Tellabs Inc. Q4 2005 Earnings Conference Call Transcript (TLAB)

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Tellabs Inc. (NASDAQ:TLAB)

Q4 2005 Earnings Conference Call

January 26th 2006, 8:30 AM.

Executives

Tom Scottino, Senior Investor Relations Manager

Krish Prabhu, Chief Executive Officer and President

Timothy Wiggins, Chief Financial Officer and Executive Vice President

Analysts

Brant Thompson, Goldman Sachs.

Gina Sockolow, Buckingham research

John Anthony, SG Cowen & Co

Alex Henderson, Citigroup

Nikos Theodosopoulos, UBS

Ehud Gelblum, J.P. Morgan

George Notter, Jefferies

Markus Buchner, Lehman Brothers

Tim Long, Banc of America Securities

Simon Leopold, Morgan, Keegan &Company, Inc

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Tellabs Investor Relations Conference Call. During the presentation all participants will be in a listen-only mode, afterwards we will conduct a question and answer session. At that time if you have a question please press “1” followed by the “4” on your telephone. As a reminder this conference is being recorded Thursday, January 26th, 2006. I will now turn the conference over to Tom Scottino. Please go ahead sir.

Tom Scottino, Senior Investor Relations Manager

Thank you James and good morning everyone. With me today are Tellabs President and CEO Mr. 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 that at www.tellabs.com. Before we begin, I would remind you that certain statements made on the call today maybe considered forward-looking. I direct you to the risk factors contained in today’s news release and then the reports filed by Tellabs with the Securities and Exchange Commission. Having said that I will turn the call over to Krish.

Krish Prabhu, Chief Executive Officer and President

Thank you Tom and good morning everyone, and I welcome to our earnings call. We recorded our 4Q results today. Revenue came in strong, driven by cross connects, access and data products. We also had gross margin that came in above guidance. We were successful in holding operating expenses under control. The net results was strong earnings $0.20 EPS on a GAAP basis, $0.22 EPS on a non-GAAP basis. All in all a very satisfying quarter.

Tim Wiggins is going to walk you through the details, so I won’t go into that. Instead, let me take little time to reflect upon 2005 and to give you some sense of what we’ve seen in 2006. When we acquired AFC in late 2004, the consensus view was that it was a good move in the long run, but potentially painful in the near-term. So in 2005 we stayed focused on insuring that the FTTP program at Verizon was back on track and likewise with the FTTC effort at Bellsouth. The fruits of this labor is reflected in a strong momentum in access revenue during the year. We also successfully transitioned to a newer version of the ONT product. This is the product that we acquired from Vinci, because the AFC’s ONT product had significant losses associated with it.

By doing this transition on plan and on third quarter of last year, we managed to maintain our earnings potential and subsequently we saw both in the third quarter as well as in the fourth quarter improving gross margins. We extracted significant operational synergies; Tim Wiggins will detail that and give you a little more color on that. So when we compare 2004 and 2005 and you take the full P&L of AFC in 2004 and Tellabs in 2004 and compare that with 2005 revenue grew 13% and operating profit grew nearly 50%. This to me is a significant accomplishment and then I am very proud of what our teams at Tellabs has achieved.

On the data front, we more than tripled our year-on-year revenue and earlier in the year we had stated our target of trying to achieve $60 million annual revenue level, we did achieve that, and we came in with $30 million of whereabouts for data products revenue in the fourth quarter.

After our earlier debacle with one of our customers in Europe, our sales team worked very hard to ensure that projects that we were working on that successfully delivered and executed to and this reflects in the $30 million revenue we gained in the fourth quarter.

Internationally our managed access products grew 10% year-on-year, and lastly our cross connect revenue grew double-digit between 2004 and 2005. Let me spend a few minutes on this because lately there had been some notes or some speculation as to whether this is poised to decline. When we look at our deployed cross-connect base and when we look at shipments and we give you color on what we ship each quarter, Tim will give you that in the course of his presentation. We try to reflect the number of port cards to be shipped. We tried to convey, how many systems that had already deployed in the field grow, so that they grow the size of the systems, so that they can expand that kind of the more capacity, we also conveyed the amount of new systems we ship out.

So, when you look at all that and try to measure it in the context of what seems to be a good independent variable, the number of T-1 lines or equivalent T-1 lines shipped, that number grew more than 10% between 2004 and 2005. This is a good indication of the underlying demand, traffic demand on the network and to me it's very satisfying especially knowing that in 2004 we had a large build out at Verizon wireless. Tim Wiggins will give you little more details, specific detail on that.

As we get into 2006, we expect to continue to build upon the moment in access and data, and we expect continued good performance in transport and managed access. Our expenses are in check and we continue to work towards achieving our target gross margin of 50%. Here the trend over the last four quarters has been very good. We will look for more opportunities to partner, especially internationally. Our three growth platforms: the 1000 family of accesses products, the 8000 family of data products, and the 7100 DWDM product are all designed for international market applications. I will handover to Tim now and I will come back to answer to your questions. Tim.

Timothy Wiggins, Chief Financial Officer and Executive Vice President

Thanks Krish and good morning. As Krish mentioned at the top of the call, vigorous customer demand for broadband wireless and fiber access continues to propel Tellabs’ growth. Total revenue for the quarter was $521 million, up 37% compared with $379 million that Tellabs reported in the fourth quarter of 2004, when AFC was part of our company for only a month.

Compared with the combine results of Tellabs and AFC for the complete fourth quarter of 2004, the $521 million represents a 16% year-on-year revenue growth. For the full year 2005, total revenue amounted to about $1.9 billion, more than 13% greater than the combined revenue of Tellabs, AFC, Marconi and Vinci for all of 2004. And the strength of these results, non-GAAP operating income for 2005 increased 45% to $251 million from $173 million in 2004. On a geographic basis, 4Q revenue from customers in North America amounted to 76% of total versus 77% in the third quarter of 2005.

Transport revenue for the quarter amounted to $170 million, up 8% from $157 million in the fourth quarter 2004. For the full year 2005, Transport revenue totaled $638 million, up 7% from 2004. Wireless continues to a prominent driver for transport sales. For the quarter, wireless customers accounted for approximately 54% of all transport revenue, that’s up 42% in the fourth quarter of 2004. For the full year 2005, wireless customers accounted for 55% of transport sales, compared with 50 in 2004. This translates into nearly 18% increase in transport revenue from wireless customers in 2005.

Looking at the Tellabs 5500 wideband cross-connect business specifically, about 68% of this quarter’s revenue came from port card growth and our install base. With the balance consisting of new systems, systems expansion and software upgrades. That compares with about 69% in the fourth quarter of 2004 and 80% in the third quarter of 2005. We shipped approximately 1.9 million T-1 equivalents during the quarter, up from 1.7 million T-1 equivalent in the fourth quarter of 2004. That’s encouraging to us because it signals our customers continued use, Tellabs 5500 platform to build out their networks. For the full year 2005, we shipped 7.3 million T-1 equivalents versus 6.4 million in 2004.

Revenue from our accesses products amounted to $180 million. That makes four sequential quarters of consecutive revenue growth, since we acquired AFC in 2004. These revenue levels are greater than any ever reported by AFC. Excluding $9.5 million of cost of revenue associated with video bills, bills of fiber platforms at FTTP and FTTC, amounted to 53% of access product revenue in the fourth quarter with the balance being top our access platform. The continuing growth in access and the increase in revenue from FTTx applications reflect our strategic position in the Fiber-to-the-Premise and Fiber-to-the-Curb applications.

For the full year 2005, accesses revenue totaled $617 million, up 29% from the 2004 results of AFC and Marconi. Revenue for the manage access category came in at 91 million versus 122 million in the fourth quarter of ‘04. If you recall, we have a big fourth quarter in ‘04 in part as we are catching up from some outsource manufacturing issues, that prevent us from shipping about 10 million to 12 million of managed access products in third quarter of ‘04.

For the full year of ’05, revenue from managed access category grew 10% versus last year. Revenue in the broadband data category, which includes the Tellabs 8800 Multi Service Switch, and the Tellabs 8600 managed edge system was $31 million, that compares with $3 million in the fourth quarter 2004.

For the full year broadband data amounted to $60 million, more than threefold increase compared with $17 million last year. Overall revenue for the voice-quality enhancement category was down year-over-year, sales for standalone VQE equipment are declining as voice quality enhancement technology is integrated into higher order platforms, such as our Tellabs 5500 wideband cross-connect. As this transition continues, we will include all VQE revenue in the transport category beginning in 2006.

Fourth quarter revenue from services was $44 million, up 8%, from the fourth quarter of last year. Net earning for the fourth quarter amounted to $92 million or $0.20 per share on a GAAP basis, and that compares with the GAAP net loss of $139 million or $0.32 per share in the fourth quarter 2004, and we recorded $187 million in charges including a $102 million in-process R&D charges associated with the acquisition of AFC and Vinci.

Excluding non-GAAP adjustment detailed in the press release, which include things like purchase, in-process R&D and the amortization of intangible, non-GAAP net income amount to $100 million or $0.23 per share on the fully diluted basis.

This represents a doubling from our non-GAAP net income of $49 million or $0.11 per share in the fourth quarter of last year. On a GAAP basis, we earned $176 million and $0.39 per share in ‘05, and that compares with a GAAP net loss of $30 million or $0.07 per share in ‘04. On a non-GAAP basis, we earned $252 million or $0.55 per share in ’05, and that compares with non-GAAP earnings of $182 million or $0.43 per share in ‘04. As usual you will find a complete reconciliation of our GAAP and non-GAAP results in this morning’s press release.

Gross margin was 47.6%, compared with 47% in the third quarter, largely as a result of improved services gross margin. Going into the first quarter of ’06, we expected the gross margin will be in the same range standing of course on product and customer mix.

Turning to operating expenses, non-GAAP operating expenses excluding all charges for amortization and deal-related to deferred stock compensation being at about $152 million or 29% of sales. That compares with $150 million in the third quarter of ‘05, when operating expenses amounted to 32% of sales. For the quarter R&D expenses came in at $85 million, and SG&A expenses were $67 million. That $85 million R&D is equal to 16% of sales.

As we began 2005, we set a target to realize $30 million in OpEx reductions based on the combined 2004 operating expenses of Tellabs, AFC, Marconi, North America, and Vinci. By year-end we have realized more than $50 million in total OpEx reductions. At the same time we set a target to achieve $50 million and above the line margin improvements associated with AFC acquisition in ’05. For the year we achieved above $30 million in margin improvement from both acquisition and non-acquisition cost, and other cost saving initiatives. For the first quarter of 2006, we are looking for non-GAAP OpEx to be up slightly in the mid $150 million range as we complete DRP project and absorb some near-term program cost.

Our target is to have quarterly operating expenses trend modestly down through the course of 2006. Beginning with the first quarter of 2006, we have adopted FAS 123(NYSE:R), under which we will begin to expense stock options. For the last few years, we have been examining our equity compensation plans and evaluating how we can be most effective with this form of compensation. As part of that process, we’ve made changes to our overall compensation program to reduce the amount of equity expense. In 2006, we expect to reduce our annual awards to about 1% of shares outstanding, compared with about 2% in 2005. In Q1 we expect the effect of expensing stock options, we have approximately $10 million in cost for operating expense and cost of goods sold with the majority impacting the OpEx line. Non-GAAP operating income was $96 million in the quarter or 18% of sales and that compares with $68 million or 15% of sales in the third quarter of 2005. For the full year non-GAAP operating income totaled $251 million, that’s up 45% from operating income with the year ago.

Other income on a non-GAAP basis amounted to $5.5 million versus $8 million in the third quarter of ‘05. Our tax provision on non-GAAP pretax income from the quarter was approximately $1.5 million. The tax provision for the quarter, primarily reflects tax and income from international operation, cost acquired the benefit of using net operating loss carry-forwards to largely covered tax and income from domestic operations. It also reflects the benefit of $10 million related to certain foreign tax reserves that are no longer required and were reversed during the quarter.

We have exhausted the financial statement benefit from the net operating loss carry-forwards that largely sheltered us from tax and domestic operation throughout ‘05. As a result, we anticipate that our effective tax rate for the first quarter and the full year’06, will be around 35%.

Turning to the balance sheet, day sales outstanding was 56 days compared with 61 days in Q3, for on due to collection and activity. Inventory turns were up 9.8 times verses 7.6 in Q3 ‘05, inventory in terms of dollars decreased to $109 million from $113 million in the third quarter of ‘05. CapEx during the quarter was $26.5 million compared with $13.8 in the third quarter.

At the end of the quarter, our cash and investments balance stood at $1.190 billion, up $101 million from the third quarter of ‘05. The change here reflects $136 million of cash generated during the fourth quarter, including $36 million generated from stock option exercise reduced by about $35million use for the share buyback program. By the end of ’05, we have bought back a total of $193 million worth of shares under the $300 million program authorized by the board in February 2005.

At the end of the quarter, the actual numbers shares outstanding was $449 million that compares with $448 million at the end of the third quarter as the effect of the buyback was offset by stock option exercise. In light of the increasing option exercise activity, our Board of Directors has approved a new 10b5-1 stock buyback plan as announced in this morning’s press release. Under the new plan, we are authorized to use up to $100 million of cash generated from employee stock option exercises to buyback share. This new plan is in addition to the plan authorized by the Board in February of ‘05.

Headcount at the end of the quarter stood at approximately 3600. Our book-to-bill was over one. Taking backlog in the consideration along with other internal indicators, we expect the momentum reflected in our strong fourth quarter results to carry-forward into the first quarter of 2006. Factoring in the kind of seasonality we’ve historically seen in the first quarter, we expect first quarter 2006 revenues to be in the mid $490 million range, that would represent about 14% increase over the first quarter of 2005.

At this point we will open the floor for your questions, James, we are ready for the first question.

Questions-and-Answer Session

Operator

Operator instructions Our first question comes from the line of Brant Thompson with Goldman Sachs. Please proceed.

Q - Brantley Thompson

Good morning. I was wondering if you could walk through kind of puts and takes going forward to achieving the 50% gross margin target and kind of where we are and some of the product transitions that are driving towards that mix?

A - Krish Prabhu

Yes, Brant, I will give you some color and Tim feel free to chime in. The mix of products that we have today largely determines our gross margin, aggregate gross margin. On the one hand, we have cross-connect products and the managed access products family, which is an international product line and both of them grew quite nicely, more than 10% year-on-year between’ 04 and ’05. That had healthy gross margins generally about 50%. We have access products, the platform side, the OLT of the line terminating, the one that goes into the central office, which has gross margins between 40% and 50%. By the way, our data products: the 8800 and the 8600 also have gross margins similar to the cross connects and the managed access. And then, we have ONT, that in the first launch in’04, especially with the AFC version, the gross margin was grossly negative. We have now managed to make it breakeven and as we look at the next version of the ONT that comes out, we will have positive gross margins and its not clear at this time, the transition from BPON to GPON, how that would impact the pricing as well as the margin on that product line. So, when we factored in all this, we feel fairly comfortable that we are at 47% gross margin that obviously would be better if we sell more cross-connects and more products with gross margin higher than 50%, that will obviously be impacted negatively if there is a large ONT shipment, at least in the near-term till we get the ONTs to better gross margin. Tim.

A – Timothy Wiggins

I would just add to that perhaps is, that we are obviously in a market where there is competitive pressures than, Tellabs competes in those markets and we are in basically its our end products in a deflationary pricing arena. So the other comment I would add is that the cost downs in our supply chain and engineering houses are very important element in addition to the mix that Krish mentioned and pushing our margins higher from where they are today, if they challenge but as long I think we are up for and we will continue to work on.

Q - Brantley Thompson

And if I could just follow-up, any update on when we expect to have an idea of the GPON, DPON decisions in terms of how that’s going to, when that’s going to come out?

A - Krish Prabhu

Yeah, there is open audit fee, and I think the responses are in. We believe that the transition from BPON to GPON is driven largely by desire to offer 100 meg service as supposed to 30 meg service. Exactly, the timing of that transition will depend upon our customer’s ability to market the service and their ability to scale the service. In our assessment, we don’t think it's a technology issue because the transition from BPON to GPON is primarily, the GPON standard accounts for a new link layer protocol and that’s largely offered by chipsets, which are fairly common to all equipment suppliers. It’s more an issue of time to volume rather than time to market and we are fairly confident that given our experience with integrating these systems and the operational systems for the customers, we are very well positioned from a time to volume standpoint. Now, exactly when it’s going to happen? It's really the customers’ call.

Q - Brantley Thompson

Thank you.

Operator

Our next question comes from the line of Gina Sockolow from Buckingham Research, please proceed.

Q - Gina Sockolow

Thank you. Could you just give us an idea of how large your cable business is, and how you view the impact of Cisco’s acquisitions of Scientific-Atlanta on that business?

A - Krish Prabhu

Yeah, thanks Gina. We have negligible cable business, frankly the only cable product that we sold in any volume at one-time was a 2300 product, which in 2005 had declined down to less than $30 million of annual sales. It is one of the products inside our managed access category. We do sell version of the cross-connect, so-called 5500 NGX for Voice over IP applications in cable but those volumes are very small between 1% and 2% of our total revenue.

Q - Gina Sockolow

Thank you and can you also comment on, if you haven’t already, whether there was a service provider type of spending surge at the end of the year?

A - Krish Prabhu

The so-called budget-flush?

Q - Gina Sockolow

Yes.

A - Krish Prabhu

Yeah, I don’t know what a budget-flush is frankly and don’t even know if it's relevant to D&A because what we see is, our customers out they are constrained by their ability to spend capital. They are watching their capital very carefully and that they also have strategic initiatives like fiber or broadband lines, which provide significant pressure on the capital, constraint capital dollar. What we do see is, that there are pain points in the network especially we saw rehabilitation efforts associated with Hurricane activity in the South East with one of our customers. We also saw traffic capacity constraints in some of the networks, which helps our cross-connect sales. So, we are focused more on addressing these network pain points rather than anticipating budget flush.

Q - Gina Sockolow

Okay and lastly, were there any reserves or charges taken on either the income statement or in the inventory or the other balance sheet items for product issues?

A - Krish Prabhu

Yes, we accrue on a quarterly basis for (bad audio) we have cost to come in and costs that are charged against the reserve and that would be included in our footnotes.

Q - Gina Sockolow

Was there anything unusual?

A - Krish Prabhu

No.

Q - Gina Sockolow

No, good, thank you.

A - Krish Prabhu

Thank you.

Operator

Our next question comes from the line of John Anthony from SG Cowen & Co, please proceed.

Q - John Anthony

Good morning guys, congratulations. A few questions, I apologized to be hitting you this. Could you just give us an update on the 8800 outlook for this year, last year you guys obviously made a lot of progress going into more live networks and getting new customers? Will you just give us a little more detail about your expectations there? Could you also tell us whether you have any customers that take both the 8800 and 7100 as of yet in terms of revenue recognition, and if not our folks out there kind of buying into the holistic architecture that you presented between the 8800 and the 7100? And lastly, can you give us an update on the 612-ONT, when you expect to have that out, if we are still on target for that? And that will be great, thanks.

A - Krish Prabhu

Okay, John, again Tim will free to join chime in. The 8800 has seen good traction in the fourth quarter in wireless applications. We have identified a new application where with the transition from 2G to 3G especially GSM networks are going to UMTS networks. There is a need to transition ATM based traffic or carry mixed ATM/IP traffic. And our 8800 is ideally suited for such multi-service applications. This is a category that we think, is a gross category for us and we expect to take this application to several customers in 2006. It’s too early to guide you as to what kind of revenue growth will come out of it because sometimes these sales cycles takes some time. We also have in drop our ability issues and we also have customer acceptance test in the constraint. But this is a significant development that occurred in the fourth quarter and I am very pleased personally that we did manage to get a couple of applications and record the $30 million revenue. On the other hand, the 8800 is also seeing good application in converged packet architectures, this is the time that a long-distance carrier would use especially as they handle wide area networking needs of their enterprise customers, with one large long distance carriers in the US now, of course part of our outbox. We have nearly 30 cities where this equipment has been treated. We also have a more or less similar application in defense. So, as we look into 2006, we believe that this category of applications has now hit time to volume and I do believe that, it will be driven more by the customers demand for transitioning their networks onto this converged packet architecture.

A – Timothy Wiggins

On the 612-ONT, before that let me address the mix 8800 and 7100. We do believe that, as vary or more same to the fixed networks, the primary module for transport is going to go transition from T-1 or DS3 or STS or SONET chunk is going to transition into Ethernet. Our 7100 product, which is a Roudem (ph) or DWDM product, is optimized for Ethernet transport. And we do have the capability to inter-operate with the 8800 and use its ability to grew Ethernet traffic. So we think an 8800, 7100 combination is going to be tomorrow’s answer to yesterdays SONET ATM's and SONET cross-connects. In that context, we are aggressively positioning this product portfolio or this product pair with not many of our customers starting with large and even well-operating companies share in the US. I think 2006 will be more about getting our customer comfortable with this transition and getting our customer to deploy this in small amount. And if we are successful in doing that in 2006, I think we will see a good revenue ramp in 2007.

A - Krish Prabhu

On the 612-ONT lastly, our plans are to transition to 612 mid year. We have aggressive cost reduction goals, but as I mentioned earlier, this transition schedule will be to some extent dependent on the customers’ own transition plans to incorporate GPON in their network. We do believe that transition from BPON to GPON is likely going to happen after we’ve transitioned to the 612 for BPON applications.

Q - John Anthony

Okay great, one last follow-up for Tim. Tim, where do you think you can scale revenues before you have to meaningfully add to overhead?

A - Timothy Wiggins

I think, we got a – I mean maybe Krish can answer that. I don’t see any immediate need to add overhead and particularly as you look at our cost behavior SG&A and OpEx cost. So I see, we have a quite a bit of room at this point, John.

A - Krish Prabhu

I agree, Tim, I think our revenue can scale on the strength of our momentum as well as the competitiveness of our newer products: the access products 8000 family and the 7100. And we don’t really need to increase our OpEx either in R&D or in SG&A for that. We are very focused on trying to improve margin, get our gross margins to the 50% level, and there we are very closely working with the supply chain as-well-as the cost reduction efforts that Tim talked about earlier.

Q - John Anthony

Terrific, thanks guys.

Operator

Our next question comes from the line of Alex Henderson with Citigroup, please proceed.

Q – Naik Jagadish

Great, thanks a lot. This is Naik Jagadish for Alex. I want to take down a little bit on to the transport segments. So first question in the fourth quarter, can you give us an indication of the performance of the DWDM products: 7100 and 7200, as well as comment on the outlook there for 2006?

A - Krish Prabhu

We don’t really try to spike out products within a particular product family and as you can appreciate its for competitive reasons. This is a public forum after all, but the 7100, we don’t have a 7200 product, it’s a 7100 product, which is also a product in the transport family. And that product year-on-year saw nearly, saw better than 50% growth. So, we are very encouraged with the traction that product’s getting and of course we have announced earlier that we are in negotiations with Verizon to finalize the contract and get this product at least in some of their applications. What’s the other part of the question?

Q – Naik Jagadish

Well, the second part of the question is that, in terms of the 5500 what’s shipping today, can you give us an idea of what percentage of systems and ports are going out enabled for Ethernet transport, maybe how that looks different, differently between the wireline of customers and the wireless customers. Maybe your expectations for Ethernet on that going forward or maybe talk a little bit of how you think, Ethernet may or may not keep the 5500 to be a relevant products in 2006 and 2007, or whether a more sort of routed IP solutions that you are talking about earlier might start to eat in to the 5500 sales?

A - Krish A Prabhu

We assume the 5500 sales today as Tim mentioned, we have new systems going out, we have co-expansions, we have a new shelf, the Ethernet shelve that we have introduced, which is part of our high-density shelf. In many of these applications, the footprint is restricted because there’s not much space in the central office. So we have introduced a high-density shelf, which allows them a natural way to grow without having to increase their footprint. And then of course, we have done software upgrades to be able to groom and handle Ethernet traffic. So on the fixed network side, the primary application is if more T-1s coming into the Wide Area Network carry Ethernet traffic then with this software upgrade and these Ethernet cards, that traffic can be groomed aggregated and handed out off to a router network, which is pretty much how the operators are handling Ethernet, especially Ethernet coming in in small chunk as of course to Ethernet coming in fiber in big chunks. On the wireless side, we do have a similar, we do have a potential for similar applications. But the potential that we do see is a companion product, the 8800 co-located with the 5500 and in combination, serving as the primary provisioning node in a subtending wireless network, which is the traction we saw in the fourth quarter. So, as we look at more rollouts in wireless as base stations transition to Ethernet traffic and as that Ethernet traffic hits a combination of 8800 and 5500. We do have means by which a mixture of Ethernet and non-Ethernet traffic is handled between those two products and from an operator’s standpoint its done under the same provisioning umbrella, which literally gives them a mix and match capability for bandwidth on demand.

Q – Naik Jagadish

Okay, thank you.

Operator

Our next question come from the line Nikos Theodosopoulos from UBS, please proceed.

Q- Nikos Theodosopoulos

Thank you, just a quick clarification and then a question about ‘06. Krish, do you think there were any one-time positive impacts in your access business this quarter, or just a business overall due to the Katrina re-build situation or do you think there was not, you know there was puts and takes there, there wasn’t any one-time benefit?

A- Krish Prabhu

Well it’s hard to really spell that out Nikos, we see espeically with FTTC product, which is the one would go into the hurricane affected regions. We do see increasing revenue through atleast Q2, Q3 and Q4, so I wouldn’t call it a one-time thing. But its hard for me to see what the time it is going to be next year. Again, we do see a preference on the part of this customer to deploy a fiber platform for competative broadband offerings which include multiple voice channels and data, and we’ve seen increasingly more states either in Greenfield or Rehab situation, they are deploying this product and we’ve also delivered in IPTV capability in the product just to the end of last year. We should give them some assurance that this product is really a product that fairly future proof. On the fiber to defence side, I think we are well documented especially for broad range of suppliers. As this business has its ups and downs as the customer buy stores, deploys, exhaust the inventory and buys. And I think this cycle that we have seen in DSL rollouts and we continue to see this in the fiber rollouts. And at this point in time, we don’t know if that's a one-time thing that happenend in 04 or it's something that is going to see more than normal decline in ‘06 as we go through the quarters.

Q- Nikos Theodosopoulos

Okay and you have how many 10% customers did you have in the 4th quarter?

A- Krish Prabhu

We had two 10% customers in the fourth quarter.

Q- Nikos Theodosopoulos

And for the full year were there one or two?

A- Krish Prabhu

Two possiblity, three. Not sure about the third, I think two and the third slightly below 10%.

Q- Nikos Theodosopoulos

Okay, last question I have was on the outlook for ‘06. You know you grew proforma sales, I think you said 13% or 14% in ’05, the guidance for the first quarter is above 10%. Do you think for the full year, the company can sustain 10% or better revenue growth for the full year?

A- Krish Prabhu

Well that's our plan. We want to do it, but I'll be the first to tell you that we don’t have visibility for the full year.

Q- Nikos Theodosopoulos

Okay.

A- Krish A. Prabhu

It's very difficult for us to model or predict what our customers will do. We do feel good about the momentum that we saw in the last two, three quarters and like I said earlier we have three platforms that gives us a dimenasonality that will allow us to grow the revenue in ‘06 compared to ‘05.

Q- Nikos Theodosopoulos

Okay, thanks a lot.

Operator

Our next question from the line of Ehud Gelblum, J.P. Morgan. Please proceed.

Q- Ehud Gelblum

Hi thank you. A couple of questions, the guidance that you gave Q1, Tim, does that include any additional cost of revenues now that’s there is another roughly 10 million this quarter?

A - Timothy Wiggins

Yeah, we expect that to diminish, you know I think it’s a little hard for us to predict but my suspicion is they were probably kind of self enhanced in Q1 and maybe a little in Q2 and then go away, but again that moves around a bit.

A- Krish Prabhu

And just to be clear, we’re talking about less than 10 million in Q4 and half of that in Q1.

Q- Ehud Gelblum

Right, okay if I normalize your 521 this quarter by the 10 million, the 9.9 million and then normalize I guess the guidance of mid 490s by roughly 5 million. What I am ending up with is that the seasonality would give you, what you end up is about a drop of about 4% yield quarter-on-quarter. You mentioned something about seasonal declines, should we be assuming that the 4% decline in the Q1 is the new seasonality, or are there other one-time effect for hedge, Katrina and other things that are actually boozing revenues?

A- Timothy Wiggins

I don’t, what was this, was historic.

A- Krish Prabhu

Well if you look at the last 5 years it’s been a different number every year. I think in the near-term the last couple of years, you know 4% or 5%, 6% has been what we’ve seen, but our business is changing remember that with the AFC, we changed some of the seasonality factors and how that plays through. I think the best way to think about is we had good momentum in Q4. Book-to-bill and backlogs suggests and orders through the quarter suggests a good solid first quarter and we’ll be please to see something in that 14% growth year-on-year in Q1.

Q- Ehud Gelblum

Okay, two other questions, one is, can you give us a sense of mix between 610 and 611 in a quarter and how you that mix in Q1?

A- Timothy Wiggins

I think we had like you mentioned last time, we had a one-time lapse by 610x shipment in the fourth quarter and if I am not mistaken it was about 14 thousand units, less than that. Okay, but we are talking about fairly small numbers of 610x last time by we do not expect any 610x’s going into 2006.

Q- Ehud Gelblum

And that we saw on track that the 611 has roughly breakeven gross margin, is that a correct assumption or do you think it can actually be better than that?

A- Timothy Wiggins

With the volume that we are seeing and volume efficiencies for 611 is modeled at breakeven gross margin. We are working on cost reductions and we do have 612 launch, but we are also working on cost reductions for parts and procurement of the 611. And we’ll see in the first quarter, if that’s given us more improvement in the margin.

Q- Ehud Gelblum

Okay so you can probably turn the gross margin up a little bit in Q1, even ahead of the 612 introduction?

A - Krish Prabhu

Not much, I think.

Q- Ehud Gelblum

Okay, don’t get carried away. Lastly, when you look at your guidance for the Q4 that you just reported and you compare that to what you actually did in 511, actually the pass through, I know how you compared obviously versus my estimates, I know how you compared versus the quarter before but what I don’t know is how you compared versus what your own internal model for Q4 was when you gave the guidance. Did the quarter end up being strong in all the places that you expected it to or you were surprised by strength in certain areas and weakness in others?

A- Krish Prabhu

No I think we are with circumspect when we guide the quarter, that’s more cultural and that’s just the way it collapses been and that’s the way we like it. We do have detailed plans, we have several initiatives, customer initiatives with our sales guys work around the clock. When we pack it all of that in, I think 4Q came in pretty much the way we expected. Tim did mention that we have, we did have good bookings momentum in 4Q, so we expect 1Q to be similar, in fact that’s pretty much what we’ve been doing. Buying any surprises from the supply chain side, we expect 1Q to be similar.

A- Timothy Wiggins

And maybe just to add, you know I think what we saw is little strength across the board that lifted us above where we thought we would be at the time we made the forecast if we could have seen 521 at the time, I suspect we would have probably guided a little higher. But, fiber takes strength kind of across the board and it’s the kind of thing, you know that we can’t tell till the quarter is over in terms of you know our ability to meet customer demand and their willingness to buy our products.

Q- Ehud Gelblum

Right and about the 31 million in broadband data, this is the last question. Is it safe to assume therefore that you recognize revenue from Cingular?

A- Krish Prabhu

Well I can’t, Tim be specific about customers because we let the customers talk about that just before we talk about it. But we did have wireless customers and we did have a fixed wireless application in Europe plus our other usual customers for that product line.

Q- Ehud Gelblum

Thank you, so much.

Operator

Our next question from the line of George Notter with Jefferies, please proceed.

Q - George Notter

Hi thanks very much. I guess, I was just interested in getting an update on BellSouth and you touched on this a little bit earlier, I am thinking about on the context of the Fiber to the Curb opportunity there, but I know certainly that as a company got into BellSouth that’s achieved your exclusive deal, I know there are some technology milestones there. I guess I just want to get a better sense for what the outlook on BellSouth is, how do you feel about giving over those technology milestones with the retrofit kit and why not we start to see that retrofit of the existing million lines of Fiber to the Curb starts? Thanks.

A- Krish Prabhu

We do have a very stragetical relationship with BellSouth and we have talked earlier about having exclusive supply arrangement on their FTTC product. We commited as part of the new relationship between Tellabs and BellSouth have to be acquired AFC, we committed a roadmap, which we delivered on all the milestones that needed to be delivered in ’05. I am very pleased with the effort that our engineers putout especially the engineers that came to us through AFC from that particular platform. Going forward there is a fabular effort which also looks at, so this effort focus more on having the existing platform, the one that we are delivering today, having IPTV cabability on that platform. So BellSouth were to choose to offer that aggressively, they would be ready as of the end of ’05, which is where they are atleast from our standpoint, from the standpoint of our product. There was also a parallel effort in upgrading the deployed earlier platform of Fiber-to-the-Crub, that effort is ongoing, the committed delivery for that is midyear in ’06, again it brings that platform to the same level of capability. So, that BellSouth could offer the same service from both the older platform as well as the one that they are shipping today that we are shipping today and that upgrade is going to be something that BellSouth will decide when they do it. From our standpoint we are on track to deliver the capability midyear in ’06.

Q - George Notter

Thanks.

Operator

Our next question comes from line of Markus Buchner (ph) from Lehman Brothers, please proceed.

Q - Markus Buchner

Good morning guys. One of several questions, can you talk a little bit, it looks like the copper access business was again pretty stable sequentially, are you seeing any benefit in there from the hurricane rebuilding activities or do you think that occurs, or how are you thinking about that copper access business going forward and what do you think is stable again in this quarter?

A – Krish Prabhu

Let me address the issue about the copper versus fiber and hurricanes and I will let Tim give you little color, again we try not to be too specific, and its not because we don’t want you to have the transparency but we also recognize that in this forum its an open forum for both analyst like yourself as well as competitors. But let me address the issue. We have seen a tendency on the part of the customer to deploy fiber preferentially over copper for Narrowband applications, especially in Greenfield and it also applies to Rehab, because to a some extent rehab following a major hurricane disaster is almost like a Greenfield application. To that extend I think we did see strong fiber sales, so even on increasing revenue we saw the fiber to copper content after we’ve normalized it for video shipment taken that out of the question, the third party video equipment. We saw that ratio holds same between third and fourth quarter that would signal that copper sales were strong in the fourth quarter. Tim I don’t, you have anymore to add.

A - Timothy Wiggins

Exactly right. As you know Markus that we have expected a mild secular decline in that space, this is our customer. So we think their network designs and either post-on or move in the direction on fiber, so actually I think we’ve been positively surprised by the performance of that business this year.

Q - Markus Buchner

Alright, I mean just to be clear, I mean give a sense of what we should think about, do you continue to think this is a sector decline in business or does Tellabs doing anything despite that declining markets?

A - Krish Prabhu

On the copper side, well I guess its pretty clear, our state of strategy is indeed fiber platforms and we believe that fixed wire line operators worldwide would preferentially deploy fiber rather than copper, now that the fiber has reached time to volume and this what we see. We continued to see, but the strong or the continuous strength in copper business is largely dictated by in network inventory exhaust or continued build-out or Rehab in copper networks, which would not viewed as a strategic initiative because, we see it especially the outbox for strategic initiatives move more to fiber. So all our investments really are tied to fiber. They are tied to insuring that the fiber platforms are IPTV capable, to some extend video and fiber go hand-in-hand, as well as from an operation expense standpoint, we are showing our customers that deployed fiber has potential for better operating cost than deployed copper.

Q - Markus Buchner

Thanks and just couple of other things. In the past, I think we talked about the outlook for the 5500, as the wire line operators is being more of a decline in the opportunity going forward, are you getting any feedback on the new features such as the Ethernet that make you think that maybe it’s a stable business in outstretch for the wire line operators?

A - Krish Prabhu

The Ethernet capability that we launched last year and its supported by the upgrade to cross-connect that we see in some of the accounts, we had seen in some fixed operators for wireline operators. An upgrade that occurred, that allowed them to support Ethernet. My own sense is purely to tell how much Ethernet business they will do and how quickly that will happen, but we have seen interest for them to upgrade the cross-connects to be able to support Ethernet. Maybe midway this year we will be in a better position to quantify that.

Q - Markus Buchner

Okay, and perhaps could you just give an update on for the 8800, the number of trails and revenue generating customers in metric, you given us in the past?

A - Krish Prabhu

Well, we have - since we have started getting good revenue this year. If you really look at the revenue this year for our broadband data products, the revenue growth have been pretty good through the four quarters, but at last year we did have little bit of an up and down quarter-over-quarter for revenue. We are now at the point where we have several revenue customers, several large networks. We have networks that are scaling up and we have networks in which we are seeing more applications, I mentioned the case of one operator in the US, we expanded from less than five cities to nearly 30 cities. So, we at this point are not looking at trails per se, we are looking at applications like converge packet architecture for wide area enterprise networks, the fixed mobile convergence between DSL and 2G, 3G wireless traffic, as well as 2G to 3G transitions, and Ethernet backhaul on 8800 networks. We are looking at those applications and we are getting good strength both in international markets as well as in domestic markets.

Q - Markus Buchner

Sounds great, thanks.

Operator

Our next question comes from the line of Tim Long from Banc of America Securities. Please proceed.

Q - Tim Long

Thank you just two questions, forgive me I popped on a little late here. First, could you just talk little bit about the wireless business, particularly in Europe and Asia market? You talked about some wins in the 8800, could you just update us on the progress you see for both the 5500 and the 8800 internationally? And then on the 8800, could you just update us, I am not sure if you gave a number of customers or trail that you are working on there, and how that’s growing in the quarter and potential impact for this year of that product? That would be great.

A - Krish Prabhu

Well we don’t sell the 5500 outside the US, so the question about wireless customers outside the US is largely related to, two sets of products, the two products family, it’s managed access product family which has the 5300 SDH platform, as well as the 8100 managed access platform. And we saw in those two platforms year-on-year between ’04 and ’05, we saw good growth more than 10%. And then the other category is our 8600, 8800 family of product, which we are seeing good application in fixed mobile convergence wherein DSO traffic coming off of our fixed network as well as data traffic coming up of the wireless network goes into one common backhaul network in which the 8600 and 8800 play before it handed out to an IP core network. We do think there’s good potential for this kind of application in Europe. Our sense is that we would need additional partnering with the channel partner because Tellabs essentially plays well in Tier 2 markets in Europe but it’s slowly gaining momentum in Tier 1. We did have one significant deployment of this combination in one Tier 1 operator with the help of Tier 1 supplier as the channel partner last quarter. I think managed access products will continue to see good opportunities in as wireless transitions from voice to data overseas. We have provided this product in Ericsson Networks, we have also provided this products through Nokia channels and we have launched some newer versions of the products that have very good past performance data points and we do expect that this will help us get additional revenue through our channel partners in Europe.

Q - Tim Long

And then on the 8800?

A – Krish Prabhu

The 8800, I did talk about the fixed wireless application overseas, which we refer to earlier we do have a deployment in Japan, we continue to see the 8800 deployed in certain Vodacom networks all across the globe, which may have sold this combination in the Philippines, we were working some opportunities in other countries, we would rather not be more specific because of competitive issues. I am personally very pleased with the progress we are making in the rollout of these products overseas.

Operator

Our next question comes from line of Cobb Sadler, Deutsche Bank Securities.

Q - Cobb Sadler

Thanks a lot, my question is just following on with the 6300 managed assess products, I guess a couple of quarters ago you talked about bundling with the 8100 in that maybe some marginal advantages in doing that, what is the action you are seeing out in the Chinese competitors and maybe Israeli competitors? And I have a follow-up too thanks.

A – Krish Prabhu

We bundle up 6300, which is the SDH product family with our 8100 under umbrella manager, which is the one that we offer through channel partners like Ericsson and Nokia. But we also offer a directly ourselves and that’s the Vodacom subsidiaries that I talk about. We internationally our strategy is to sell value, we don’t want to get into a mud wrestling contest with Asian suppliers, and I guess the Israeli suppliers a little bit of that is also true. So our strategy clearly to sell the value proposition, we will work it our customers to understand their business case, so we are not arrogant about the price but at the same time we just don’t want to get caught up in situations where revenue comes at a great margin exposure, and we don’t need to do that in order to grow our business.

Q - Cobb Sadler

Great and then product family was up nicely during the quarter but it’s kind of averaged to look back over maybe the last ten quarters, it averaged about 85 million, not too far from where it is now, can you take market share, is that business going to be a growth business or should we look at it as a kind of seasonally strong quarter in the second half of the year going forward?

A – Krish Prabhu

See you are referring to the managed access products family?

Q - Cobb Sadler

That’s right

A – Krish Prabhu

Yeah, the managed access product family, if we look at several quarters, it had no relevant in it the 2300 which is the on a earlier question I answered about the cable telephony, and what we do with cable markets. That products we really have to take off, if you take that off year-on-year growth for managed access has been better than 10% and that really reflects the strength of selling into an incumbent base, as that incumbent base sees pressure for traffic more traffic coming in to it, we are getting new customers, we have introduced some newer products, in particular we have micro MSPP, which is fully protected micro MSPP that has, that is a very nice price point as well as very full featured capability set and it is very attractive product so going forward I do believe that this product family will continue to hold its own, and again as I said our stated strategy is to grow by selling value to our customers.

Q - Cobb Sadler

Okay sounds great, thanks a lot.

A – Krish Prabhu

Yeah time for one more question.

Operator

Our next question comes from line of Simon Leopold, Morgan, Keegan &Company, Inc, please proceed.

Q - Simon Leopold

Thank you very much. I want to see if you could build on a little bit more on seasonality question by product group, when we go back and look at some of the historical trends for your own mature products as well as AFC’s old business, we have typically seen some weakness and I guess what’s implied here is that the access business remains stable, it doesn’t likely show typical seasonal declines based on what your customers are saying and it’s looks like your 8800 family should be quiet strong and I just want to make sure that read through is correct but whether there’s some other factors on the more mature products that offset some of the historical trends? Thank you.

A – Krish Prabhu

Well the danger in trying to be very specific as we look at first quarter guidance is that we get into the knickers of how we run our business and again as I said for competitive reasons, we prefer for not to get into that, but let me just give you little sense. We bound our guidance by what we did in the first quarter of last year because it captures a lot of underlying phenomenon quarter-over-quarter and based on that we saw year-on-year growth of 14% in the fourth quarter, we said the momentum is strong going into the first quarter based on our bookings, so we guided you to mid, I think Tim call it mid 493 sorry he said 495, that would reflect the 14% growth year-on-year between '05 and ’06 for the first quarter. Sequentially we have seen 3% to 6% or 4% to 6% decline between the fourth quarter of each year and next year’s first quarter so that’s the other bound we apply in trying to arrive at our 495 guidance based on the 521 we did in the fourth quarter. Individual product lines: Access, I do believe you have to factor in that some of the historical AFC seasonality maybe different now because Access is primarily driven by what the Hurricane Relief activity will do in the first quarter based on the shipments as the bookings they have placed and the shipments they have received in the fourth quarter and the shipments they may received in the first quarter as well as the fiber activity and how it start ramping up especially at Verizon. So I think historical comparison with AFC’s Q4 and Q1 is the little distorted largely because we are transitioning from copper to fiber much more aggressively on the access products. On the data product, we filed a new application in wireless we’ll have to see what kind of ramp up it has in the first quarter and we are working closely with our customer to understand what their needs are.

Q - Simon Leopold

Thanks and a just quick clarification, when we are looking at the access business we are looking at the pass through and the FTTx revenue, I just want to make sure we are doing the math correctly here, we should look at the 53% of access business as FTTx excluding the pass through?

A – Krish Prabhu

That’s correct.

Q - Simon Leopold

Great, thank you.

A – Timothy Wiggins

I would read the curb plus 5-year trend excluding pass through.

Q - Simon Leopold

Okay, thank you very much.

Krish Prabhu, Chief Executive Officer and President

Okay thanks, thanks everyone, we appreciate your interest in Tellabs, and we shall come back to you on the next call some time in April. Okay, thank you.

Operator

Ladies and gentlemen, that does concludes the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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