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Executives

Tom Scottino -

Robert W. Pullen - Chief Executive Officer, President and Director

Thomas P. Minichiello - Acting Chief Financial Officer, Chief Accounting Officer and Vice President of Finance

Analysts

Rod B. Hall - JP Morgan Chase & Co, Research Division

Joseph Longobardi - RBC Capital Markets, LLC, Research Division

Alex B. Henderson - Miller Tabak + Co., LLC, Research Division

Simon M. Leopold - Morgan Keegan & Company, Inc., Research Division

Nikos Theodosopoulos - UBS Investment Bank, Research Division

Michael Genovese - MKM Partners LLC, Research Division

Jim Suva - Citigroup Inc, Research Division

George C. Notter - Jefferies & Company, Inc., Research Division

Jeffrey T. Kvaal - Barclays Capital, Research Division

Ehud Gelblum - Morgan Stanley, Research Division

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

Tellabs (TLAB) Q4 2011 Earnings Call January 31, 2012 8:30 AM ET

Operator

Good morning. My name is Brooke, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Tellabs Fourth Quarter 2011 Earnings Conference Call. [Operator Instructions] Thank you. Mr. Tom Scottino, you may begin your conference.

Tom Scottino

Thank you, and good morning, everyone. With me today are Tellabs' CEO, Rob Pullen; and our Interim Chief Financial Officer, Vice President of Finance and Chief Accounting Officer, Tom Minichiello. 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 are contained in Tellabs' most recent SEC filings.

The forward-looking statements made in this presentation are being made as of the time and date of its live presentation. If the presentation is reviewed after the time and date of 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 some non-GAAP financial measures. Reconciliation between our non-GAAP financial measures and GAAP financial measures can be found at our tellabs.com website and our SEC filings.

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

Robert W. Pullen

Thanks, Tom, and good morning, everyone. Tellabs is focusing our business and restructuring our operations. In a climate of economic uncertainty, Tellabs needs to align expenses with revenue, so we're working to reduce our operating expenses and costs by $100 million. That means stopping new development work on the Tellabs 9100 LTE product. We will continue to support, however, Tellabs 9100 WiMAX customers. Unfortunately, this new restructuring will affect about 530 people starting today and continuing through the first quarter of 2013. We are consolidating R&D facilities in fewer locations to gain efficiencies. We'll close facilities in Petaluma, California; Vancouver, Canada; Bangalore, India and Karachi, Pakistan. These actions result from Tellabs' strategic review of the business.

Going forward, we will focus on helping our customers address the trends that are driving huge growth in data and video traffic. These trends, as all of you know, include smartphones, tablets, smart TVs and cloud computing. Tellabs will focus our solutions where customers face major challenges and need Tellabs the most. We address these needs through our next-generation portfolio for the smart mobile Internet, including Tellabs Mobile Backhaul Solution, Tellabs Packet Optical Solution and professional services such as Insight Analytics. We'll also continue to develop Tellabs optical LAN.

Our goal is to build Tellabs' market share in mobile backhaul and packet optical networks by helping customers succeed in a challenging environment, where it's unsustainable to continue increasing CapEx in line with traffic growth. Instead, we can help customers reduce CapEx and OpEx needs, so they can lower their cost per bit dramatically, improve availability and ensure quality and reliability.

Now, let's look at Tellabs' fourth quarter results. Fourth quarter revenue was $317 million within our guidance. Fourth quarter revenue outside of North America was $171 million or 54% of overall revenue. On a non-GAAP basis, we earned $4 million or $0.01 per share in the fourth quarter of 2011.

Fourth quarter 2011 non-GAAP gross profit margins were the highest in 5 quarters at 42.7%, up from 41.6% in the third quarter. Compared with the year-ago quarter, gross margins were up more than 4 percentage points. Non-GAAP operating expenses in the fourth quarter were down slightly from the third quarter at $131 million and down about $20 million from the year-ago quarter. Non-GAAP operating profits were $4 million compared with $6 million in the year-ago quarter. Non-GAAP operating margin was 1.3% compared with the 1.4% in the year-ago quarter.

Now let's turn to Tellabs' full year 2011 results. Our annual revenue was $1,286,000,000. Revenue outside of North America grew 27% year-over-year to $636 million in 2011. That marked Tellabs' highest revenue outside of North America since the year 2000. Tellabs' revenue outside of North America was 49% of overall 2011 revenue, the highest percentage ever. Growth products generated 59% of overall revenue, up from 56% in 2010. Tellabs' non-GAAP 2011 net loss was $18 million or $0.05 a share. While we used some cash in the fourth quarter, our balance sheet remained strong with nearly $1 billion in cash and equivalents and no debt.

Over the past 8 years, Tellabs has spent about $1 billion to buy back more than 25% of our shares. We have an existing share buyback authorization of $225 million. That said, in the face of the economic uncertainty, the Tellabs Board of Directors believe that we need our cash to fund business operations, expand our business, potentially through acquisitions, to repurchase stock and to pay a cash dividend.

We continue to return capital to shareholders through dividends as we initiated in 2010. The Tellabs Board of Directors today announced a $0.02 per share dividend, which provides a current yield of almost 2%. We continue building our business with customers and growth products around the world.

In the fourth quarter, we recognized revenue from 11 new customers for the Tellabs Packet Optical Solution, including our Optical 7100 and 7300 systems. In the fourth quarter, we recognized revenue from 2 new customers for the Tellabs Mobile Backhaul Solution, including the Tellabs 8600 and 8800 systems. We continue to shift to new Tellabs 8609 and Ethernet-optimized mobile backhaul platform for LTE networks. We now have 2 8600 LTE networks running and LTE trials underway with 3 customers.

The Tellabs 8611 will be shipping here in the first quarter. We're also working with a customer in a proof of concept for one of our new professional services called Tellabs Insight Analytics Services. We expect our first revenue later this year.

For the full year of 2011, we won 45 new customers for growth products, including 29 customers for Tellabs Packet Optical Solution and 16 customers for the Tellabs Mobile Backhaul Solution.

Let's look ahead at the forecast for our first quarter 2012. Looking at the first quarter, we expect revenue to be in the range from $260 million to $290 million. We expect non-GAAP gross margin to be 39% plus or minus 1 or 2 points. We expect non-GAAP operating expenses to be in the mid-120s.

As you know, Tellabs has also started working with a recruiter on a search for a new Chief Financial Officer. We're considering both internal and external candidates for the position, and we've already begun the process of interviewing potential CFO candidates.

That said, now I'd like to introduce Tellabs' Interim Chief Financial Officer, Tom Minichiello. Tom has worked at Tellabs for about 11 years in a series of increasingly responsible financial leadership roles. Most recently, Tom has served as Tellabs' Vice President of Finance and Chief Accounting Officer. Tom, welcome to the call.

Thomas P. Minichiello

Thanks, Rob, and good morning, everyone. Before we get into the fourth quarter numbers, let me talk about 2011, as it's useful to look at our fourth year results in the context of the full year.

After a successful 2010, we entered 2011 in a difficult position, driven by a dramatic change in our business with one North American customer. However, through the course of 2011, we still made some real improvements. We improved our performance outside North America, growing full year revenue by 27% to $636 million. Along the way, in the third and fourth quarters, we had our first 10% customers outside North America, and we increased our business outside North America to nearly half of total revenue. We increased non-GAAP gross margin by more than 4 points from 38.3% in 1Q to 42.7% in 4Q. Non-GAAP operating expenses at $547 million improved by $10 million even as we increased R&D by $25 million.

We successfully brought the new Tellabs 8609 product to market, improving our position in Ethernet mobile backhaul, and we made significant progress on the Tellabs 8611 with our first shipments expected this quarter.

We announced 2 new major initiatives: the Tellabs SmartCore 9200 Platform and the Tellabs Insight Analytics Service offering. We secured 45 new customers for growth products: 29 for packet optical and 16 for mobile backhaul. We achieved non-GAAP profitability in the back half of the year, following losses in the first 2 quarters. We generated $32 million in positive cash flow from operations from 2Q to 4Q, finishing the year with our cash and investments balance of $977 million.

We announced in July that we would reduce costs and expenses by $50 million. In short, 2011 was the most challenging year in our recent history. We made good progress during the course of the year, and we're making the key decisions that we expect to ultimately benefit customers, employees and shareholders.

For example, today, we're announcing the additional reductions of $100 million to drive increased profitability and focus the business on packet optical and mobile backhaul solutions. We entered 2012 with a sharper focus on these 2 large and growing markets. Our packet optical solutions target a global market that analysts estimated at $1.7 billion in 2010. Analysts expect it to grow at a compound annual rate of 13% through 2015. Our mobile backhaul solutions target a global market that analysts estimated at $2 billion in 2010. Analysts expect this market to grow at a compound annual rate of 9% through 2015.

Let's now take a look at the fourth quarter numbers. Revenue was $317 million compared with $330 million in 3Q, better than the midpoint of the guidance range we gave you in October. On a GAAP basis, we reduced our operating loss to $3 million in 4Q from $132 million in 3Q, which included $122 million in charges.

4Q non-GAAP net earnings were about $4 million or $0.01 per share, [indiscernible] or $0.01 per share in 3Q. So if you take the $4 million in non-GAAP net earnings and subtract $2.8 million pretax or $0.005 per share after-tax for equity based comp to be consistent with first call estimates, the result rounds to $0.01 per share in 4Q.

On a geographic basis, 4Q revenue from customers in North America was $146 million compared with $151 million in 3Q. In both periods, North American customers accounted for 46% of total revenue. 4Q revenue from customers outside North America was $171 million compared with $179 million in 3Q. Revenue outside North America was 54% of total revenue in both periods. 4Q revenue from our growth portfolio accounted for 54% of total revenue.

Taking a look at the full year. Revenue was $1.286 billion compared with $1.642 billion in 2010. North American revenue was $650 million or 51% of total revenue compared with $1.143 billion in 2010, primarily as a result of the change in our North American business I mentioned earlier.

Revenue outside North America was $636 million, up 27% from $499 million in 2010. Customers outside North America accounted for 49% of total 2011 revenue compared with 30% in 2010. For the full year, growth portfolio revenue accounted for 59% of total revenue, up from 56% in 2010.

Now let's take a look at the fourth quarter segment data on a sequential basis. Lower Broadband segment revenue was partly offset by increased Transport and Services segment revenue. 4Q Broadband segment revenue was $166 million compared with $182 million in 3Q.

Looking within Broadband, data revenue declined, access revenue was flat and managed access increased. 4Q revenue from data products was $76 million compared with $94 million in 3Q. 4Q access revenue was $43 million, flat with 3Q. 4Q managed access revenue was $47 million, up from $45 million in 3Q. 4Q Broadband segment profit was $16 million compared with $28 million in 3Q.

4Q Transport segment revenue was $92 million, up from $90 million in 3Q. 4Q Transport segment profit was $19 million, up from $7 million in 3Q.

4Q Services segment revenue was $59 million, up from $57 million in 3Q. 4Q Services segment profit was $21 million compared with $23 million in 3Q.

Turning to gross margin. 4Q non-GAAP gross margin was 42.7% compared with 41.6% in 3Q. Gross margin is highly dependent on product and customer mix. The roughly one-point increase was primarily driven by the following factors: while we had about a 2.5-point decline related to lower data product revenue and another 0.5-point decline due to lower services gross margin, we had about 2 points of improvement related to the higher level of revenue from Digital Cross-Connects and Managed Access Systems and about another 2 points of improvement related to better margins on our Optical Transport Systems.

Turning to the operating expenses. Tight control of expenses enabled us to continue to reduce non-GAAP operating expenses on a sequential basis. 4Q non-GAAP OpEx came in at $131 million, better than 3Q and guidance. 4Q non-GAAP R&D expenses were $79 million, essentially flat with 3Q. 4Q non-GAAP SG&A expenses were $52 million, down from $57 million in 3Q. For the full year, non-GAAP OpEx was $547 million, down $10 million from $557 million the year before even as we increased R&D by $25 million. As we announced this morning, we will reduce costs and expenses by $100 million through the end of 2012. 80% of the reduction or $80 million will come from OpEx and the balance from cost of goods sold. Together with the restructuring plan announced last July, we expect to reduce quarterly non-GAAP OpEx to around the $110 million range by the end of 2012 for an annualized target of around $440 million.

In connection with the restructuring plan announced today, we'll reduce employment levels by about 530 people and recognize an estimated $107 million charge in 1Q. Given the uncertainty we see, we believe these are the right actions to drive increased profitability and focus the business on packet optical and mobile backhaul solutions.

Returning back to the income statement, 4Q other income on a non-GAAP basis was $2 million compared with $3 million in 3Q. The 4Q non-GAAP tax rate of 32% resulted in a tax provision of $2 million.

Now turning to the balance sheet. Day sales outstanding was 77 in 4Q compared with 71 in 3Q. This reflects the trend of a higher percentage of revenue from customers outside North America.

Inventory turns were 4.7 compared to 4.4 in 3Q. At the end of the year, inventory was $144 million, an improvement from $156 million in 3Q.

CapEx was $19 million in 4Q and $65 million for the full year. We returned about $7 million to shareholders via our quarterly cash dividend. We used $17 million in cash from operations in 4Q. Overall, our cash and investment balance was $977 million at the end of 2011.

There were no open-market stock buybacks during the quarter. The actual number of shares outstanding at the end of 2011 was about $365 million.

Employment at the end of 4Q stood at approximately 3,250 people compared with about 3,300 people at the end of 3Q. Book-to-bill was below one for the quarter.

Turning to our outlook for 1Q. Based on our bookings trend, backlog and market conditions, we expect 1Q revenue to be in the range from $260 million to $290 million. Given the lower sequential revenue outlook, we expect non-GAAP gross margin to be about 39% plus or minus 1 or 2 points depending on mix. We expect 1Q non-GAAP OpEx to improve again into the mid-$120 million range. We expect equity-based comp in 1Q to be about $6 million, split between operating expenses and cost of goods sold. We expect the non-GAAP tax rate to be 32%.

In conclusion, we've talked about a lot today, but it really boils down to this: 2011 was the most challenging year in our recent history. We made good progress through the course of the year, and we're making the right decisions today to drive increased profitability and focus the business on packet optical and mobile backhaul, which we expect to ultimately benefit customers, employees and shareholders.

Okay, we'll now open the floor to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Rod Hall with JPMorgan.

Rod B. Hall - JP Morgan Chase & Co, Research Division

Just a couple, if I could. First of all, I wonder if you could just talk a little bit about the trajectory of the 8800, 8600 and 7100 in Q4, and just give us some idea whether those were up, down or unchanged and, if you can, how much they might have changed? And then, Tom, I know you're new on the job, but I just wanted to ask you about the marketable securities. You're taking $107 million charge for restructuring in Q1 and your cash balance, therefore, is dwindling down. I just wonder, why would you guys continue to expose yourself to market volatility? Why not just sell those securities and put the cash on the balance sheet? So just wondering about that. And then also just following on from that in the cash flow statement. If you could talk about whether the dividend really makes sense anymore considering that you're still trying to stabilize the business. So those are my questions.

Robert W. Pullen

Okay, Rod, those are a lot of questions in one, but we'll take a shot at it. We saw some softness in the 8800, 8600 and 7100 in the fourth quarter, which wasn't surprising. We saw a softness in CapEx around the world, including in North America. Next, as for the dividend, we obviously made the decision to give back to shareholders at least in this environment a 2% return on investment. And as you know, the board makes a decision every quarter as to whether we continue on. In this -- and as you know in our announcement, we did just approve a dividend, and we'll evaluate that on a going-forward basis, but we hope to continue that. Tom, do you want to comment on the other issues on the marketable securities?

Thomas P. Minichiello

Yes, sure. Hi, Rod. Yes, the charge of $107 million for the restructuring, a good chunk of that is noncash. It's -- there's intangible assets that are on the books that are included, and that's a big chunk, around 50. And then there is some fixed assets and other noncash items. There is some cash, of course, there's severance and some facility-related items that are also cash, but it's a much smaller portion of the $107 million. It's around $30 million in cash.

Rod B. Hall - JP Morgan Chase & Co, Research Division

Okay. And Tom, could you just talk about those marketable securities and what's your intention there? Do you just sell them as you need additional cash if you do or any thinking toward potentially just liquidating those and putting the cash on the balance sheet?

Thomas P. Minichiello

Well, if you're talking about our short-term investments, Rod, those are -- yes, we don't plan to make any changes there.

Rod B. Hall - JP Morgan Chase & Co, Research Division

Okay. And then Rob, can you -- you said general weakness in carrier spending. I mean, can you give us any more color? I mean, do you think that -- do you expect any kind of a rebound in Q2? I know some people had thought maybe Q1 would be a little bit better, but it doesn't look like it is much. What do you think the trajectory is going to look like this year? Do you have any feel for it?

Robert W. Pullen

Yes, well first of all, Rod, the fourth quarter and first quarter, as you can see based on our guidance, looked to be more variable than we wanted it to. Next, when you look in general, we expect flat to slightly down CapEx on a global basis. We continue to expect more in the mobile space than the wireline or fixed line space. It looks like carriers are -- not all of them, but many of them are focusing on profitability, and so we do expect to see some tightness at least in the first quarter. We're hopeful that the second quarter is going to improve based on what we're hearing so far, but we do not have great visibility, and that's one of the reasons why we guide only quarter-by-quarter.

Operator

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

Joseph Longobardi - RBC Capital Markets, LLC, Research Division

This is Joe Longobardi on for Mark. How do you feel about your overall competitive positioning and how might that improve this year with your key customers? We're under the assumption that you may regain some lost share, yet the outlook indicates yet a -- yet is that a maybe another like down?

Robert W. Pullen

Actually, we're going to -- I like our competitive positioning with this new strategy. We're going to be more focused and responsive to customers, which is what made Tellabs great today, which is Tellabs being a specialist and a more focused company. We've -- in our -- as you guys can imagine, we had some conversations with customers over the past couple of days, and they even brought up the fact that they were happy that we're more focused as a company. And we do hope to increase our share. That's one of our goals here, both focusing the company, improving profitability while investing for the future but doing it in a more specific space, Joe, which is that -- the mobile backhaul, the packet optical and the professional services.

Operator

Our next question comes from Alex Henderson with Miller Tabak.

Alex B. Henderson - Miller Tabak + Co., LLC, Research Division

So on the $58 million worth of cost savings that you announced in the June, July time frame, how much of that is completed at this point? Is that fully in the numbers and, therefore, the benefits going forward are from the additional $100 million announced in the December quarter? Is that the right way to think about it?

Thomas P. Minichiello

Yes, hey, Alex. Yes, that's -- it's almost done. We -- remember, when we made that announcement, it was to run through June of this year, but it's -- the majority of it is completed. There's still a little bit more to go, so there's still a little bit of that left. And then on top of that, the new restructuring that we're announcing today will save another $100 million. About $80 million of that will be in the operating expenses.

Alex B. Henderson - Miller Tabak + Co., LLC, Research Division

And so on that $100 million, I would assume that the bulk of that comes out in the first 2 quarters. Is that the reason -- a reasonable way to think about it?

Thomas P. Minichiello

Yes, that's a good way to think about it. In fact, more so in 1Q.

Robert W. Pullen

That's right, Alex. We...

Alex B. Henderson - Miller Tabak + Co., LLC, Research Division

On the product side, can you talk a little bit about the data products line. You kind of talked a little bit more about other areas being the focus. Are you reducing the product portfolio on that side? And how should we think about your commitment to that piece of the business?

Robert W. Pullen

Oh, no, we're highly committed to the data space. That's the infrastructure of our mobile backhaul, which is our 8600, 8800 and 9200 products. Additionally, we're committed even on the optical space, Alex, which is we're doing Ethernet over optics to try and save customers expensive router ports. We've done studies where we can save up to 50% versus the present method of operation. Having said that, we continue to invest heavily in data. We just introduced in the third quarter of the past year the 8609 and recognized revenue both in the third quarter and the fourth quarter. We are investing in a new redundant version of that product, of the 8611, which should be out this quarter. And we continue to invest in extensions both in the 8600, 8800 and 9200 programs.

Alex B. Henderson - Miller Tabak + Co., LLC, Research Division

So you're not eliminating any of the projects in that segment?

Robert W. Pullen

No, no. We -- our main focus has been to reduce in the packet core going forward. We didn't see a credible -- as a return on investment as we focus the company. It was our -- while we would've liked to keep that technology, and we saw a lot of unique applications, the return on it -- we had opportunities for better return on investment projects.

Alex B. Henderson - Miller Tabak + Co., LLC, Research Division

So one last question, the optical business is subscale relative to most of the larger competitors in the space. You haven't been able to produce much profit. Why continue to invest there?

Robert W. Pullen

Because we continue to improve our profitability. We have customers all over the world as Tier 1 customers. We're growing market share. We've just added 45 new customers in general, 29 of which in 2011 were in the packet optical space. And customers, as well as analysts, are saying we're ranked amongst the top packet optical solutions in the industry. And the market, Alex, is growing at faster -- the market that we are addressing is growing at faster than the average rate is. It's predicted to grow at about 13% compound annual growth rate on a going-forward basis.

Operator

Your next question comes from Simon Leopold with Morgan Keegan.

Simon M. Leopold - Morgan Keegan & Company, Inc., Research Division

I wanted to see if we could talk a little bit about some of the product groups you haven't talked about as much. So the focus on optical and backhaul we understand, and it sounds like you're backing away from the Mobile Packet Core 9100. Just wondering if you could talk about how you see your managed access, broadband access businesses fitting into this overall strategy. And then if you could just talk a little bit about the trajectory for the expense savings in terms of how we should think about OpEx in Q2, Q3. You talked about where you exited the year in Q1. I'm just trying to figure out the linearity of the cost savings.

Robert W. Pullen

Sure, Simon. So first of all, we continue to support our optical local area network for access products. The -- I think you also asked a question about managed -- our managed access. That was actually up slightly in the quarter from 3Q to 4Q and helped our gross margins there. Tom, do you want to comment on the OpEx?

Thomas P. Minichiello

Yes, sure. Hi, Simon. On the OpEx, like we mentioned, it's -- the new restructuring plan is going to be substantially completed or done in the first quarter. It does take till the end of 2012 to complete the entire plan, but it will be more early in the first quarter than our last plan. So you could see a lot of the expenses will be coming out in 1Q and more so in 2Q. It will then thin out and be done by the end of the year.

Simon M. Leopold - Morgan Keegan & Company, Inc., Research Division

And Rob, just following up on your answer. I noticed in the list of locations, you're shutting down Petaluma, which I recall is the former advanced fiber -- your fiber-to-the-x business was largely out of that facility. So that's one line of business I just would like to understand how you're managing that one.

Robert W. Pullen

Sure. Well, first of all, as I said in my words, it's unfortunate that we have to divest of any of our teammates and resources. That's a terrible thing. Having said that, Simon, we had already transitioned the support for the access products to both Texas and Naperville, and also a little bit in Shanghai in China. And so that transition had occurred some time ago. The team in Petaluma was dominantly working on the 9100 program, and so that focus won't interrupt the access program at all.

Operator

Your next question comes from Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos - UBS Investment Bank, Research Division

Some quick questions. Do you have the 10% -- who the 10% customers were for the full year and the size of their contribution?

Robert W. Pullen

Well, first of all, Nikos, we haven't been giving out our 10% customers for competitive reasons, but we only had one 10% customer in 2011. As Tom mentioned, we had 2 in the fourth quarter but only one for 2011. And as I think Tom mentioned as well, even in the fourth quarter, one of those 10% customers was out -- from outside of North America.

Nikos Theodosopoulos - UBS Investment Bank, Research Division

Okay, okay. And the one for the full year, that's a North American customer?

Robert W. Pullen

Yes. Yes, it is.

Nikos Theodosopoulos - UBS Investment Bank, Research Division

Okay. And do you have the year-end backlog?

Thomas P. Minichiello

It's around $300 million.

Nikos Theodosopoulos - UBS Investment Bank, Research Division

$300 million. Okay. And then another question is you mentioned that the gross margin partly improved due to improvement in the optical transport business. What led to that improvement sequentially? And is it sustainable or is this still volatile up and down, quarter-to-quarter?

Thomas P. Minichiello

Yes, well, we -- it was -- we have been consistently improving the margins in our optical business, and it's a couple of factors: one is cost reductions, and the other is more customers and more diversification of the customer base for the products we offer in the optical space.

Robert W. Pullen

And Nikos, to your last implication, as we win new business, it could be lumpy going forward but, as Tom mentioned, our trend has been positive thus far. And by the way, part of it is we have an aggressive plan for cost reductions.

Nikos Theodosopoulos - UBS Investment Bank, Research Division

Okay. So you see that margin continuing to improve in 2012?

Robert W. Pullen

We hope so, but it will have some variability to it based on new business.

Nikos Theodosopoulos - UBS Investment Bank, Research Division

Okay. And one last question, Rob, as you look at your -- your reporting segments -- your main product segments. Do you have any confidence -- or I should say, which area or which -- sorry, which product group do you have the most confidence will grow in 2012?

Robert W. Pullen

Well, dominantly the packet optical, the mobile backhaul and the professional services, that's at the highest level, Nikos. And as you know the packet Optical includes our 7100 and 7300 products. Our mobile backhaul includes our 8600, 8800 and future 9200 products and, of course, our 8000 network management system for all of the above. We're one of the few companies in the world that can manage from photons to packets and manage both transport and routers out of the same management system. And services in general could grow with us. So those are the high-level areas.

Operator

Your next question comes from Michael Genovese with MKM Partners.

Michael Genovese - MKM Partners LLC, Research Division

Rob, you're a veteran in the industry. I'm just wondering, can you give us perspective on whether you think consolidation is needed at this point? And just generally, at a very high level, what your view of -- what your view on M&A is?

Robert W. Pullen

Sure. Well, as you know, consolidation -- you have to think about it, Michael, from a lot of different perspectives, but consolidation is already occurring in the service provider space, and so that's an irrefutable trend that you need to watch out. Next, there's been both a consolidation in the industry from some of the manufacturers, and most of those haven't worked out very well, in all candor. And at the same time, the industry is fragmenting in a more -- into specialists again, too. At the same time, there's not as many startups in our space, not surprisingly because of these trends. And so there will be pressure toward consolidation over time, both in the service providers and in the manufacturers, but we believe there will continue to be a room for specialists as well. As for acquisitions, the optical space is probably the most fragmented, Michael. And as many of you probably had questions about the use of our cash, our -- the board said, "hey, we have some global uncertainty right here probably in CapEx and capital markets. Let's utilize our assets to fund our operations and expand our business, potentially through acquisitions," and so that will be an area that we continue to look at going forward. If we can help shareholders and our customers, and it makes sense for those reasons, we'll consider it.

Operator

Your next question comes from Jim Suva with Citi.

Jim Suva - Citigroup Inc, Research Division

A quick question on the restructuring. If I remember right, I believe it was just literally about 3 months ago when you guys announced a pretty large restructuring there. Can you walk us through about really what you have seen that has changed? Just it seems like in 3 months that you're now going through another very large structuring. And a follow-up is, do you think this restructuring is enough to stabilize and move to where you're going because if you look at your OpEx as a proportion of sales, it looks like a little bit higher than a lot of the other companies out there, and maybe that's just a function of the step down in sales that we're seeing in Q1.

Robert W. Pullen

Well, first of all, Jim, it was 6 months since the last time we announced it, but -- and Tom had explained that, that would end somewhere around the second quarter this year. Second, what changed is we saw softening in CapEx globally but, in particular, North America, but we did see it globally. We were concerned about the impact on Western Europe as well. Next, "is this OpEx enough?" was one of your questions. We believe that it was necessary for us to take this to improve our profitability, while focusing on where our customers need the most help and what our best return on investment would be, which is, as we mentioned, the backhaul, packet optical and services space. Will this be the last one? No, we can't guarantee that. We will continue to look at OpEx and improvement in efficiencies going forward, while trying to grow the top line.

Jim Suva - Citigroup Inc, Research Division

All right. And then on gross margins year-over-year, you're guiding to 39% plus or minus a few. And that compares to a year ago. I think year-over-year removes a lot of the seasonality. A year ago, you're 38%, but you guided to like 40%. Is the guidance change of 39% versus a year ago of about 40% plus or minus just a function of the revenue mix or the lower revenues? Or how should we think about it? Is that 39% kind of a new going run rate of the company given the sales rate?

Robert W. Pullen

Well, you make a good point because the first quarter is -- if you look at our history is usually seasonally down from 1Q. And yes, there's 2 things, right? There's the product and customer mix, but there's also the overall business volumes that you mentioned, and so that's really the driver more so going into the 1Q. And the 39% guidance we gave you, plus or minus 1 or 2 points is the variation on mix, but the volume is a driver because we've got certain costs in there that we need to absorb and cover. And the lower sequential revenue outlook puts pressure on the rate.

Operator

Your next question comes from George Notter with Jefferies.

George C. Notter - Jefferies & Company, Inc., Research Division

I wanted to ask about the 9200 SmartCore Platform. Can you remind us when that product is coming out for general availability? And also I'd love to know where you guys are in terms of milestones at that platform from a development perspective. And then to the follow-on to that, how do you envision transitioning customers there? You've got a base of 9100 and 8800 customers, who I think are going to wind up potentially transitioning to 9200. How do you kind of manage that transition and not overhang those exiting products from a demand perspective in the interim?

Robert W. Pullen

Sure, George. I'll take a stab at that. First of all, the 9200, we've actually shipped hardware to our first trial customer, and it is very preliminary software. I underline "very." And as most of you know, this product is a very sophisticated software product, and it'll take some time. And we're just not going to ship it until it's right. Meaning, it meets our standards and our customers' standards. It's feasible that this product could take throughout the entire part of this year, George, and we wouldn't recognize revenue on it this year. If we get lucky, we may, but the odds are we wouldn't at this stage. And so that's the current status of the 9200. Now as for transitioning the base, that's actually relatively easy. And it's because of our 8000 network management system. We designed the product with one. All of the optimal features of the 8600 and 8800 from an operations administration and maintenance and provisioning perspective, things like this integrated packet loop test to do equick [ph] turn up and easier troubleshooting. But most importantly, we put it on under our 8000 Manager system. Our customers are using the 8000 Manager, and we'll integrate it into that. And so it'll look like a seamless, point-click graphical user interface. And so the key point is the leverage of the 8000 Manager.

George C. Notter - Jefferies & Company, Inc., Research Division

I think I was worried about the potential for overhanging demand with existing 8800 customers. And certainly the 9100 customers made it potential that these guys kind of wait for the 9200 in the future?

Robert W. Pullen

No, I don't think so. We won't overhang the market. We work with our customers candidly and show them our end process development metrics as to where we are. And so we'll continue to do that going forward. There's no reason for us to overhang the market in this case.

Operator

Your next question comes from Jeffrey Kvaal with Barclays Capital.

Jeffrey T. Kvaal - Barclays Capital, Research Division

I have 2 questions. One is on the trajectory of revenues on the growth portfolio. I think we can see that down sequentially more than on the legacy side and actually even year-over-year, it's not done like what -- I think we would all like it to do. And then the second thing is, I was -- you talked about growth in services. I was wondering if you felt that the services revenue could grow independent of product revenue, or is service revenue in fact dependent on your ability to grow the product line as well.

Robert W. Pullen

Okay, Jeff, I'll take a stab at that. As you know, our percentage of revenue from growth products in the fourth quarter was 54%. And in all candor, we had a pickup of our -- some of our core products in the fourth quarter, which assisted in our gross margin as well. Then when you look to the full year, we are 59% of our total revenue, which was about consistent with our forecast. Would we have liked it higher? Yes. And so that's kind of a trend we have there. And Jeff, what was the second part of your question?

Jeffrey T. Kvaal - Barclays Capital, Research Division

Well, just a follow-up on that for a second. The growth revenue seems to have come down as a percentage of the mix for the last few quarters, which isn't a trajectory that we would've expected necessarily. Can you tell us a little bit about what's behind that?

Robert W. Pullen

Well, actually, the growth revenue, that's not correct. The percentage of revenue from growth products in the second quarter '11 was 58%. It went up to 61% in the third quarter, and it's down to 54%, as I've shared with you. It was really a combination of 2 things here in the fourth quarter: the first one was we had some increased demand from some of our core products; and we had some pushouts in demand for some of our growth products, but we expect those to rebound.

Jeffrey T. Kvaal - Barclays Capital, Research Division

Okay. And then the second part was on the services line. Does that grow independently of product?

Robert W. Pullen

Oh, yes, sorry, I forgot you -- the second part of your question. Yes and no. There's 2 aspects to services, Jeff. There's what we call all of our essential services which are highly correlated, the R-squared factor is really high to product sales. Those are things like service and support, technical assistance, engineering, furnish and installation, acceptance testing, training of our equipment, all of that is highly correlated to products. Then -- and that'll-- so that'll grow or decline with the products. The professional services, on the other hand, is more independent of the -- our products. The R-squared is not as high, and that can grow independently, and we've seen that over time.

Operator

Your next question comes from Ehud Gelblum with Morgan Stanley.

Ehud Gelblum - Morgan Stanley, Research Division

A couple of things. First of all, when you -- Rob, I think you mentioned that you had a 7100 customer that declined in the fourth quarter and that 7100 was soft, I think was the word you used. Yet your revenue in Transport was flattish. I assume that, that means that the 5500 was strong, and does that have an impact on gross margin? Is that kind of why the margin was a little bit better for the whole company?

Robert W. Pullen

Yes. And by the way, Ehud, the 7100 was slightly down from the third quarter, but the conclusion is still correct. And by the way, it just wasn't one customer. We saw softness in North America in several customers. They are concerned about the economy, Ehud, even though it's starting to improve by most people's critical standards.

Ehud Gelblum - Morgan Stanley, Research Division

Now one of your major 7100 customers had a work stoppage earlier in the year. Did that -- they never actually resigned an official contract with the labor union, I think. Is that still having any impact at all?

Robert W. Pullen

It is. And from everything we can tell, the people are back to work, even though they don't have a formal contract, and that should pick up over time.

Ehud Gelblum - Morgan Stanley, Research Division

Okay. Do you think any of the softness in the 7100 was due to share loss at all to one of your competitors over there?

Robert W. Pullen

No, not at all. In fact, we gained 11 new packet optical customers in the fourth quarter and 29 over the year. Our market share and some of our top customers remain strong, even though at one major customer here in North America, as all of you know, they introduced a second source over a year ago.

Ehud Gelblum - Morgan Stanley, Research Division

But at that particular customer, it could have been some share loss as that second source has gotten larger?

Robert W. Pullen

We don't see that, Ehud. No.

Ehud Gelblum - Morgan Stanley, Research Division

Okay. So do you expect 7100 to come back as we go through this year and be stronger?

Robert W. Pullen

We hope so.

Ehud Gelblum - Morgan Stanley, Research Division

Okay. Going back to a big picture kind of thing. What do carriers actually tell you right now? What does the environment feel like? If you can kind of just walk us through the conversations you've had with them over the last several weeks, last month or so, when you're going to them and trying to understand what their spending outlook looks like this year? Are they telling you, Rob, it's going to be down? Or are they telling you, look we just don't know, and so when you and Tom were sitting down and deciding what guidance would be, you came up with something that just is more a picture of your customers aren't telling you yet because they don't know themselves? Or are they actually telling you that this is what it's going to be in Q1 and be ready for something similar for the rest of the year?

Robert W. Pullen

Well, unfortunately, Ehud, they're all over the map on a global basis. Some are saying, "I'm going to have down CapEx year-over-year because I'm focused on profitability, but my spending needs to be more toward mobile than to wireline, fixed." And that's a fairly common discussion. Others are saying, "hey, I need to keep up with the bandwidth expansion, and I need to spend more, even though my budget may not tolerate that." And so we have a large group of our customers saying, "We need to spend similar to more." Then we have some that are saying, "We have -- we don't have our budgets yet. We're sitting here in February, and we don't have our budgets yet." But the general theme is flat, plus or minus, CapEx. It's -- we're focusing on some profitability, and we need to keep up with the bandwidth demand out in the marketplace, that it continues unabated, both from the enterprise and from the demand in the mobile networks. And so, Ehud, I wish I could give you a better answer. They're all over. I'm, after this call, on a road trip to visit our top customers here in North America, India and then I'm going to Mobile World Congress to meet some of our top customers from around the world. I'll be getting more insight over the next coming weeks and month as I travel around the world.

Ehud Gelblum - Morgan Stanley, Research Division

That's great. One last thing. When you sit down and you talk to the board, what is the long-term plan of how you envision Tellabs a couple of years out, once the ship is righted and revenue starts growing again? Is this a business that's forever going to be more international than North America? How do you and what does that mean about gross margins? How do you -- when you think about what the long-term plan of what this business looks like, both from a margin and margin perspective and a mix perspective, how do you -- where are you trying to take it?

Robert W. Pullen

Well, first of all, we're focusing to be a specialist, Ehud, which is really what Tellabs' heritage is all about. And that some of the moves that you saw us take here at the unfortunate expense of some of our teammates. Next is you guys, as you know, 2/3 or 3/4 of the CapEx is outside the United States. And 3 years ago, the management team said and the board said we need to invest more outside. That's paid off. We're up 27% year-over-year in our international growth. Now I would -- we have a friendly competition going on internally here between North America and outside of North America, and we'd like them to compete like heck to continue expanding North America, and we believe that, that is viable. Now as for your question about gross margin, Ehud, we've seen some actually mixed perceptions about our gross margin. Our gross -- our contribution margin, to start out with, is better outside of North America. Meaning, our margins outside of North America, let me just pick here in the fourth quarter of 2011, our contribution margins were all better in every region outside of North America, so North America was about our smallest contribution margin.

Thomas P. Minichiello

I think I would add that if you look at it more as a product and customer as opposed to where you are in the world. So it's really more of a function more weighted towards what you're selling and who you're selling to as opposed to international versus North America.

Robert W. Pullen

Yes, good point, Tom. And maybe my last point, Ehud, I would say is China and India is still -- tend to be the roughest on our margins on a going-forward basis.

Thomas P. Minichiello

Brooke, this is Tom. We have time for one more question.

Operator

Our last question comes from Todd Koffman with Raymond James.

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

Somebody was asking earlier about your growth portfolio, and I think your growth portfolio was actually down year-over-year every single quarter the last 4 quarters, and you called out the 7100 as you think being potentially a growth opportunity in 2012. My question is, was the 7100 down in 2011? And is there another product line in the growth portfolio that you feel reasonably comfortable about growth in 2012 from a product perspective inside the growth portfolio?

Robert W. Pullen

Well, first, Todd, let me make sure that you understand that the growth portfolio as a percent of sales was 60% in the first quarter of 2011, 58% in the second quarter of 2011, 61% in the third quarter of 2011 and then 54% in the fourth quarter. Next, our 7100 was up slightly from '10 to '11, and we expect it to be up in -- from '11 to '12, even though we don't have great visibility, but we do expect it to be up.

Thomas P. Minichiello

Yes, one other fact there is that year-over-year, the growth product portfolio as a percentage of the total was up. It's 59% this year versus 56% in 2010.

Todd K. Koffman - Raymond James & Associates, Inc., Research Division

Yes, the growth portfolio has been declining. It is declining. It's been declining a number of quarters, so -- while it's a percentage of revenue yet comparing to the core. But I wanted to ask, is there another product line inside that growth portfolio, outside the 7100 that you feel going forward or you're pretty hopeful will be a growth year in 2012?

Robert W. Pullen

Sure. Yes, we just introduced the 8609. That looks to be a growth product. The 7300 aspect of the 7100 is a growth product. Our -- we're just about to introduce the 8611 here this quarter. It'll be a growth product. We are doing new extensions on the 8660 for new higher-density Ethernet. That should increment our growth. We -- our pro services continue to grow, Todd. And we -- while I don't expect a lot of revenue from the 9200 this year, that's an investment in our whole mobile backhaul program as well. So we are optimistic about products even outside the 7100 and, as I said, our hope is that, that 7100 does grow and that's consistent with our internal plan.

So let me kind of wrap up here, everyone. Thanks for your questions. As you can tell, Tellabs is focusing our business on both mobile backhaul to packet optical and professional services. Our goal is to improve our profitability. You saw some of our both negatives areas as well as positive areas, our revenue growing outside of North America by 20% -- or 27%, and we continue to invest for our future. So thank you very much for the support. We're going to continue to keep focused on our customers and move Tellabs in this new strategic direction. Thanks for your support, folks.

Operator

Thank you. This concludes the conference. You may now disconnect.

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