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Executives

Tom Scottino

Daniel P. Kelly - Acting Chief Executive Officer and Acting President

Andrew B. Szafran - Chief Financial Officer and Executive Vice President

Analysts

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

Mark Sue - RBC Capital Markets, LLC, Research Division

James Kelleher - Argus Research Company

Simona Jankowski - Goldman Sachs Group Inc., Research Division

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

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Ehud A. Gelblum - Morgan Stanley, Research Division

Michael Genovese - MKM Partners LLC, Research Division

Eric A. Ghernati - BofA Merrill Lynch, Research Division

Tellabs (TLAB) Q3 2012 Earnings Call October 25, 2012 10:00 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 Investor Relations Conference Call. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Tom Scottino, Senior Manager of Investor Relations. Thank you. Mr. Scottino, you may begin your conference.

Tom Scottino

Thank you, and good morning, everyone. With me today are Tellabs' Acting CEO and President, Dan Kelly; and our executive Vice President and CFO, Andrew Szafran. This morning, Dan will review progress across the business and Andrew will cover the third quarter results. After that, we'll open the floor to your questions. Before we begin, I want to say that if you have not seen the news release we issued yesterday after the market closed, you can access it at tellabs.com. I will also remind you that this presentation contains forward-looking statements about future results, performance and achievements, financial and otherwise. These statements reflect management's expectations, estimates and assumptions. The 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 Tellabs' future results is contained in Tellabs' most recent SEC filings. The forward-looking statements made in this presentation are being made as of the time and date of its live presentation. If the presentation is reviewed after the time and date of 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 non-GAAP financial measures and GAAP financial measures can be found on our tellabs.com website and in our SEC filings. Having said all that, I'll turn the call over to Dan.

Daniel P. Kelly

Thank you, Tom, and good morning, everyone. As economic uncertainty continues around the world, we saw customers spending cautiously in the third quarter. Customers are pushing out project timelines, yet they're continuing to invest in key growth areas.

Tellabs third quarter revenue was within our guidance range, at $264 million. On a non-GAAP basis, we cut operating expenses to $97 million and earned $0.02 per share. We generated $10 million in cash from operations. Now, Tellabs is focused on creating a path to sustainable future growth and profitability, which requires 2 steps: Step 1, we're restructuring to lower our costs and expenses. The restructuring that we announced today will affect about 200 employees over the next 5 quarters. We expect this restructuring to generate about $20 million in annual savings, about half from cost of goods sold and about half from selling, general and administrative expenses. Step 2, we're increasing R&D on our next-generation products, which will drive our future growth. That's why we expect our operating expenses to increase by about $10 million in the fourth quarter, compared with the third quarter. We continue investing in Tellabs Mobile Backhaul, Packet Optical and Access Solutions, which are growth markets where we have differentiated solutions.

Now I'd like to review our third quarter progress with you. In our Optical segment, we're making progress with our products and customers. During the third quarter, we conducted several customer demonstrations of our new 100-gig capability on the Tellabs 7100 Optical Transport System. In a field trial, we successfully turned up a 1,200 kilometer span. We're working towards customer deployments on our new 100-gig module in the fourth quarter. We are also conducting a proof of concept test for a data and optical cloud ecosystem in support of Software-defined networking applications. We've broadened our customer base for Tellabs Packet Optical Solutions. For the first time, more than 1/3 of Tellabs 7100 and 7300 revenue came from outside North America in the third quarter.

During the quarter, we added 9 new optical customers for the Tellabs' 7100 and 7300 systems, including wireline carriers, mobile operators, power utilities and providers that deliver enterprise and Mobile Backhaul services. Our customers continue to buy and deploy the Tellabs 5500 system, one of the most successful products in telecom history. Over time, customers have bought more than $10 billion worth of Tellabs 5500 systems. But today, the lion's share of Tellabs revenue comes from our newer products. Today, the Tellabs 5500 generates about 5% of our overall annual revenue.

In the Data segment, we continued to improve our Mobile Backhaul solutions. We made the latest system release for the Tellabs 8600 smart routers generally available last month. Customers like our new release because it gives them a smooth transition to LTE. We've already shipped thousands of our new Tellabs 8600 Ethernet modules to more than a dozen customers. Our new Ethernet modules offer customers up to 80% cost savings. We also completed multiple customer upgrades with the new switching module for the Tellabs 8800 smart router. Our new module provides more bandwidth, capacity and processing speed, which enables one of our Tier 1 customers to offer new, cost-effective layer 2 business services, such as virtual private LAN and point-to-point Ethernet services. During the quarter, we added 9 new data customers for the Tellabs' 8600 and 8800 smart routers, including mobile, wireline and enterprise customers. And we continued working closely with multiple customers to bring the new Tellabs 9200 smart routers into their networks where they already used the Tellabs 8600, 8800 and 8000 systems.

In the Access segment, we made progress on Tellabs Optical LAN solution. We announced the new Tellabs 120 Mini ONTs, which shrink optical network terminals so they fit into a wall outlet or cubicle raceway. These new ONTs make our optical LAN solution even more competitive with traditional, active Ethernet LANs. We expect our new ONTs to ship early next year. Tellabs Optical LAN costs less up front, offers higher security, uses less energy and takes far less space than traditional active Ethernet LAN. During the third quarter, we added 2 new Access customers.

Going forward, we're transforming Tellabs' business model to create a path to sustainable future growth and profitability. First, we're reducing costs and expenses. At the same time, we're investing in next generation Packet Optical, Mobile Backhaul and Access Solutions. We're confident that our portfolio will continue to offer what customers need to succeed. Looking to the fourth quarter, we expect revenue of $240 million to $260 million; gross margin of 40% plus or minus one or 2 points; and operating expenses about $10 million higher than the third quarter, as a result of our investments in next-generation products. Now to share more details on our third quarter results, here's Tellabs CFO, Andrew Szafran.

Andrew B. Szafran

Thanks, Dan, and good morning, everyone. Let's take a look at the third quarter numbers on a sequential basis. Revenue in the third quarter was $264 million compared with $288 million in the second quarter. On a geographic basis, revenue from customers outside North America was $138 million in the third quarter, compared with $150 million in the prior quarter. While we saw a significant sequential revenue growth in Asia-Pac and essentially flat revenue in Latin America, that solid performance was more than offset by weakness in Europe. All told, customers outside North America accounted for 52% of our third quarter revenue.

Revenue from customers in North America was $126 million in the third quarter. That compares with $138 million in 2Q. North American customers accounted for 48% of total revenue in the quarter. On a GAAP basis, we recorded a net loss of $4 million, or $0.01 per share, in 3Q. That compares with net loss of $5 million, or $0.01 per share, in the second quarter of this year. On a non-GAAP basis, net earnings in the second quarter were $6 million, or $0.02 per share. Again, consistent with what we achieved in the second quarter.

Now let's take a look at the segment data on a sequential basis. Optical revenue was $108 million in 3Q, compared with $122 million in 2Q, as we saw sequential revenue declines across the segment. Optical profit, driven primarily by the lower level of segment revenue, was $24 million in 3Q compared with $29 million in the prior quarter. Revenue for the Data segment was $66 million compared with $78 million in the prior quarter. Increased revenue from our 8800 smart routers was offset by lower revenue from 8600 smart routers and our 8100 Managed Edge Systems. Data profit, driven primarily by the lower overall level of segment revenue, was $1 million. That compares with $5 million in 2Q. Revenue in the Access segment was $42 million in 3Q, up about 13% from $37 million in the prior quarter. Access profit, driven by the higher overall level of revenue, nearly doubled from $6 million in 2Q to $11 million in 3Q. Services revenue was $48 million in 3Q compared with $51 million in the prior quarter. At $60 million, services profit was down about $2 million from the second quarter.

So now turning to the gross margin. Non-GAAP gross margin was 39.4% in the third quarter compared with 39.9% in the prior quarter. Our gross margin is highly dependent on product and customer mix. The slight decline in gross margin is attributable to the overall lower level of product revenue.

Now turning to operating expenses. Better control of expenses enabled us to continue to reduce non-GAAP operating expense on a sequential basis. Non-GAAP OpEx came in at $97 million in 3Q, compared with $106 million in the prior quarter. Non-GAAP R&D expenses were $53 million in 3Q, down from $57 million in the second quarter. Non-GAAP SG&A expenses were $44 million, down from $49 million in the prior quarter. As we announced yesterday, we will restructure the business to reduce costs of goods sold and sales, general and administrative expenses by about $20 million annually. This restructuring is designed to enable us to increase R&D on next-generation platforms, with a near-term goal of maintaining nominal, non-GAAP profitability and positive cash flow from operations. As a result, we expect quarterly non-GAAP OpEx to run on an ongoing basis at about $10 million higher than the 3Q level, with the caveat that there may be some fluctuations in a particular quarter.

In connection with yesterday's announcement, we plan to take a restructuring charge of about $11 million in the fourth quarter.

Given the economic uncertainty we see and the impact it has on our customers, we believe that these actions will create a path to sustain revenue growth and profitability in the future.

Other income was $2 million, up from $500,000 in the second quarter. Our non-GAAP tax rate of 32% resulted in $3.1 million of tax expense.

So now looking at the balance sheet. Inventory turns were 5.1 in the third quarter compared with 5.0 in the second quarter. At the end of the quarter, inventory was at $101 million, an improvement from $124 million in the second quarter. Capital expenditures were $7 million in the third quarter compared with $5 million in the second quarter. We also returned about $7 million to shareholders via our cash dividend.

We generated $10 million in cash from operations during the quarter. Our overall cash investments balance at the end of the third quarter totaled $942 million, up $4 million from the prior quarter. There was no open market stock buyback during the quarter. The actual number of shares outstanding at the end of the quarter was about $368 million. Employment at the end of third quarter stood at approximately 2,600 compared with 2,650 at the end of the prior quarter. Our book-to-bill ratio was less than 1 on a quarterly basis, but greater than 1 on a year-to-date basis.

So now turning to our outlook for the fourth quarter. Based on our bookings trend, backlog and mindful of current market conditions and uncertainty in Europe, as well as the rest of the world, we expect fourth quarter revenue to be in a range between $240 million and $260 million. We expect non-GAAP gross margin to be about 40%, plus or minus a point or 2, depending on mix. We also expect non-GAAP OpEx in the fourth quarter to be about $10 million greater than the third quarter level, as a result of increased investment in next-generation products R&D. In addition, we expect our non-GAAP tax rate to continue at 32%.

So in conclusion, our third quarter revenue reflects the economic uncertainty that has caused our customers around the world to push out project timelines. Our ability to maintain a nominal level of non-GAAP profitability, while generating positive cash flow from operations, is a result of the actions we have previously taken to reduce our cost structure. Moving forward, the restructuring we announced last night is designed to create a path to future profitability and growth. We continue to transform the company so that we can increase investment in R&D for future growth. At the same time, we have a near-term goal of maintaining nominal profitability on a non-GAAP basis and generating positive cash flow from operations. Now I'll open the floor to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from George Notter with Jefferies.

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

I guess I wanted to ask about where you are at some of these new product initiatives? Obviously, I think new products are part of the story that's going to drive the company forward. Where are we with the 9200 platform in terms of timing? And how do you see that kind of competing in the marketplace, relative to your existing data products and other competing offerings that are out there?

Daniel P. Kelly

George, this is Dan. As far as the 9200 goes, that's in active development at this point in time. Throughout this year, we have been delivering pre-release software loads into key customer labs, as well as doing fairly extensive customer demos of the Tellabs 9200 throughout this year. It will formally be released at the end of the year, with subsequent releases scheduled for later in the year. Our strategy with the 9200 is to build on our success with the Tellabs 8800 and 8600. So our initial market focus is those customers who are very familiar with the Tellabs 8600, Tellabs 8800, as well as the Tellabs 8000 INM, Intelligent Network Manager. They will be our key focus customers as we roll out the product and generate revenue next year.

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

Got it. And then, I'm sorry can you just talk about how that product expands upon the 8600 or 8800 platforms?

Daniel P. Kelly

So it is a much higher capacity product, as well as a fairly unique software architecture, which brings in additional capabilities required by our customers as they expand their networks, specifically around the large LTE expansion that we see taking place over the next 3 to 5 years. So it's a much higher capacity product, much higher density, edge router-focused, mainly for Layer 2 and Layer 3 applications.

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

And then you guys also talked more aggressively about the Access product line, and I understand you got some new products there. I think Fiber-to-the-Desktop or Fiber-to-the-Premise platforms, or ONT platforms. Can you just talk about those? And the Access business is particularly strong this quarter. That was surprising. What drove that? Maybe some more flavor for what you're doing strategically in Access?

Daniel P. Kelly

Sure. So Access remains a very important part of our portfolio, as well as many key customers that have deployed various Tellabs Access products, including the Tellabs 1000, as well as the Tellabs 1100 series of products. We're really focused in a couple of areas in the Access. One is with the newer technology, where we've taken our GPON fiber-to-the-x platform and repurpose that for Fiber-to-the-Desktop application, what we're referring to as the optical LAN solution, which has clear benefits from a cost, size and power perspective over traditional active Ethernet applications. The initial market thrust there has been largely around the Federal government space, where we have taken those products through government certification testing and have successfully deployed that product in various branches of the Federal government. We're also looking at, and we've had some success in the greater enterprise market, as well as we're working on an ecosystem to take that product farther than we have in the past. The other area is we do have a large embedded base of Tellabs 1000 and 1100 at some very large carriers here in North America, and we've invested over the past few years to IP enable that product to deliver a higher bandwidth, double and triple play services over that platform. And we do see opportunities there that we want to continue working with our customers to continue the runway on those products, because of the large embedded base, the innovations we've built into the products, as well as the opportunities in end-customer demand for triple play services.

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

Okay. Oh, and then one last question. I guess I'm wondering at what point the Board winds up making a decision on CEO in terms of kind of keeping you in the role or going out and finding another person externally? Is there some timetable for when that gets settled finally?

Daniel P. Kelly

So that's something that the Board discusses on a regular basis. I can guarantee you, George, that myself and my management team have the full support of the Board. And it's up to them to make the final decision. But for the time being, they have the full faith and confidence in myself, as well as my management team to drive the business forward.

Operator

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

Mark Sue - RBC Capital Markets, LLC, Research Division

Gentlemen, a big picture question. Considering the environment, I can understand the lack of sequential growth in the near-term, yet on a year-over-year basis, the deterioration actually seems to be getting worse. And when it's all said and done, I think your revenue base will be half of what it used to be 5 years ago. And to date, I guess the focus has been to make new products so that customers who eventually buy them and the revenues and margins will eventually get better. Are there other things that you can do aside from operational -- improving operational metrics, strategic initiatives of rethink to kind of turn the business around? Because I think, structurally, I think investors are concerned about the carriers just getting more powerful, and I think everyone is just running faster on a treadmill instead.

Daniel P. Kelly

Okay. Mark, the -- a couple of answers to your questions and comments there. We're constantly reevaluating different ways of taking products to market, as I mentioned earlier, as well as partnerships. Partnerships form a very important part of our business, specifically in areas like Europe, where we do have large global partners. So we're constantly evaluating ways that we can continue those relationships, as well as deepen those relationships, as well as some of the other things we're doing in looking at taking our current portfolio in future innovations that we're bringing to market and moving them into other areas. We certainly see a shift towards more spending in the data center area. And we do believe, at least Phase I from a data center connectivity perspective, we see opportunities, first with our optical platform. And we are working with partners in that space in order to put 1-plus-1-equals-3 type programs together where we can extend our products into more nontraditional areas where there is a fair amount of spend and a fair amount of spend growing. So we're constantly evaluating our partner strategy, our product strategy in order to anticipate and capture the future waves in spending. So we're not just focused on cost. We're focused on the 2 key areas, as far as the Packet Optical and the Mobile Backhaul area, with looking at extensions around partnerships, as well as other applications for those products and technologies.

Mark Sue - RBC Capital Markets, LLC, Research Division

If you had to choose between shrinking the business but improving the margins or trying to regrow the business, with which direction would you be leaning towards?

Daniel P. Kelly

So it's a balancing act. And the challenge that we have in front of us and the opportunity is that we want to grow the business, as well as maintain profitability. So while it's challenging, that's a task in front of us. And that's the task that we're committed to is to maintain being profitable but invest. And as Andrew mentioned in his opening comments, we are cutting costs in certain parts of the business, but we're also anticipating in investing for the future, which is future profitable growth in the areas as stated. So that's why we're cutting in one direction, but also adding back in other directions, investing in the R&D and innovations that we believe we need to grow over the next 3 to 5 years.

Operator

Our next question comes from Amitabh Passi with UBS.

James Kelleher - Argus Research Company

This Jim Kelleher for Amitabh. A question here on your 7100 product. It looks like that was maybe down a little bit, both on a sequential an annual basis. If you could talk about your outlook for the business, if you think this was more of a one quarter blip, and where do you potentially see some incremental opportunities? Also if you think that the recent announcement that one of your smaller competitors is exiting the business might ultimately benefit you down the road?

Daniel P. Kelly

Jim, a couple of questions there around the 7100. So we don't split out the 7100 from our Optical segment. So I think you're looking at the Optical segment, assuming that the 7100 is down sequentially. The 7100 business is strong. It's our largest product line in the company. And we did add new customers in the Optical segment, 9 new customers in the last quarter. So we see that business as strong and as a growth engine for the future for Tellabs. As far as the -- I presume you're talking about someone who just gave out a lot of cash and is divesting their business. There could be opportunities there. We do have some customers that also have that product there. So that is something that we are aware of. And it's something that may be an opportunity in the future to gain more market share.

James Kelleher - Argus Research Company

Got it. And then just one more housekeeping. I'm positive I've missed it, but did you have any 10% customers in the quarter?

Daniel P. Kelly

Yes, we had 2 10% customers in the quarter.

Andrew B. Szafran

One in North America and one in Europe.

Operator

Our next question comes from Simona Jankowski from Goldman Sachs.

Simona Jankowski - Goldman Sachs Group Inc., Research Division

I'm just wanted to make sure I understood the puts and takes of the restructuring and then the offsetting investment in R&D. So, $20 million is going to come out of COGS and SG&A. Is that then offset by a $20 million increase in R&D? In other words, is there a net reduction in cost, or is it just more of a shift? And then just for the follow-up, given that big step up in R&D, can you just give us some idea of what areas of focus you plan to spend it on? And is it still going to be within the same segments of Data Optical and Access or anything adjacent?

Andrew B. Szafran

Simona, it's Andrew. What I would tell you is that the $20 million reduction is split about 50-50 between reducing our cost of goods as well as OpEx. So in the cost of goods side, that's going to help us on our gross margin. The increase in R&D is about $10 million, taking from the reduction in OpEx. And that's just a combination of efficiencies and just running our support functions in a leaner, more efficient fashion. The areas that we're working on are all the areas that we've talked about in terms of R&D. So its broad-based. It's on the 9200. It's on 7100, 100-gig. All of those key product areas for next-generation developments.

Simona Jankowski - Goldman Sachs Group Inc., Research Division

Okay. And then just another quick follow-up was on the 9200 where you gave an update there on the timing of the release of the product. Should we still be thinking about revenues around the middle of next year?

Daniel P. Kelly

Yes.

Operator

Your next question comes from Rod Hall with JP Morgan.

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

So I guess I've got a basic question that I've never asked you guys before, which is to what extent -- you talked about the $10 billion worth of 5500 that's been bought. It's a pretty impressive number. And I think it represents a huge amount of prime real estate in carrier switching offices. And I just wondered if you could talk a little bit about how your new products, or existing products even, leverage that footprint? Are you able to use that rack space, or reuse it, so that carriers don't have to rip and replace? Just wondering if you could talk a little bit about how you leverage that or whether you're leveraging that. It just seems like a pretty valuable piece of real estate and carrier switching offices that you've got there. And I've got a follow-up question to that.

Daniel P. Kelly

Okay. Rod, great -- good question. And the 5500 embedded base represents a 20-year history of working with the largest carriers and small, medium, large carriers mainly in North America. And we value those relationships with our customers very much. And what we have -- it's not just the dollar amount that matters. What really matters is the 20-year history of collaboration with those carriers and providing a very high reliability carrier class solution there. So that's first and foremost. The second is more of an operational issue. And yes, an obvious place to sell the 7100 and where we've been successful is where we have a long track record of successful deployment of the 5500. And many of the largest 5500 customers are 7100 customers today. There's more that we can convert and add to our customer relationships with the 7100 and we're working that every day. But some of our largest customers of the Tellabs 7100 also represent some of our largest 5500 customers. So it's certainly what we've been doing over the last 5 or 6 years, is building on that relationship and being able to integrate the 7100 solution into their networks as well. So there is a lot of opportunities there still in front of us, and we're pursuing those opportunities today. We've won new business. And I can tell you in one case for a Tier 2 carrier in North America, we won the business. And a significant part of that was our long history of collaboration with that customer, as well as the ability to leverage the 5500 with the 7100 to win new business.

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

Yes. I'm just trying to -- Dan, I guess anybody that's had any experience in planning in these central offices knows that it's a lot more than just products. I mean, it's about power, space, et cetera. And so I've seen other vendors leverage chassis deployment. So in other words, the chassis is not ripped out and replaced by a new chassis. They're reusing the old chassis. And maybe that's not possible with the 5500 bugs. I'm just wondering if there is any way to leverage those chassis that are already out there to install new equipment, so that maybe carriers don't see it as much -- don't see as much friction with your solution as opposed to other competitive solutions they might consider?

Daniel P. Kelly

Right. So as far as reclaiming chassis, they are different products. In some cases, when you look at a 7100 and what's done on a transponder module with an add/drop multiplexer, there are certainly capabilities there that are similar to some of the capabilities within the 5500. The 5500 is a lot -- wideband, very dense, scalable Digital Cross-Connect System. What we've really done on the 5500 is, over the last few releases on the 5500, we did introduce new switch core as well as new port shelf complexes for the 5500 that really extended the runway for our customers on those products, significantly reduced the cost per T-1 equivalent, as well as gave higher density. And we allowed our customers to reclaim lots of floor space through the innovations on the 5500 with the higher-density switch core complex, as well as higher-density port shelf complexes.

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

Okay. And then I just wanted to come back to the question on the 7100. Was their revenue down or up? I'm trying to just check that one-off. It looks does like it had to be down for the Optical Revenue to be down the way it was? Is that correct?

Daniel P. Kelly

So Rod, we don't split out the 7100. It's part of the Optical category. As I said earlier, we did add several new customers with that space. And we do -- it is our largest revenue product in our portfolio. And we see that business as steady and growing.

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

Okay. And then I guess you're not willing to give us a directional move on 8800 and 8600 either?

Daniel P. Kelly

That is correct, Rod.

Operator

Your next question comes from Simon Leopold with Raymond James.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

I wanted to just first go back to the restructuring question and see if we can just get that to be very simple, given the number of moving parts. You were pretty clear about the sequential increase in the December quarter. And I guess what I'm trying to get my hands around is, really, how to interpret the $20 million in annual savings. So can you give us some sense of what you expect the operating expenses will be in your March '13 quarter after all the job cuts are finished, and how you expect to exit the year? And the reason I'm asking about exiting 2013 is, I guess, the language talks about the restructuring continuing through the fourth quarter of '13. So I'm just a little bit of confused as to what goes on after this.

Andrew B. Szafran

Yes. Okay, Simon. It's Andrew. We just gave guidance out one quarter. And I think what we've stated is that we expect to be about $10 million higher in expenses, overall. And you have to realize that we're continuously iterating on our expense base. I think we've done a very admirable job in lowering our expenses and demonstrating our capability to do that. It's a conscious decision at the same time to reinvest a portion of those back into our research and development. But we're not really giving guidance for next year at this time.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Okay. But if you don't want to give us specific numbers, it's still I think somewhat's confusing because you're raising expenses sequentially by $10 million, which could be $40 million incremental through the year. And then you're essentially cutting expenses. It doesn't really look like you're changing your cost structure here. And so maybe I think I'm not the only one confused by this.

Daniel P. Kelly

Simon, I understand that. I guess I would like to add a couple of points, adding on to what Andrew said. When we manage our expenses, as you've seen that we've done fairly aggressively over the last 1.5 years, you can take costs out of the business without putting it into a restructuring. So there's ways to drive costs down. So just looking at the restructuring, I know it goes into the model, but it's not the only piece. And we'll be able to have better visibility and share more details on the next earnings call for Q1. But, for example, there's cost in the business that we can take out by managing different parts of our operating expenses that don't necessarily go into restructuring.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Okay. Well, maybe shifting gears to a different topic, then. If we can get an update on your progress with bringing 100-gig to market as being generally available, update on the timeline and then how material do you think that is as an element for fueling growth in 2013?

Daniel P. Kelly

As mentioned at the last earnings call, we are engaged with customer testing and it's progressed very well over the last 90 days since we last talked. We have one large carrier that we focused on as our first customer that will go live with the 100-gig. The technology, the software, et cetera, has been in their lab for the past few months and the testing has gone extremely well. We've also done intensive lab testing with other customers and demo testing with other customers. We do expect to have a customer with live traffic by the end of the year. As far as looking into 2013, if we look back to the 40-gig adoption -- and I know some people are predicting maybe 100-gig may go faster, we don't believe it will be a huge revenue contributor in 2013. But where it's important is when you -- to win new business and it's an important part of our portfolio. It's not the only piece of our portfolio. There's other innovations and feature sets required there. But we do see it being rolled out in 2013. But I don't think it will be a large revenue source in 2013. This wave will last for many years and we're just at the beginning of it for where Tellabs is positioned in the metro space.

Andrew B. Szafran

Simon, it's Andrew. I just want to circle back to your first question and just make sure that you're clear that half of the cost reductions are going to wind themselves in our cost of goods.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Yes, I'm okay with that. It's the OpEx line that I'm struggling with. So I'm trying to figure out, do I think about the March quarter as being down by roughly $5 million from the December quarter and sort of flat through the year; if that's the right way to think about it?

Andrew B. Szafran

I think the right way to think about it is at a flat level with the fourth quarter.

Operator

Your next question comes from Ehud Gelblum from Morgan Stanley.

Ehud A. Gelblum - Morgan Stanley, Research Division

Couple of questions. First of all, do you have a sense as to what percentage of your revenues, and maybe we can take it piece by piece, but it's clearly Access doesn't fallen into this category, but which percent -- what percentage of your revenues sells into a wireless-type application, whether it's wireless backhaul or some other type of possibly wireless routing on the 8600 side? Do you have a sense as to what percentage is dispersed by wireless versus wireline?

Daniel P. Kelly

Ehud, we've -- I think we talked about this on the last call and it's an important question. What we see is a fair amount of our data products, specifically the Tellabs 8600, is really focused on the Mobile Backhaul area. So that, you'd certainly put in the bucket where a vast majority of that revenue would fall into the wireless area. Some of it is wireline. When we look at the 8800, supporting business services off the 8800. So the 8800 is a mix. But it's a platform that can support Fixed Mobile Convergence, support business services, as well as Mobile Backhaul, as well as the 9200. When it's rolled out, we'll also support that. So you have to be careful not to classify all of that as wireless or wireline. But majority of our Data business, because of our focus and success over the many years, is Mobile Backhaul. So that would fall clearly in the Mobile Backhaul area, with the exceptions I noted. As far as the other big pieces of our business, the Optical is traditionally more wireline than wireless. But you have to be careful there, because we sell that product to traditional wireline carriers that are offering wholesale Mobile Backhaul services to wireless carriers. In many cases, they're not wireless carriers. So they're offering that out-of-region service to those carriers. So it's really tough to nail down an exact percentage of that. We'd look at that more from an application perspective. And the splits, it's tough to say. But when the general ballpark of what I've stated, majority of the data, applications would be wireless, Mobile Backhaul and most of our Optical portfolio would be more traditional wireline applications.

Ehud A. Gelblum - Morgan Stanley, Research Division

Okay, that's helpful. Then if you went through this year, if you look back at the last 9 months, have you seen patterns of one of the 2 sides doing better than the other, perhaps wireless doing better, or maybe wireline doing better, or maybe wireline falling off? What we see from the outside, I don't want to bias your answer, but we see a much bigger shift towards wireless. And I'm wondering, because you're seeing strength in your 7100, it appears and -- but weakness in your 8800, I'm just trying to get a sense -- is there kind of generalizations we can make with how your major carrier customers are spending their wireless versus wireline budgets?

Daniel P. Kelly

So I would agree with the general statement that the wireless spend is stronger than wireline. But in general, for the 7100, that has not hurt us and we've won business and will continue to win business with that product. And so that dynamic isn't impacting us from a wireline perspective. I would say the one thing, there is more spend in wireless. But we're also seeing the uncertainty and some of the slowdown in spending, specifically in Europe, which has hurt us. And while the macro trend may be wireless is stronger, it's on a relative basis and we read a lot of reports that the people on this call write, and so we agree with the trends. But in the case of the wireline, it's strong. But we do see wireless moving out, even though it appears to be stronger on a macro level than wireline.

Ehud A. Gelblum - Morgan Stanley, Research Division

Okay. First thing is that the last thing you should do is listen to what we all write as a basis. Because it becomes circular because we write what you guys -- what you tell us and so forth.

Daniel P. Kelly

Well. We like to keep up with what you guys are doing, so we do read it but... Well, what's most important is talking to our customers.

Ehud A. Gelblum - Morgan Stanley, Research Division

I like that. A question on your international business. You obviously, internationally, face Huawei a lot more that you would in the U.S. And recently, the U.S. House of Representatives and the Intelligence committee put out some pretty serious comments about what carriers should be doing with their networks with respect to deploying Huawei equipment. Are you seeing that have any effect internationally? Clearly in the U.S., they weren't here to begin with. But internationally, are you seeing any carriers starting to maybe second guess putting their Huawei equipment into their networks and possibly benefiting you because they're fearful of the U.S. Government possibly wanting them to connect their embassies or doing something that in the end would impact those carriers? And so therefore, could you see these actions as actually helping your international business at all? Or is that just kind of a pipe dream?

Daniel P. Kelly

No, it's not a pipe dream. It's a reality. And we certainly want to do whatever we can to work with customers around the world who have those concerns and to grow business. And we, in particular in one market, specifically in Australia, the Australians have publicly stated concerns about bringing some of the Chinese competitors into their networks. And we do see that as an opportunity to gain market share. But we also have to win against the other big competitors that are there. So it's not just because one or 2 Chinese competitors are knocked out, suddenly the door opens up for us. We still got to fight and win business, and we are. And we do see opportunities, at least, in Australia and possibly other countries. But we still have to win business the old-fashioned way against all the other competitors as well.

Ehud A. Gelblum - Morgan Stanley, Research Division

I guess I'm going to ask you a structural question about Tellabs. You're raising your R&D budget to develop new products and grow the company. If you decided that, hypothetically speaking, I'm sure you've done one of these types of exercises, but if you decided not to drive growth, if you decided not to come up with new products and you decided to take the products that you have today and essentially support it and ride the revenue down as low as it eventually gets, to some maintenance level, and legitimately say, "We're not going to develop any new products." What do you think your employee base would need to be to support that? Would that have to be still 2,600? Could it get down to 1,300? Could it get down to 1,000? And what could the OpEx level be if that were to be the direction to go in?

Daniel P. Kelly

So that's a very hypothetical question and, frankly, it's something that we don't spend time looking at. We're committed to driving profitable growth for our shareholders and continuing to win business around the world and help our customers as they advance their networks to the next generation. That's what we're 100% focused on.

Operator

Your next question comes from James Bosch with Dielectric.

Unknown Analyst

I have a couple of questions. The first is, Andrew, you -- unless I misheard you, you said earlier that going forward, we should be expecting that $10 million increase that we're going to see in the December quarter to continue at that level, although with a caveat that there might be fluctuations on any given quarter. So if you're not willing, in a couple of clarifying questions that people asked on this call, to talk about forward guidance beyond December and clarify statement you made before? And then I have a couple of follow-ups.

Andrew B. Szafran

What clarification are you looking for, James?

Unknown Analyst

You said that beyond December, OpEx would be at roughly the same level as in December, which is, I think, around $110 million with the caveat that there might be fluctuations in any given quarter. So is that true? What should we be modeling?

Andrew B. Szafran

I said that we -- about $10 million higher than the Q3 level, so that's not quite $110 million. And with -- and the fluctuations over the near-term are going to be coming in our R&D area, which is a little lumpy. There are certain aspects of the spend, such as prototypes, which aren't smooth expense, okay? So that's clarification on the fluctuations. So that's what we're seeing in the near term. And at the same time, we're continuing to iterate in other expense reductions, with our intent to continually drive down our operating expense. What we've given is our current view on where we're at, the current actions on the restructuring and where things are headed as of our view today.

Unknown Analyst

Okay. So but when Simon and Simona along with me are trying to clarify, how do we come up with some rough model for 2013 in how you guys are managing COGS and operating expenses? Here is my takeaway, and it sounded like from what you just said, which is different than what I gleaned before, that I shouldn't necessarily have this as concrete numbers that I should be modeling. But what I get to is a reduction around 10 -- $2.5 million a quarter in COGS. This is, again, on a quarterly basis, because you gave $20 million and annual reductions in COGS and SG&A split roughly, equally between the 2. So a reduction of roughly $2.5 million in COGS, a reduction of roughly $2.5 million a quarter in SG&A and an increase of roughly $10 million in R&D. So in aggregate, reduction in spend of $20 million from COGS and SG&A, but an addition of $40 million of R&D on an annual basis.

Daniel P. Kelly

James, this is Dan. I understand your need and desire to develop your 2013 business model. We're giving guidance into the current quarter, and we're in the early phases of locking down our 2013 plan. So in some cases, you may be farther ahead than us. But I think what's really important is the stuff that Andrew was talking about is the restructuring that is largely around headcount, and employees' teammates, the 200 people that was in the press release. There's a ton of leverage when we run a business like this that we can push on to manage OpEx. And we are pushing on them. We've been doing that for the last 1.5 years fairly aggressively. So I think we have to be really careful as not just to take the restructuring thing and plug that into your 2013 model. We're working through a lot of different things and a lot of ways that we can cut costs, as we have done over the last 1.5 years, and we'll continue to do into 2013.

Unknown Analyst

Okay. All right. So it feeds into the next question. The reason why it's so important is because we haven't found a floor yet in top line. So what people want to see first, given the kind of a loose range of restructuring going forward, is top line stabilize, so that your commitment to generating positive free cash flow seems more likely to happen, more predictable. Because if $250 million is truly the bottom and we're around $100 million in OpEx, we're going to roughly get to a breakeven level. So I guess the next question then is, why should $250 million be the kind of stabilization floor? How can you give us the confidence, Dan, that $250 million is the floor?

Daniel P. Kelly

So as we've seen over the last 90 days since the last call, we have seen some headwinds and we're reacting to those. And we've seen some slowdown in spend, projects moving out and we're reacting to that. The first thing you saw yesterday was a restructuring announcement. We're still early in our 2013 planning. We've been doing a fair amount of 2- to 3- to 4-year planning over the past 90 days. We're continuing to do that. And we're also looking at not only the reality of the business and some of the challenges we have, but also the growth engines. So there's puts and takes on the top line, and there are puts and takes on the expense side that we're working through, and we're going to continue to work through. So as far as where the floor is, we're more focused on where are we today, what do we see in the short term and what are we doing via other things with partnerships, et cetera, to push the top line, as well as push the OpEx line down.

Unknown Analyst

Okay. And then the last question is how committed are you to free cash flow generation? It sounds like you have different levers to push in terms of potentially reducing OpEx more. I wanted to confirm that if the macro environment doesn't get any better or maybe even gets worse. And then finally, I should say 2 questions then, why not an aggressive share buyback at this level? Your stock was trading at around cash. Where do need it to trade to aggressively buyback stock?

Daniel P. Kelly

So what was the previous question? I'll take that one. I understand the share repurchase. The previous question?

Unknown Analyst

The level of commitment to free cash flow.

Daniel P. Kelly

Oh, okay. So thank you. We have many levels of commitment that we're driving the business to. One is profitability, one is free cash flow, another is investing for the future to drive profitable growth. So we don't have just one goal. We have multiple goals. It's a -- there's many constraints and many variables that we work with on a day-to-day basis. So we are committed to that as one of many goals for the company. As far as the share repurchase, that is reviewed on a quarterly basis by our Board of Directors as they met this week. And it was decided to not resume the share repurchase previously authorized.

Unknown Analyst

Okay. If the operating business is basically being valued at 0, what is more potentially accretive if you think you're going to be profitable than a free business that we think is going to get, hopefully, more profitable over time? How is that decision not to resume the stock buyback responsibly made? If shareholders are going to buy back or buy stock at free, it seems pretty compelling to me, why wouldn't we do it alongside the company?

Daniel P. Kelly

So this issue is reviewed on a quarterly basis by our Board of Directors. And at the last Board meeting, it was decided not to resume the previously authorized share repurchase. And that decision gets reviewed on a very regular basis by our Board of Directors, who are very conscious of not only that issue. They're there to represent the shareholders, which they do. And it is reviewed and discussed on a regular basis by the Board of Directors. It's a very high-priority question that they do spend time on with thoughtful deliberation.

Operator

Our next question comes from Michael Genovese with MKM Partners.

Michael Genovese - MKM Partners LLC, Research Division

Can you just talk about any strategic options as you talked about the share buyback decisions that you make and review on a quarterly basis? How about strategic directions? Are -- is selling the company or selling pieces of the company something that you are considering? How does the fact that Nokia Siemens networks also or does seem to be for sale? Does that change the calculation there? Any comments, any further comments on the path Sycamore took kind of shutting down operations and returning the cash? Any other strategic options that are on the table at this point?

Daniel P. Kelly

Tellabs is 100% committed to being a stand-alone public company. As far as with other companies are doing in our space, we take a look at what's going on. I think comparing Tellabs to Sycamore is not a valid comparison. And our goal is to remain a publicly-traded, stand-alone company that's developing products to help our customers as they expand and grow into the future. And that's what we are 100% committed to.

Michael Genovese - MKM Partners LLC, Research Division

Okay, so that's a very clear answer. So as a follow-up to that, I mean, when I look across -- I'm just estimating, but when I look at you in optical, metro optical, and I look at you in routing, probably globally in fiber access, you've got a bunch of products that are at about 5% market share. And in this business, 5% market share doesn't get you anything. That's not scale. So which of these areas, or is it all of them, are you going to -- which of these areas can you conceivably get to 20% market share? Because that seems to be, for these telecom equipment markets, kind of the minimum scale that you need to be to actually be a long-term viable competitor deal? Or do you disagree with that? And what areas should we think about you growing market share in? And do you think that you can actually have a scale business at sub-10% market share?

Daniel P. Kelly

So first of all, Mike, I don't necessarily agree with your numbers as far as market share. So let's just agree to disagree there. We are cognizant of the fact that scale is very important. And there's different ways to get scale, both organically as well as inorganically, which we are continually evaluating there. Our 2 main areas in where we spend, I believe I've said in the past, around 90% of our R&D, is in the Data, Mobile Backhaul areas, as well as the Packet Optical area. That's where most of our investments go. We have a track record of producing competitive products and winning market share with Tier 1 and Tier 2, Tier 3 carriers around the world, which we're going to continue to do. In the Access area, we have a more focused strategy, building on our embedded base in North America, as well as on the new Optical LAN solution, but we are not, with the exception of a couple of markets, we are not a global Access player. We are focused Access player that has 2 very capable platforms with some interesting opportunities, both in North America, around our embedded base as well as around the Optical LAN solution. So really, where we're focusing our R&D dollars, where we have won business, where we have shown that we can win, we're going to continue to focus. But we also -- I will also agree with you that scale is a very important factor. And it's something that we're evaluating continuously, making sure we have the right focused portfolio and applications, but also looking at inorganic as well as organic opportunities to increase scale. I do agree with you, scale is very important.

Operator

Our final question comes from Tal Liani with BOA Merrill Lynch.

Eric A. Ghernati - BofA Merrill Lynch, Research Division

This is Eric Ghernati for Tal. Just a clarification. You said earlier that your focus is in immediate attempt to generate like a nominal non-GAAP profitability but, call it like, $250 million revenue, and you've got it for $106 million OpEx on a run rate basis. That seems unlikely. What are we missing? Is it the restructuring or is there something else?

Andrew B. Szafran

I think what we've said is, that's our goal, is to be nominally profitable on a non-GAAP basis. We've did give a range of revenue.

Eric A. Ghernati - BofA Merrill Lynch, Research Division

Sorry, the -- but again, like it's $106 million, $0.40 gross margin. The math just doesn't work, just using the midpoints?

Andrew B. Szafran

I think -- yes, using the midpoints, you can do the math. But there is a range. We give a range for reason.

Eric A. Ghernati - BofA Merrill Lynch, Research Division

Okay. The second question, the last time you -- on the call, you said that you saw your gross margin at 40% as sustainable for the foreseeable future. Now I'm just looking to your subsequential ads like kind of, is that -- should we assume like 41%, 41.5% is the right number? Or is 40% -- are you standing by your comments from the last call?

Andrew B. Szafran

We're saying 40% with a range of plus or minus 1 or 2 points. It really is highly dependent on what products actually ship and that's what drives it.

Operator

There are no further questions. I'll turn it back for closing remarks.

Daniel P. Kelly

Thank you. We've talked about a lot of things today, and here's how I'd sum it up. The reality is that the global economic weakness has translated into slower customer spending. Our customers still plan to go forward with projects and they need to upgrade to new technologies such as LTE, but they'll do so on longer timelines. We have to adjust to adjust to that reality. Going forward we're transforming Tellabs' business model to clear a path to sustainable future growth and profitability. We're reducing costs and expenses. At the same time, we're investing in next-generation products that customers need to succeed. Last quarter, we added 2 new customers -- 20 new customers to the Tellabs solutions. I'm confident that we got the right team and that we're on the right track. I'd like to thank everyone for being here today, and I look forward to seeing you on the next call.

Operator

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

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