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Tellabs (NASDAQ:TLAB)

Q2 2011 Earnings Call

July 26, 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

Tal Liani - BofA Merrill Lynch

Mark Sue - RBC Capital Markets, LLC

Ari Bensinger - S&P Equity Research

Nikos Theodosopoulos - UBS Investment Bank

Alex Henderson - Miller Tabak + Co., LLC

Jess Lubert - Wells Fargo Securities, LLC

Rod Hall - JP Morgan Chase & Co

Michael Genovese - MKM Partners LLC

George Notter - Jefferies & Company, Inc.

Ehud Gelblum - Morgan Stanley

Operator

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

Tom Scottino

Thank you, Lakeisha, and good morning, everyone. First off, I'd like to apologize for being a little bit late here. We had some little bit of technical trouble, but I think everything is going to work from now on out.

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

Having said that, I'll turn the call over to Rob.

Robert Pullen

Thank you, Tom, and good morning. While we are never satisfied with a loss, in the second quarter, we made significant progress on a sequential basis to improve Tellabs' performance. We're making progress as we work through a transition of our business to focus on the mobile Internet opportunity. Second quarter revenue was $334 million, up 4% from the first quarter. Our international investments are making progress.

Second quarter international revenue was up 70% compared with a year ago, and up 7% compared with the first quarter. We have strong performance in all 3 regions: Europe, the Middle East and Africa; Asia-Pacific and Latin America. North America revenue was up 1% over the first quarter. Now our revenue mix is far more balanced with 53% of revenue from North America and 47% from international.

Tellabs' growth products are doing well. A record 61% of our second quarter revenue came from growth products. Second quarter revenue from the 7100 was our best ever. And first half 2011 revenue from the Tellabs 8600 was our best ever as well.

Non-GAAP gross profit margins were 37.7%, in line with our guidance. Non-GAAP operating expense decreased by $4 million, from $142 million in the first quarter to $138 million in the second quarter. As a percent of revenue, operating expense dropped 3 percentage points to 41%.

We generated positive cash flow from operations of $28.2 million in the second quarter. We lost $0.06 a share on a GAAP basis and $0.02 a share on a non-GAAP basis. We returned about $7.3 million to stockholders through our cash dividend.

Our second quarter cash, cash equivalents and marketable securities were up slightly compared with the first quarter. We ended the quarter with more than $1.05 billion in cash, equivalents and marketable securities. To keep making progress in our performance, today we're announcing a restructuring. It will improve our profitability by aligning our expenses with the revenue. We will cut $50 million in expenses and costs over the next 4 quarters. We plan to take a restructuring charge of $19 million in the third quarter. Unfortunately, restructuring will affect about 330 or 10% of our employees. Since we're still hiring, we expect our net headcount to decline about 200 people over the next year.

We're making progress as we concentrate more of our research and development on the smart mobile Internet. Tellabs is aggressively investing in R&D on next-generation platforms for the mobile Internet. We invested about $84 million in R&D in the second quarter, up 17% from the year ago quarter. R&D expense was 25% of our second quarter revenue.

About 90% of R&D goes into our growth product. The lion's share is dedicated to smart networks for mobile Internet. We believe that accelerating our research and development is crucial to position Tellabs and our customers for success in the mobile Internet. If you use a smartphone or a tablet, you'll see that the mobile Internet presents our industry's biggest challenge and its biggest growth opportunity in the generation. A torrent of mobile data traffic continues to challenge our customer's networks and their business models.

To differentiate Tellabs' mobile Internet solution, we're building an unparalleled level of intelligence into our next-generation platforms. That's how we intend to advance the smart mobile Internet. By smart, we mean networks that provides customers the visibility, control, optimization and monetization capabilities that they need. Smart networks will include both wireless and wired.

For example, I recently met executives from the cable TV companies at the NCTA show in Chicago. We discussed the problems with delivering good quality over-the-top video. We shared how Tellabs' next-generation platform could address these needs, optimizing over-the-top video for multiple devices, such as TVs, PCs, tablets and smartphones. One CTO we met with gave us this feedback. "Hey, no one's talked to us about this idea. What you guys are doing is innovative and unique." That's just one example of positive feedback we're hearing from our customers and industry analysts about the unique architecture of our next-generation platforms. Our next-generation platform will make networks smarter, offer customers a way to monetize the Internet through personalization and advertising, and provide customers a sustainable competitive advantage.

We're making progress in gaining customers around the world. During the second quarter, we announced the Tellabs SmartCore 9100 win at ChinaComm and the Tellabs 8600 win at Yoigo in Spain. We also announced the Tellabs 7100 win at CELESTE in France and the Tellabs 7100 win at Vtesse in the United Kingdom.

In the second quarter, we won 6 new customers for our Optical Tellabs 7100 and 7300 Systems. We won 6 new customers for the Tellabs 8600 and 8800 Systems. And we now have more than 160 mobile backhaul customers worldwide. We won 5 new customers for the Tellabs SmartCore 9100 platform, and we now have 25 Mobile Packet Core customers. We are also seeing encouraging developments in customer trials as we introduce our next-generation product portfolio for the mobile Internet. First out of the gate is our Tellabs 8609. It's a high-density, low-cost, ethernet-optimized mobile backhaul platform that fits LTE networks perfectly. The Tellabs 8609 went into trials with customers during the second quarter, and our customers are excited about it.

Next, the Tellabs SmartCore 9100 LTE platform plays a key role in our next-generation architecture. We're working with 15 customers on trials of the Tellabs SmartCore 9100 platform, including the WiMAX, GGSN and LTE versions of the product. The Tellabs 7100 is also in customer trial now, with a focus on new OTN services.

Looking ahead into the third quarter, although Tellabs' third quarter revenue can be seasonally down, we expect revenue to be flat with 2Q in a range from $325 million to $345 million. In the third quarter, we expect a non-GAAP gross margin of about 39% plus or minus a point or 2 depending on mix. We expect operating expenses to decline again to the mid $130 million range, third quarter non-GAAP gross margin excludes $1 million, and non-GAAP operating expense excludes approximately $6 million in equity-based compensation expense. We expect third quarter non-GAAP tax rate of about 32%.

At the midpoint of our revenue, margin and OpEx guidance, we would expect to show further sequential progress in improving our performance with positive cash flow from operations and non-GAAP earnings close to break even.

In summary, Tellabs is encouraged by the progress we're making across the business. Our international business was strong. We've improved cash from operations dramatically. We're taking out $15 million in expenses and costs over the next year to improve our profitability. And we will keep on investing aggressively in next-generation platforms to advance the smart mobile Internet and help our customers succeed.

I'm confident that we're on the right track.

Timothy Wiggins

Thanks, Rob, and good morning, everyone. Before I get into the numbers, I'll make a few observations about our overall performance in 2Q. We made sequential progress toward improving performance in the quarter. Tellabs people around the world are executing on the international strategy we put in place in 2008. We're winning new customers, and we're introducing new products, and increasing R&D for the smart mobile Internet.

Let's take a look at the second quarter numbers. Total revenue for the second quarter was $334 million, down 21% from $423 million in the second quarter of last year. Given the significant changes that have occurred in our business over the last year, this quarter is a tough comp on a year-over-year basis.

On a sequential basis, 2Q revenue was up 4% from $322 million in the first quarter this year and within the guidance range we gave you in April. On a GAAP basis, we reduced our operating loss from $33 million in the first quarter to $25 million in 2Q. Non-GAAP operating losses reduced from $19 million in Q1 and $12 million in 2Q.

We reduced GAAP net loss from $24 million or $0.07 a share in Q1 to $20 million or $0.06 a share in 2Q.

On a non-GAAP basis, net loss for the quarter -- second quarter 2011, excluding charges for special items, was $7 million or $0.02 a share, and that compares with $11 million or $0.03 a share net loss in Q1. If you take $7 million, a non-GAAP net loss, and add $8 million pretax or $1.05 per share after tax for equity based comp, and that's to be consistent with the way First Call Reuters compiles and reports estimates for Tellabs, the result rounds to $0.03 net loss for the quarter of 2011.

On a geographic basis, revenue from customers outside North America was $157 million in the second quarter, up 7% sequentially. That amounts to 47% of total revenue and compares with 46% in the prior quarter and only 22% in the year ago quarter.

On a year-over-year basis, international revenue grew 70%, from 2Q '10 to 2Q '11. North American revenue grew 1% sequentially to $177 million and accounts for 53% of total 2Q revenue. In the quarter, our top 2 customers accounted for 33% of total revenue, compared with 35% in the prior quarter.

On a portfolio basis, revenue from our growth portfolio accounted for 61% of total revenue in the second quarter, compared with 60% in the prior quarter. At $203 million, growth portfolio revenue is up 4% sequentially.

Let's take a look at the segment data for the second quarter. On a sequential basis, lower Broadband segment revenue was offset by higher Transport and Services segment revenue. Broadband segment revenue for the second quarter of 2011 was $163 million compared with $173 million in the prior quarter.

Looking within the Broadband segment, data revenue declined, access revenue was essentially flat and managed access revenue grew 5% sequentially. Revenue from the data product category was $95 million in the second quarter of '11 compared with $107 million in Q1. On a sequential basis, higher revenue from our 8800 multiservice router series was offset by lower revenue from the 8600 Managed Edge System. The lower level of 8600 revenue in 2Q follows what was a record revenue quarter for the 8600 in Q1. Looking at the first six months of the year, 8600 revenue hit a record level.

Access revenue was sequentially flat at approximately $40 million, as higher sales of single family ONTs were offset by lower sales from access systems. Turning to the Managed Access category, revenue in the second quarter of 2011 was $28 million compared with $26 million in Q1. Increased revenue from our 8100 Managed Access System offset lower revenue from the 6300 SPH transport system. Taking all that into account, Broadband segment loss for the second quarter of 2011 was $3 million compared with a segment profit of $20 million in the prior quarter. The decline in segment profit was driven primarily by the lower overall level of data revenue and higher R&D expenses related to data products.

Within the Transport segment, we saw a sequential revenue growth from our 7100 Optical Transport System. Second quarter revenue from our 7100 system hit a new record, more than offsetting lower revenue from the Digital Cross-Connect systems. In total, we had $114 million in Transport revenue for the second quarter, and that's up 15% from $99 million in Q1. In Q2, Digital Cross-Connect system revenue declined 16% sequentially, compared with the 50% rate of decline we saw from 3Q '10 to 4Q '10.

Transport segment profit, driven primarily by the higher level of segment revenue and improved 7100 margins, was $27 million in the second quarter, up from $16 million in the prior quarter. Services segment revenue was $57 million in Q2, up 14% from $50 million in the prior quarter. Services segment profit, driven by the higher level of revenue and lower costs, was $22 million compared with $10 million in the first quarter of 2011.

Non-GAAP gross margin for the second quarter of '11 was 37.7%, compared with 38.3% in the prior quarter. Higher services gross margins partially offset lower product gross margins. Services margins increased due to the higher level of revenue and lower costs. Product margins decreased due to the lower level of data and Cross-Connect system revenue, which was somewhat offset by improved margins on Optical Transport Systems.

Turning to expenses. Tight control of expenses enabled us to reduce overall non-GAAP operating expense on a sequential basis. Total OpEx on a non-GAAP basis came in at $138 million, below the prior quarter and lower than our guidance. Non-GAAP R&D expenses for the quarter increased to $80 million from $78 million in the first quarter of this year and $69 million in the second quarter of 2010. SG&A expenses for the quarter were $58 million, down from $64 million in the prior quarter and $65 million in the year-ago quarter.

Given the changes we've seen in the business during this transition period, we're maintaining downward pressure on overall expenses, while increasing investment in products for future growth. In addition, as we announced in this morning's press release, we'll take a total to $50 million out of operating expenses and costs over the next 4 quarters. 75% of the reduction will come from OpEx and the balance from cost of goods sold.

I think about the OpEx reduction this way: In Q1 of this year, our non-GAAP OpEx spend was $142 million. That equates to an annual run rate of about $568 million. Once all the cost reduction plans are implemented, we expect our quarterly OpEx to be reduced to the low $130 million range for an annualized non-GAAP OpEx target of about $530 million. As part of this effort, we will reduce overall headcount by 330 employees or about 10% of our workforce. We plan to add headcount in low-cost geographies, and I expect our net headcount to come down about by 200 over the next 4 quarters. In connection with these cost reduction efforts, we expect to take $23 million in restructuring charges, of which we expect about $19 million will be taken in 3Q.

Other income on a non-GAAP basis amounted to $2 million in the second quarter compared with $3 million in the prior quarter. Our tax provision on non-GAAP pretax earnings for the quarter was a benefit of $3.3 million for an effective rate of 32%.

Turning to the balance sheet. We generated $28 million in cash from operations during the quarter. CapEx was $22 million for the quarter as we continue to expand lab facilities for development activities related to the smart mobile Internet. DSO was 76 days down from 81 in Q1. Inventory terms were 4.6x compared with 4.1x in the first quarter. At the end of the second quarter in 2011, inventory in terms of dollars was $56 million, down from $34 million -- down $34 million, excuse me, from $190 million at the end of the prior quarter.

During the quarter, we returned about $7 million to shareholders via our cash dividend. While there was no open market stock buyback during the quarter, we purchased over 7,000 shares -- or almost 7,000 shares of our stock at a cost of about $32 million under the 10b5-1 plan. Actual number of shares outstanding at quarter's end was about $365 million, compared with $363 million in the prior quarter. Headcount at the end of the quarter stood at approximately 3,350, consistent with the end of the first quarter.

Our book-to-bill for the quarter was below 1. Turning to our outlook for the third quarter, based on orders in 2Q, backlog and given the overall market conditions, we're guiding for third quarter revenue to be flat with 2Q in a range from $325 million to $345 million. We expect gross margins of about 39%, plus or minus a point or 2 depending on mix. We expect non-GAAP OpEx for the third quarter to be down again in the mid-130s range. We expect the effective expensing equity-based compensation in the third quarter will be about $7 million, split between operating expenses and cost of goods sold. In addition, we expect third quarter non-GAAP tax rate to be about 32%. Assuming we hit the midpoints of our guidance ranges, we'd be in a position to show an improvement to essentially break-even operating results with positive cash flow from operations in 3Q.

In summary, we're moving ahead. We've made sequential progress in improving our performance in the quarter. We're executing on our international strategy we put in place in 2008. We're adding new customers, and we're introducing new products and increasing R&D for the future.

Okay, we'll open the floor to your questions. Lakeisha, we're ready for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question is from the line of Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos - UBS Investment Bank

Just a couple of questions. So on the data portfolio, this quarter you mentioned further decline was due to the very strong 8600 last quarter. Do you think that, that business now is in a position given what's happening with one of your larger U.S. customers and the international demand that we've potentially bottomed here? Or is there still moving parts there that we could see additional downside in that business?

Timothy Wiggins

Nikos, are you talking about the 8600 as a data category?

Nikos Theodosopoulos - UBS Investment Bank

No, the whole data networking category. I guess, if you look at it, it was down again sequentially, and I understand why it was down. You gave good color on that. I guess, I'm trying to understand, going forward, do you think all those moving parts will allow it to stabilize and grow? Or is there still some potential downside as we move forward?

Timothy Wiggins

Yes, I think we should see some similar quarter in 4Q -- I'm sorry, in 3Q as we-- based on how we see it today. So kind of a flattish kind of quarter plus or minus a few, depending on how it rolls out. And we'd expect growth in the fourth quarter. As we mentioned on the call, we have a very strong Q1 in our 8600. And while it wasn't quite as strong in 2Q, if you look at the six months to date, it's a record. And we expect the 8600 will continue to grow for the rest of the year. The 8800 has been a little more lumpy just based on big customer deployments. It has fewer customers that tend to have larger deployments compared to the broad base of the 8600.

Nikos Theodosopoulos - UBS Investment Bank

Okay. And then just one other question. You mentioned all-time high for the 7100. I think a lot of that -- well, a portion of it was tied to some of the inventory last quarter. Do you -- and you also mentioned you hit improving gross margins there. So going forward on that product, was the gross margin improvement kind of a onetime fluke? Or is it now part of a trend that, that business can continue to see improving gross margins? And would we expect that to decline next quarter, given the big step up you had this quarter?

Robert Pullen

Yes. Part of it was -- it was coming off of a relatively low margin period in Q1. And it's -- I think as we've talked to you about this before that it's a function of mix. We're shipping a lot of product into new installations. Early in the product cycle, the margins tend to be lower. It was in part an inventory adjustment from Q1. We'd expect to see 3Q to be in, kind of, a similar range, Nikos, but I'd expect the margins to back up. It was kind of an alignment of positives after having a particularly poorer margin quarter in Q1.

Operator

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

Rod Hall - JP Morgan Chase & Co

I just got a couple. I wanted to just go back to the growth product portfolio and ask whether you would expect that to be up in 2011 over last year, considering all the trajectories of the various different products within that? And then also just curious. We were looking at the Broadband segment commentary down in the financial statement, and you guys are talking about a possible impairment there. I just wonder if you could say when you might make that call on that and what that will be based on? Would it be in Q3 or later? I might have a follow-up or 2 on that after.

Robert Pullen

Rod, I'll take the first part of the question. Tim, you take the second part. We had expected growth products to be up in 2011 versus 2010, and that's played itself out. We would expect that to continue for the second half of the year as well.

Timothy Wiggins

On the goodwill disclosure, there really are normal practices to look at that on an annual basis, unless there's some potential factors that might indicate an impairment. We had really 2 things. One is significant change in our business in the Broadband segment from a major North American customer. And the second one is that our stock price has been trading below our tangible book value so -- or our book value, I'm sorry. So we went back and looked at it, and what we came away with is saying is that we need to do a step to review the 3Q. We can't tell at this point, whether it's impaired or not. What we do know is that the work we did in 2Q said we need to come back and take a more in-depth review. So we'll see how that plays out in 3Q, and I believe we would be in a position to determine in 3Q whether there's an impairment or not. There's some $82 million or $83 million of goodwill associated with the Broadband segment.

Rod Hall - JP Morgan Chase & Co

Okay. And then I also wanted to ask, can you guys give us a little more color on the international revenue? Just where you're seeing strength, where you've seen some weakness, for instance, in Europe from a few different companies in the earnings season here. So just curious what you're seeing out there?

Robert Pullen

We actually -- even though we consider that there could be some CapEx softness in Europe, Rod, we saw strength in all 3 of our international regions, both Europe, the Middle East and Africa; Latin America and Asia-Pacific. As both Tim and I said, we're up 70% year-over-year, and we're up sequentially international. We do expect Asia and Latin America to grow at higher CapEx than Europe, but as I said, we did see some strength in all 3 regions in the quarter. And by the way, we would expect to see more of an international mix going forward as well, so even more strength international versus North America.

Rod Hall - JP Morgan Chase & Co

And would you expect that strength to be in APAC and LATAM more? I guess, you would, based on your comments. Or do you think you're -- just based on the new customer wins or whatever it is that's going on there could continue to grow for you?

Robert Pullen

We expect that we could continue to grow in all 3 regions. We've won both customer wins, as well as extensions on the embedded base. I mentioned in my comments that we have introduced the 8609 as we had told everyone we would. It's in trials right now, and we just received purchase orders from one customer in Russia. And so we've already seen some positive trends on that as well.

Operator

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

George Notter - Jefferies & Company, Inc.

I have a few questions about some of the new products. So could you give us an update on the 8611? I know that was a new platform that was in the pipeline as well. Where is that in terms of trials or availability?

Robert Pullen

The 8611 is currently in development, George, and will be introduced in the second half of the year, probably between the third and fourth quarter.

George Notter - Jefferies & Company, Inc.

And is that a product in -- when might you start generating revenues with that product?

Robert Pullen

I'd say the first half of 2012.

George Notter - Jefferies & Company, Inc.

And then I also wanted to ask about the 9100. I heard what you said about having 15 customers on trial. I assume that's with the LTE version of the product. I guess, I'd love to get an update in terms of where you are on -- in quarters past, you talked about number of customers and then field trials in the aggregate. I guess, I was hoping that you could kind of clarify that relative to the LTE field trial. Where are you in total with customers?

Robert Pullen

Sure. Well, first of all, we have 15 trials going on now, George, and it's a combination of WiMAX, 3G, GGSN and LTE. It's not just LTE. Next, we now have 25 paying customers for the 9100 platform. We introduced the first version of the LTE software here in the quarter. We're in trials with that right now, and we expect 2 additional software loads. One at the end of the third quarter, beginning of the fourth quarter, and one at the beginning of the first quarter to fill out the LTE functionality of the product.

Operator

Your next question is from the line of Jess Lubert.

Jess Lubert - Wells Fargo Securities, LLC

First, on gross margins. They came in towards the lower end of your guidance range and have now been below 40% for several quarters. So can you let us know, where were you surprised in gross margins during the quarter? And given the shift to international, some of the pressures in your legacy business and the weakness in broadband data, can you help us understand what gets gross margins back into the 40% range?

Timothy Wiggins

A couple of things. One is that we are hoping to see improving margins as we go from 2Q to 3Q. Part of it is around volume and our ability to absorb some of our costs. Certainly the -- but the biggest piece of it is around mix. And so we saw, in the second quarter, increase 7100, which has below corporate average. We saw lower sales of Cross-Connects in the data systems. So while we saw improvement in the margins in the 7100, still from a mix standpoint, that impacts us. So I think it's really a mix question as we go forward with the secondary factor being seeing some lifting of the volume.

Jess Lubert - Wells Fargo Securities, LLC

Is 40% a reasonable assumption for 2012?

Timothy Wiggins

Well, depending on the mix, sure. It's inside our range. One of the things that we're working on in the business is moving to the smart mobile Internet, which has the underlying targeted margins that are significantly above our corporate average. So as we see, for example, our ONT business continue to wind down, we're hopeful that these data products, including the 86 and 88, which have margins above corporate average along with adding new products in this space, will allow us to lift the margins. And our targets are above 40% over the long term, but it's really a question of how fast can we get there.

Jess Lubert - Wells Fargo Securities, LLC

And then I just had a couple on the product side. Can you tell us how data revenue performs sequentially and year-over-year excluding the large North American customer?

Timothy Wiggins

Well, certainly, we haven't disclosed that. But the North American customer had a major impact, particularly, a year ago. If you go back and look at our MD&A, you can pretty well track it out for yourself where we've talked about the increases and where they came from. But certainly, it's had a big effect. And in fact, if you look at a year ago, 2Q, the majority of revenue in the category was coming from the 8800. Today, and even since the fourth quarter this year -- I'm sorry, last year, the 8600 has been the larger part of the category. And in fact, in the first quarter of this year, the relationship had completely flipped where the majority of the revenue was coming from 86.

So we've seen some changes in the business space on that the overall change, but we also see some positive trends. We're levered to 160 networks for these products. One of the questioners earlier was asking about Europe. We believe that we're levered to some of the traffic growth there, and that we're starting to see some of these networks expand, at the same time, we've added new customers.

Robert Pullen

I would also add, Jeff that we talked about international being up 70%. But if you take away a big North American customer in the North American segment, we were up double digits year-over-year in revenue from this quarter to last quarter at this time.

Jess Lubert - Wells Fargo Securities, LLC

And then lastly, are Digital Cross-Connect sales now less than 1/3 of transport?

Robert Pullen

Yes.

Operator

The next question is from the line of Ari Bensinger with Standard & Poor's.

Ari Bensinger - S&P Equity Research

One of your peers mentioned that the broadband stimulus spending started funneling through finally to the carriers. And I'm wondering if that could be a boost for the next several quarters going forward. And if so, if you could sort of quantify it.

Robert Pullen

Well, we've said in the past that first of all, we -- I don't know who said that, but I agree with the thought process. We're starting to see some of that money flow through. It's a tailwind for us as well. And we have seen some increase in demand looking forward for the access products.

Operator

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

Mark Sue - RBC Capital Markets, LLC

Maybe if we combine all the commentary, excluding the large North American customer, how we should see the regional mix for the balance of the year and maybe in aggregate, the thought that maybe North America has bottomed from a dollar point of view, and maybe if you could just give us a sense of how the mix might end up as we finish the year.

Robert Pullen

It's very possible, Mark, that we could see for the first time in Tellabs' history that more revenue from -- or more revenue outside of North America or our international regions exceed the North America revenue. So it's very possible that, that could flip over the next couple of quarters.

Mark Sue - RBC Capital Markets, LLC

And then if we think about the international mix over the North America mix, should that take precedence over product mix as it impacts gross margin? Or is it not really related to the type of data products on the impact on gross margins?

Robert Pullen

Yes, it's not so simple, Mark. It's really a factor of the product mix for certain. As Tim and I have mentioned in the past, our data networking portfolio, including the SmartCore product, is higher than corporate average margins versus the transport or optical products or certainly the access. But it also depends on geography. Some of our international markets are higher gross, both standard margin and gross margin, than North America, and some are lower. And so it's a mix -- the short answer is it varies based on product and geography. But don't make the conclusion that all international revenue is lower margin, because some of our international revenue is higher margin than North America.

Mark Sue - RBC Capital Markets, LLC

I see. That's helpful. And then just lastly on LTE and the pace of rollout in North America and how other regions might follow, it seems to be pausing somewhat, and we just want to get the sense of what you're seeing. Is there a little bit of digestion going on in how you're seeing the wireless backhaul projects develop as well.

Robert Pullen

Well, there's -- in North America, there is a little bit of digestion, but North America is far more aggressive in the LTE rollout than the rest of the world. But we would expect the LTE adoption to continue to happen. I'm going to call it at a modest pace on a global basis with the developed countries emerging sooner than the emerging economies.

Operator

Your next question is from the line of Tal Liani with Bank of America ML.

Tal Liani - BofA Merrill Lynch

Question first about DSOs, it went up to 92 days, if you can comment. And the second, if I calculate property, 7100 or the optical side was up 35% sequentially. Can you speak a little bit about the characteristics? It's a little bit disconnected from what other optical companies have seen recently. And what's the source? And then what do you think about longevity of this growth?

Timothy Wiggins

Let me handle the DSO, and Rob can pick up the other part. We calculated on an average, and it was 76 days down from 81. What we do see happening -- so it's an improvement, Tal, and some of that improvement helped us turn negative cash flow in Q1 to a positive in 2Q. Inventory also terms improved and reduced as a dollar amount. But one of the consequences of our business shifting to more international is that our terms with our customers have consistently been significantly longer than North America in general. There are some markets in the international space that have terms that are more like the western terms, but in general, we see longer terms. And so we haven't seen any fundamental changes in terms of the terms that we're extending our customer behavior. What we're seeing is just basically the shift from North America business to international business that has these extended terms.

Robert Pullen

And then as for the optical, Tal, you're right. 2Q was up sequentially from 1Q. And it was really a manifestation of we're stealing market share. As I mentioned in my comments, we had won -- we announced a couple of customers, CELESTE in France and Vtesse in the U.K., but we also won 6 new customers and recognized revenue from 6 new -- excuse me, when I say we won 6 new customers, I mean that we recognized revenue from 6 new customers on the 7100 product. While we don't give guidance on the next quarter, something in a similar range is feasible for the 7100.

Operator

Your next question is from the line of Mike Genovese with MKM Partners.

Michael Genovese - MKM Partners LLC

It looks like the R&D as a percentage of revenue is about 24% the last 2 quarters. Rob, in the press release, you seem to suggest it's going to stay at about those levels. And I'm wondering how to reconcile that with the OpEx reduction commentary. Does that suggest that more is going to come out of the other 2 line items in R&D or is there a little bit downward pressure on the R&D level?

Robert Pullen

First of all, you're right. We're at almost 24% to 25% as a percent of revenue for the second quarter here. Hopefully, our revenue will increase towards the second half of the year, and so maybe that percentage will be downward. But we are up 17% year-over-year in the R&D. As for the OpEx reductions, it's dominantly outside of R&D. So we're cutting more in the SG&A areas than in the R&D. We will touch a little bit of R&D, but we're trying to minimize that, so that we make sure that we've got longevity in our future.

Timothy Wiggins

Just to add a couple of comments there. One is that, you'll see our R&D is kind of a net. It was $78 million in Q1, $80 million in 2Q, and it's probably going to stay there, but there's a lot of movement going on there. Rob mentioned 90% of it is focused in these growth portfolios. So we continue to work on optimizing and moving R&D dollars around where it makes the most sense. And so in order to drive costs down, it means that we're putting a lot of pressure in the rest of the organization, so that we can continue to make these important investments.

Michael Genovese - MKM Partners LLC

Great. And then one more question. On the 7100 strength in the quarter, you mentioned 2 of these new customers being in Europe. Was all the strength in the 7100 driven overseas or was there domestic strength as well?

Robert Pullen

Well, there's both. There was domestic strength as well. We also had strong demand -- relatively strong demand both in Europe and Latin America, but it's a combination Europe, Latin America and North America.

Operator

Your next question is from the line of David Gavilan (sic) [Ehud Gelblum] with Morgan Stanley.

Ehud Gelblum - Morgan Stanley

It's Ehud. A couple of questions. On the Broadband segment margin that fell, I calculated roughly, about $20 million sequentially, Rob, you mentioned or I think Tim mentioned, that it was a combination of the lower data revenues and the rest of R&D. I just want to see if my math is roughly correct. The data revenue seems to have fallen about $12 million sequentially, and yet total operating profit for that segment fell $20 million. So I'm trying to just correlate how much R&D may have been up in that segment. It sounds like it must have been up, I mean, of a $12 million decline in data revenues. I can imagine that took more than $6 million or $7 million tops from the profitability. And so did R&D really go up by, call it $14 million, in that segment? And how should we be looking at that going forward?

Timothy Wiggins

Well, I think we'll stand on the comments in the MD&A. But there's certainly mix going on there, Ehud, and certainly are increasing the investment. One of the hallmarks of what we've been doing here is scaling the investment in our 91 and future platforms there, which is an important element. So if you think about -- just a comment in the R&D, we've talked about 90% being spent in the growth portfolio. And if I could just give you a little more different way to think about it, if you think about R&D running in the low $300 million that means that 90% means $270 million-plus of that spend is focused on those categories.

From a very high level, think about $100 million being spent in the 86 and 88 area, and that's to maintain and grow the existing relationships. About $100 million is being spent in the 9100 and its next-generation platforms. And about -- the balance is about $70 million, give or take, is being spent in the optical space. So you'll also notice that our R&D increased $11 million from 2Q of last year to this quarter, $69 million to $80 million. So we're absolutely scaling in that space. That hopefully gives you some sense. And then back to your question, it was a function of volume mix and increased R&D spend.

Ehud Gelblum - Morgan Stanley

That was very interesting, I appreciate that. Nice split there. On the -- in the smaller part of the business, when you look at the Managed Access piece, there are times in your past when that's been very strong, at times also very weak. How should we be looking at the growth in the 8100 and the 6300, and what do they do? And not just in the next quarter or next year, but what's the trajectory that those are on in terms of they're not really in your -- I mean, I could be wrong, but not really in your R&D budget for growth products. So I'm wondering how do you -- are those in maintenance mode? Do does decline for the next couple of years and get cut in half in a couple years or they stay where they are, they're not going anywhere? Or is there investment going into those areas that should grow them?

Timothy Wiggins

Yes. Well, we are investing. We're trying to maintain the relevance of these products. I'd expect them to drop for the year, probably in the 10% range, plus or minus a couple of points. So given later life cycle, the important or an interesting thing about these products is they're very strategic to customers in the sense that they handle a lot of their traffic and there's a lot of install base, not in the sense that maybe they're the shiniest and brightest objects. So we see them as being in decline. They're important contributors to profitability, and I suspect that they'll remain relatively stable on a secular decline, and they'll continue to be supporting customer network needs for several years to come.

Tom Scottino

Lakeisha, I think we have time for one more question.

Operator

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

Alex Henderson - Miller Tabak + Co., LLC

Quick question. First, the ending share count, if you had been profitable?

Timothy Wiggins

Oh, I don't have that with me. I can check on that.

Alex Henderson - Miller Tabak + Co., LLC

Okay, maybe you can get to me later on it. The second question is, the services gross margins were quite a bit above trajectory from the prior couple 2, 3 quarters, should we be anticipating that coming back down to more normal numbers? Can you talk a bit more about what's going on in the service gross margins?

Timothy Wiggins

There are a couple of things that the service team did well. First off, the services guys got caught short with a bunch of costs that were difficult to manage in the first quarter where they ended up with revenues below their target. So we had margins significantly below planned just because it's very difficult, kind of, mid-quarter to realize that we're not going to hit our numbers and manage the cost. So the team did a good job of doing a couple of things: one is revenues grew, including the pro services area which is part of our growth portfolio; two, the team is able to reduce costs, so we have kind of a double whammy of higher revenue, lower cost. The margins are higher than I'd expect. And I expect to see those, kind of, get back to their normal levels in their low 30% range for the year.

Alex Henderson - Miller Tabak + Co., LLC

Second, you talked a lot about the one large North American customer going away. But the same trajectories and the same line of logic that got people to move away from multi-service is also being expressed over the other large customer in North America. I'm just wondering if you could talk a little bit about the risk of a second shoe falling on that business, if the other large North American customer chooses to follow the footsteps of the first.

Robert Pullen

Yes, Alex, I'll take that. First of all, we have never been in the Verizon Wireless network for mobile backhaul per se in the wireless side. What we are, though, on the other hand, is in the wireline side with our 7100, and that is quickly transitioning to Ethernet. And so we innovated a unique development on our ROADM or optical technology, which is due ethernet, both termination and aggregation, to save and bypass router ports in the core of the networks. And so we should participate in that Ethernet transition with the other carrier in North America.

Alex Henderson - Miller Tabak + Co., LLC

And then on the Cross-Connects, can you give us any sense of -- are you still selling chassis or are you just simply selling blades at this point? And if it's just blades, are we getting close to the point where we've filled that install base? How should we think about the mix of chassis to blades within that?

Robert Pullen

Well actually, we're still selling new systems. And we're also doing core expansions at a similar rate as we had last year, and also filling out ports, Alex. So while the 5500 is in decline, we continue to see both new systems expansions from smaller systems to larger systems and growth on ports.

Alex Henderson - Miller Tabak + Co., LLC

If we were to look at prospects for the full year, what is the rate of decline in the business that you're anticipating?

Robert Pullen

Well first of all, remember, we had a growth year from 2009 to 2010, but we should have a fairly steep decline from 2010 to 2011 on the order of almost 50%.

Alex Henderson - Miller Tabak + Co., LLC

And so I assume then that the chassis is falling faster than the blades, is that not correct?

Robert Pullen

Well, we -- surprisingly, we shipped one more new system in the first half of '11 versus the first half of '10. So...

Alex Henderson - Miller Tabak + Co., LLC

I don't understand. How do you get a 50% decline if you're shipping more chassis this year than last year?

Robert Pullen

They're smaller systems. They're less than average sell price per system.

Alex Henderson - Miller Tabak + Co., LLC

And so what's the decline in the ASP that we're looking at?

Robert Pullen

Oh, we don't -- I don't have that information, Alex.

Alex Henderson - Miller Tabak + Co., LLC

Okay. And then finally, I'm looking at the numbers. You said your ONT business was going to be down, but it was actually up sequentially. I assume that's just straight seasonality. Should we be anticipating that will be down as we go into the back half at a more aggressive pace?

Robert Pullen

Well, we don't give out specific forecasts on individual line items, Alex, but you should probably model it to flat to slightly up.

Timothy Wiggins

We had a pretty strong back half of last year, 3Q and 4Q. 4Q was particularly strong. So the business is -- I think Rob's right. It will be down probably in the 30% range year-on-year, based on the way we see it. But it's flatter than it was last year.

Alex Henderson - Miller Tabak + Co., LLC

And that should help the margins quite a bit.

Timothy Wiggins

Well, you mean, in terms of having fewer -- yes, in the back half of the year from a mix standpoint.

Robert Pullen

Okay, everyone. Thanks for joining us today, and thanks for your good questions. We continue to try and make progress as we're transitioning the business. You can see that some of our strategies are paying off. While it's never good, and we're never satisfied with the loss, we have made significant progress in a sequential basis, and we're moving in the right direction to improve our performance and reducing costs are consistent with that. Again, thanks a lot for your time and your good questions, and we'll talk to you soon.

Operator

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

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