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Tellabs (NASDAQ:TLAB)

Q4 2010 Earnings Call

January 25, 2011 8:30 am ET

Executives

Tom Scottino -

Robert Pullen - Chief Executive Officer, President and Director

Timothy Wiggins - Chief Financial Officer and Executive Vice President

Analysts

Nikos Theodosopoulos - UBS Investment Bank

Blair King - Avondale Partners, LLC

Thomas Lee - Goldman Sachs

Joseph Longobardi

Rod Hall - JP Morgan Chase & Co

Jeffrey Kvaal - Barclays Capital

Ehud Gelblum - Morgan Stanley

Simon Leopold - Morgan Keegan & Company, Inc.

Alex Henderson - Miller Tabak & Co., LLC

Michael Genovese - Citigroup

Operator

Good morning, my name is Susan and I will be your conference operator today. At this time, I would like to welcome everyone to the Tellabs' Investor Relations Conference Call. [Operator Instructions] Mr. Tom Scottino, you may begin your conference.

Tom Scottino

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

Before we begin, I'd like 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 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 this presentation is reviewed after the time and date of its 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 may also include non-GAAP financial measures. Reconciliations between non-GAAP financial measures and GAAP financial measures can be found at our tellabs.com website and in our SEC filings. Thank you.

Robert Pullen

Thanks, Tom, and good morning, everyone. The fourth quarter brought revenue growth, but a setback in profitability. Our fourth quarter of 2010 revenue was $410 million, up 5% compared with the fourth quarter of 2009. Our revenue for growth products was strong at 56% for this quarter as compared with 48% in the fourth quarter of 2009.

Our fourth quarter 2010 data of revenue rose 8% by comparison with the third quarter of 2010 and 33% compared with the fourth quarter of 2009. Data revenue for multiple international carriers more than offset weaknesses in North America. In fact, our international mobile data reached an all-time high in the fourth quarter of 2010. On a GAAP basis, we lost $11 million or $0.03 per share in the fourth quarter. On a non-GAAP basis, we earned $0.02 per share.

Fourth quarter, in the revenue, was within our guidance range. But we wanted to share with you also some modifications we've had. We have early adopted two required revenue recognition rules to better reflect the economics of our multi-year deals that we've already entered into. And that increased our revenue about $9 million. Our fourth quarter revenue also reflected our agreement with the North American customers to add our data products to other products already sold to this customer through distributor. This change decreased our revenue by about $21 million. Fourth quarter international revenue was 41% of our overall revenue. That was up from 31% in the third quarter. This is a positive trend as we diversify our global customer base.

Our fourth quarter GAAP gross margin was 38%. This includes a pretax charge of $16.5 million related to a canceled tender in India. Excluding this charge, our gross margin would have been 42%, within the guidance range that we gave you. Tim will give you more detail on this charge in a moment.

Looking to our guidance for the third quarter, we expect revenue to be in the range of $315 million to $335 million. We expect non-GAAP gross margin to be 40%, plus or minus two points, again depending on product mix.

We expect non-GAAP operating expenses to be slightly down and probably in the high 140s. Obviously, we're disappointed in our fourth quarter results and our guidance for the first quarter. After three quarters of strong performance in 2010, we certainly didn't want to end the year this way.

During the first three quarters of last year, our revenue and profits were driven by growth in Digital Cross-Connect and our data products, dominantly for Mobile Backhaul and primarily in North America. In the fourth quarter, our Digital Cross-Connect and data revenue in North America declined. As a result, our revenue declined sequentially in fourth quarter and will decline again in the first quarter. That's the outlook as we see it today, and we'll certainly work hard to improve it.

Despite lower revenue in North America, our fourth quarter data revenue grew, both sequentially and on a year-over-year basis. We won 21 new customers for our data products and generated higher revenue from our SmartCore platform. It was all positive signs in the fourth quarter. The increase investment we've made in sales and services resources outside of North America since 2008 is delivering new customers. Last year in 2010, we won 87 new customers for our growth products.

Customers continued to embrace Tellabs growth products during the fourth quarter. The Tellabs 8600 and 8800 systems gained 15 new customers during the fourth quarter, two in North America and 13 in international markets. The Tellabs 9100 SmartCore platform gained six new customers in the fourth quarter, two in North America and four in international markets. The Tellabs 7100 Optical Transport System gained four new international customers during the fourth quarter.

But today, given the level of competition in the international markets, some of this new business comes at initially lower margins than certainly our more established business, and you can see that in our fourth quarter results and our first quarter guidance.

Now turning to Tellabs' annual results. We achieved our goal of profitable growth in 2010. 2010 revenue was $1.642 billion, up 8% from 2009. Revenue rose in all of our segments, the Transport, Broadband and Services.

In 2010, we won 87 new customers for Tellabs growth products, including 26 new customers in Optical, 48 new customers in Mobile Backhaul and 13 customers in Mobile Packet Core. Our balance sheet is strong with about $1.15 billion in cash and cash equivalents and no debt.

We believe we are positioned with the right customers, resources and solutions to make this transition. Over the past three years, we've made significant progress on Tellabs goal of profitable growth. And as most of you know, we had a transition from two and half to three years ago.

Our non-GAAP gross margin rose from 35.5% in 2007, to 48.3% in 2010. Non-GAAP net earnings increased 69% from $104 million in 2007, to $176 million in 2010. Non-GAAP net earnings per share grew from $0.24 in 2007, to $0.46 in 2010. Our growth products revenue increased from 25% of overall revenue in 2007, to 56% in 2010. And we continue to return capital to our shareholders through both share repurchases and dividends.

When we look at our overall markets, we've strengthened the business by expanding geographically and gaining new customers. We told you all that we had emphasis in the brick countries and South Africa, Brazil, Russia, India, China and South Africa. We expanded our business in Brazil and now do business with five of the top five service providers there. We've gained new customers in Russia and now do business with two of the top three wireless providers. We've expanded our sales presence in India, and now serve seven of the top 12 service providers there. We've expanded our business in South Africa and now serve three of the top four customers there. We serve two of the top three service providers in China. Also, about 18% of Tellabs research and development employees are now in China. We've also won new SmartCore business in China, and we're building on that promising start. In these five countries, Brazil, Russia, India, China and South Africa, Tellabs' 2010 bookings increased by approximately 53%.

In December of 2009, we acquired the SmartCore 9100 platform. Since then, we focused the company on evolving from Mobile Backhaul to advancing to smart mobile Internet. So where's Tellabs today? We are managing a core business in secular decline. That's also as we nurture the growth of new and more global business. A key challenge since I took this job has been to replace our core product revenue with new growth product revenue and diversify our customers. We're making progress here. With our solid balance sheet, we have resources that we need to manage successfully through this transition, but we will manage through the transition. We could be solidly profitable today if we have reduced our investment in growth technology and growth markets, but that's not the right thing to do for the long term. I believe that creating shareholder value is all about building a bright future for the business. Sometimes it takes longer than we like. But I'm confident we're in the right path. We will stick with our strategy to invest in key technologies and markets. We'll also exercise continued discipline to drive down our expenses in other areas of the business. We'll do what's right for our shareholders, our people and our customers. And that's what we believe in.

Looking ahead, we feel that mobile Internet presents new challenges to our customers and challenges that Tellabs is uniquely positioned to solve. Let me tell you about this once-in-a-generation opportunity we're pursuing. The age of the smart mobile Internet is only beginning. In our addressable markets, we see compound annual growth rates that are about in the mid-teens of growth. Let me highlight four points to you. First, the mobile Internet represents one of the biggest growth opportunities in telecom history. Starting with a half a billion wireless devices today that are connected to the Internet, we see a 20-fold increase to more than 10 billion wireless devices over the next decade, that's both people to people and machine to machine.

Second, mobile data traffic is growing explosively. Over the last three years, our customers mobile data traffic has grown 10 to 40x. Over the next few years, we see 40x growth in that mobile data. Third, this opportunity is still in its very early stages. There's less than 10% smartphone penetration worldwide. And each smartphone generate six to 10x more data traffic than a regular mobile phone. The application flood gate is opening wide, causing further increases in mobile data. And over the top video is another major catalyst for mobile data traffic growth. Four, right now, we're into a new technology cycle and it's starting with Long Term Evolution. To meet these demand, it will take more than adding capacity. It will take adding intelligence networks to make them aware of both applications and users. We've been investing and will continue to invest to advance the smart mobile Internet.

In 2011, we plan to increase Tellabs research and development investment in our growth products, just as we did in 2010. We will evolve our current platforms and launch new platforms. We'll evolve our current platforms with higher density, higher speed and lower cost Ethernet. We'll launch new optical networking platforms such as our Optical Transport node. We'll offer next-generation Mobile Backhaul platforms both for access and aggregation. And we'll deliver on our promise of a combined WiMAX, 3G and Long Term Evolution packet core. All this will be managed by our 8,000 intelligent network managers.

We're building and are growing global business with more than 160 Mobile Backhaul customers. We have now 18 Mobile Packet Core customers and more than 175 Optical customers. Throughout this year, we're going to introduce new solutions, such as Smart Backhaul to improve the quality of service and the quality of user experiences. We're going to deliver the content-aware packet core to deliver personalized services and smart analytics to help our customers optimize and enable monetization of this content. Based on positive feedback from our customers, we're confident that our solutions address customers' needs, to help them succeed in this growing mobile Internet era. With this, I'll pass it over to Tim for a little bit more detail for financial discussion and then we'll answer any questions you have'

Timothy Wiggins

Thanks, Rob. Good morning, everyone. To begin, I'll give a little more background on some of the items affecting this quarter's results.

We had two items that positively affected our results in the fourth quarter and one item with a negative effect. All these items are described in the MD&A section of this morning's press release. But let me tell you about them now.

First, during the quarter, we adopted ASU No. 2009-13 and ASU No. 2009-14, the new revenue recognition standards for multi-deliverable contracts and contracts with software elements. Although we have planned to adopt these standards in the first quarter of 2011, we did it last year because we are entering into several large multi-year contracts, and we believe the new rules would best reflect the economics of those deals over time.

As a result, revenue and net earnings in the fourth quarter of 2010 increased by $8.8 million and $0.5 million, respectively. For the year 2010, revenue and net earnings increased by $9.1 million and $0.5 million respectively. We adopted these standards as of the beginning of 2010, and our previously reported quarterly results have been revised to reflect the impact of the adoption.

Second, revenue in the quarter also reflected our agreement with a North American customer to add a data product to other Tellabs products already sold to that customer through a distributor. This way of doing business helps the customer better manage inventory and deployment schedules. As a result, we recognized $20.8 million in revenue in the fourth quarter of 2010, that otherwise, would have been recognized in the first quarter of 2011.

And now for the third item, during the quarter, we took a pretax charge of $16.5 million, that's $12.2 million net of tax for excess purchase commitments related to a number of Tellabs specific components we ordered last year for a large project in India. The tender was canceled in January, and we are writing down the parts we estimate to be in excess of our needs.

Let's take a look at the fourth quarter numbers. After that, I'll review our guidance for the first quarter of 2011. Total revenue for the fourth quarter of 2010 was $410 million compared with $430 million in the prior quarter and at the low end of the guidance range we gave you in October. On a year-over-year basis, total revenue for the quarter was up 5% compared with the fourth quarter of last year.

On a sequential basis, Broadband segment revenue grew, the Service segment was essentially flat and Transport segment revenue declined. Looking at the Broadband segment, we saw sequential growth in all three product categories, data, access and managed access. Within Transport, the vast majority of the decline came from lower Digital Cross-Connect revenue. Optical transport revenue was down slightly compared with the prior quarter.

GAAP net loss for the quarter, driven primarily by a sequentially lower revenue and gross margin and higher operating expenses was $11 million or $0.03 a share. On a non-GAAP basis, net earnings for the fourth quarter of 2010, excluding charges for special items, were $6 million or $0.02 a share.

If you take $6 million in non-GAAP net earnings and subtract $4.3 million or $1.2 a share for equity base comp, by the way that's net of tax, to be consistent with the way first call Reuters compiles and reports the estimates for Tellabs, the result rounds to break-even non-GAAP EPS for the fourth quarter.

On a portfolio basis, revenue from our growth portfolio accounted for 56% of total revenue in the fourth quarter, up from 52% in the prior quarter. On a geographic basis, revenue from customers outside North America grew to account for 41% of total revenue in the fourth quarter, up from 31% in the prior quarter.

Let's take a look at segment data for the fourth quarter. Broadband segment revenue for the fourth quarter of 2010 was $227 million, up 14% from $199 million in the prior quarter. Revenue from the data product category grew to $120 million in the fourth quarter of 2010, up 8% from $111 million in the prior quarter. Growth came from international customers in the EMEA region and higher revenue from our SmartCore platform.

Looking at the full-year of 2010, data continues to be our fastest growing product category. Data revenue grew 52% to $520 million in 2010, compared with 2009. Access revenue grew to $70 million in the fourth quarter, up 20% from $58 million in the prior quarter, sequential growth in this product category was driven largely by an anticipated increase in single-family ONTs.

Turning to Managed Access, revenue in the fourth quarter of 2010 grew to $37 million, up 24% from the prior quarter. We saw increased revenue from both our Tellabs 8100 Managed Access System and the Tellabs 6300 Managed Transport System. Taking all that into account, Broadband segment profits for the fourth quarter of 2010 was $34 million compared with $49 million in the prior quarter, reflecting the $16.5 million charge for excess purchase commitments.

Transport segment revenue was $123 million in the fourth quarter of 2010, compared with $170 million in the prior quarter, driven primarily by an anticipated drop in Digital Cross-Connect system revenue and a small drop in optical transport revenue. Transport segment profit was $24 million in the fourth quarter compared with $71 million in the prior quarter, driven primarily by the lower level of Digital Cross-Connect and Optical Transport System revenue.

Service segment revenue was $60 million in the fourth quarter, consistent with the third quarter. Services segment profit was $18 million compared with $22 million in the third quarter of 2010, driven by a mix of lower margin service revenue in the quarter. On a gross margin basis, non-GAAP gross margin for the fourth quarter of 2010 was 38.2% compared with 50.5% in the prior quarter. Excluding the impact of the $16.5 million charge for excess purchase commitments, gross margin for the quarter would have been 42.2%. Gross margin is dependent on product and customer mix. The shift this quarter is attributable primarily to a number of moving pieces. When you compare the 38.2% with the 50.5% margin, these changes look as follows: about 6.5 points of the decline is related to the lower level of transport revenue, primarily Digital Cross-Connect systems, about four points is related to the purchase commitment charge I described a moment ago. About two points is related to higher international data revenue and lower services margin.

Turning to operating expenses. Total operating expenses on a non-GAAP basis came in at $151 million. Non-GAAP R&D expenses for the quarter grew to $81 million or 20% of revenue. SG&A expenses for the quarter were $70 million compared with $64 million in the prior quarter, as we saw higher spending for sales and marketing. Other income on a non-GAAP basis amounted to $3 million in the fourth quarter compared with $7 million in the prior quarter as a result of lower capital gains on sales and marketable securities.

Our tax provision on non-GAAP pretax earnings for the quarter was $3 million for an effective rate of 32%. Turning to the balance sheet. During the quarter, we generated $53 million of positive cash flow from operations. CapEx was $25 million for the quarter and $55 million for the full year. Day sales outstanding was 65 days compared with 63 days in the prior quarter. Inventory turned 5.9x compared with 5.8x at the end of the third quarter. At the end of the fourth quarter of 2010, inventory in terms of dollars was $162 million compared with $142 million at the end of the prior quarter. The increase in inventory is primarily related to lower-than-anticipated revenue in the fourth quarter.

During the quarter, we returned about $7 million to shareholders via our quarterly cash dividend. At the same time, we purchased 7.6 million shares of our stock at a cost of about $51 million. For the full year, we distributed $30 million to shareholders via quarterly dividends and we purchased 25 million shares at a cost of about $179 million.

At this time, we have 225 million remaining in our Board of Director authorization for stock buybacks. The actual number of shares outstanding at quarter's end was about 363 million down from 370 million at the end of 3Q. Headcount at the end of the quarter stood at approximately 3,400. Book-to-bill was below one for the quarter, and slightly above one for the year.

Turning to our outlook for the first quarter of this year, based on orders and 4Q backlog and given the overall market conditions, we're guiding for the first quarter revenue to be in the range between $315 million and $335 million. We expect gross margin on the lower level of first quarter revenue to be about 40%, plus or minus two points based on mix. We expect non-GAAP OpEx for the first quarter to be down slightly in the high $140 million range. In addition, we expect the effect of expensing equity base compensation in the first quarter will be about $7 million, split between operating expenses and cost of goods sold.

Having said that, we'll open the floor to your questions. Susan, we're ready for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos - UBS Investment Bank

On the $16.5 million charge, you might have said it, but what product category was that?

Timothy Wiggins

Managed Access, Nikos.

Robert Pullen

It was the 8100 in particular, Nikos. Let me give you some insight into that. We were awarded a bid on the 8100. But there's a fair amount of controversy in India about spectrum auction and it prompted our customer to cancel some awards including ours, but we're still trying to position to win that back, the demand for the service and the equipment. There was just more politics in the country, and we are toiling over that this weekend. And we thought that it's a matter of criteria to take that charge.

Nikos Theodosopoulos - UBS Investment Bank

So that flows through the Broadband profitability, not Transport, correct?

Timothy Wiggins

Right, correct.

Nikos Theodosopoulos - UBS Investment Bank

So I guess when I look at the first quarter guidance around the data products you had, even though the business was up a little bit here, the $20 million revenue recognition looked like it should have been in the first quarter of next year. So is that the big delta that we're looking at in the first quarter guidance in addition to Cross-Connect being soft? Is that your perspective on that? And can you provide a little bit more insight as to what surprised you here in terms of what this customer decided to do?

Timothy Wiggins

Well, Nikos, there's a couple of thoughts. One, we did not anticipate -- when we set the guidance and provided it to you in October, we did anticipate the change in this distribution arrangement with the customer. We did not anticipate, as we mentioned, change in the revenue recognition standards. But we did have a couple of very large contracts that we wanted to sign in 4Q. And we felt that the accounting under the new rules better reflected the economics.

Robert Pullen

As for the first quarter, Nikos, we expect Cross-Connect to decline and the 8800 to decline. And that's reflected within our guidance.

Nikos Theodosopoulos - UBS Investment Bank

Sequentially?

Robert Pullen

Yes.

Operator

Your next question comes from the line of Alex Henderson with Miller Tabak.

Alex Henderson - Miller Tabak & Co., LLC

So just coming back to this margin issue for clarification. So if I take the $16.5 million out of the COGS line, your operating margins are closer to the 42%. So can you give us a little bit of a sense of what goes into the guidance for the 1Q gross margins? And second, what you intend to do with that written-off inventory? Are you planning on holding on to it and potentially parsing it back in if you get that contract back? How should we think about those two issues?

Timothy Wiggins

Alex, it's Tim. Let me touch on the inventory charge. It's really an access purchase commitment. As you are aware, there's still very tight constraints in the supply chain. So when we won the technical requirements of the contract and the customer recommend awarding it, it had some fairly tight delivery dates. It was also a large order. So we placed orders that turns out that many of these items are unique to Tellabs and to our products. As Rob mentioned, we agonized over this, analyzed it carefully. Made a decision over the weekend that, at this point, we think the right answer is we're not certain that we're going to win the business and so we made the adjustment. We will maintain the inventory. Our hope is that the customer will come back and order the equipment. We have a long-standing relationship with this customer. We have a large install base of this equipment. The customers desperately needs to expand their capacity and this equipment is the right answer. So if in the end, we're not able to win that business back, we would look to stimulate demand elsewhere. But as of this weekend when we made the decision, we just didn't have a high enough level of certainty that we'd be able to consume this over the next couple of years and we made the charge.

Alex Henderson - Miller Tabak & Co., LLC

If I could, so you took the inventory or you didn't take the inventory?

Timothy Wiggins

Well, the inventory is in the supply chain. This is really us working into our supply chain saying, it will be here over the next couple of months. So the accounting is, it's in addition to what's on your books, you're also constantly evaluating what you've committed to in your supply chain.

Alex Henderson - Miller Tabak & Co., LLC

These are Optical components or Optical Systems related?

Timothy Wiggins

They're chips. DSL chip would be one of the large items here.

Robert Pullen

For the 8100 system. It's our manage asset system, which is a product in secular decline later in its life cycle. And Tim, I think the other point to Alex's question is that if and when we're able to recover this business, either with the customer or other existing customers, we would sell this at a pure profit after writing down that inventory.

Timothy Wiggins

If we're able to find a use for it, Alex, it would flow through with no cost.

Alex Henderson - Miller Tabak & Co., LLC

I assume you'll call that out?

Timothy Wiggins

Sure, if we do it.

Alex Henderson - Miller Tabak & Co., LLC

And then, finally, can you talk about the guidance on the gross margins of the pings and pongs for the upcoming quarter, since you're implying a decline of couple 100 basis points of these?

Timothy Wiggins

Yes. Great question, Alex. It's really now become a volume issue. So let me give you a couple of data points. If you looked at a pure mix of our products going from 4Q, let's ignore for a moment the inventory -- excess inventory charge. If you look at pure product mix, we pick up about of two points margin from 4Q to our forecasted 1Q just on products. But what we're seeing here , I guess, 1.8 to be precise. What we're seeing here is the negative impact of volume against our semi-variable cost of manufacturing largely. We've also been experiencing in the last couple of quarters favorable experience in our warranty claims based on the mix of our products. So the sum of, we think those favorable adjustments will diminish and we have a significantly lower volume. And when you spread that across the -- these semi-variable costs and manufacturing, it's a negative variance relative to our margin guidance. So we see positive mix in the products, negative absorption on those costs.

Alex Henderson - Miller Tabak & Co., LLC

So just onto the mix, just to clarify. No further declines sequentially in Cross-Connect implied given the mix improvement?

Timothy Wiggins

No, Rob did mention that we expect a sequential decline in Cross-Connect from 4Q to 1Q, but it's not enormous.

Operator

Your next question comes from the line of Michael Genovese with MKM Partners.

Michael Genovese - Citigroup

Just to clarify for me, you talked about this $21 million in revenues. It sounds like the recognition was pulled forward. But then the press release notes a $9 million difference in the quarter. What's the total impact from accounting change and other that impacted 4Q revenue positively?

Timothy Wiggins

Well, there are couple of items, Michael. One is that we adapted the new revenue recognition standards, which we did not contemplate when we gave the guidance. It was $8.8 million or call it $9 million. In 4Q, it had very little impact in Q periods, one, two and three, as you can see the difference between the $8.8 million and the $9.1 million. So revenue recognition was the first thing. The second thing was we had changed in how we sell to a customer in North America for a product. It's now included with other products that had been previously sold through the distributor. The net result was that those orders for us occurred in 4Q, otherwise, would have been in Q1. That was about $21 million. The sum of the two together are about $30 million.

Robert Pullen

And we -- as for the distributor, we had contemplated that when we gave the guidance, Michael. And as Tim mentioned, we are even doing business with this distributor to the end customer and the distributor helps the end customer both manage inventory, deployment schedule and gives them content and Minority and Women Business Enterprises and Disabled Veterans Enterprise, which curries favor for government contracts. So we had already been doing business with these distributors.

Michael Genovese - Citigroup

Now the first quarter revenue guidance at the midpoint, it looks like it's down about 15% year-over-year. I mean how should we think about the drivers as we move forward throughout the year? Specifically, if could you talk about broadband access as a potential growth driver for the year, what you're thinking about your Broadband business. But just secondly, I mean, this mid-teens growth rate of decline. Why shouldn't we flow through the model for the year? What could happen in the second quarter and the back half to get those revenue numbers up?

Timothy Wiggins

Well, first of all, we're not giving guidance for the full year. We're only for the first quarter. But if you look back on our past couple of years, Michael, our first quarter has been our lowest quarter for the year. That's the first thing. And broadband, right now, we do expect to be sequentially down from fourth quarter of 2010, to first quarter 2011.

Operator

Your next question comes from the line of Mark Sue with RBC Capital Markets.

Joseph Longobardi

This is Joe Longobardi on for Mark Sue. Can you guys give us additional color as it relates to overall customer concentration? Your two largest customers, AT&T and Verizon, still account for greater than 50% of revenue? And just on the international front, are you seeing concentrations develop there? Or is the revenue base a bit more dispersed?

Timothy Wiggins

It's Tim. Let me just touch on customer concentration. In 2009, we had two customers that represent 51% of our business and we disclosed that was Verizon at about 30% and AT&T at about 21%. For 2010, those two customers, the concentration increased slightly to 53%. But they flipped positions, AT&T is 35% of our business in 2010, and Verizon is 18%. But I would note in 4Q that the customer concentration was down significantly to around 41%. In terms of the international, we do have some larger customers, where we -- relative to the other ones, we have many more customers internationally. A few of them represent a larger component. But nothing near the concentration that we see here in North America.

Joseph Longobardi

And are there any specific points that we could look at in order to give investors comfort in your overall position at AT&T?

Robert Pullen

We'll we have shared with you last quarter that they introduced a new vendor in the Mobile Backhaul, that market share transition is happening. We are also participating in the LTE deployment. And that whole transition is reflected in our guidance both in the fourth quarter actual and the first quarter.

Operator

Your next question comes from the line of Rod Hall with JPMorgan.

Rod Hall - JP Morgan Chase & Co

I was just wondering if you guys could talk to us a little bit about the U.S. and backhaul programs. It seems like, to us anyway, this might be slowing by the middle part of 2011, as people finish the build-out of backhaul. But I just wondered if you could comment on whether you think that's right or are they quite a more to go for in backhaul in the U.S.? And then my second question that leads on from that is on the international side of things. Clearly, you're talking about EMEA growing. Can you say what part of it and could you tell us, by what part of it I mean, is it Europe, Middle East or Africa or just a combination across all of those? And could you talk to us about the prospects for growth there as we get into the middle and back-end of 2011? Are those growth prospects increasing? Or are they about the same? Just trying to get a feel for how the regional split of revenue might go through the year.

Robert Pullen

Let me see if I can take a stab at that, Rob. First of all, we expect overall CapEx to be flat and slightly up in 2011. Furthermore, we expect faster growth in wireless than wireline. As far as the backhaul and so on, we expect North America to be flat and faster growth in both Latin America and Asia. But also promising, slight promising growth in Europe, the Middle East and Africa. Next, our business globally is expanded as we shared with you our bookings from just the brick countries alone, plus South Africa increased by 53%. And our book-to-bill ratio actually was about higher than 1/4 for the year. In EMEA, one of your questions was the concentrated [indiscernible]. We broadened our customer base in Europe, the Middle East and Africa. And so that actually is positive. We've seen growth from 2009 to 2010, both for Europe, Middle East and Africa, as well as for Latin America. In fact, in '09, '10, we have slight decline and we're hoping that, that picks up in 2011.

Rod Hall - JP Morgan Chase & Co

And then just one other follow up on this. I think you guys said earlier that two percentage points of the margin decline in the quarter were due to international revenue mix, is that correct?

Timothy Wiggins

Actually, Rob there were two elements there I combined. They reach about a point, one of them was more of international data revenue, where we see slightly lower margins. The other point in that two-point was the service margin decline for us sequentially.

Rod Hall - JP Morgan Chase & Co

On the data revenue internationally, just on margins. Can you give us any more color on why those are lower? Is it just more competitive internationally? Are you finding -- or just any color on that would be interesting.

Robert Pullen

It is competitive all over the world, Rod. But it's really start-up cost. We typically sell our equipment. We lower the entry price and then make more profit on the growth. And so it's nominally start-up and market penetration.

Rod Hall - JP Morgan Chase & Co

And Rob, would you guys intend to keep doing that through the year? I mean, do you think you're still, I guess, you consider yourself in startup mode through all of 2011, so the more international revenues we see on data, the more dilution of margins we expect?

Robert Pullen

Likely.

Operator

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

Simon Leopold - Morgan Keegan & Company, Inc.

Rob, in answering a number of questions you've pointed to several segments as being down sequentially. I wonder if you could just step back because just simple math at the midpoint overall revenue was down about 20% sequentially or in that neighborhood. Typically, Europe or international markets might have that kind of steep sequential decline. But North America maybe not so much in your past. So you're looking at something different than your normal seasonality. So maybe if you could summarize what's going on in the mix on a sequential basis?

Robert Pullen

Well, first of all, on a sequential basis, 3Q to 4Q, it went from $429 million to $410 million. And then from 4Q to 1Q we're in the range of $315 million to $335 million. Next, we do expect transport to be slightly down, Simon, dominantly driven by lower 5500 Cross-Connect revenue. We also expect the broadband revenue to be sequentially down from 4Q to 1Q, dominantly driven by the 8800.

Simon Leopold - Morgan Keegan & Company, Inc.

Well, should I interpret this as suggesting that the 8800 will be down by more than 20%, so that the average is in that neighborhood, just talking to the midpoint of your range?

Robert Pullen

Simon, let me just from a high-level perspective, you're right. This was out of our normal. But now, I would say to you, we've seen a decrease of momentum in our North American business and so we see continuing into the first quarter. So I think that's probably one of the key drivers here. We also typically see when we go from 4Q to 1Q, weakness across all of our product lines just from a seasonal basis. So I think it's largely those two elements. We expect to have continued strength in our 8600 product, which is going to reflect outside although, I don't expect it to grow from 4Q to 1Q. So I think we're just seeing those two factors, Q1 seasonality along with deceleration in North America are the principal drivers here.

Simon Leopold - Morgan Keegan & Company, Inc.

And then if we could step back and talk a little bit about the 9000 product, the WiChorus platform. It sounds like you got a good base of customer wins. I know if we go back about a year, you're looking at kind of bookings for 2010 around $25 million, I think, you dialed that back mid-year. If we could get an update on how to think about that particular product starting with what was the contribution in the fourth quarter and how we should think about that trending through 2011?

Robert Pullen

Well, as I mentioned, the contribution of the fourth quarter, Simon, was the largest quarter of recognized revenue that we've had all year. You're right, as we kind of re-prioritized and re-guide it, we're well off our $25 million plan. But on the other hand, we have many new customers that we introduced this year and we're actively now involved with either over 20 trials and demonstrations. And customers are liking our strategy and the technology.

Simon Leopold - Morgan Keegan & Company, Inc.

So is this something you think could hit the $25 million in 2011?

Robert Pullen

It's feasible.

Operator

Your next question comes from the line of David [sic] Gelblum with Morgan Stanley.

Ehud Gelblum - Morgan Stanley

It's Ehud. First of all, if we're to take the $30 million of accounting changes in Q4, and put them back into Q1, then this quarter would have been $380 million instead of $410 million and the walk down into Q1, I assume that'd be $30 million higher. So taking the midpoint, maybe you're down to $355 million. So it looks like your normal seasonality to Q1 from this lower Q4 sort of make sense when viewed in the old accounting construct. I want to make sure that's correct. But then we have the issue of doing a $380 million, when you had been guiding to, let's take the midpoint of your guidance to $420 million. Tim, could you just walk us down, was that all 5500-related the $40 million missing between the $420 million that you sort of expected and the $380 million under the prior accounting?

Timothy Wiggins

Well, Ehid, interesting math. But let me touch on a couple of things. One, as Rob pointed out, the change in this distribution agreement was something we contemplated when we gave the guidance, albeit we came in at the low end of the $410 million range. The revenue recognition standard was something that we did not anticipate. And by the way, that revenue wouldn't simply flap into Q1 had we signed these agreements under the old rules, we would have been forced to account for these projects under the old rules and it would've been amortized over the life of the contract. So that was a pretty easy decision. So certainly, it's right. I think your analysis is directionally correct on moving the distribution agreement revenue from 4Q to 1Q. I think the revenue recognition is probably not the right way to think about it. So hopefully that's a little bit helpful, Ehud. Is there something else? What was the second part of the question?

Ehud Gelblum - Morgan Stanley

I guess, that was basically it. So then if we do move the correct piece of the accounting change, the walk down versus what you had expected would all be 5500 in Q4?

Timothy Wiggins

No, this distribution agreement was for our multiservice router, it's for the 8800.

Ehud Gelblum - Morgan Stanley

Right. But if we put the accounting back, however, it ends up being versus your guidance, you're now below guidance?

Timothy Wiggins

Yes. Probably the largest thing is we saw some weakness in our other North American customer and our 7100.

Ehud Gelblum - Morgan Stanley

So that was the delta versus what you had?

Timothy Wiggins

That's a big one.

Ehud Gelblum - Morgan Stanley

And looking at your AT&T and Verizon mix down to 41%, I think you said in the fourth quarter. Was that primarily due to AT&T? You had hinted that they would be weaker in terms of their growth when you went into fourth quarter?

Robert Pullen

Yes, it was primarily due to AT&T, Ehud.

Ehud Gelblum - Morgan Stanley

And would you expect them -- they basically shut down a lot of their spending to get to the end of the year, would you expect that to come back? I would think that, that would just be a budgeting issue and when we get past budgets in February, we might be back to the regular run rate, or do you think there's some sort of more permanent change?

Robert Pullen

Well, we hope so. But we're just going through the budget cycle with them right now. And so we don't have great visibility yet.

Ehud Gelblum - Morgan Stanley

And then going back to the India charge. So they did not award this business to anyone else? It's still sitting there and they're not allowed to build on their network and they're waiting. And then, if I'm understanding correctly, they have a network of 8100 already. And so the most -- the easiest, the path of least resistance for them is to award more 8100, but they're just waiting? And if you can kind of quantify, its $16.5 million, was for, I'm assuming a portion of the component, I can't believe that's all the COGs. And if your gross margin of that product is roughly around 50%, then minimum revenue for that contract is 2x $16.5 million or $33 million. If it's a portion of the COGs, should we be looking at sort of $60 million, $70 million, $80 million contract and that could come back in some time this year?

Robert Pullen

First, we are the deployed network today with 8100. So we're in the network and we've been here for many years and the product is performing well. Second, after positioning with the customer and going through the whole back process and competitive bidding process, we were selected as the recommended sole winner. I underline sole winner for this evolution of the business. Third, is I think I mentioned earlier, I believe I mentioned earlier, there's a real demand from end-users for services and the customer now is actually turning them down, which is even more troubling. Lastly, this is competitive bids in India. And so the margins are going to be considerably lower than our typical margin on the 8100 program. And lastly, I think your question was, did you have all this inventory? This is most of the inventory that we had associated with the program. But the margins are considerably lower than our typical 8100 margins.

Operator

Your next question comes from the line of Simona Jankowski with Goldman Sachs.

Thomas Lee - Goldman Sachs

This is Tom Lee For Simona. I guess on you're Optical business, you talked earlier about you saw some weakness in the 7100. Can you just expand on that a little bit in terms of what drove that? Was it more market share shifts or perhaps, a function of just carriers pulling in spending? And then how should we think about this business next quarter in Q1?

Robert Pullen

Well, first of all, it was really carrier spending. It was more deferral, Tom. Next, as far as the Transport segment, the bigger driver was the 5500 was down from 3Q to 4Q. Now for the record, the 5500 was up in 2010, by comparison to 2009. This is a data point for you. But the bigger driver was the 5500 was down. And we expect our market share and demand to continue throughout in 2011.

Thomas Lee - Goldman Sachs

On the Optical side?

Robert Pullen

On the Optical side.

Thomas Lee - Goldman Sachs

Is that primarily North America? Or is that...

Robert Pullen

No, it's global. One of the good points is we diversified our customer base here in 2010. And we expect to do the same in 2011.

Thomas Lee - Goldman Sachs

And, I guess, just kind of more broadly speaking on your North America business, it looks like it was the lowest in several quarters. Any sense in terms of visibility when you think that business can turn, I mean, you talked about you're going through budgeting issues with AT&T. How you guys thinking about when that business potentially stabilizes or when the geography potentially stabilizes?

Robert Pullen

Well, you're right. Fourth quarter 2010 revenue was down in North America by comparison to 3Q of 2010. We don't have great visibility at this point, as to when North America could turn around, which is why we have been aggressive over the past two years of diversifying our customer base globally. And that as I said, it's paying off. It's picking up in our bookings. But we don't have great visibility into 2011 in North America.

Thomas Lee - Goldman Sachs

Are you seeing a faster transition kind of broadly to kind of this next gen Ethernet platform, which is maybe creating a little bit of an air pocket for you guys?

Robert Pullen

No, the transition to Ethernet has been happening for a decade and we'll continue to follow that path. Furthermore, we're participating in that Ethernet and that's why we're also, both with our current product, which is why we're also doing higher density, lower cost extensions in the current base, as well as introducing new platforms.

Operator

Your next question comes from the line of Blair King with Avondale Partners.

Blair King - Avondale Partners, LLC

I really just have one, which focuses back on the OpEx piece of it. I know the guidance for the fourth quarter was in the mid to high-40s. It looks like you came in a little ahead of that. And I was wondering if you could give an update on some of the development efforts that you have, where you are in the process and how should we think about that OpEx number turning through 2011, understanding you've only got it into the first quarter. But kind of looking ahead, are we in that kind of high $40 million range for the balance of the year, do you think?

Timothy Wiggins

Yes, good question. It was a little higher than we had expected. We've been running lower for most of the year. We have a number of R&D-related items hit, just kind of stacked up on the 4Q. So it was a little higher than we expected. And as Rob mentioned, there's intense focus on driving cost side of the business and all areas. But we have continued to look at investing in R&D and sales and marketing for the reasons that Rob articulated. So we're going to continue to pull a lot of pressure on this, but it's important that in those two areas we continue to invest R&D up maybe in the 10% range depending on how the year progresses and sales and marketing up slightly, the rest of the business we would expect to reduce expenses for the year.

Blair King - Avondale Partners, LLC

Is that R&D up 10%, year-over-year?

Timothy Wiggins

Yes. That's kind of directional. We'll see how the year develops and how these various projects, Rob also mentioned in his talk, we have a number of extensions and new platforms. So I encourage you to go back and look at some of his comments. There's a lot of stuff happening this year in terms of things that we're delivering to the market. It's exciting from that standpoint.

Robert Pullen

But what you're thinking about the right way, which is why we're not providing annual guidance. It is likely our operating expenses will be higher because of investing more in R&D and the sales channel, sales and service channel.

Operator

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

Jeffrey Kvaal - Barclays Capital

I was wondering should we be thinking about the first quarter outlook now as the new ongoing run rate for the business that we should be basing our sequential growth from? Or are there one-time factors in that number that depress it artificially?

Robert Pullen

Well, we hope it's not the ongoing run rate, Jeff. As I mentioned earlier, that while history is no predictor of the future, first quarter of the past couple of years has been our lowest quarter. And we're hoping that picks up over time. We are in transition. Some of the factors decline in some of our core products and we're hoping that, that will grow over time.

Timothy Wiggins

And just to add to Rob's point, as think Rob said, this is the way we see it today. We hope that we can improve it. We do also expect later in the year to see some increased activity internationally, where we have some larger projects on our radar screen. I think to Rob's point that this is how we see Q1 and as he said, typically it's our lowest quarter of the year.

Jeffrey Kvaal - Barclays Capital

Yes, it is the lowest quarter. But it's not necessarily the lowest quarter by a dramatic amount, I guess, really?

Timothy Wiggins

Yes, there's nothing other than the deceleration we talked about in North America and the normal seasonality, those are the two elements that are driving the Q1 numbers. So if North America business picked up and we would expect to see some improvements to these numbers. And I also mentioned we expect internationally to see some improvemed activity in the back half of the year.

Robert Pullen

And we shared with you, Jeff, that our book-to-bill, our North America was greater than one. It was greater than one for the entire year. Slightly under one for the fourth quarter for North America. But greater than one outside of North America.

Jeffrey Kvaal - Barclays Capital

I guess, given what we can see about the revenue trajectory at this stage, is it possible that you would take a sharper eye on the OpEx structure after a couple of quarters of this, should revenues not pick up?

Robert Pullen

We're investing for our future. I would expect OpEx to be up. But we're going to be -- we would reserve the right to constantly be critical about OpEx, and we've been known to do that.

Operator

We have reached our allotted time for questions. Mr. Scottino, do you have any closing remarks?

Tom Scottino

I'll turn the phone over to Mr. Pullen.

Robert Pullen

Thanks, everyone. Good questions. As I mentioned, while we have revenue growth, we're disappointed and our profitability took a turn for the worse in the fourth quarter. Our guidance for the first quarter was below our expectations. But we're working hard to both invest in new geographies, as well as extensions to existing platforms and new platforms. And obviously, our goal is profitable revenue growth. And so thanks for your questions, your support and your time. And we'll talk to you soon.

Operator

This concludes today's Tellabs' Investor Relations Conference Call. You may now disconnect.

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