way to return capital to Tellabs shareholders. We are confident that Tellabs will continue to generate cash from operations, and we believe that is sufficient to invest in growth of our business, repurchase shares, and pay dividends. Tellabs plans (ph) to continue with share repurchase during 2010. And, as I mentioned, we are going to analyze and pay out. Our intent is to pay out a quarterly dividend as voted on and approved from our Board of Directors.

While we have achieved many positive changes over the past year, we are only going to be satisfied when we achieve profitable year-over-year revenue growth. Tellabs is going to continue to innovate to make both our company and our customers successful. Tomorrow, we are going to do even more for them. We are going to focus on making them successful in the mobile Internet, as this revolution goes forward. When we focus, we will win. We are already seeing positive signs from our recent merger and acquisition with WiChorus. We are seeing increased trials and customer interest. I just came off an annual sales meeting where our sales force is excited. In fact, they have already talked about winning new customers real time during the sales meeting.

And so with that, I am going to turn it over for more of the details with Tim.

Timothy J. Wiggins

Thanks, Rob, and good morning everyone. I am sure you noticed the change in the way we delivered our earnings release this morning. Instead of e-mailing the complete 13 page document, we e-mailed a short notification to the wire services and you with a hyperlink that leads to our tellabs.com website where the complete earnings release resides. Given the length of our earnings release, this new delivery method significantly reduces our wire service cost. I would be interested in hearing any feedback you might have on this change.

Today’s earnings release contains all the normal year-over-year comparisons, as well as a reconciliation between GAAP and non-GAAP financial measures. In my remarks this morning, I am going to provide some additional insights where I think it is a helpful addition to the year-over-year data.

First, let’s take a look at the fourth quarter numbers. After that, I will make some observations about our full year 2009 performance and update you on our guidance for the first quarter of 2010.

Total revenue for the fourth quarter of 2009 amounted to $389 million, which was consistent with the third quarter of ’09. We saw sequential growth in the transport and services segments, which were offset by lower overall broadband segment revenue. Looking a little deeper into the broadband segment, sequential growth in data and managed access revenue was offset by lower access revenue.

GAAP net income for the fourth quarter of 2009 amounted to $62 million, or $0.16 earnings per share. That is a little more than double the $29 million we recorded in the third quarter of ’09, and up nearly five-fold from the $12.8 million, or $0.03 a share we recorded in the fourth quarter of ’08.

On a non-GAAP basis, net income excluding pre-tax charges for special items was $36 million, or $0.09 per share in the fourth quarter of ’09. If you are wondering why our non-GAAP net income is less than our GAAP net income, it is due to a tax benefit that impacts only our GAAP expenses, as I will explain more fully when we talk about taxes.

Okay, if you take $36 million in non-GAAP net income and subtract $5 million for equity-based compensation to be consistent with the first call (ph) compiles and reports estimates for Tellabs, the result is $0.08 in non-GAAP EPS for the fourth quarter of ’09.

On a geographic basis, revenue from customers outside North America grew to account for 34% of the total revenue in the fourth quarter, compared with 30% in the prior quarter.

Let’s take a look at the segment data for the fourth quarter. Broadband segment revenue in the fourth quarter of 2009 was $191 million, compared with $206 million in the prior quarter. As I said, on a sequential basis, growth and data and managed access product revenue was offset by a decline in access revenue. Specifically, data revenue for the fourth quarter came in at $90 million. That is up 10% from $82 million in the third quarter of 2009, and up 52% from $60 million in the fourth quarter of 2008. At $90 million in revenue, the fourth quarter marks our second highest level of data revenue. The strength we saw in sales of these products into North American wireless applications in the third quarter of 2009 continued into the fourth quarter. In all, data continues to be our fastest growing product category. For the full year 2009, data revenue totaled $342 million, up 59% from $215 million in 2008.

Total revenue for the data category in the fourth quarter also includes our first contribution from the Tellabs© 9000 SmartCore platform that came to us via the WiChorus acquisition that closed early last month. While the revenue we were able to recognize from the SmartCore platform for December was negligible, shipments in the fourth quarter were solid. On a full year 2009 basis, shipments were solidly within the 6-8 million forecasts that we gave you in December.

Turning to managed access category, revenue in the fourth quarter of 2009 came in at $45 million, up 19% from $38 million in the prior quarter. Revenue from both the Tellabs© 8100 and 6300 systems was up on a sequential basis as anticipated, driven by an up tick (ph) from some of our traditional customers in the Nordic region and projects in India.

Access revenue was $56 million in the fourth quarter, compared with $86 million in the prior quarter, driven primarily by an anticipated sequential decline in sales of single family ONTs. Taking all that into account, broadband segment profit for the fourth quarter of 2009 was $44 million, compared with $50 million in the third quarter of this year.

Segment profit declined primarily as a result of higher research and development costs. In the transport segment, revenue was $133 million in the fourth quarter of 2009, up 4% from the prior quarter. An increased revenue from cross-connects and voice-quality enhancement systems. Transport segment profits, driven primarily by the higher level of revenue from voice-quality and digital cross-connect systems and lower research and development cost, was $45 million in the fourth quarter, up 55% from $29 million in the third quarter of ’09. Like the data products, our voice-quality enhancement and digital cross-connect systems carry gross margins better than the corporate average.

Services segment revenue was $65 million in 4Q, up 17% from $55 million in the prior quarter. Services segment profit amounted to $23 million, up from $20 million in the third quarter of ’09.

On a portfolio basis, revenue from the growth products, which includes the Tellabs© 6300 transport system, the Tellabs© 7100 Optical Transport system, Tellabs© 8600 and 8800 data products, professional services, and the recently acquired Tellabs© 9000 SmartCore platform grew in the fourth quarter to account for 48% of total revenue, compared with 45% in the third quarter of ’09, while core products contributed the balance of revenue in each period.

On a gross margin basis, non-GAAP gross margin in the fourth quarter was better than anticipated at 45.5% compared with 41.9% in the prior quarter. Gross margin is dependant upon product and customer mix. Contributing to the favorable shift, this quarter was about two points related to lower level of revenue from single family OMPs (ph), which carry gross margins lower than corporate average.

A little more than a point of improvement related to profitability improvements in our Tellabs© 7100 Optical networking system. We have been diligent about proving optical networking profitability and have done so in eight of the last eleven quarters. And by the way, the story is the same for the single family OMPs, or even proof profitability in eight of the last eleven quarters as well. The balance of the improvement in gross margin came from a higher level of revenue from Tellabs© 5500 cross-connect products.

Let’s take a look at operating expenses. Total operating expenses on a non-GAAP basis came in at $128 million, just above $127 million we recorded in the third quarter of 2009, with $1.1 million representing expenses attributable to WiChorus, which became part of Tellabs in early December. In the fourth quarter of 2009, non-GAAP R&D expenses came in at $66 million, or almost 17% of revenue. As G&A expenses for the quarter were $62 million. Other income amounted to $4 million in the fourth quarter, compared with $5 million in the prior quarter.

Our tax revision on non-GAAP pre-tax income from the quarter was $17 million for an effective rate of 32%. Our GAAP results including a tax benefit of $23.4 million, compared with the $17 million tax expense for non-GAAP. A number of items affected this difference. The largest was a $24 million tax benefit for the release of valuation allowances relating to the accounting for the WiChorus acquisition. Looking ahead, we expect our affective non-GAAP tax rate for 2010 to be about 32%.

Turning to the balance sheet, during the quarter we generated $60 million in positive cash from operations. On a full year basis, positive cash from operations totaled $234 million. CapEx was about $21 million in the quarter and $46 million for the full year. You can expect 2010 CapEx to be similar to 2009. Day sales outstanding dropped to 61 days from 63 in the prior quarter (ph). The inventory turns were 5.9 times versus 6.2 in the third quarter. At the end of the fourth quarter, inventory in terms of dollars was at $128 million, comparing with $127 million at the end of 3Q, and down $49 million from $177 million at the end of 2008.

During the quarter we purchased 3.4 million shares of our stock at a cost of about $21 million. Looking at the full year, we purchased 13 million shares of our common stock at a cost of $83 million. The actual number of shares outstanding at quarter’s end was about $384 million. A headcount at the end of the quarter stood at 3,300, which reflects the addition of about 100 employees from WiChorus. As Rob mentioned, book-to-bill for the quarter was above 1.

Looking at the full year that just passed, the 2009 total revenue reflecting industry conditions and the decisions we made in early 2008 to reduce investment in unprofitable businesses was $1.5 billion, compared with $1.7 billion in 2008. Non-GAAP gross margin for the full year was $43.9. That is up 5.4 points from 2008 on improved product mix and profitability improvements. Total non-GAAP operating expenses came in at $517 million. That is $39 million less than 2008, and better than the $520 million target we set for ourselves in the beginning of 2008.

So, on revenue that was done 12% in 2009 we delivered $152 million in non-GAAP operating income, which represents a 39% improvement, compared with $109 million in 2008. And on a full year basis, cash (inaudible) was strong at $234 million.

Turning to our outlook for the first quarter of this year, based on our orders in 4Q backlog and given the overall market conditions, we are guiding for first quarter revenue to be about $370 million, plus or minus 2%. Near term we expect gross margins in the first quarter to be up from 45.5% in the fourth quarter to 48.5%, plus or minus a point or two, depending again on product mix. This improvement is being driven from an anticipated favorable product mix in Q1.

Looking further out, we have more uncertainty, but we expect full year 2010 gross margins to be up over 2009 in the mid-forties range, depending again on product and customer mix. We expect non-GAAP operating expense for the first quarter to be in the low $130 million range, which includes expenses related from the WiChorus acquisition. In addition, we expect the affective expensing equity-based compensation in the first quarter will be about $5 million, split between operating expense and cost of goods sold.

For the recap, we made good progress in the fourth quarter and throughout 2009. We made significant improvements to gross margins, operating expenses, and operating income. We expanded our presence in the mobile Internet market. We continued to generate cash and return some of that capital to our shareholders via stock buyback, and we are confident enough in the business to initiate our first cash dividend. Having said all that, we will open the floor to your questions. Tania, we are ready for the first question.

Question-and-Answer Session

Operator

(Operator's Instructions) You're first question comes from Alex Henderson.

Alex Henderson - Miller Tabak

Hey, guys. So you announced a small restructuring here, 2009 people. You didn't talk at all about the cost savings from it so I guess there's two questions. One is, excluding reinvestment of it, what is the dollar value of the savings and then the obvious second question is do you reinvest most of that, hence the lack of guidance on the benefit?

Timothy Wiggins

Sure. Alex, let me take that. We also issued this morning an 8-K that has some of the details on the restructure so let me give them to you. We expect to record pretax charges in the first quarter of 2010 in the range of $11-$14 million that would be $9-$11 million for workforce reduction and what you mentioned approximately 200 employees and $2-$3 million for facility related charges. We estimate cash payments under this plan to be in the range of $9-$11 million beginning in the first quarter of 2010. I think really what's fundamentally difference from this restructure from others is as Rob mentioned, we expect to end the year with more employees than we start so we have an estimated savings from this action, but we expect to reinvest it. We do expect to see our OpEx above our 2009 levels as a result of the reinvestment in the WiChorus acquisition.

Robert Pullen

And Alex, I would also add we're seeing opportunities for investment not only in the SmartCore platform with the WiChorus acquisition, but also on our sales and distribution channel for our international regions as well as our government channel. And so we'll evaluate that as we proceed throughout the year, but right now our intent is to hire back slightly more than we are proposing to restructure here.

Alex Henderson - Miller Tabak

I'm sorry, but for purposes of those who keep track of this type of stuff, can you at least give us an estimate of what the savings is and what the reinvestment therefore is?

Timothy Wiggins

Yeah. So it's around $20 million of savings on an annual basis so that would be the level of the reinvestment plus some additional.

Alex Henderson - Miller Tabak

And the timing of completion is the end of the second quarter, did I catch that correct?

Timothy Wiggins

No. These will impact employers through the first quarter of 2011, five quarter.

Alex Henderson - Miller Tabak

Oh, five quarters?

Timothy Wiggins

Yes.

Alex Henderson - Miller Tabak

Great thank you.

Operator

Your next question comes from the line of Jim Suva.

Jason Gersky - Unidentified Company

Hey, it's Jason Gersky (ph) stepping in for Jim. Just maybe a bigger picture question, if you could talk a little bit about what your plans are for the legacy business, kind of meaning what you're going to do going forward allocating R&D, things like that, and what your gross margins and operating profits are in the legacy business versus the growth businesses?

Robert Pullen

Okay. So first of all, as we shared with all of you for some time, we've shifted our research and development dollars to our growth products where roughly 80% of our research and development is going toward our growth products. Currently we're investing about 17% as a percent of sales.

As for gross margins, our gross margins on our core products are higher than corporate average margins, but our growth products mainly in the data area are also in that category of higher than corporate average martins. Our optical networking (inaudible) while the growth product is below corporate average margins, but as both Tim and I said, we're improving our margins in the 7100 space quarter over quarter in at least eight of the past 11 quarters.

Jason Gersky - Unidentified Company

Great. And then just a quick followup question, do you have a sense of what percentage of your sales go into LTE at this point?

Robert Pullen

Oh, the question was long term evolution, what percent of our sales. We don't actually have a breakout, but it's a modest amount, but we are in trials now in three different customers for long-term evolution. The customers are currently using our Ethernet and IP backhaul products for long-term volition. Now at the same time we are in the mobile packet core space, we're already in the 4G WiMax being deployed in live traffic with our SmartCore 9000 product family. We anticipate that one of our strategies is that we'll evolve the WiMax not only into 3G, which is also now one of our current trials of the Tier 1 is a GGSN, but we're also evolving the mobile packet core into 4G LTE as well. Again, 4G is both WiMax and long-term evolution.

On the next cover of the Inspire magazine we're going to focus on one of our top customers and the long-term evolution trials that we're in, but all of our strategy is go participate in 3G today with our purpose-built 4G technology and migrate into both WiMax 4G as well as long-term evolution.

Jason Gersky - Unidentified Company

Great, thank you.

Operator

Our next question comes from Mr. Ehud Jablaum (ph).

Ehud Jablaum - Unidentified Company

Hi, guys. Good morning, thanks. A couple of questions basically on the gross margin progression and Tim, you gave a nice breakdown a little bit about the 7100, I think you said it contributed 100 basis points to total gross margin this quarter?

Timothy Wiggins

About a point, yeah.

Ehud Jablaum - Unidentified Company

Should we assume that the higher 5500 contributed another 100 and then you mentioned something else that may have, maybe it's the lower access contributing to the other 100. Is that basically how we get to 300 basis points?

Timothy Wiggins

Let me go back, Ehud. There were two points related to lower level of revenue from the single family ONTs, a little more than a point from improved profitability on our 7100, and then the balance was from the 5500.

Robert Pullen

And what I would also say, Tim, that our data mix in the quarter, helped us out as well.

Timothy Wiggins

It's in the noise. I mean we're trying to give you the high points here, Ehud. There are certainly other moving pieces here.

Ehud Jablaum - Unidentified Company

Right. And then as you look at next quarter and what happens, revenue is clearly down, but are you getting actual WiChorus revenue next quarter? I think the original numbers you were talking about in terms of shipments when you bought WiChorus were in the order of mid-20s, $24-$26 million. Did any of that turn into actual revenue in Q1 and is that helping boost the gross margin? Can you just help us bridge the gross margin from 45 to 58?

Timothy Wiggins

Sure, yeah. We think early in 2010 WiChorus shipments should remain strong. Revenue is probably going to be more towards the back half as we work through some (inaudible) issues for them.

Robert Pullen

But our revenue forecast is still consistent with what we've shared with you in the past.

Timothy Wiggins

Exactly. So if you want to take a — how do we go from the 4Q margins 45.5 to the guidance levels that we were talking about —

Ehud Jablaum - Unidentified Company

Right. So I imagine you lose some of the 5500 in Q1.

Timothy Wiggins

5500, Q1's usually a good quarter for us. What we're really seeing is we expect even lower ONTs in Q1. We expect improved data and a little less 7100 compared to 4Q so those are really the key drivers that explain how we move from where we are to that improved 3% improvement sequentially.

Robert Pullen

And, Tim, I would also add for Ehud's and others benefit that while revenue is forecasted to be down in the first quarter, that's typical with seasonality, and furthermore we expect it to be up slightly over the first quarter of 2009.

Ehud Jablaum - Unidentified Company

Absolutely. So it's stronger than seasonal, that was my next question. What are you basing that on when you look at what carriers are telling you? Is there sort of a pent up demand that's coming back after weak spending in 2009? What's the genesis, do you think? Do you think you're gaining share? What's the genesis of the better than seasonal decline in Q1?

Robert Pullen

Well, first Ehud I'd answer your question when we talk to customers around the world, CapEx in general is flat to slightly up. Next, it's probably customers are telling us that wireline will likely be down in CapEx year over year, but the investment in mobility and delivering business services to enterprises will be up in investment, and that's actually where our sweet spot is. Over the past couple of years we've refocused the company and said let's go invest in mobility, mobile backhaul was my mantra to date and now we're extending that to be a broader sense of the mobile Internet with our recent merger and acquisition with WiChorus, and we're focused on optical networking and business services delivery.

Those are expected to be growing at greater than the CapEx spend, and in short we're gaining share.

Ehud Jablaum - Unidentified Company

Okay, then last two questions; one is 10% customers and the final was the decision internally to go with a dividend versus a larger buyback, can you just give us some insight as to what the discussion was between those two?

Robert Pullen

First of all for the 10% customers we had two. Second of all, as a dividend, as you know we've spent over $800 million — well, roughly $900 million since 2005 on repurchases and we knew that was the right thing to do. At the same time we believe that dividends are a good way to return capital to our shareholders in addition to that, and we're confident that we can generate sufficient cash from operations to invest in the growth of our business organically and inorganically, continue to share buyback shares, and to pay a dividend to shareholders.

We're confident in our financial strength. We're strong on a balance sheet and we're generating a fair amount of cash that we can do all the above and try and reward our shareholders.

Ehud Jablaum - Unidentified Company

I know you had two 10% customers, can you tell us how big those two were?

Robert Pullen

We haven't given out that information for competitive reasons —

Timothy Wiggins

It will be in the 10-K later released.

Ehud Jablaum - Unidentified Company

Okay. Thanks, guys.

Operator

Your next question comes from the line of Michael Genovese.

Michael Genovese - Soleil Securities

Great, thanks a lot. I want to take the gross margin question beyond the first quarter. I mean, your statements sort of implied that possibly the first quarter could be a peak and if that is the case and you’re saying the full year would be mid-40s, why would that be? Are you expecting an up tick in the ONT revenues later in the year and also just generally speaking, how should we think about the access business? Is that a business that should be in decline towards zero or do you expect some kind of recovery in the access business?

Thomas Scottino

Sure, good question. We certainly were delighted to outperform our margins in 4Q and when we saw the very favorable product mix in Q1, that certainly was nice to see as well. The thing that we wanted to make sure folks didn't do is take that margin guidance and then roll it out for the full year. We're seeing a very favorable product mix that has, in Q1 particularly, very low ONTs, our normal positive corners for our 5500. So what I think you need to say rather than peaking, I think what you need to think about is we don't know how the rest of the year is going to come out for sure. We're continuing to work on things like the mix. We're also working on cost reductions and other efficiencies, but based on what we know today we thought it would be unfair to our investors to say that we expect to be able to maintain these margins throughout the year.

So we're not sure. If you'd ask me what my margin was going to be in Q1 and then I was out on the street in early December, I would never have forecasted or thought we were going to roll out to 48.5. So it's a function of what our mix is, what our customers are doing, what's happening — so your question about ONTs, yes we expect to see ONTs to pick up later in the year and it would certainly impact our mix. And yes ONTs we expect to be a declining business.

Robert Pullen

On the other hand, I would add, Michael, that don't assume that access goes to zero for a couple of reasons. One is that we expect the stimulus funding to give us some tailwinds here. As I've shared with all of you as we keep close to our customers and what's going on with the US government I thought it was going to be a slow rollout. It's a little bit slower than we thought, but we do expect some tailwinds for support there and we're also seeing an up tick in opportunities for optical enterprise business, i.e. fiber to the desktop for high speed land connection as well as reduced power and increased revenue opportunities. So I wouldn't assume that that goes to zero.

Michael Genovese - Soleil Securities

Okay, thanks. And when Tim talks about ONTs possibly picking up later in the year, would that be from a customer like Verizon or are there other customers there that we should think about perhaps stimulus related? And then finally, speaking of customers like Verizon and others, are you seeing a pickup in RSPs both in the metro and the core asking for converged data plus optical solutions and how do you think Tellabs is positioned to compete in this packet optical space having the optical plus the data platform?

Robert Pullen

Sure. Well first of all, with respect to ONTs, Michael, we expect it from Verizon and others. We have a broader base. And there's a seasonality part of the ONT business where if you're building fiber home node or curb, you’re doing it in the spring through fall months, not during the dead of winter so that's kind of some insight there on seasonality.

That's for the mobile packet, but for the packet core for metro and for the core, there's no question we're innovators and integrating the Ethernet over optical layer, we're sealing the 7100 all over the world and furthermore we’re doing a unique thing which is we're cannibalizing router ports. We're saving 50% of CapEx on router ports for customers doing low-speed layer two or Ethernet aggregation in the optical layer. It's a trend we continue to see around the world that adds a lot of value and with the increased public and private IP networking including virtual private networks, we believe that that low speed Ethernet aggregation over the optical layer is going to be a winner over time and so there's no question we see that convergence and we're starting to see it around the world.

Michael Genovese - Soleil Securities

Great, thanks a lot. Also, congratulations on the strong quarter and the strong guidance.

Operator

Your next question comes from the line of Tal Leoni (ph).

Vivek Arya - Bank of America

Thanks. Good morning. It's Vivek in for Tal.. Rob, I just wanted to dig deeper into the legacy products. Sales were down 26% in 2009, what's your baseline expectation for legacy product declines in 2010 if you could help us quantify that it would be very helpful.

Robert Pullen

We don't give the specific guidance for competitive reasons on the decline and it's going to be based on quarter by quarter. We expect that the core products will have a long tail in their lifecycle. Things don't change that quickly in our industry. In fact, even the 5500 here in 4Q of '09 was up slightly over 3Q of '09 (inaudible) for mobile backhaul.

Thomas Scottino

Let me add Vick, a couple of thoughts. One is that we're starting off the year on a solid footing. We're starting off the year providing guidance that shows growth, and that's a change in some of the trends you've seen from us over the last three years. We'll see how the rest of the year plays out, we're not sure, but we also entered the year with expectations of our growth portfolio, which we've articulated, will grow in the mid-25% range or higher. So if we can produce that and they maintain the decline of our core products below that rate given their both about 50-50, we produce overall growth which we'd certainly like to see. So the good news is we're starting off with guidance that suggests growth, we don't have great visibility through the full year, we do feel very confident that our growth portfolio will continue to outperform and where the core business comes out we're not exactly sure at this point.

Vivek Arya - Bank of America

Okay, very helpful. In broadband data, how's the competitive situation? Do you think you are growing with the market or you're taking shares, and if yes, who are you taking share from?

Robert Pullen

Well, Viveck, it's highly competitive. We compete all over the world day by day, but there's no question we're winning share. We're growing at 52% year over year in the IP and Ethernet product space. Our strategy's paying off. You can compare it to all the different market research firms, but there's no question we're taking share.

Vivek Arya - Bank of America

Got it. And then just one final question, how should we think of OpEx in 2010? You mentioned that it would be up, but for the full year is it up 1%, 2%, 5%, any quantification would be very helpful, thank you.

Timothy Wiggins

Sure. A couple of data points, one, certainly the key driver here for OpEx increase for 2010 is going to come around the investments we're making with the WiChorus team. And so we tried to give you a couple of data points, one is that there's around 100 employees today. In 4Q their spend was $1.1 million. We're talking about almost quadrupling their shipments based on the guidance we've given you with the time of the acquisition. They're on track to do that or better so what it'll require is a significant ramp in headcount. So as we talk about ending the year with more headcount at Tellabs than we start the year, a lot of that will go to the WiChorus team because we're really excited about the opportunities in the WiMax and the 3G and the LTE markets for their products.

So the Tellabs proper if you will, without WiChorus, we expect OpEx will be down for the year and then we'd add a ramping expense from the WiChorus team in our investment in those product lines. So at this point that's how we're comfortable since we don't provide full-year guidance, but expect we'll continue to ramp the expense at WiChorus above that $1.1 million fairly quickly as we look to support this quadrupling of shipments at least in this planned year.

Vivek Arya - Bank of America

But then is this mid-130, the low-130s, is that sort of the baseline that we should think about and then it probably grows slightly from there?

Timothy Wiggins

Yes, that's probably a good way to think about it.

Vivek Arya - Bank of America

Okay. Thanks a good luck.

Operator

Your next question is from the line of Simon Leopold.

Simon Leopold - Morgan, Keegan & Co.

Good morning, thanks. A couple of quick ones and then a thematic, first, just following up on some of the discussion about the operating expenses, it sounds like a great investment in R&D, but I'm sure it requires a little bit of additional sales and marketing expense. Just wondering how we should think about the split of your expenses in terms of at least the increase?

Timothy Wiggins

You're exactly right. We're asking most of our support functions to decrease our expenses and to become more productive, more efficient, but we did make a decision to invest more in R&D and more in the sales and marketing areas so certainly the R&D increased expenses would be around our growth portfolio, the most significant increase coming in the WiChorus portfolio. In the sales and marketing area we're trying or we're really investing in growth markets, so geographies outside the US, channel partnerships, and relationships there. So you're exactly right on where we're making those investments.

Simon Leopold - Morgan, Keegan & Co.

So would it be fair to assume that a higher proportion of the increase shows up in R&D than sales and marketing?

Timothy Wiggins

I have to look. Unfortunately I didn't bring that down with me so when you call back I can give you some insight.

Simon Leopold - Morgan, Keegan & Co.

Okay. And then just on the 7100 platform it sounds like trend wise you talked about some improvements on the 5500 which might imply a little bit of a sequential decline from the 7100, if you could tell me if that's correct?

Timothy Wiggins

We do expecting Q1 to have a small decline and that's one of the things we expect will help us on our revenue. It's just more of a seasonal thing with customers. We do expect to grow the 7100 business in 2010 over 2009.

Robert Pullen

And Simon I would also add that for the 7100 we recognize we had our first revenue recognized from a customer in Latin America, Brazil, and India, in the fourth quarter. And we had our first booking, so new customers both in North America and Malaysia.

Simon Leopold - Morgan, Keegan & Co.

Well okay, but the Q4 number compared to Q3?

Timothy Wiggins

It was about flat.

Simon Leopold - Morgan, Keegan & Co.

Okay. And them more of a — and I know this is a hard one to answer so really best effort would be great, but in terms of your exposure to mobility, I know in the past you've been able to break out the 5500 sales into mobile carriers, and I’d like to step back and look at your total portfolio, particular with the data products selling it to mobile. A good way to estimate your exposure to mobile currently and how that looks for 2010, even a range of what percent of revenue might come from that market?

Robert Pullen

First of all, Simon, great question, difficult to answer in all candor. We know for sure it's increasing at far greater than the CapEx rate of the overall industry. On a just linear simple thinking, we're over 40% in our wireless exposure, but it's hard to articulate that. For example, you have a company like Telesure in Australia where they're changing out all their frame relay and ATM network for business services for dominantly their business customers or enterprise customers. But now they're using the system for mobile backhaul, for Ethernet connections beyond just the Ethernet IPBPNs and ATM service that are being performed on the 8800. And so it's not so simple, but at a minimum we probably are in the mid-40s exposure to wireless.

Simon Leopold - Morgan, Keegan & Co.

Great, thank you very much.

Operator

Your next question comes from Jeffrey Kvaal.

Jeffrey Kvaal - Barclays Capital

Yes, thanks very much. I was noticing that you tightened the guidance range a little bit on the revenues up plus or minus two versus plus or minus three. I'm wondering if that is tied to your overall visibility or what we should make of that?

Robert Pullen

Well, Jeff, it certainly is a small change, but having said that our book to bill is greater than one and with a little bit more visibility we believe that slightly tighter range was accurate, including the improvement on profitability quarter over quarter.

Jeffrey Kvaal - Barclays Capital

All right, perfect. Thank you very much.

Operator

Your next question comes from Andy Schopick.

Andy Schopick - Nutmeg Securities

Thank you. My questions have been answered so I will pass it along.

Operator

Your next question comes from Nicos (ph).

Jack Monty - UBS

Hi. This is Jack Monty in for Nicos. A couple of quick questions here, first on the international mix is it fair to say the best opportunities in 2010 for growth at Tellabs are internationally versus domestic? I guess I'm thinking that because there's a higher sales marketing presence investment that the company's making, but also I was curious if I could take that further and say where exactly, are there any regions that Tellabs feels more comfortable with than others, maybe Asia or the EU or Australia? Can you help us think about that?

Robert Pullen

Sure. Well, first of all don't discount North America. We exceeded our plan this year in North America. We saw some positive signs and it's still a very important region for us. I don't want to deemphasize that and so do not discount North America. In fact, we're seeing some signs of opportunities here as we speak including in our clear wire opportunities with the SmartCore 9000 family.

Next, we do see different participation in growth around the world. Asia and (inaudible) showed some signs of strength and we expect that to continue in 2010. Latin America and Brazil in particular was dramatically dampened in 2009 and we expect upside in 2010. Europe, the Middle East, and Africa, Western Europe and Eastern Europe in particular were down in 2009 and we expect them to have a slow recovery in 2010, but we do expect some positive contributions in the Middle East and also in Africa.

And so things are happening different around the world. We do expect some increase in China. We've had some success in 2009 in the mobile backhaul space and we expect that to continue here in 2010 as well.

Jack Monty - UBS

That was very helpful, thanks. And one other thing, if I think about enterprise, you guys previously mentioned the fiber to the desktop opportunities, I think even earlier in the year we were talking about longer lead times to penetrate some government accounts and some new government enterprise business, how should we think about that progressing into 2010 and can you help us think about how large that is as a percent of sales now?

Robert Pullen

Well first of all it's relatively small. Second of all we've made significant progress on our success in the US federal government and I expect that to continue in 2010. We just received certification testing approval from the Joint Interoperability Test Command Center, which you refer to as JITCC testing, and so we expect that to also be an enabler here in 2010.

Jack Monty - UBS

Thank you very much.

Operator

Your next question comes from the line of Todd Koffman.

Todd Koffman - Raymond James

Thank you. On the access business you made a comment that you thought the ONT business would pick back up, but then decline. If you step back and look at your access segment in total you said yeah it's not going to zero, but it's down pretty much. Where do you see that business moving the next few quarters?

Timothy Wiggins

We expect very low ONT activity. So we were down sequentially $30 million and from the third quarter to the fourth quarter in our access business and most of that came from the ONTs. So just imagine for a moment if that business was humming along, and certainly that business is directly related to consumer spend and housing starts and/or people moving between houses. So I think that business is softer in a number of markets than our customers would like to see.

So we're going to start the year with a fairly low level as our customers adjust to inventory and change some of their marketing. I think we expect that business to pick up as we get into the warmer times of the year and new marketing initiatives are out and inventories are adjusted. But having said that we'd still expect the ONT shipments to be down. They were about three-quarters of a million products shipped. They would be down again this year as the customer moves towards a different technology there and has been passed the majority of the homes.

So we still are very active in the access business and our other product lines. I think Rob's talked about some of those opportunities. So we'll continue to work on those. We've made great investments here, we have good customer relationships. We see some potential tailwinds coming from the government spend in that area. So we've got a couple of factors driving there, particularly the ONTs where it's been a big part of the access business. So we do expect the ONTs to pick up later in the year, but for the full year to be off on volume.

Todd Koffman - Raymond James

Okay, so that all said and that was a lot of things you mentioned, you're on a little bit over $200 million run rate for that business coming off this quarter. For the full year would you guess it's up or down off that run rate or it's impossible to tell?

Robert Pullen

We're not giving guidance on specific products. It's difficult to tell at this stage. You have the negative impact of some of our top customers finishing out some of their deployment and the positive impact of the stimulus funding and the optical enterprise business.

Todd Koffman - Raymond James

Thank you very much, good luck.

Operator

Your next question comes from the line of Brian Coyne.

Brian Coyne - Wedge Partners

Hey, guys. Thanks for taking my question and congrats on the quarter and the outlook. I just had a couple of questions first on the broadband data segment. I was wondering if you could talk a little bit about whether there was any revenue recognition or any lumpiness from something like that that came at all behind some of the strength you saw in the segment? Any color you could possibly give us on order trends and whether your really sort of are seeing a better tone from your customers that's sort of translating into I guess some of the better visibility that you've got for the upcoming quarter?

And then following on that, on the segment profit side its sounds like again, most of the change sequentially is due primarily to the addition of WiChorus. Is that right or was R&D up noticeably for the other products as well?

Timothy Wiggins

Okay, a couple of thoughts. One, we did not have any significant lumpiness from revenue recognition in the data products. We're delighted with the momentum of that product that it's showing us and we expect that that strength will continue. We mentioned that we saw strength in the third quarter in the North American wireless rollouts. We saw that continue into 4Q and we'd expect that that would continue into 2010 as this is an important product for our customers to deal with bandwidth management issues. What were some of the other questions?

Brian Coyne - Wedge Partners

Sure. I guess beyond that it was really about the change in the broadband segment profit. And again maybe I think you may have commented that it sounded like most of that change was supposed to be primarily due to WiChorus?

Timothy Wiggins

No. I think it has to do with — well, let me go back to my notes here.

Robert Pullen

It's really our 88 and 8600 product family in the broadband data segment driving profitability that's higher than corporate average margins. But also we only recognize a modest amount of December revenue for WiChorus, but it too will have higher than corporate average margins over time.

Brian Coyne - Wedge Partners

Right. I'm sorry, I'm speaking mostly about the segment profitability I mean, because of the decline it sounds like at least on a dollar basis it was WiChorus primarily, right?

Timothy Wiggins

I'm looking here, hang on. Why don't you give Tom a call back and I'll get you an answer to that.

Brian Coyne - Wedge Partners

Yeah, no problem. And then just finally, following up on the 7100, if you could just comment perhaps a little bit on customer wins, service provider wins, and maybe a little bit about the applications? I mean for instance, are you seeing more 40 gigs than in the last quarter? Do you sort of see 40 gig upgrades and then sells as an important business driver this year?

Robert Pullen

Well first of all, as I mentioned we continue to win market share and customers around the world. I think I've mentioned earlier that we recognized revenue from a company in Latin America, Brazil, in addition within Latin America, and India. We had our first bookings from a carrier in Malaysia and a new competitive service provider here in North America. As for the 40 gig yes, customers are starting to transition to 40 gig, but very few of our sales have been 40 gig at this stage. They've been in the metro and let me call it the regional long haul, which is where we participate. It's just starting to be deployed with 40 gigs so we haven't seen that upgrade cycle yet and we're hoping that that will be a 2010 phenomena. Actually we're counting on it.

Timothy Wiggins

Just back to you on the question about the segment profit, it was not WiChorus although that contributed. It was from our 8600 product and our 8100 product and the 9000 SmartCore products being the smaller piece.

Thomas Scottino

We'll take one more question.

Operator

Okay. Your final question comes from Shendin Sarkar (ph).

Shendin Sarkar - Unidentified Company

I feel like I just made. Rob, you mentioned in your comments earlier in response to a previous question that you thought that a lot of the uptick in 5500 sales might be related to wireless backhaul, and I'm just wondering if that's the case do you see that as sort of a one or two quarter phenomenon or as something that might last throughout the year?

Robert Pullen

Well, it's hard to tell, Shendin. For sure we've seen seasonality in our 5500 business throughout its lifecycle where we see an uptick in both 4Q and 1Q and it's where wireless companies spend their budgets. At the same time we know there's a shift to run an optical and Ethernet out to cell sites and of course we're participating in that phenomenon, one of the market share leaders there. But it's hard to tell, Shendin. We know for sure there's carriers out in the world that have severe bandwidth limitations between their cell sites and the mobile switching center and they don't have optics or Ethernet out there today so they're buying E1s and T1s and that's helping the 5500 extend its long tail. And so it's unclear, but for sure we see an uptick in both 4Q and 1Q based on normal seasonality.

Shendin Sarkar - Unidentified Company

Thank you.

Robert Pullen

Let me thank all of you for your participation. As you know we believe we've had a strong 2009 notwithstanding the tough economic environment. We're well poised here in 2010. We're seeing some cautiously optimistic signs. We think that it's too early to predict a big recovery in the industry, but we know that we're getting our fair share and we continue to transform Tellabs, integrate the WiChorus acquisition, and continue to help our customers succeed and help our company succeed. Thank a lot for all your questions and your time and we'll talk to you soon.

Operator

That concludes today's conference call. You may now disconnect.

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Source: Tellabs Q4 2009 Earnings Call Transcript
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