Tellabs Q1 2007 Earnings Call Transcript

TRANSCRIPT SPONSOR

Tellabs, Inc. (TLAB)
Q1 2007 Earnings Call
April 24, 2007 8:30 am ET

Executives:

Krish A. Prabhu – President and Chief Executive Officer
Timothy J. Wiggins – Executive Vice President and Chief Financial Officer
Tom Scottino - Senior Manager of Investor Relations

Analysts:

Ehud Gelblum - JP Morgan
Tal Liani - Merrill Lynch
Ken Muth - Robert Baird
Tim Long - Banc of America
John Anthony - Cowen and Company
Nikos Theodosopoulous – UBS
Tim Daubenspeck – Pacific Crest Securities
Simon Leopold – Morgan Keegan
Cobb Sadler - Deutsche Bank
Brantley Thompson – Goldman Sachs
Brian Coyne - Friedman Billings
Andy Schopick - Nutmeg Securities

Presentation

Operator

Welcome to the Tellabs investor relations conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question at that time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question press the pound key.

It is now my pleasure to turn the call over to your host, Mr. Tom Scottino. Please go ahead sir.

TRANSCRIPT SPONSOR

Do you get frustrated during earnings season? Have you had trades go south because of bad earnings dates? We know what it's like. We’ve been there. We’re Wall Street Horizon and we work with some of the largest firms on Wall Street. Founded by former Fidelity Investments executives, we understand the power of trading on good information and the pain and suffering of trading otherwise. We obsess about earnings and economic events calendars so you don’t have to. Accurate. On time. Guaranteed. Let us help. Get Smart Get Wall Street Horizon. View our Free 30-day trial for investment professionals To sponsor a Seeking Alpha transcript click here.

Tom Scottino

Thank you and good morning everyone. With me today are Tellabs President and CEO Krish Prabhu 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 Tellabs.com.

Before we begin, I would like to remind you that certain statements made on this call this morning may be considered forward looking. Such statements are subject to risk and uncertainties and actual results might differ materially. A discussion of the factors that may affect future results is contained in Tellabs most recent SEC filings. Tellabs disclaims any obligations to update and revise statements contained in this presentation based on new information or otherwise.

This presentation may also include non-GAAP financial measures, reconciliation between the non-GAAP financial measures and the GAAP financial measures can be found at our Tellabs.com website.

Having said that, I will turn the call over to Krish.

Krish A. Prabhu

Thanks Tom and good morning everyone. Welcome to our first quarter earnings call. The quarter turned out pretty much as we expected and as we had guided at the end of the last quarter. Year end year comparisons are a little misleading since over the past year, two of our top ten customers have been part of a major merger in North America which has impacted our business.

However, as I reflect upon one queue I do see some bright spots. Transport revenue is up 21%. On the strength of North American wireless, international revenue is up 7% year over year. Data revenue is up 32% year over year as we continue to make good gains in wireless and multi-service applications. The FTTP business remains strong and our plans for transitioning are on track. Expenses are under control and gross margin is up slightly in Q1 when compared to Q4.

In our assessment, there is a beginning of a new spin cycle around video. Some estimates have video constituting sixty percent of the internet traffic. With our three primary platforms, fiber access, multi service fiber access, and IPMPLS aggregation, we are very well positioned to benefit from this new spin cycle. We are in several evaluation trials and have had some recent wins and altered platforms.

Let me pause here for now. I’ll hand it over to Tim who will take you through the results and I’ll be back to answer your questions. Tim?

Timothy J. Wiggins

Thank you Krish and good morning everyone.

Total revenue for the first quarter of 2007 amounted to $452 million compared with $515 million in the first quarter of 2006. The year over year decline can be attributed primarily to lower revenue in the transport and broadband segment. On a sequential basis, the first quarter revenue level was essentially consistent with the fourth quarter of last year as increased transport segment revenue offset lower revenue in other segments.

For the first quarter of 2007, revenue from customers in North America amounted to 75% of the total versus 80% in the first quarter of 2006. Revenue from customers outside North America amounted to $111 million in the quarter, up 7% from $103 million in the comparable period of 2006.

Turning to the individual business segments, broadband segment revenue for the first quarter of 2007 was $219 million compared with $260 million in the first quarter of 2006. As you know, the broadband segment includes our access, managed access, and data products. The year over year decline in the broadband segment is primarily related to lower revenue from our access and managed access equipment.

Looking at the elements of our broadband segments, access revenue was $121 million for the first quarter of 2007 compared with $164 million in the first quarter of 2006. The year over year decline can be attributed primarily to lower revenue from the fiber to the curb access platforms and lower sales of both fiber and copper access platforms to independent telephone company customers.

Fiber platforms overall, both fiber to the curb and fiber to the premise accounted for approximately 65% of access product revenue in the first quarter of 2007 compared with 56% in the first quarter of 2006.

Manage access revenue in Q1 of 2007 was $69 million compared with $74 million in the first quarter of 2006. The decline here is related primarily to reduce 6300 SPH transport product until its 2300 cable polyphony product revenue partially offset by a nice increase in Tellabs’ 8100 revenue.

The Tellabs’ 8800 multi-service router series and the Tellabs 86 managed system make up our data category. For the first quarter of 2007, revenue from data was $29 million, up 32% from the $22 million we recorded in the comparable period of 2006. Sales growth across the segment was driven by global line and wireless customers.

In Q1 of 2007, broadband segment loss was $15 million compared with a segment profit of $21 million in Q1 of 2006. The decline here is primarily related to the lower levels of access and managed access revenue, new pricing on single families LNTs and a mixed shift toward lower margin access products.

For the first quarter of 2007 transport segment revenue was $191 million. That compares with $214 million in the first quarter of 2006. The year over year decline primarily reflects lower sales of Tellabs’ 5500 system to one major wireless carrier. On a sequential basis, Q1 of 2007 transport revenue of $191 million increased 21% as Krish mentioned from $159 million in Q4 of 2006 due to stronger sales of Tellabs’ 5500 systems to the other major North American wireless carriers. North American wireless customers accounted for approximately 65% of all transport revenue in Q1 of 2007 compared with 50% in Q4 of 2006.

Looking at the Tellabs 5500 cross connect business specifically, we shipped approximately 2.4 million T1 equivalents in the first quarter of 2007, up from 1.8 million T1 equivalents in 4Q06.

In the first quarter of 2006, we shipped approximately 2.8 million T1 equivalents. About 36% of this course requires (inaudible) about 5500 system revenue came from new systems, system expansion and software upgrades, with the balance of 64% consisting of port card on our installed base. The new system percentages are consistent with 4Q06 and 3Q06.

At the end of the quarter, 20% of the card slots in our installed base were open, this compares with 20% at the end of last year and 21% at the end of Q1 ‘06. Driven by the lower level of Tellabs’ 5500 revenue, transport segment profit in Q1 ‘07 was $111 million compared with $123 million in Q1 ‘06.

Looking at the service segment, for the first quarter of 2007, services segment revenue was $42 million which is up slightly from the comparable period in 2006. For the first quarter of 2007, service segment profit amounted to $10 million versus $11 million in the comparable period of 2006. The modest decline reflects increasing staffing levels to support future anticipated revenue growth.

Turning to overall profitability, GAAP net income for the first quarter of 2007 amounted to $25 million or $0.06 a share that compares with $52 million or $0.11 per share in the first quarter of 2006. Non-GAAP net income for the first quarter of 2007 amounted to $34 million or $0.08 a share. That compares with $65 million or $0.14 per share in the first quarter of 2006. Our non-GAAP net income calculations exclude unitizations of purchase tangibles and equity base compensation expense as described in this mornings press release.

The effect of equity based compensation expense in Q1 ‘07 was $8 million or about 1.2 cents worth of EPS. That would reduce our non-GAAP EPS to $0.07 cents, consistent with how first call and Reuters compile mini EPS in (inaudible). As usual, you’ll find a complete reconciliation of our GAAP and non-GAAP results in this morning’s news release. Our non-GAAP gross margin at 41.5% for the first quarter of 2007 compares with 40.7% in the fourth quarter of 2006. As you know, our gross profit margin is dependent on product and customer mix, which was responsible for the shift between 4Q ‘06 and Q1 ‘07.

Contributing to the modest improvement this quarter was the number of puts and takes including higher 5500 revenue and lower services margin. Trained operating expenses and non-GAAP operating expenses for the first quarter of 2007 came in at $150 million or about 33% of revenue consistent with the fourth quarter of 2006. For the quarter, non-GAAP R&D expenses came in at $81 million and SG&A expenses were $69 million. At $81 million R&D equals about 18% of revenue.

Our tax provision on non-GAAP pretext income for the quarter was $15 million. That makes our effective non-GAAP rate 30%. This rate is lower than our previous guidance, due to higher R&D credits and a shift towards earnings from lower tax geographies. We expect our effective tax rate for the year to be about 30% plus or minus.

Turning to the balance sheet, as you recall in the fourth quarter of last year, we changed our way of calculating our inventory terms.

To give you a better view of our working capital, we are now calculating these metrics using a three month average receivable and inventory balance, which provides a more realistic review of working capital performance. Using this method, turnover was 59 days in Q1 on an apples to apples basis, which is consistent with 4Q ‘06. Inventory turns were 4.9 times versus 5.8 in 4Q ‘06.

Inventory in terms of dollars increased to $210 million from $167 million in the fourth quarter of ‘06. The increase here is primarily related to higher levels of deferred revenue.

CapEx during the quarter was $10 million compared $18 million in the fourth quarter of last year.

During the quarter, we purchased about 2.4 million shares of our stock at a cost of $25 million. At quarter’s end, the actual number of shares outstanding was 437 million, compared to 439 million at the end of 2006. Since February of ’05, we have purchased about 49 million shares of our stock at a cost of $490 million under our previously announced share-repurchase programs.

At the end of the quarter, our cash investment balance stood at $1.301 billion up $1.6 million from the fourth quarter of 06. This increase was largely driven by cash provided by operations offset by the cash used to repurchase our shares during the quarter. Headcount at the end of the quarter stood at 3,800, slightly higher than the level at the end of the fourth quarter. Our book to bill ratio was above one.

Looking at the outlook from what I see in the marketplace, we expect revenue from the second quarter to be up and arranged between 10-15% compared with the first quarter this year. That’s about $500-520 million. As part of the total, we expect to meet the criteria that would enable us to recognize $60-70 million of revenue related to the 7100 ROADM rollout at essentially a break-even margin. Excluding the $60-70 million of 7100 ROADM revenue that I just mentioned, we expect the balance of our 2Q revenue to be flat to down slightly from Q1 ‘07.

We expect gross margin on the balance of our 2Q revenue to be about 40%, plus or minus. That’s consistent with the margin guidance we gave you for the first quarter. We expect our non-GAAP operating expenses to be flat compared to Q1 ‘07 and we expect the effective expensing equity based compensation in Q2 will be about $8 million split between operating expense and cost of revenue.

At this point, we’ll open to the floor to your questions. We’re ready for the first question.

Question-and-Answer Session

Operator

At this time, I would like to remind everyone who will like to ask a question, please press star and then the number one on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster.

Your first question comes from Ehud Gelblum.

Ehud Gelblum - JP Morgan

Hi, guys, thank you. A couple questions if I could. When, as we look at the gross margins for next quarter, X to 7100 you would said it would be about 40% with the 7100, I’m calculating some number around 35% just using a blended average of zero for the most part which leads to a break even for the $60-70 million part and then the 40% for the rest. I want to first make sure that the calculation is correct and then as you move into Q3, since you now have recognition capabilities in the 7100, my guess is that there will be a 7100 component going forward that there was never before and so my guess is that you won’t be at 40% anymore.

I just want to correlate if that’s correct or not because the 40% is for non-7100 revenues, so as we get into the Q3-Q4 and going forward, where we are actually recognizing real 7100, is it right to assume that the gross margin is a little bit less than 40%? We’re on a going forward rate in the 38-39% range now.

And then if you can comment on the 8800, which seems to have been flat now for three quarters as well as copper access and what’s happening there, what your thoughts are on that Krish? That would be very helpful.

Krish A. Prabhu

Let me comment on the gross margins and Tim can add more color. The 7100 revenue recognition is recognition with one large customer. The gross margin is suppressed because there were some free systems that were given as part of training. Also, their early deployment is heating systems which typically go into large (inaudible) with an optical amplifier, rich configuration with very little tributaries or transponders.

As we change the configurations to accommodate more traffic and put more transponders, the margin improves. We’re also doing a major cost-reduction in China on our optical amplifier modules so the blended average of 10-100 becomes a key component of a transport business. We’ll just have to wait and see. It’s too early to tell right now. Tim?

Timothy J. Wiggins

Yeah, I agree with Krish. I think, Ehud, why we don’t provide guidance beyond the immediate quarter, I think the question around 3Q is really a question of mix. We see a number of moving pieces in the business and certainly I think you’re thinking around them, the ROADM is (inaudible), but I think there’s enough moving pieces, that I would come to the conclusion that you drew. It’s really a function of how the business plays out.

Krish A. Prabhu

Let me address the two other issues. The 8800, you said it was flat? I’m not sure….what was that?

Ehud Gelblum - JP Morgan

The broadband data piece has been around $30 million for three straight quarters after being released strong in ‘06, and now it seems to be, I don’t know if stuck is the right word, but at $30 million a quarter.

Krish A. Prabhu

Well it starts out typically low, last year, at this time, the broadband data component was more like $22 million and this year, it is $30 million. Last year, it started out in the first quarter at $22 million and went up to $31 million in the fourth quarter. We have 5-6 very large networks and we see traffic growth in all those networks. We also have a large number of smaller customers and if they put more traffic on it, we will see some growth. Our 8600 product is designed to 3-D network offerings from European OEM players who have won some recent 3-D business. So I’d say, we have to wait and see what kind of momentum we tender this year, but the traction has been pretty good as I mentioned my opening comments.

And lastly, on the independence, we have a plan to migrate the 1000 based 1150. I mentioned in my earlier comments that we have a lot of 1150 trials. Sequentially, the independence access business has flattened out. I think the comparisons that Tim talked about were more of a year on year. I fully expect that we’ll do a very successful transition from 1000 to 1150. We also have deployed some early systems and optimized applications around the combination of 8800 and 1150. So I feel like this configuration will take good root in the independent market.

Ehud Gelblum - JP Morgan

Thanks. Tim, was my calculation on the 35% all in blended, right?.

Timothy J. Wiggins

Yeah, that is actually correct.

Ehud Gelblum - JP Morgan

Thank you.

Operator

Your next question comes from Tal Liani of Merrill Lynch.

Tal Liani - Merrill Lynch

Hi, good morning. I have two questions. The first one is ROADM project. It carries near zero margins, very low margins, and the question is, after being or after suffering from the ONP business, why were you willing to take such a low margin project especially for a new kind of activity and what is the outlook for the margins for this product?

And the second question is, can we discuss the cross-connect nearer term outlook and longer term outlook. What about inventory, all equipment, and with the carriers, and the plans to deploy, what is sort of the outlook for ’07 in your longer term outlook? Thanks.

Krish A. Prabhu

Well, I think I mentioned about the ROADM. The first revenue recognition of the ROADM had several systems that were given for free training systems which were offered to the customer so the margin appears to be somewhat suppressed because of that as well as configurations being more rich around the optical subsystem which includes article amplifiers and knock around transponders tributary. I think it’s a very different business than the ONT business. I really believe it’s not a fair comparison because the cost reduction opportunity on ONT is limited by chip technology and system on a chip kind of technology which just hasn’t matured.

Cost reduction opportunity on the road is tremendous and we have plans where the modem will end up with good margin. We’re just not prepared to talk about specific margins at this time but you can be assured that the margin profile on the modem is going to be quite different than that on the ONTs.

Tal Liani - Merrill Lynch

And Krish, how long will it take you to get there, your sort of target margins?

Krish A. Prabhu

We have plans. First of all the second half of this year, we will be seeing positive growth margins but we will be seeing them as configurations settled down and the mix establishes itself based on traffic. But going into next year, we fully expect some of the margin improvements will start kicking in and they will continue to kick in through out next year.

Tal Liani - Merrill Lynch

The second question about cross connect?

Krish A. Prabhu

Yeah I don’t know what you mean by inventory. We do not have inventory here and we don’t think the customer has inventory.

Tal Liani - Merrill Lynch

Sorry, I meant taking my comment back. I meant specifically access inventory is singular but without speaking about specific customers, what is your outlook for 2007 and 2008?

Krish A. Prabhu

I think the first quarter has been a very good start. It came back nicely after what happened in 2004 because as you know Q4 of 2006 the cross connect was somewhat suppressed. The second quarter, we’ve got to wait and see. We have good backlog but we have to wait and see how the quarter plays out. Quite a lot of our business is also book shift within a quarter.

I think we still hold what we said earlier and we will give you an update at the end of Q2. Our cross connect business will continue to look like what it did in 2006. It may not be as strong as 2006 but it’s not going to be to off from 2006 and I think this is the position we maintained in our prior cause. I think at this time there is no need to correct that.

Operator

The next question comes from Ken Muth of Robert Baird.

Ken Muth - Robert Baird

Hi guys, can you just give us a little more color about the GPond update. When do you think you will be ready to ship the OLT’s and the ONT’s?

Krish A. Prabhu

We have a configuration that’s already in test at the customer and actually has done very well in the first round of testing. To extend when we start shipping this is dictated by changes to the customer has to do on there end, especially in their ID systems, their OSS, and their own plans for cutting over to Gpond. So I can’t comment too much on that, but from our standpoint, we had certain milestones for delivery to the customer and we met those milestones and we continue to be on track.

Ken Muth - Robert Baird

On a quick glance, the independent customers, the tier two, tier three markets that you’re looking at…is that a market that you look to stay in longer term and try to upgrade or is that gotten too price competitive with the players of the world. Is that something that you want to stay in longer term?

Krish A. Prabhu

We actually are committed to this market. The 1150 is a great platform for the market because it does fiber to the curve, fiber to the premise, and fiber to the (inaudible), all for one platform and it talks about fiber to the curve upgrade to fiber to the premise.

We use the same ONTs that we use in our business with the box. We have a very strong competitive advantage when it comes to cost and price. We expect to be in this market. I know that you mentioned two other players but we will not only be price competitive but we fully expect to be able to build upon our declared 1000 base and do a successful transition to 1150.

Ken Muth - Robert Baird

OK, thank you.

Operator

The next question comes from Tim Long of Banc of America.

Tim Long - Banc of America

Thank you. Just two quick ones if I could. First can you talk a little bit about some international opportunities for the 8800, particularly Japan? What are you seeing from the next generation build and what do you think of the opportunity for the 8800 and then just back to the US wireless markets? Just update on your views of sustainability and your outlook on where you think broadband spending should take first access.

Thank you.

Krish A. Prabhu

We do have a pretty large network in Japan and with NTT and that network continues to grow. In terms of where does this go in the future and what additional opportunities there are, we have a road map that looks at enhancement of the product that are somewhat tied to what the market expects with our major customers, one of them being NTT and based on that roadmap, I do believe we will get our shares of opportunities in Japan.

But again, I want to be cautious, I can’t comment on a customers plan to spend money and transition to next generation networking. We have some customers who are more aggressive on that transition than others and I don’t know specifically what the Japanese have in mind nor do I want to comment publicly on their plans.

Further, US wireless carriers are concerned, you talked about broadband, did you specifically refer to the 8800 or were you talking about cross connects?

Tim Long - Banc of America

More on the cross connect front.

Krish A. Prabhu

More on the cross connect front, OK. Our premise on the US market is that our cross connects business with North American wireless carriers are driven by traffic growth and minutes of usage growth. That is still a valid premise based on what we’ve seen on one queue. I think Tim gave you the Q1 equivalent shift, $2.4 million if I’m not mistaken. That’s a very strong number; the most we’ve done in the last five years is $2.8 million.

Again, I think Tim mentioned in his commentary that one out of the four carriers, the business conditions and the business opportunities for us is suppressed. So all in all, I think our premise still holds if the wireless traffic continues to rise because our applications of transition to 3G, we continue to benefit.

The other interesting aspect of our cross connect business is that for several quarters now, the number of new systems deplored in system expansions has remained steady and the number of open slots has remained steady which all bauds well for the longevity of this business.

Tim Long - Banc of America

OK, thank you.

Operator

The next question comes from Marcus Kupferschmidt of Lehman Brothers.

Marcus Kupferschmidt - Lehman Brothers

Hey guys.

Krish A. Prabhu

Good morning Marcus.

Marcus Kupferschmidt - Lehman Brothers

A couple of things I want to go into. I guess first, to talk about the manage access business. Do we still believe the total business should be flat in 2007 or the decline in what you see products more than offsetting the potential growth on the next generation products there?

Krish A. Prabhu

Well the managed access business, the decline was driven by…there are three pieces to it. The decline was driven by the 2300 and the fee is no decline in the 6300 and there was balance by a growth in the 8100. We do have a large product on the 8100 in a developing market which is a substantial piece of the revenue. This particular product is used in wireless backhole applications. That is being replaced by our 8600 and 8800 combination. So I do believe that over time managed access will continue to decline especially as traffic transitions from TDM to IP internet.

You know in 2007, will we see a great decline, our best guess and Tim can add my assessment in 2007 we will see a smallish decline. We have not assumed that the decline is going to be in 2007 but I think in 2008, 2009 and 2010 some of the decline may because of the positioning of the KDM deployed to an IP internet base, as we, under the same management umbrella, use the 8600 to do a lot of what the 8100 does. And so you will see a more rapid decline as we transition from older products to Next Gen products in those years.

Timothy J. Wiggins

Just to add to that, Krish, Marcus, a big piece of the decline that Krish is talking about, comes from the 2300 Cable telephony product which is very light in its life cycle.

Marcus Kupferschmidt - Lehman Brothers

OK, and if I could clarify two other things. Krish commented that the 5500 outlook for the year should look like ’06. I assume he meant the full year sales number. You’re not talking about the seasonal or the quarterly trends, or do you have that kind of visibility now?

Krish A. Prabhu

No, we don’t have that visibility. I was just, to make sure we don’t have any confusion around this, we have stated on all attending investor conferences that the 5500, at least in ’06 and ’07, will be largely…that business will be largely determined by traffic growth and minutes to usage growth, and I think at this time, looking at the first quarter and looking at some underlying trends, I think that premise is still valid.

Marcus Kupferschmidt - Lehman Brothers

Anything you’d highlight in terms for the bookings in the quarter? You said the book to bill was over one?. So, thanks.

Krish A. Prabhu

I’ll let Tim address that if he wants to get into any specifics.

Timothy J. Wiggins

I think it was the broad-based markets. I think as typical, we have a strong (inaudible) also in our service business when we get renewals of service contracts and that also plays into the next.

Operator

The next question comes from John Anthony from Cowen and Company.

John Anthony - Cowen and Company

Morning gentlemen. A few questions. So, I just want to, and I apologize if you’ve already covered this, have you talked about evaluations of the 7100 and other carriers and where you stand with that?

Krish A. Prabhu

No we have not.

John Anthony - Cowen and Company

Well, can you give us an update?

Krish A. Prabhu

Yeah, I wasn’t sure if you had more questions, or if that was the question. OK, we have a few in the wind which we haven’t publicized, and part of the problem is making, in going public, is that we respect our customer’s desire to make that announcement for their time table, and some of our customers choose not to make technology deficient announcements.

So we’ve had that, we have three markets in which this particular product placed. It placed in our box, it placed in what we call a key account which is really part of the independence, but part of it is other than our box in North America, and it also plays today in Latin American markets, and so we are selling in a few markets. We have trials ongoing and deployments that have started and then again, in all these deployments based on the configuration they buy we have a spectrum of gross margin.

John Anthony - Cowen and Company

OK, so I just want to make sure I understand. The $60-70 million in the June quarter of ROADM revenue, that’s specific to one customer. That’s not across the board?

Krish A. Prabhu

That’s correct.

John Anthony - Cowen and Company

OK, so if I look at the demand that’s coming out of the initial customer, is that primarily one by eights or are you seeing a variety of application?

Krish A. Prabhu

No the eight degree ROADM is actually the largest configuration they can deploy and that particular configuration, I’m not even sure, nor do I want to speculate on it because it’s really the customer’s information for them to talk about, but the eight degree and the four degree ROADMs have a higher starting cost, which is advertised over a large number of transponders especially if they fill them up.

We have a two degree ROADM configuration which we call the Nano that actually plays very well in networks, and that’s the bulk of the configuration that we expect all our customers, even the big ones, to have once these networks are built up and that particular configuration has very decent margins, and it also has a very nice cost profile for us. So, those are the configurations that really will start getting deployed once a backboned ring is put in place and we expect the bulk of the business, I’d say in more in a way, to be around that configuration. Up to that point, I think most customers will try to get a backbone ring deployed before they deploy the Nano on their networks.

John Anthony - Cowen and Company

OK. So the backbone is going to be four degree and eight degree ROADMs. When do you expect to have the integration of the amplifier completed on the design?

Krish A. Prabhu

Well the amplifier is an integral part of the optical sub-system and we are doing a major cost-reduction effort on the amplifier. I think its impact will start showing up late this year or early part of next year.

John Anthony - Cowen and Company

Will you actually be shipping product with that late this year?

Krish A. Prabhu

Yeah, it’s a typical cost reduction exercise, much like the work we do with all our products. The customer doesn’t see any difference and we continue to improve the cost because we take our existing design and manufacture it for a better cost profile.

John Anthony - Cowen and Company

Two other quick questions: Operating expenses, how much lower can you go than this kind of 150ish level?

Krish A. Prabhu

Well, I don’t want to speculate on that. The end of the day we could as low as a business model mandates. I think getting talked about how much of it is R&D and how much of it is SG&A and compared to the industry, we are a little high on R&D and maybe a little low on SG&A, and we’ve always used the operating expense. We’ve set the operating expense to a business model. As the business model evolves, we’ll continue looking at the operating expense.

John Anthony - Cowen and Company

OK, and lastly Krish, just looking at the guidance and the implication for the non-ROADM revenue here, June is typically a seasonally strong quarter for you and if you’ve answered this, I apologize, but can you give us a sense for what revenue lines are going to be declining or going to be flattish given the implication if we strip out that ROADM revenue, especially on the heels of kind of the dynamics of your wireless customer base and their spending pattern in the first quarter?

Krish A. Prabhu

Yeah, and I’ll give you a broad-based answer and Tim can add more specifics. We assume that conditions in Tokyo, especially when it comes to purchases made by our two large top tier customers will persist to some extent. We have no evidence that they will, nor do we have any evidence that it has snapped back, but when Tim said the quarter, the business looks, and the core business without the ROADM business looks a lot like 1Q both on margin as well as on revenue, I think what we were saying is that we expect a similar mix. We expect some suppressed conditions with one or two customers who spent a little bit more last year at the same period.

Tokyo, a lot of our business is book-ship. We book business in the quarter and we ship business in the quarter especially with the large number of customers including the wireless customers. So at this point, I think that guidance is about the best we can give as the quarter progresses. We’ll just have to wait and see. And you’re right I think in the past, the second quarter has looked stronger than the first quarter.

John Anthony - Cowen and Company

Thanks guys.

Operator

Your next question comes from Nikos Theodosopoulos of UBS.

Nikos Theodosopoulous - UBS

Yes, thank you. I have a couple questions. The first one is on the ROADM, obviously in the June quarter, you’ve given the preferred revenue. What happens to that product line post 2Q in terms of the revenue and the margins? Will we see it come down another $50-60 million and then have a better margin? Will it come down less cause the big customer will be filling in the (inaudible). I’m trying to get a sense of what happens post 2Q on that product line.

Krish A. Prabhu

Well, we never give product lines specific information and the only reason why we spiked out this particular product is because there is this big wave due to preferred revenue that we’ve been shipping the product for a couple of quarters, and there were certain conditions that we had to get done, and because of the new accounting rules, we couldn’t recognize this revenue until that was done. And that’s the only reason why we spiked this up.

What happens to the margin as we go forward, I think we now have a mix of customers. We have one large customer who is certainly going to build our large networks and start filling these networks as traffic goes up. We have smaller customers in North America and we have some customers in the Latin American markets. We continue to have every good success with this product. I totally believe it’s an industry leading product.

We've showcased that it had some really good price points, cost points, around ROADMs that are only two-degree ROADMs, traffic coming in east and going out west, no drops north or south. And this is going to be the bulk of the applications.

I can't answer any more than that Nikos, for two reasons. One, we don't want to discuss product-specific information, and secondly, I think a little bit earlier, a lot of what we said will have more material effect in '08. Until that time, we just have to watch how the blended margin between this product and the cross connect product looks over the next two quarters.

Nikos Theodosopoulous - UBS

OK, and do you have a 10% customers for the quarter?

Timothy J. Wiggins

Yes, we have three, Nikos.

Krish Prabhu

Three 10% customers, yeah.

Nikos Theodosopoulous - UBS

Three 10% customers, and you're counting AT&T as one inclusive company now?

Timothy J. Wiggins

Yes, that's correct.

Nikos Theodosopoulous - UBS

Not breaking out Cingular or anything like that?

Timothy J. Wiggins

That is correct.

Nikos Theodosopoulous - UBS

OK, and just the last question. This quarter your gross margins were 41%, and next quarter you are saying the gross margin excluding ROADM would be about 40%. And I'm just trying to get a sense of, why would the gross margin ex-ROADM go down sequentially?

Krish Prabhu

It's very mix-dependent. At one of the product spectrum we have the O&Ps, and you're talking about non-ROADM product mix. And at the other end of the product spectrum you have the cross connect, and in fourth quarter we had a certain amount of business, O&P business, and everything in the middle kind of clusters nicely with a little bit of wash and spread. But the two big things are really the cross connect at the high end of the margin spectrum, and the O&Ps at the low end of the margin spectrum.

A lot of our business is book shipped, so we just can't give you any better guidance than that. I think Tim did say that this was similar to what had guided you for the first quarter. We ended up with 41.6% or 41.7%, when we said 40% plus or minus. We'll just have to wait and see how this quarter plays out.

Nikos Theodosopoulous - UBS

OK, great. Thank you.

Operator

Your next question comes from Tim Daubenspeck of Pacific Crest Securities.

Tim Daubenspeck – Pacific Crest Securities

Thank you. First question is around BellSouth and Cingular. Have you seen any change in the last three months in terms of decisions being made, organization kind-of being realigned? Has there been really any change up until, here we are, the 24th of April?

Krish Prabhu

I can't really comment about specific customers. But I think that we made a general comment that the business foundation (inaudible), so with two of our top-ten customers who were involved in a merger, were suppressed for the last couple of quarters, and we have presumed that there isn't any substantial snapback as we look at next quarter. We just have to wait and see what happens.

Tim Daubenspeck – Pacific Crest Securities

OK, and Tim, just to go back to the OpEx question. You guys have done a great job in terms of OpEx control. Is there any strategic discussion about a change in that, in terms of long-term, maybe some pressure to increase R&D, to increase the product breadth, or sales and marketing longer terms to address a market that you're not addressing now?

Timothy J. Wiggins

No, I think that as we continue to look at, “how can we get more done with less?” as opposed to us seeing a wave of additional heavy investments.

Tim Daubenspeck – Pacific Crest Securities

Thank you.

Krish Prabhu

I think, just to add to Tim's point, if there is going to be any change in OpEx, based on what we can see right now, it's going to be where we can look to continue to reduce our OpEx as we try generate more revenue. And that is consistent with the margin decline that we have seen over the last twelve months.

Operator

Your next question comes from Simon Leopold of Morgan Keegan.

Simon Leopold – Morgan Keegan

Thank you. I wanted to first see if you could give me some clarification on the breakdown for the broadband business, summing up the managed access and data, coming up with something a few million less. So if you could just review that.

And then, in terms of trending, we haven't talked too much about the fiber to the curb product. My impression is that that was down significantly in the quarter. And I assume some of that is the pause post AT&T's acquisition of BellSouth, but if you could talk about the trending of that business and your outlook for fiber to the curb products for the full year? Thank you.

Timothy J. Wiggins

Simon, on the breakdown, why don't we take that off line after the call, and then I'll turn the fiber to the curb question over to Krish.

Krish Prabhu

Yeah, the fiber to the curb product, the business that was reflected today, or that was commented upon earlier in Tim's comments, is primarily one customer. So we don't sell that fiber to the curb configuration. We have a little bit of business here and there, but the bulk of it is one customer.

What we are doing, though, is the next generation product based on the same technology, a component-level technology, is the 1150 platform, which is a multi-service access platform that supports FTTC, FTTP, and FTTN. And this particular product is in several trials. We've had some wins that we have not announced, and we fully expect to transition a lot of our IOC base with this product.

So either you think that the trend line for the proper traditions, whether fiber to the curb, or fiber to the (inaudible) will be more obvious as the year unfolds, especially as other customers come on. For the time being, the revenue numbers for FTTC are largely dependent on one customer.

Simon Leopold – Morgan Keegan

And is that one customer purchasing less in '07 than it did in '06?

Krish Prabhu

Don't know yet. I mean, we've talked about the last two quarters as two of our top-end customers have been spending with us. I don't know what they spend with others, but that's what we've talked about, and that's all we can say. Looking forward, I really can't comment, but it depends on what their plans are.

Simon Leopold – Morgan Keegan

Thank you.

Operator

Your next question comes from Cobb Sadler of Deutsche Bank.

Cobb Sadler - Deutsche Bank

Thanks a lot. I had a question on your PON business. I know you don't want to talk about one particular customer, but for North America, when do you think the material cut-over will happen from BPON to GPON? Have one of your competitors had any trouble, and is it going to happen any sooner or later than you originally thought?

Krish Prabhu

I really don't want to talk on behalf of our customers. You'll forgive me because I wouldn't want my supplier to talk on behalf of us, so I'm respecting that. I don't know what's happening with the other competitors. I do believe that our product testing has gone very well.

There's a whole lot of stuff that happens in PON. It's not just the GPON protocol and testing that protocol and the access part of the network. It's also what happens with the video that's distributed, as well as voice, and how it interfaces with the existing voice switches, and how does the voice gateway work, how does the network provisioning work.

We've done a very good job in all of those things, our testing went really well, and I'm very pleased. Now, when does that turnover happen? It's going to be decided by the customer.

Cobb Sadler - Deutsche Bank

OK, and the prices for ONT, as well, is the BPON product you are shipping now reflective of the new GPON pricing?

Krish Prabhu

Yeah, largely, without having very carefully studied it, I think it's safe to say that to a first starter, yeah, the cut in BPON pricing reflects GPON pricing. The impact of that business is somewhat baked into our existing business.

Cobb Sadler - Deutsche Bank

Great, thanks a lot.

Operator

Your next question comes from Brant Thompson of Goldman.

Brantley Thompson – Goldman Sachs

Hi. I was wondering if you could give us an idea of where you see the gross margins over the long term or what your targeted ranges would be. And also, could you talk a little bit about uses of cash flow, and whether or not there are any plans to step up the level of buy-backs, or whether that would be considered a greater level, or their targeted acquisitions are things that would be considered at this point? Thanks.

Krish Prabhu

I would answer the second question. And let me just comment on the gross margins directionally. We have one business that has decreasing margins. Let’s put it that way. It’s the ONT and to some extent the opportunity to cut costs is largely dependent on component level investments, such as system on a chip and those investments need substantial upfront capital investments from whoever wants to pursue it, and that needs substantial volume or at least a line of sight to substantial volumes. So, all that kind of plays into how quickly can we cut down the margin on that particular product.

We are exploring partnering opportunities. We want to see if there are ways in which to partner with someone for the ONT business, whether we can, the two partners can share in the pain as well as in the gain, and we are in some discussions, but it’s too early to give you specifics at this stage.

Outside of the ONT, the rest of the business, we have very active programs to get us to levels that we believe are business model driven gross margins, and we want to be a model-driven gross margin somewhere between 45 and 50% if you take the ONT out of it.

And I really believe there’s a line of sight on every product line to get there, there are active programs we work with sourcing, we work with contract manufacturers, we are working with ODMs, and we are actively working on cost reduction initiatives on targeted high volume modules.

All of that takes a little time, and we won some new deals like the ROADM for example, we got the 1150 business that’s looking very attractive, we’ve got the ONTs, we’ve got the 8800 and the 8600, and I think over the next four or five quarters, our primary focus is to get the margin for that set of products to be in that range that I talked about. Tim, you want to take the question on cash?

Sure. Brant, we’re kind of two years into a pretty active program approaching half a billion dollars at buyback. We’re essentially consuming our free cash flow in share buyback. I can tell you that we’re, and continually to carefully study the options. I think your question about acquisitions that I’ll push (inaudible) which plays into this. We’re certainly studying this very carefully and considering what is the proper capital structure for the business going forward.

Krish A. Prabhu

As far as the acquisitions are concerned, the sharp answer is there is a company out there that we think we’d like to spend our cash on and that would move the needle for us strategically. We’ve actually studied this picture very carefully, and I think it’s also a little bit risky at this state because in a consolidating environment, we also have to take into consideration what our customers want to do with their suppliers and their supply chain. So I think it’s safe to say, other than really small technology acquisitions that plug a gap for us, we are not looking at acquisitions as a means for the use of our cash at this time.

Brantley Thompson – Goldman Sachs

Thank you.

Operator

Your next question comes from Brian Coyne from Friedman Billings.

Brian Coyne- Friedman Billings

Good morning, thanks for taking my call. Just one question. On the 7100, I was wondering if you would talk qualitatively about how you think that’s going to trend in the second half of the year. Do you expect any other large deferrals, sort of like the $40 million deferral that you took last quarter, perhaps not that large, and again, qualitatively, how much lower do you think your normalized run rate in a product ought to be? Thanks.

Krish A. Prabhu

Well, maybe Tim can answer that question.

Well, from a deferral standpoint, we expect to meet the criteria on the large rollout that would allow us to initiate the revenue recognition and once we get to that point, we wish the (inaudible) to continue rather than revenue recognition on a quarterly basis. So, that while there are some other rollouts, that’s the largest one that I see for the balance of the year.

Krish A. Prabhu

What was the second half of the question?

Brian Coyne- Friedman Billings

It was really just about the normalized run rate that you would see in the second half.

Krish A. Prabhu

Oh OK. Again, we don’t like to spike out revenue by product. You can kind of get a glimpse of what a convention that is between $50 and $70 million for a product that we had shipped, and this was an early start so this is one customer and this was over, it’s safe to say, average in over two quarters. So for a run rate, if you’re doing a run rate, we brought in this business to include other customers, necessary smaller customers, we have an existing customer about which we have talked about earlier.

So, you can do the math, it’s a pretty good run rate for a new product. And we feel very encouraged that these networks take route and as more and more traffic gets puts on these networks, there are two degree ROADMs that will act as feeder nodes that pick up the traffic, and we have a very good product coming out that we should be showcasing here very soon. So all in all, going into ‘08, this is going to be a major revenue contributor to the business.

Operator

OK, final question comes from Andy Schopick from Nutmeg Securities.

Andy Schopick- Nutmeg Securities

Thank you very much and good morning. I want to clarify one thing with Tim before I come back to you Krish. On the split of the revenues by geography, North America was 75%, International was the balance. What I thought I heard you say was that International was $111 million versus $103 million. By inference, would I be correct if the splits are on total revenues, I assume they are, as opposed to just product, that North America was about $341-342 million?

That’s correct Andy.

Andy Schopick- Nutmeg Securities

OK. Krish, I wonder if you could comment on which foreign geographies you believe offer Tellabs the most attractive growth prospects at this time and what initiatives the company is putting in place to try to pursue that?

Krish A. Prabhu

Looking at existing success or success to date, we’ve had data products especially the 8800, we have secured some good wins in Europe and in Asia and with that 8600 product, we have continued to generate all over the world which is traditionally what our product line did.

I talked earlier about transitioning that managed access product line more to an 8600 based deployment scenario. But we’re also using channels, especially wireless carriers who are looking for backhaul or wireless OEMs looking for backhaul, and we’re also working directly with wireless carriers so we have several deployments of our data products with a customer and with another we haven’t yet announced.

We don’t have a deployment with them, but we have been selected for deployment with this customer which is in the works right now. So anyway, as I look at our existing data product business, we have a little bit of a road map as to where we can sell value internationally. We don’t want to go into emerging markets and drop the price just to get some business, mainly because it doesn’t conform to our business model. We want to pick the spots where we can sell value.

As we look at our access products and our ROADM products, which are two product lines which we will take internationally, we have to do a little bit of an assessment as to whether we use the same strategy part OEM, part DSLing to tier ones and selling into tier twos where we have a legacy business or do we change that a little bit? It’s too early to tell. We’re looking at what is the timing of these opportunities, especially in access internationally.

Where does that show up? I think it’s more a developed market opportunity rather than a developing market opportunity, and we just need to understand the timing and then see what the best strategy is. But yes, we are cognizant that with the US market having consolidated, those outside the US is of great importance to Tellabs.

Andy Schopick- Nutmeg Securities

Thank you.

Krish A. Prabhu

Alright, I want to thank everyone for your interest in Tellabs and thank you very much. We’ll see you in the next call.

Operator

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

TRANSCRIPT SPONSOR

Do you get frustrated during earnings season? Have you had trades go south because of bad earnings dates? We know what it's like. We’ve been there. We’re Wall Street Horizon and we work with some of the largest firms on Wall Street. Founded by former Fidelity Investments executives, we understand the power of trading on good information and the pain and suffering of trading otherwise. We obsess about earnings and economic events calendars so you don’t have to. Accurate. On time. Guaranteed. Let us help. Get Smart Get Wall Street Horizon. View our Free 30-day trial for investment professionals To sponsor a Seeking Alpha transcript click here.

Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.