Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 1, 2011

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file Number: 0-09692

 

 

TELLABS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		36-3831568
(State of Incorporation)		(I.R.S. Employer Identification No.)

 

One Tellabs Center, 1415 W. Diehl Road, Naperville, Illinois		60563
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code: (630) 798-8800

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES   x    NO   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     YES  x     NO   ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

		Large Accelerated Filer   x		Accelerated Filer  ¨
		Non-Accelerated Filer  ¨		Smaller reporting company  ¨
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in  Rule 12b-2 of the Exchange Act).    YES   ¨    NO  x

Common Shares, $0.01 Par Value – 363,295,297 shares outstanding on April 29, 2011.

 

 

 

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TELLABS, INC.

INDEX

 

				PAGE
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Statements of Operations		3
		Consolidated Balance Sheets		4
		Consolidated Statements of Cash Flows		5
		Notes to Consolidated Financial Statements		6
Item 2.		Management’s Discussion and Analysis of Results of Operations and Financial Condition		20
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		29
Item 4.		Controls and Procedures		30
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings		30
Item 1A.		Risk Factors		32
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		32
Item 6.		Exhibits		33
SIGNATURE				34

 

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PART I . FINANCIAL INFORMATION

 

Item 1.

Financial Statements

TELLABS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		First Quarter
		4/1/11				4/2/10
In millions, except per-share data
Revenue
Products		$	272.4			$	318.5
Services			50.0				60.7
Total revenue			322.4				379.2
Cost of Revenue
Products			159.5				145.6
Services			40.6				41.7
Total cost of revenue			200.1				187.3
Gross Profit			122.3				191.9
Gross profit as a percentage of revenue			37.9	%			50.6	%
Gross profit as a percentage of revenue - products			41.4	%			54.3	%
Gross profit as a percentage of revenue - services			18.8	%			31.3	%
Operating Expenses
Research and development			80.3				69.2
Sales and marketing			44.7				45.1
General and administrative			23.7				24.8
Intangible asset amortization			5.2				7.4
Restructuring and other charges			1.0				10.0
Total operating expenses			154.9				156.5
Operating (Loss) Earnings			(32.6	)			35.4
Operating (loss) earnings as a percentage of revenue			-10.1	%			9.3	%
Other Income
Interest income, net			3.3				3.9
Other (expense) income, net			(0.6	)			2.7
Total other income			2.7				6.6
(Loss) Earnings Before Income Tax			(29.9	)			42.0
Income tax benefit			5.8				3.6
Net (Loss) Earnings		$	(24.1	)		$	45.6
Weighted Average Shares Outstanding
Basic			363.0				384.7
Diluted			363.0				388.6
Net (Loss) Earnings Per Share
Basic		$	(0.07	)		$	0.12
Diluted		$	(0.07	)		$	0.12
Cash Dividends Per Share		$	0.02			$	0.02

The accompanying notes are an integral part of these statements.

 

 

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TELLABS, INC.

CONSOLIDATED BALANCE SHEETS

 

		4/1/11				12/31/10
In millions, except share data		Unaudited
Assets
Current Assets
Cash and cash equivalents		$	190.7			$	208.8
Investments in marketable securities			866.5				925.7
Total cash, cash equivalents and marketable securities			1,057.2				1,134.5
Other marketable securities			179.9				213.6
Accounts receivable, net of allowances of $1.4 and $1.3			318.9				342.6
Inventories
Raw materials			38.2				30.3
Work in process			0.5				—
Finished goods			151.2				132.0
Total inventories			189.9				162.3
Income taxes			30.4				14.8
Miscellaneous receivables and other current assets			44.9				45.0
Total Current Assets			1,821.2				1,912.8
Property, Plant and Equipment
Land			21.1				20.8
Buildings and improvements			208.6				204.2
Equipment			434.4				422.8
Total property, plant and equipment			664.1				647.8
Accumulated depreciation			(394.6	)			(378.5	)
Property, plant and equipment, net			269.5				269.3
Goodwill			205.2				204.9
Intangible Assets, Net of Amortization			91.5				96.7
Other Assets			118.5				119.2
Total Assets		$	2,505.9			$	2,602.9
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts payable		$	94.2			$	123.4
Accrued compensation			51.2				97.2
Restructuring and other charges			6.2				7.7
Income taxes			94.2				88.4
Loan related to other marketable securities			179.9				213.6
Deferred revenue			52.6				43.0
Other accrued liabilities			89.2				89.8
Total Current Liabilities			567.5				663.1
Long-Term Restructuring Liabilities			2.7				3.1
Income Taxes			24.5				28.1
Other Long-Term Liabilities			50.0				47.1
Stockholders’ Equity
Preferred stock: authorized 5,000,000 shares of $0.01 par value; no shares issued and outstanding			—				—
Common stock: authorized 1,000,000,000 shares of $0.01 par value; 502,881,004 and 501,744,627 shares issued			5.0				5.0
Additional paid-in capital			1,555.5				1,547.9
Treasury stock, at cost: 139,600,060 and 139,243,079 shares			(1,224.1	)			(1,222.1	)
Retained earnings			1,390.8				1,422.1
Accumulated other comprehensive income			134.0				108.6
Total Stockholders’ Equity			1,861.2				1,861.5
Total Liabilities and Stockholders’ Equity		$	2,505.9			$	2,602.9

The accompanying notes are an integral part of these statements.

 

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TELLABS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		First Quarter
		4/1/11				4/2/10
In millions
Operating Activities
Net (loss) earnings		$	(24.1	)		$	45.6
Adjustments to reconcile net earnings to net cash (used for) provided by operating activities:
Depreciation and amortization			19.5				19.8
Equity-based compensation			7.6				5.8
Deferred income taxes			11.5				3.1
Restructuring and other charges			1.0				10.0
Net loss (gain) on investments in marketable securities			0.1				(3.1	)
Excess tax benefits from equity-based compensation			(0.2	)			0.7
Net changes in assets and liabilities:
Accounts receivable			33.6				26.6
Inventories			(25.6	)			(1.1	)
Miscellaneous receivables and other current assets			(15.3	)			4.6
Other assets			(1.6	)			2.3
Accounts payable			(30.6	)			(32.0	)
Restructuring and other charges			(2.9	)			(3.3	)
Deferred revenue			7.7				15.7
Other accrued liabilities			(57.8	)			(22.7	)
Income taxes			(7.1	)			(11.3	)
Other long-term liabilities			2.7				(0.4	)
Net Cash (Used for) Provided by Operating Activities			(81.5	)			60.3
Investing Activities
Capital expenditures			(10.4	)			(4.0	)
Payments for purchases of investments			(177.8	)			(268.4	)
Proceeds from sales and maturities of investments			253.5				299.3
Net Cash Provided by Investing Activities			65.3				26.9
Financing Activities
Proceeds from issuance of common stock under stock plans			0.4				1.1
Repurchase of common stock			(2.0	)			(2.3	)
Excess tax benefits from equity-based compensation			0.2				(0.7	)
Dividends paid			(7.2	)			(7.7	)
Net Cash Used for Financing Activities			(8.6	)			(9.6	)
Effect of Exchange Rate Changes on Cash			6.7				(2.3	)
Net (Decrease) Increase in Cash and Cash Equivalents			(18.1	)			75.3
Cash and Cash Equivalents - Beginning of Year			208.8				154.0
Cash and Cash Equivalents - End of Period		$	190.7			$	229.3

The accompanying notes are an integral part of these statements.

 

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TELLABS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

IN MILLIONS, EXCEPT SHARE AND PER-SHARE DATA

1. Basis of Presentation

We prepared the accompanying unaudited consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial statements, the requirements of Form 10-Q and applicable rules of the U.S. Securities and Exchange Commission’s Regulation S-X. Therefore, they do not include all disclosures normally required by U.S. generally accepted accounting principles for complete financial statements. Accordingly, the financial statements and notes herein are to be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2010.

In our opinion, the accompanying unaudited consolidated financial statements include all adjustments (consisting of normal recurring accruals) that are necessary for a fair presentation. Operating results for interim periods are not necessarily indicative of operating results for the full year.

2. Restructuring and Other Charges

On January 25, 2010, management initiated a restructuring plan to enable us to shift investment from TDM (Time Division Multiplexing) to Ethernet and IP (Internet Protocol) products, move our supply chain closer to suppliers, and reduce general and administrative expenses. Restructuring expense for the first quarter of 2011 was $0.5 million for severance-related charges. The cumulative pretax restructuring charges for this plan are $9.5 million, which consists of $6.9 million for workforce reductions of 169 employees and $2.6 million for facility- and asset-related charges. By segment, total charges to date under this plan are $6.0 million for Broadband, $3.2 million for Transport, and $0.3 million for Services. Cash payments under this plan are $7.1 million. Restructuring actions under this plan were completed in the first quarter of 2011.

On July 6, 2009, management initiated a restructuring plan as we aligned costs with customer spending and market conditions at that time. Restructuring expense for the first quarter of 2011 was $0.7 million for severance-related charges. The cumulative pretax restructuring charges for this plan are $7.1 million, which consists of $6.7 million in severance charges for workforce reductions and $0.4 million for facility- and asset-related charges. By segment, total charges to date under this plan are $2.6 million for Broadband, $2.2 million for Transport, and $2.3 million for Services. Cash payments under this plan are $6.9 million for workforce reductions of 164 employees. Restructuring actions under this plan were completed in the first quarter of 2011.

Reductions of $0.2 million to restructuring expense for previous restructuring plans in the first quarter of 2011 are facility-related. These net reductions are due to changes in estimates to previous restructuring plans.

The balance for restructuring plans relates to net lease obligations that expire through 2015 and cash severance that we expect to pay through the third quarter of 2012.

The following table summarizes restructuring and other charges recorded for the plans mentioned above, as well as adjustments to reserves recorded for prior restructurings:

 

		First Quarter
		4/1/11				4/2/10
Severance and other termination benefits		$	1.2			$	7.6
Facility and other exit costs			(0.2	)			2.4
Total restructuring and other charges		$	1.0			$	10.0

The following table summarizes restructuring and other charges activity by segment for the first quarter of 2011 and the status of the reserves at April 1, 2011:

 

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		Balance at 12/31/10				Restructuring Expense				Cash Payments				Balance at 4/1/11
2010 Restructuring Plan
Broadband			1.4				0.3				(0.3	)			1.4
Transport			1.0				—				(0.1	)			0.9
Services			—				0.2				—				0.2
Subtotal 2010 Restructuring Plans			2.4				0.5				(0.4	)			2.5
Previous Restructuring Plans
Broadband			6.4				0.1				(1.4	)			5.1
Transport			1.5				(0.1	)			(0.9	)			0.5
Services			0.5				0.5				(0.2	)			0.8
Subtotal Previous Restructuring Plans			8.4				0.5				(2.5	)			6.4
Total Restructuring Plans		$	10.8			$	1.0			$	(2.9	)		$	8.9

3. Fair Value Measurements

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, marketable securities and derivatives. The carrying value of the cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of their fair value because of their short-term nature. We determine the fair value of marketable securities and derivatives based on observable inputs such as quoted prices in active markets, or other than quoted prices in active markets, that are observable either directly or indirectly.

Fair value is measured as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a three-tier fair value hierarchy has been established, which prioritizes the inputs used in measuring fair value as follows:

 

•

Level 1 – Observable inputs, such as quoted prices in active markets;

 

•

Level 2 – Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

 

•

Level 3 – Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. In determining fair value for recurring financial assets and liabilities, we separate our financial instruments into three categories: marketable securities, other marketable securities and loan related to other marketable securities, and derivative financial instruments. These assets and liabilities are all valued based on the market approach that uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

Marketable Securities

We use a third-party provider to determine fair values of marketable securities. The third-party provider receives market prices for each marketable security from a variety of industry standard data providers, security master files from large financial institutions and other third-party sources with reasonable levels of price transparency. The third-party provider uses these multiple prices as inputs into a pricing model to determine a weighted average price for each security. We classify U.S. Treasury bills and bonds as Level 1 based upon quoted prices in active markets. All other marketable securities are classified as Level 2 based upon the other than quoted prices with observable market data. The type of instruments valued based upon the observable market data include U.S. government sponsored enterprise (agency) debt obligations, Federal Deposit Insurance Corporation (FDIC)-backed corporate debt obligations, investment grade corporate bonds, state and municipal debt obligations, mortgaged backed debt obligations guaranteed by the Government National Mortgage Association (GNMA), certain FDIC-backed bank certificates of deposit, foreign government debt obligations and foreign corporate debt obligations guaranteed by foreign governments.

 

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Other Marketable Securities and Loan Related to Other Marketable Securities

We classify holdings in other marketable securities (Cisco common stock) and the related loan as Level 1 in the fair value hierarchy. We classify these as Level 1 since they are actively traded through a governed exchange.

Derivative Financial Instruments

Our foreign currency forward contracts are executed as exchange-traded. Market participants can be described as large money center or regional banks. Exchange-traded derivatives typically fall within Level 1 or Level 2 in the fair value hierarchy depending on whether they are deemed to be actively traded or not.

We have elected to value derivatives as Level 2, using observable market data at the measurement date and standard valuation techniques to convert future amounts to a single present amount (discounted). Mid-market pricing is used as a practical expedient for fair value measurements. Key inputs for currency derivatives are the spot rate, interest rates and credit derivative markets. The spot rate for each currency is the same spot rate used for all balance sheet translations at the measurement date. The following values are calculated from commonly quoted intervals available from a third-party financial information provider. Forward points and LIBOR rates are used to calculate a discount rate to apply to assets and liabilities. One-year credit default swap spreads are used to discount derivative assets, all of which have final maturities of less than 12 months. We calculate the discount to the derivative liabilities to reflect the potential credit risk to lenders and have used the spread over LIBOR based on the credit risk of our counterparties. Each asset is individually discounted to reflect our potential credit risk and we have used the spread over LIBOR based on similar credit risk. We do not adjust the fair value for immaterial credit risk.

We have applied a valuation method for financial assets and liabilities and recurring non-financial assets consistently during this period and prior periods. The following table sets forth by level within the fair value hierarchy “Financial instruments owned at fair value.” Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Assets and liabilities measured at fair value on a recurring basis are:

 

		Fair Value Measurements at April 1, 2011
		Balance at 4/1/11				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets
Investments in marketable securities
U.S. government debt obligations		$	177.1			$	177.1			$	—			$	—
Corporate debt obligations guaranteed by FDIC			100.6				—				100.6				—
Corporate debt obligations			145.9				—				145.9				—
Mortgaged backed debt obligations guaranteed by GNMA			133.5				—				133.5				—
Certificates of deposit guaranteed by FDIC			2.4				—				2.4				—
Foreign government debt obligations			199.4				—				199.4				—
Foreign corporate debt obligations guaranteed by foreign governments			107.6				—				107.6				—
Subtotal			866.5				177.1				689.4				—
Other marketable securities			179.9				179.9				—				—
Derivative financial instruments			0.1				—				0.1				—
Total Assets		$	1,046.5			$	357.0			$	689.5			$	—
Liabilities
Loan related to other marketable securities		$	179.9			$	179.9			$	—			$	—
Derivative financial instruments			0.9				—				0.9				—
Total Liabilities		$	180.8			$	179.9			$	0.9			$	—

 

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		Fair Value Measurements at December 31, 2010
		Balance at 12/31/10				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets
Investments in marketable securities
U.S. government debt obligations		$	258.4			$	258.4			$	—			$	—
Corporate debt obligations guaranteed by FDIC			102.6				—				102.6				—
Corporate debt obligations			95.9				—				95.9				—
Mortgaged backed debt obligations guaranteed by GNMA			175.1				—				175.1				—
Certificates of deposit guaranteed by FDIC			3.3				—				3.3				—
Foreign government debt obligations			202.1				—				202.1				—
Foreign corporate debt obligations guaranteed by foreign governments			88.3				—				88.3				—
Subtotal			925.7				258.4				667.3				—
Other marketable securities			213.6				213.6				—				—
Derivative financial instruments			0.2				—				0.2				—
Total Assets		$	1,139.5			$	472.0			$	667.5			$	—
Liabilities
Loan related to other marketable securities		$	213.6			$	213.6			$	—			$	—
Derivative financial instruments			1.0				—				1.0				—
Total Liabilities		$	214.6			$	213.6			$	1.0			$	—

4. Investments

We account for investments in marketable securities at fair value, with the unrealized gain or loss, less deferred income taxes, shown as a separate component of stockholders’ equity. We base realized gains and losses on specific identification of the security sold. At April 1, 2011, and December 31, 2010, available-for-sale marketable securities consisted of the following:

 

		Amortized Cost				Unrealized Gain				Unrealized Loss				Fair Value
April 1, 2011
U.S. government debt obligations		$	178.0			$	—			$	(0.9	)		$	177.1
Corporate debt obligations guaranteed by FDIC			100.4				0.3				(0.1	)			100.6
Corporate debt obligations			145.8				0.5				(0.4	)			145.9
Mortgaged backed debt obligations guaranteed by GNMA			133.9				0.8				(1.2	)			133.5
Certificates of deposit guaranteed by FDIC			2.4				—				—				2.4
Foreign government debt obligations			201.7				0.4				(2.7	)			199.4
Foreign corporate debt obligations guaranteed by foreign governments			107.9				0.3				(0.6	)			107.6
Total		$	870.1			$	2.3			$	(5.9	)		$	866.5

 

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December 31, 2010
U.S. government debt obligations		$	259.0			$	0.1			$	(0.7	)		$	258.4
Corporate debt obligations guaranteed by FDIC			102.3				0.3				—				102.6
Corporate debt obligations			95.6				0.5				(0.2	)			95.9
Mortgaged backed debt obligations guaranteed by GNMA			175.5				0.8				(1.2	)			175.1
Certificates of deposit guaranteed by FDIC			3.3				—				—				3.3
Foreign government debt obligations			201.4				1.6				(0.9	)			202.1
Foreign corporate debt obligations guaranteed by foreign governments			87.8				0.6				(0.1	)			88.3
Total		$	924.9			$	3.9			$	(3.1	)		$	925.7

Of the available-for-sale debt obligations at April 1, 2011, $152.0 million have contractual maturities of less than 12 months, $581.0 million have contractual maturities of greater than one year up to five years and $133.5 million have contractual maturities greater than five years. Actual maturities will likely differ from the contractual maturities because borrowers have the right to call or prepay certain obligations.

Gross unrealized gains and losses related to fixed-income securities were caused by interest rate fluctuations. We review investments held with unrealized losses to determine if the loss is other-than-temporary. We evaluated near-term prospects of the security in relation to the severity and duration of the unrealized loss. We also assessed our intent to sell the security, whether it is more likely than not that the security will be required to be sold before recovery, or the security is not expected to recover its entire amortized cost basis. Based on our review, we do not intend to sell these securities and believe that they will recover their entire amortized cost basis; therefore, we do not consider these investments to be other-than-temporarily impaired at April 1, 2011. No other-than-temporary impairments were recorded in the first quarter of 2011.

Investments in marketable securities with unrealized losses at April 1, 2011, and December 31, 2010, were as follows:

 

		Unrealized Loss Less than 12 months								Unrealized Loss Greater than 12 months								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
April 1, 2011
U.S. government debt obligations		$	140.6			$	(0.9	)		$	—			$	—			$	140.6			$	(0.9	)
Corporate debt obligations guaranteed by FDIC			37.2				(0.1	)			—				—				37.2				(0.1	)
Corporate debt obligations			73.5				(0.4	)			—				—				73.5				(0.4	)
Mortgaged backed debt obligations guaranteed by GNMA			65.8				(1.2	)			—				—				65.8				(1.2	)
Foreign government debt obligations			145.4				(2.7	)			—				—				145.4				(2.7	)
Foreign government debt obligations guaranteed by foreign governments			57.1				(0.6	)			—				—				57.1				(0.6	)
Total		$	519.6			$	(5.9	)		$	—			$	—			$	519.6			$	(5.9	)
December 31, 2010
U.S. government debt obligations		$	218.6			$	(0.7	)		$	—			$	—			$	218.6			$	(0.7	)
Corporate debt obligations			47.5				(0.2	)			—				—				47.5				(0.2	)
Mortgaged backed debt obligations guaranteed by GNMA			115.7				(1.2	)			—				—				115.7				(1.2	)
Foreign government debt obligations			92.9				(0.9	)			—				—				92.9				(0.9	)
Foreign government debt obligations guaranteed by foreign governments			32.6				(0.1	)			—				—				32.6				(0.1	)
Total		$	507.3			$	(3.1	)		$	—			$	—			$	507.3			$	(3.1	)

 

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The following table presents gross realized gains and losses related to fixed income investments for the three months ending April 1, 2011, and April 2, 2010:

 

		4/1/11				4/2/10
Gross realized gains		$	0.4			$	3.3
Gross realized losses			(0.5	)			(0.2	)
Total		$	(0.1	)		$	3.1

As a result of the acquisition of Advanced Fibre Communications, Inc. (AFC) in 2004, we acquired 10.6 million shares of Cisco common stock, shown as Other marketable securities in Current Assets. AFC owned this stock as a result of its investment in privately held Cerent Corporation, which was acquired by Cisco in 1999. In 2000, AFC entered into two three-year hedge contracts, pledging all of the Cisco stock to secure the obligations under the contracts. When the hedge contracts matured in 2003, AFC entered into stock loan agreements with a lender, borrowing 10.6 million shares of Cisco stock to settle the hedge contracts on the Cisco stock. The aggregate amount of the fair values of those stock loans is reflected as a current liability on the balance sheets as of April 1, 2011, and December 31, 2010. The values of both the asset and liability move in tandem with each other since each is based on the number of shares we hold at the current stock price. At April 1, 2011, Other marketable securities and Loan related to other marketable securities was $179.9 million at a market price of $17.04 per share and $213.6 million at a market price of $20.23 per share at December 31, 2010. The fees associated with the stock loan agreement were $0.3 million in the first quarter of 2011 and $0.4 million for the first quarter of 2010.

In addition to the above investments, we maintain investments in partnerships and start-up technology companies. We record these investments in Other Assets, at cost. These investments totaled $6.0 million at April 1, 2011, and $6.3 million at December 31, 2010. We review each investment quarterly, including historical and projected financial performance, expected cash needs and recent funding events. We recognize other-than-temporary impairments if the market value of the investment is below its cost basis for an extended period of time or if the issuer has experienced significant financial declines or difficulties in raising capital to continue operations. No other-than-temporary impairments were recorded for the first quarters of 2011 and 2010.

5. Derivative Financial Instruments

Financial Contracts and Market Risk

We conduct business on a global basis in U.S. and foreign currencies subjecting us to risks associated with fluctuating foreign exchange rates. To mitigate these risks, we use derivative foreign exchange contracts to address nonfunctional exposures that are expected to be settled in one year or less. The derivative foreign exchange contracts consist of foreign currency forward and option contracts.

Derivative financial contracts involve elements of market and credit risk. The market risk that results from these contracts relates to changes in foreign currency exchange rates, which generally are offset by changes in the value of the underlying assets or liabilities being held. Credit risk relates to the risk of nonperformance by a counterparty to one of the derivative contracts. We do not believe there is a significant credit risk associated with our hedging activities. We monitor the counterparties’ credit ratings and other market data to minimize credit risk. In addition, we also limit the aggregate contract amount entered into with any one financial institution to mitigate credit risk.

Cash Flow Hedges

At April 1, 2011, we did not have any cash flow hedges outstanding. We use foreign currency forward and option contracts, designated as cash flow hedges, to mitigate currency risk related to an imbalance of nonfunctional currency denominated costs and related revenue. We conduct monthly effectiveness tests of these hedging relationships on a spot-to-spot basis, excluding forward points. Effective gains and losses from derivative contracts are recorded in Accumulated other comprehensive income until the underlying transactions occur, at which time they are reclassified to Total cost of revenue. Ineffectiveness is recorded to Other (expense) income, net. If it becomes probable that an anticipated transaction that is hedged will not occur, we immediately reclassify the gains or losses related to that hedge from Accumulated other comprehensive income to Other (expense) income, net. We continue to monitor the Company’s overall currency exposure and may elect to add additional cash flow hedges in the future if deemed necessary.

Balance Sheet Hedges (Non-designated Hedges)

Short-term monetary assets and liabilities denominated in currencies other than the functional currency of the Tellabs entity entering into the transaction are remeasured through income as foreign currency rates fluctuate. Changes in the value of

 

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derivative contracts intended to offset these fluctuations are also recorded in income. These derivative contracts are not designated as hedges. At April 1, 2011, we held non-designated foreign currency forward contracts in 12 currencies, with a gross notional equivalent of $138.1 million.

Net Investment Hedges

We entered into three-month foreign currency forward contracts, designated as net investment hedges, to hedge a portion of our net investment in one of our foreign subsidiaries to preserve the U.S. dollar value of our Euro cash. Effective changes in the fair value of these contracts due to exchange rate fluctuations are recorded within Accumulated other comprehensive income. Those amounts will be reflected in income only when we dispose of the investment in the foreign subsidiary. We conduct monthly effectiveness tests of net investment hedges on a spot-to-spot basis, excluding forward points, and any measurement of ineffectiveness is recorded in income. As of April 1, 2011, we had a net unrealized gain of $9.4 million in Accumulated other comprehensive income, which includes a net gain of $10.1 million related to settled contracts and a net loss of $0.7 million related to unsettled contracts. We held net investment hedges with a notional value of 85 million Euros at the end of the quarter.

The fair value of derivative instruments in the Consolidated Balance Sheet as of April 1, 2011, was as follows:

 

		Asset Derivatives Reported in Miscellaneous Receivables and Other Current Assets				Liability Derivatives Reported in Other Accrued Liabilities
Net investment hedges		$	—			$	0.7
Balance sheet hedges (Non-designated hedges)			0.1				0.2
Total derivatives		$	0.1			$	0.9

The fair value of derivative instruments in the Consolidated Balance Sheet as of December 31, 2010, was as follows:

 

		Asset Derivatives Reported in Miscellaneous Receivables and Other Current Assets				Liability Derivatives Reported in Other Accrued Liabilities
Cash flow and net investment hedges		$	—			$	0.8
Balance sheet hedges (Non-designated hedges)			0.2				0.2
Total derivatives		$	0.2			$	1.0

The effect of derivative instruments designated as hedging instruments on the Consolidated Statements of Operations for the three months ended April 1, 2011, and April 2, 2010, was as follows:

 

		(Loss) Gain Recognized in Accumulated OCI, net (Effective Portion)								Loss Reclassified from Accumulated OCI into Total Cost of Revenue (Effective Portion)
		4/1/11				4/2/10				4/1/11				4/2/10
Cash flow hedges		$	—			$	0.9			$	—			$	(0.5	)
Net investment hedges		$	(7.3	)		$	4.7				N/A				N/A

The effect of derivative instruments not designated as hedging instruments on the Consolidated Statements of Operations for the three months ended April 1, 2011, and April 2, 2010, was as follows:

 

		Gain (Loss) Recognized in Other  (Expense) Income, net 1
		4/1/11				4/2/10
Foreign currency forward and option contracts		$	4.4			$	(5.4	)

¹ The gains or losses from changes in the fair value of the derivative contracts are generally offset by gains or losses of the underlying transactions being hedged.

 

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6. Product Warranties

We provide warranties for all of our products. The specific terms and conditions of those warranties vary depending on the product. We provide a basic limited warranty, including parts and labor, for all products except access products for periods ranging from 90 days to 5 years. The basic limited warranty for access products covers parts and labor for periods ranging from 2 to 6 years.

The estimate of warranty liability involves many factors, including the number of units shipped, historical and anticipated rates of warranty claims, and cost per claim. We periodically assess the adequacy of the recorded warranty liability and adjust the amounts as necessary. Other adjustments to accruals for product warranties represent reductions due to favorable experience to previous estimates.

We classify the portion of warranty liability that we expect to incur in the next 12 months as a current liability. We classify the portion of warranty liability that we expect to incur more than 12 months in the future as a long-term liability. Product warranty liabilities are as follows:

 

		First Quarter
		4/1/11				4/2/10
Balance – beginning of period		$	19.4			$	31.4
Accruals for product warranties			2.8				2.4
Settlements			(0.4	)			(2.2	)
Other adjustments to accruals for product warranties			(0.6	)			(2.7	)
Balance – end of period		$	21.2			$	28.9

 

Balance sheet classification - end of period		Balance at 4/1/11				Balance at 4/2/10
Other accrued liabilities		$	9.2			$	11.9
Other long-term liabilities			12.0				17.0
Total product warranty liabilities		$	21.2			$	28.9

7. Equity-Based Compensation

The Tellabs, Inc. Amended and Restated 2004 Incentive Compensation Plan (2004 Plan) provides for the grant of short-term and long-term incentives, including stock options, stock appreciation rights (SARs), restricted stock and performance stock units (PSUs). Equity-based grants vest over one to four years, with the majority vesting over a three-year period. We recognize compensation expense for stock options and restricted stock on a straight-line basis over the service period based on the fair value on the grant date. Stock options and SARs granted but unexercised expire 10 years from the grant date. Stockholders previously approved 53,889,977 shares for grant under the 2004 Plan, of which 18,740,402 remain available for grant at April 1, 2011.

Stock Options

We estimate the fair value of stock options using the Black-Scholes option-pricing model. This model requires the use of assumptions that will have a significant impact on the fair value estimate. The following table summarizes the assumptions used to compute the weighted average fair value of stock option grants:

 

		4/1/11				4/2/10
Expected volatility			46.8	%			42.8	%
Risk-free interest rate			2.2	%			2.4	%
Expected term (in years)			5.3				5.3
Expected dividend yield			1.5	%			1.3	%

We based our calculation of expected volatility on a combination of historical and implied volatility for options granted. We based the risk-free interest rate on the U.S. Treasury yield curve in effect at the date of grant. We estimated the expected term of the options using their vesting period, post-vesting employment termination behavior and historical exercise patterns. We based the expected dividend yield on the option’s exercise price and annualized dividend rate at the date of grant.

 

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The following is a summary of stock option activity during 2011 as of April 1, 2011:

 

		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (in years)				Aggregate Intrinsic Value (in  millions)
Outstanding – beginning of year			26,851,964			$	11.18
Granted			1,784,590			$	5.45
Exercised			(186,122	)		$	2.42
Forfeited/expired			(1,582,626	)		$	40.79
Outstanding – end of period			26,867,806			$	9.11				4.1			$	2.4
Exercisable – end of period			21,727,169			$	9.79				2.9			$	1.6
Shares expected to vest			26,469,550			$	9.15				4.0			$	2.3

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on our closing stock price as of April 1, 2011, that the option holders would have received had all holders exercised their options as of that date. The aggregate intrinsic value of exercised stock options during the first quarter of 2011 was $0.7 million.

The weighted average fair value of stock options granted during the first quarter of 2011 was $2.12.

Cash-Settled Stock Appreciation Rights

The 2004 Plan provides for the granting of cash-settled SARs in conjunction with, or independent of, the stock options under the 2004 Plan. These SARs allow the holder to receive in cash the difference between the cash-settled SARs’ grant price (the market value of our stock on the grant date) and the market value of our stock on the date the holder exercises the SAR. These cash payments were negligible for the first quarter of 2011 and 2010.

The following is a summary of cash-settled SARs activity during 2011 as of April 1, 2011:

 

		Shares				Weighted Average Exercise Price
Outstanding – beginning of year			445,233			$	7.73
Granted			20,500			$	6.07
Forfeited/expired			(6,400	)		$	8.71
Outstanding – end of period			459,333			$	7.64

Restricted Stock

The fair market value of restricted stock vested was $0.9 million in the first quarter of 2011. The weighted average grant date fair value of restricted stock was $5.43 per share in the first quarter of 2011 and $6.32 per share in the first quarter of 2010.

The following is a summary of restricted stock activity during 2011 as of April 1, 2011:

 

		Shares				Weighted Average Grant Date Fair Value
Non-vested – beginning of year			5,372,417			$	7.19
Granted			2,541,452			$	5.43
Vested			(146,595	)		$	5.25
Forfeited			(200,140	)		$	6.22
Non-vested – end of period			7,567,134			$	6.66

 

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Performance Stock Units

The 2004 Plan provides for the granting of PSUs. We granted 1,611,541 PSUs in the first quarter of 2011 and 747,700 PSUs in the first quarter of 2010. The PSUs granted in the first quarter of 2011 entitle the recipients to receive shares of our common stock commencing in March 2012, contingent on the achievement of strategic goals for the 2011 fiscal year. Following achievement of these measures and subject to continued employment, one-third of such shares will be issued in annual installments in February 2012, February 2013 and February 2014. At maximum target performance, we will issue two shares for each PSU granted. The weighted average price of PSUs granted in the first quarter of 2011 was $5.42 per share and the weighted average price of PSUs granted in the first quarter of 2010 was $7.18 per share.

The PSUs granted in 2010 entitle the recipients to receive shares of our common stock commencing in March 2011, contingent on the achievement of operating earnings targets for the 2010 fiscal year. Based upon above-target operating earnings of $237.0 million and market share and market penetration gains in some of the identified product areas, 125% of the PSUs were earned and 1.25 shares for each PSU (183,737 additional shares) granted will be paid out, subject to continued employment. We issued one-third (306,155 shares) of the total shares in the first quarter of 2011 and generally, one-third of such shares will be issued in annual installments in March 2012 and March 2013.

The following is a summary of PSU activity during 2011 as of April 1, 2011:

 

		Shares				Weighted Average Grant Date Fair Value
Non-vested – beginning of year			2,127,318			$	5.86
Granted 1			1,795,278			$	5.60
Vested			(798,241	)		$	5.07
Forfeited			(452,813	)		$	8.21
Non-vested – end of period			2,671,542			$	5.52

¹ This includes the additional 183,737 shares from the 2010 grant that were earned based on 2010 operating earnings and strategic goals.

Equity-Based Compensation Expense

The following table sets forth the total equity-based compensation expense resulting from stock options, SARs, restricted stock, and PSUs by line item on the statement of operations:

 

		First Quarter
		4/1/11				4/2/10
Cost of revenue – products		$	0.5			$	0.4
Cost of revenue – services			0.6				0.5
Research and development			2.5				1.8
Sales and marketing			1.3				1.2
General and administrative			2.7				1.9
Equity-based compensation expense before income taxes			7.6				5.8
Income tax benefit			(1.4	)			(1.8	)
Total equity-based compensation expense after income taxes		$	6.2			$	4.0

The following table sets forth the total equity-based compensation expense by type:

 

		First Quarter
		4/1/11				4/2/10
Stock options		$	1.3			$	1.3
Cash-Settled SARs			(0.1	)			0.2
Restricted Stock			4.4				3.5
Performance stock units			2.0				0.8
Total		$	7.6			$	5.8

 

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As of April 1, 2011, we had $49.5 million of unrecognized equity-based compensation cost that we expect to recognize over a weighted average period of 2.0 years.

8. Income Taxes

We recorded a tax benefit of $5.8 million in the first quarter of 2011, compared with a tax benefit of $3.6 million for the first quarter of 2010. The effective tax rate for the quarter is below the federal statutory rate of 35% due to limitations on our ability to record a full tax benefit on losses from domestic operations, and the effect of establishing a valuation allowance against domestic deferred tax assets. In addition, our effective tax rate was favorably impacted by a $3.4 million benefit from the reversal of tax accruals no longer required due to the expiration of a statute of limitations.

9. Comprehensive Income

Comprehensive income for the first quarter of 2011 and 2010 consists of the following:

 

		First Quarter
		4/1/11				4/2/10
Net (loss) earnings		$	(24.1	)		$	45.6
Net change in unrealized (losses) gains related to:
Available-for-sale securities, net of tax			(3.0	)			0.4
Cash flow hedges, net of tax			—				1.4
Net investment hedges, net of tax			(7.3	)			4.7
Foreign currency translation adjustments			35.7				(29.7	)
Comprehensive income		$	1.3			$	22.4

10. Segment Information

We report operating results for three segments: Broadband, Transport and Services.

The Broadband segment includes data, access and managed access product portfolios that facilitate delivery of next-generation wireline and wireless services and the delivery of bundled voice, video and high-speed Internet/data services over copper-based and/or fiber-based networks. Data products include the Tellabs^® 7300 Metro Ethernet Switching Series, the Tellabs^® 8600 Managed Edge System, the Tellabs^® 8800 Multiservice Router Series and the Tellabs^® SmartCore^® 9100 Platform. Access offerings include the Tellabs^® 1000 Multiservice Access Series, the Tellabs^® 1100 Multiservice Access Series and the Tellabs^® 1600 Optical Network Terminal (ONT) Series. Managed access products include the Tellabs^® 6300 Managed Transport System and the Tellabs^® 8100 Managed Access System.

The Transport segment includes solutions that enable service providers to transport service and manage optical bandwidth by adding capacity when and where it’s needed. Wireline and wireless carriers use these products within the metropolitan portion of their transport networks to support wireless services, business services for enterprise customers, and triple-play voice, video and data services for residential customers. Product offerings include the Tellabs^® 3000 Series of voice-enhancement products, the Tellabs^® 5000 Series of digital cross-connect systems, and the Tellabs^® 7100 Optical Transport System (OTS).

The Services segment includes deployment, support, training and professional services. These services support all phases of the network: planning, building and operating.

We define segment profit as gross profit less research and development expenses. Segment profit excludes sales and marketing expenses, general and administrative expenses, the amortization of intangibles, restructuring and other charges and the impact of equity-based compensation.

 

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Consolidated revenue by segment follows:

 

		First Quarter
		4/1/11				4/2/10
Broadband		$	173.0			$	191.1
Transport			99.4				127.4
Services			50.0				60.7
Total		$	322.4			$	379.2

Segment profit and reconciliation to operating (loss) earnings by segment follows:

 

		First Quarter
		4/1/11				4/2/10
Broadband		$	19.7			$	60.8
Transport			16.0				45.0
Services			10.0				19.5
Total segment profit			45.7				125.3
Sales and marketing expenses			(44.7	)			(45.1	)
General and administrative expenses			(23.7	)			(24.8	)
Equity-based compensation			(3.7	)			(2.6	)
Intangible asset amortization			(5.2	)			(7.4	)
Restructuring and other charges			(1.0	)			(10.0	)
Operating (loss) earnings		$	(32.6	)		$	35.4

The segments use many of the same assets. For internal reporting purposes, we do not allocate assets by segment and therefore asset, depreciation and amortization, or capital expenditure by segment information is not provided to our chief operating decision maker.

11. Contingencies

Legal Proceedings

We are subject to legal claims and litigation arising in the ordinary course of business, such as employment or intellectual property claims, including the matters described below. We are unable to determine the likelihood of an unfavorable outcome against us and are unable to reasonably estimate a range of loss, if any.

Makor Issues & Rights, Ltd. v. Tellabs, Inc. On June 18, 2002, a class action complaint was filed in the United States District Court of the Northern District of Illinois against Tellabs, Michael Birck (Chairman of the Board of Tellabs) and Richard Notebaert (former CEO, President and Director of Tellabs). Thereafter, eight similar complaints were also filed in the United States District Court of the Northern District of Illinois. All nine of these actions were subsequently consolidated, and on December 3, 2002, a consolidated amended class action complaint was filed against Tellabs, Mr. Birck, Mr. Notebaert, and certain other of our current or former officers and/or directors. The consolidated amended complaint alleged that during the class period (December 11, 2000-June 19, 2001) the defendants violated the federal securities laws by making materially false and misleading statements, including, among other things, allegedly providing revenue forecasts that were false and misleading, misrepresenting demand for our products, and reporting overstated revenue for the fourth quarter 2000 in our financial statements. Further, certain of the individual defendants were alleged to have violated the federal securities laws by trading our securities while allegedly in possession of material, non-public information about us pertaining to these matters. The consolidated amended complaint seeks unspecified restitution, damages and other relief.

On January 17, 2003, Tellabs and the other named defendants filed a motion to dismiss the consolidated amended class action complaint in its entirety. On May 19, 2003, the Court granted our motion and dismissed all counts of the consolidated amended complaint, while affording plaintiffs an opportunity to replead. On July 11, 2003, plaintiffs filed a second consolidated amended class action complaint against Tellabs, Messrs. Birck and Notebaert, and many (although not all) of the other previously named individual defendants, realleging claims similar to those contained in the previously dismissed consolidated amended class action complaint. We filed a second motion to dismiss on August 22, 2003, seeking the dismissal

 

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with prejudice of all claims alleged in the second consolidated amended class action complaint. On February 19, 2004, the Court issued an order granting that motion and dismissed the action with prejudice. On March 18, 2004, the plaintiffs filed a Notice of Appeal to the United States Federal Court of Appeal for the Seventh Circuit, appealing the dismissal. The appeal was fully briefed and oral argument was heard on January 21, 2005. On January 25, 2006, the Seventh Circuit issued an opinion affirming in part and reversing in part the judgment of the district court, and remanding for further proceedings. On February 8, 2006, defendants filed with the Seventh Circuit a petition for rehearing with suggestion for rehearing en banc. On April 19, 2006, the Seventh Circuit ordered plaintiffs to file an answer to the petition for rehearing, which was filed by the plaintiffs on May 3, 2006. On July 10, 2006, the Seventh Circuit denied the petition for rehearing with a minor modification to its opinion, and remanded the case to the district court. On September 22, 2006, defendants filed a motion in the district court to dismiss some (but not all) of the remaining claims. On October 3, 2006, the defendants filed with the United States Supreme Court a petition for a writ of certiorari seeking to appeal the Seventh Circuit’s decision. On January 5, 2007, the defendants’ petition was granted. The United States Supreme Court heard oral arguments on March 28, 2007. On June 21, 2007, the United States Supreme Court vacated the Seventh Circuit’s judgment and remanded the case for further proceedings. On November 1, 2007, the Seventh Circuit heard oral arguments for the remanded case. On January 17, 2008, the Seventh Circuit issued an opinion adhering to its earlier opinion reversing in part the judgment of the district court, and remanded the case to the district court for further proceedings. On February 24, 2009, the district court granted plaintiffs’ motion for class certification. On August 13, 2010, the Court granted in large part Tellabs’ motion for summary judgment. The parties have agreed to settle the lawsuit, which settlement is still subject to final court approval. If approved, all settlement amounts will be paid by Tellabs’ insurers.

Fujitsu Network Communications Inc. v. Tellabs, Inc. On January 28, 2008, Fujitsu Network Communications, Inc. and Fujitsu Limited filed a complaint in the United States District Court for the Eastern District of Texas against Tellabs in a case captioned Fujitsu Network Communications, Inc. and Fujitsu Limited v. Tellabs, Inc. and Tellabs Operations, Inc., Civil Action No. 6:08-cv-00022-LED. The complaint alleges infringement of U.S. Patent Nos. 5,526,163, 5,521,737, 5,386,418 and 6,487,686, and seeks unspecified damages including enhanced damages, as well as attorney fees and other remedies including injunctive relief. On March 21, 2008, Tellabs filed its answer, defenses and counterclaims in response to the complaint. A trial date had been set for May 10, 2010, in the Eastern District of Texas, however on July 7, 2009, the court granted Tellabs’ motion to transfer and issued an order transferring the action to the United States District Court for the Northern District of Illinois. On September 15, 2009, the Court in the Northern District of Illinois consolidated this action, for discovery purposes only, with the action instituted by Tellabs against Fujitsu in the Northern District of Illinois. On November 4, 2010, the Court dismissed with prejudice Fujitsu’s claim for infringement of Fujitsu’s U.S. Patent No. 6,487,686. In conjunction with the dismissal, Fujitsu signed a covenant not to sue Tellabs for infringement as to any claim of Fujitsu’s U.S. Patent No. 6,487,686, as to any Tellabs products as they currently exist or existed in the past. On March 31, 2011, the Court issued an Order denying a motion by Tellabs for summary judgment of invalidity based on indefiniteness of Fujitsu’s U.S. Patent No. 5,386,418, and granting a motion by Fujitsu for summary judgment for judicial correction of an error in asserted Claim 1 of the same patent as originally issued. The parties currently remain in the discovery phase, and a trial date has been set for January 17, 2012. The parties also await the Court’s issuance of a Markman ruling.

Tellabs Operations, Inc. v. Fujitsu Limited and Fujitsu Network Communications Inc. On June 11, 2008, Tellabs Operations, Inc. filed a complaint in the United States District Court for the Northern District of Illinois against Fujitsu Limited and Fujitsu Network Communications, Inc. in a case captioned Tellabs Operations, Inc. v. Fujitsu Limited and Fujitsu Network Communications, Inc. Civil Action No. 1:08-cv-3379. The complaint alleges infringement of Tellabs Operations, Inc.’s U.S. Patent No. 7,369,772, and seeks unspecified damages including enhanced damages, as well as attorney fees and other remedies including injunctive relief. On September 5, 2008, each of Fujitsu Limited and Fujitsu Network Communications, Inc. served its answer, defenses and counterclaims in response to the complaint. Fujitsu Limited also brought counterclaims against Tellabs, Inc. and Tellabs Operations, Inc. alleging infringement of two U.S. patents, namely U.S. Patent Nos. 5,533,006 and 7,227,681, seeking unspecified damages including enhanced damages, as well as attorney fees and other remedies including injunctive relief. On September 22, 2008, Tellabs Operations, Inc. filed its answer to the counterclaims of Fujitsu Network Communications, Inc., and also filed its counterclaims and reply to counterclaims of Fujitsu Limited. On that same date, Tellabs, Inc. filed its answer and counterclaims against Fujitsu Limited. On September 15, 2009, the Court in the Northern District of Illinois consolidated this action, for discovery purposes only, with the action filed by Fujitsu transferred to the Northern District of Illinois by the Eastern District of Texas. On March 31, 2011, the Court issued an Order granting Tellabs’ motion for summary judgment of invalidity of all claims of Fujitsu’s U.S. Patent No. 5,533,006. The parties currently remain in the discovery phase, and a trial date has been set for January 17, 2012. The parties also await the Court’s issuance of a Markman ruling.

Telcordia Technologies Inc. v. Tellabs, Inc. On May 4, 2009, Telcordia Technologies, Inc. filed a complaint against Tellabs in the United States District Court for the District of New Jersey in a case captioned Telcordia Technologies Inc. v. Tellabs, Inc., Civil Action No. 2:09-cv-02089. The complaint alleges infringement of U.S. Patent Nos. 4,893,306, 4,835,763 and Re.

 

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36,633, and seeks unspecified damages including enhanced damages, as well as attorney fees and other remedies including injunctive relief. On July 27, 2009, Telcordia filed a first amended complaint adding Tellabs Operations, Inc. and Tellabs North America, Inc. as additional defendants. On September 1, 2009, Tellabs filed answers, defenses and counterclaims in response to the first amended complaint. On December 15, 2009, the Court granted Tellabs’ motion to transfer, which resulted in a transfer of the action to the United States District Court for the District of Delaware. The parties are in the early phases of discovery. A trial date has not yet been set.

Atwater Partners of Texas LLC v. AT&T, Inc. et al. On May 27, 2010, a complaint was filed in the United States District Court for the Eastern District of Texas against Tellabs and several other companies in a case captioned Atwater Partners of Texas LLC v. AT&T, Inc. et al., Civil Action No. 2:10-cv-00175. The complaint alleges infringement of U.S. Patent Nos. 6,490,296, 7,158,523, 7,161,953, 7,310,310, and 7,349,401, and seeks unspecified damages as well as interest, costs, expenses, attorney fees and other remedies including injunctive relief. Tellabs responded to the Complaint on August 6, 2010, denying Atwater’s allegations. A non-material financial settlement of this matter was reached between Tellabs and Atwater that resulted in a dismissal of Tellabs from the action with prejudice on March 24, 2011.

Lambda Optical Solutions, LLC v. Alcatel-Lucent SA, et al. On June 4, 2010, a complaint was filed in the United States District Court for the District of Delaware against Tellabs and several other companies in a case captioned Lambda Optical Solutions, LLC v. Alcatel-Lucent SA, et al., Civil Action No. 1:10-cv-00487-UNA. The complaint alleges infringement of U.S. Patent Nos. 6,973,229, and seeks unspecified damages including enhanced damages, as well as interest, costs, expenses, attorney fees and other remedies including injunctive relief. Tellabs was served with the Complaint on September 13, 2010. Tellabs responded to the Complaint on November 2, 2010, denying Lambda’s allegations. The parties are in the earliest phases of the litigation. No trial date has been set.

Apart from the matters described above, we are and in the future may be subject to various legal proceedings, claims and litigation arising in the ordinary course of business. Any legal proceedings, claims and litigation, whether current or future, and whether with or without merit, potentially can result in: costly litigation; diverting management’s time, attention and resources; delaying or halting product shipments or services delivery; requiring us to pay damages; requiring us to enter into royalty-bearing licensing arrangements or to obtain substitute technology of lower quality or higher costs; or otherwise imposing obligations or restrictions that could adversely affect our business, financial condition and operating results.

12. Stock Repurchase Programs

We repurchase outstanding common stock under two programs authorized by our Board of Directors, the Rule 10b5-1 program and a repurchase program of up to $600 million of outstanding common stock. In addition, we purchase shares to cover withholding taxes on shares issued under employee stock plans.

Under the 10b5-1 program, we intend to continue to use cash generated by employee stock option exercises (other than those of Company officers and board members) to repurchase stock. We purchased $0.5 million (0.1 million shares) in the first quarter of 2011 under this program.

As of April 1, 2011, we purchased 56.6 million shares of our common stock under the $600 million repurchase program at a total cost of $375.4 million, leaving $224.6 million available to be purchased under this program. We did not purchase any shares under this program in the first quarter of 2011. We may change our repurchase activity and we provide no assurance that we will continue our repurchase activity in the future.

In addition, we purchased 0.3 million shares for $1.5 million in the first quarter of 2011 to cover withholding taxes on shares issued under employee stock plans.

We record repurchased shares as Treasury stock.

 

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13. Net (Loss) Earnings Per Share

The following table sets forth the computation of net (loss) earnings per share:

 

		First Quarter
		4/1/11				4/2/10
Numerator:
Net (loss) earnings		$	(24.1	)		$	45.6
Denominator:
Denominator for basic net earnings per share – weighted average shares outstanding			363.0				384.7
Effect of dilutive securities:
Employee stock options and restricted and performance stock awards			—				3.9
Denominator for diluted net earnings per share – adjusted weighted average shares outstanding and assumed conversions			363.0				388.6
Net (loss) earnings per share, basic		$	(0.07	)		$	0.12
Net (loss) earnings per share, diluted		$	(0.07	)		$	0.12

The number of securities excluded from the weighted average shares outstanding computation was 23.2 million in the first quarter of 2011 and 19.5 million in the first quarter of 2010 because the exercise price was greater than the average market price of the common shares; therefore, the effect would have been anti-dilutive.

Under U.S. GAAP, dilutive securities are not included in the computation of diluted earnings per share when a company is in a loss position. If we were not in a loss position, diluted weighted average shares outstanding would have been 365.5 million in the first quarter of 2011.

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

Introduction and Overview of Business

Tellabs designs, develops and supports telecommunications networking products. We generate revenue principally through the sale of these products to communications service providers worldwide as both stand-alone network elements and as elements of integrated solutions. We also generate revenue by providing services to our customers. We operate in three business segments: Broadband, Transport and Services.

The Broadband segment includes data, access and managed access product portfolios that facilitate mobile communications, wireline business services and bundled consumer services.

 

•

Revenue from data products is driven by the need for wireless and wireline carriers to deliver next-generation voice, video and Internet services.

 

•

Revenue from access products is primarily driven by the need for wireline carriers to deliver bundled voice, video and Internet services to residential customers.

 

•

Revenue from managed access products is driven by the need for wireless and wireline carriers to deliver mobile voice and Internet services and business-oriented voice, video and Internet services.

The Transport segment includes optical networking systems, digital cross-connect systems and voice-quality enhancement products. Revenue for these products is driven by the needs of wireline and wireless carriers to deliver mobile services, business-oriented services and residential services.

The Services segment includes deployment, support, training and professional services. Revenue from deployment, support and training services arises primarily from the sales of products and continues to represent the majority of Services revenue, while the balance comes from professional services offerings.

 

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Tellabs operates in a dynamic industry. Customer consolidation has resulted in increased pricing pressure. In addition, customer spending is pressured and competition is heightened on a global basis. Some equipment suppliers have also consolidated. Heightened competition by these suppliers has resulted in increased pricing pressure for Tellabs and some of its direct competitors.

Within this backdrop, we continue to transform the company with new products and services. The company is evolving from a core product and services portfolio based primarily on the circuit-switched Time Division Multiplexing (TDM) technology used in our digital cross-connect and managed access products to a growth portfolio based on the packet-switching and Internet Protocol (IP) technology used in our data and optical networking products. Given the level of research and development expenses in early lifecycle products, this growth portfolio is not presently profitable.

RESULTS OF OPERATIONS

For the first quarter of 2011, revenue was $322.4 million, compared with $379.2 million in the first quarter of 2010. We operate in three business segments: Broadband, Transport and Services. Revenue declined in all segments during the three-month period. (Further discussion of segment results can be found below.)

Consolidated gross profit margin in the first quarter of 2011 was 37.9%, compared with 50.6% in the year-ago quarter as products and services gross margins decreased.

Operating expenses in the first quarter of 2011 were $154.9 million, down slightly from $156.5 million in the year-ago quarter.

Operating loss in the first quarter of 2011 was $32.6 million, compared with operating earnings of $35.4 million in the year-ago quarter.

Net loss for the first quarter of 2011 was $24.1 million or $0.07 per share (basic and diluted), compared with net earnings of $45.6 million or $0.12 per share (basic and diluted) in the year-ago quarter.

Revenue (in millions)

 

		First Quarter
		2011				2010				Change
Products		$	272.4			$	318.5				(14.5	)%
Services			50.0				60.7				(17.6	)%
Total revenue		$	322.4			$	379.2				(15.0	)%

On a geographic basis, revenue from customers outside North America grew to $147.3 million (or 46% of total revenue) in the first quarter of 2011, up 40.0% from $105.2 million (or 28% of total revenue) in the year-ago quarter. The increase in revenue was driven primarily by higher revenue for data products from customers in the Europe, Middle East and Africa region.

Revenue from customers in North America (United States and Canada) was $175.1 million (or 54% of total revenue) in the first quarter of 2011, compared with $274.0 million (or 72% of total revenue) in the year-ago quarter. Revenue concentration from our two major customers was 35% in the first quarter, lower than the prior quarter. The decrease in revenue was driven primarily by lower revenue for data and digital cross-connect systems from a major North American carrier.

In the first quarter of 2011, revenue from our growth portfolio (the Tellabs^® 6300 Managed Transport System, the Tellabs^® 7100 Optical Transport System, the Tellabs^® 7300 Metro Ethernet Switching Series, the Tellabs^® 8600 Managed Edge System, the Tellabs^® 8800 Multiservice Router Series, the Tellabs SmartCore^® 9100 Platform, and professional services) was $194.4 million (or 60% of total revenue), compared with $214.6 million (or 57% of total revenue) in the year-ago quarter. Given the level of research and development expenses in early lifecycle products, this portfolio is not presently profitable.

Our core portfolio (the Tellabs^® 5000 series of digital cross-connect systems, the Tellabs^® 8100 Managed Access System, the Tellabs^® 3000 Series of voice-enhancement products, the Tellabs Access products and deployment, training and support services) accounted for $128.0 million (or 40% of total revenue), compared with $164.6 million (or 43% of total revenue) in the year-ago quarter.

 

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Gross Margin

 

		First Quarter
		2011				2010				% Point Change
Products			41.4	%			54.3	%			(12.9	)
Services			18.8	%			31.3	%			(12.5	)
Consolidated			37.9	%			50.6	%			(12.7	)

The decline in products gross margin was driven by an unfavorable product mix, including lower revenue from higher-margin data and digital cross-connect systems and higher revenue from lower-margin optical transport systems, and lower overall product revenue. Services gross margin declined primarily due to lower overall services revenue and a less favorable services mix.

Operating Expenses (in millions)

 

		First Quarter												Percent of Revenue
		2011				2010				Change				2011				2010
Research and development		$	80.3			$	69.2			$	11.1				24.9	%			18.2	%
Sales and marketing			44.7				45.1				(0.4	)			13.9	%			11.9	%
General and administrative			23.7				24.8				(1.1	)			7.4	%			6.5	%
Subtotal			148.7				139.1				9.6				46.1	%			36.7	%
Intangible asset amortization			5.2				7.4				(2.2	)
Restructuring and other charges			1.0				10.0				(9.0	)
Total operating expenses		$	154.9			$	156.5			$	(1.6	)

Operating expenses fell slightly during the first quarter of 2011, compared with the year-ago period. Higher research and development expenses primarily for products for the mobile Internet were offset by slightly lower sales, marketing, general and administrative expenses as well as lower restructuring and other charges. Restructuring and other charges of $1.0 million in 2011 are primarily due to severance expense related to previously announced restructuring plans.

Other Income (in millions)

 

		First Quarter
		2011				2010				Change
Interest income, net		$	3.3			$	3.9			$	(0.6	)
Other (expense) income, net			(0.6	)			2.7				(3.3	)
Total other income		$	2.7			$	6.6			$	(3.9	)

Interest income, net, declined due to lower yields during the first quarter of 2011, compared with the first quarter of 2010. Other (expense) income, net, was lower in the first quarter of 2011, compared with the first quarter of 2010, primarily due to gains on sales of marketable securities in the first quarter of 2010.

Income Taxes

For the first quarter of 2011, we reported a tax benefit of $5.8 million, compared with a benefit of $3.6 million for the first quarter of 2010. In the first quarter of 2011, a benefit of $3.4 million was recorded from the reversal of tax accruals that are no longer required due to an expiration of a statute of limitations, compared to a similar $13.3 million benefit recorded in the first quarter of 2010. Excluding these reversals, the tax benefit in the first quarter of 2011 was due to losses from domestic operations, partially offset by a valuation allowance on domestic deferred tax assets.

Segments

Segment Revenue (in millions)

 

		First Quarter
		2011				2010				Change
Broadband		$	173.0			$	191.1				(9.5	)%
Transport			99.4				127.4				(22.0	)%
Services			50.0				60.7				(17.6	)%
Total revenue		$	322.4			$	379.2				(15.0	)%

 

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Segment Profit* (in millions)

 

		First Quarter
		2011				2010				Change
Broadband		$	19.7			$	60.8				(67.6	)%
Transport			16.0				45.0				(64.4	)%
Services			10.0				19.5				(48.7	)%
Total segment profit		$	45.7			$	125.3				(63.5	)%

 

*	We define segment profit as gross profit less research and development expenses. Segment profit excludes sales and marketing expenses, general and administrative expenses, the amortization of intangibles, restructuring and other charges, and the impact of equity-based compensation.

Broadband

Revenue

Revenue from the Broadband segment was $173.0 million in the first quarter of 2011, compared with $191.1 million in the year-ago quarter. The Broadband segment includes data products, managed access products and access products. Reduced revenue from data and managed access products was partially offset by increased revenue from access products.

Data product revenue was $106.5 million in the first quarter of 2011, compared with $130.7 million in the year-ago quarter. Increased revenue from customers in the Europe, Middle East and Africa regions was offset by lower revenue in other geographies. Access revenue was $40.1 million in the first quarter of 2011, up 33.2% from $30.1 million in the year-ago quarter, driven by increased revenue from access systems and single-family optical network terminal (ONT) units. Managed access revenue was $26.4 million in the first quarter of 2011, compared with $30.3 million in the year-ago quarter. Most of the decline came from lower revenue from managed access systems.

Segment Profit

Broadband segment profit was $19.7 million in the first quarter of 2011, compared with $60.8 million in the year-ago quarter. The decline in segment profit was driven primarily by lower overall revenue from data products, a higher mix of lower-margin International data revenue and higher research and development expenses.

Transport

Revenue

Revenue from the Transport segment was $99.4 million in the first quarter of 2011, compared with $127.4 million in the year-ago quarter. Increased revenue from optical transport systems was offset by lower revenue from digital cross-connect systems.

Segment Profit

Transport segment profit was $16.0 million in the first quarter of 2011, compared with $45.0 million in the year-ago quarter. The decline in segment profit was driven primarily by lower revenue from higher-margin digital cross-connect systems and higher revenue from lower-margin optical transport systems.

Services

Revenue

Revenue from the Services segment was $50.0 million in the first quarter of 2011, compared with $60.7 million in the year-ago quarter. The decline in segment revenue was driven primarily by lower deployment services revenue in North America.

Segment Profit

Services segment profit was $10.0 million in the first quarter of 2011, compared with $19.5 million in the year-ago quarter. The decrease in segment profit was primarily due to lower overall services revenue and a less favorable services mix.

Financial Condition, Liquidity & Capital Resources

Our principal source of liquidity remained cash, cash equivalents and marketable securities of $1,057.2 million as of April 1, 2011, which decreased by $77.3 million since year-end 2010. Of the total cash, cash equivalents and marketable securities, as of April 1, 2011, $382.8 million was held in subsidiaries outside the United States. Cash used for operating activities during the quarter amounted to $81.5 million.

During the first quarter of 2011, we distributed $7.2 million to our stockholders through our quarterly cash dividend. We also repurchased 0.1 million shares of common stock at a cost of $0.5 million under the 10b5-1 plan. We provide no

 

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assurance as to a future declaration or payment of a cash dividend nor do we provide future assurance of a repurchase of common stock.

We believe that our investments are highly liquid instruments. We may rebalance the portfolio from time to time, which may affect the duration, credit structure and future income of investments.

Based on historical performance and current forecasts, we believe the company’s cash, cash equivalents and marketable securities will satisfy working capital needs, capital expenditures and other liquidity requirements related to existing operations for the next 12 months. Future available sources of working capital, including cash, cash equivalents, and marketable securities, cash generated from future operations, short-term or long-term financing, equity offerings or any combination of these sources, should allow us to meet our long-term liquidity needs. Current policy is to use cash, cash equivalents and marketable securities to fund business operations, to expand business, potentially through acquisitions, to repurchase common stock and to pay a cash dividend.

GAAP Sequential Comparisons

We believe that comparing some quarterly Statement of Operations data on a sequential basis provides important supplemental information to management and investors regarding financial and business trends relating to our financial results. Commonly compared sequential comparisons of GAAP data include total revenue, segment revenue and profit, our geographic revenue split and the split between our growth and core portfolios.

Comparing our first-quarter 2011 results with the fourth quarter of 2010:

For the first quarter of 2011, total revenue was $322.4 million, compared with $410.5 million in the prior quarter. On a sequential basis, revenue declined across all three segments. Revenue concentration from our major customers decreased in the first quarter of 2011, compared with the prior quarter.

Total Broadband revenue for the first quarter of 2011 was $173.0 million, compared with $227.0 million in the prior quarter. Within the Broadband segment, data revenue was $106.5 million, compared with $119.9 million in the prior quarter. Higher revenue for data products from customers outside North America was offset by lower revenue from data customers in North America. Access revenue was $40.1 million, compared with $69.6 million in the prior quarter, driven primarily by lower revenue from single-family ONT units. Managed access revenue was $26.4 million, compared with $37.5 million in the prior quarter, on lower revenue from SDH transport systems and managed access systems. Broadband segment profit for the first quarter of 2011 was $19.7 million, compared with $33.8 million in the prior quarter. The decline in segment profit was driven by lower overall segment revenue, partially offset by a $16.5 million charge for excess purchase commitments in the prior quarter.

Transport segment revenue for the first quarter of 2011 was $99.4 million, compared with $123.3 million in the prior quarter, primarily as a result of decreased revenue from optical transport and digital cross-connect systems. Transport segment profit for the first quarter of 2011, driven primarily by lower revenue from optical transport systems, was $16.0 million, compared with $23.5 million in the prior quarter.

Services segment revenue for the first quarter of 2011 was $50.0 million, compared with $60.2 million in the prior quarter. Services segment profit for the first quarter of 2011, driven primarily by lower overall services revenue and a less favorable services mix, was $10.0 million, compared with $18.5 million in the prior quarter.

North American revenue for the first quarter of 2011 was $175.1 million (or 54% of total revenue) compared with $240.5 million (or 59% of total revenue) in the prior quarter. Outside North America, revenue in the first quarter of 2011 was $147.3 million (or 46% of total revenue) compared with $170.0 million (or 41% of total revenue) in the prior quarter.

Growth portfolio revenue for the first quarter of 2011 was $194.4 million (or 60% of total revenue), compared with $231.4 million (or 56% of total revenue) in the prior quarter. Given the level of research and development expenses in early lifecycle products, this portfolio is not presently profitable. In the first quarter of 2011, core portfolio revenue was $128.0 million (or 40% of total revenue), compared with $179.1 million (or 44% of total revenue) in the prior quarter.

Non-GAAP Financial Measures and Comparisons

We believe that comparing some quarterly non-GAAP financial measures on a sequential basis provides important supplemental information to management and investors regarding financial and business trends relating to our financial results. The non-GAAP financial data we compare includes gross profit as a percentage of revenue, operating expenses, operating earnings (loss), net earnings (loss) and net earnings (loss) per share. A complete reconciliation between non-GAAP

 

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financial measures and the GAAP financial measures, along with an explanation of why we believe non-GAAP measures to be of value to management and investors, is contained in the Reconciliation of Non-GAAP Adjustments on pages 26 through 28.

Comparing our first-quarter 2011 results with the fourth quarter of 2010:

Non-GAAP gross profit margin for the first quarter of 2011 was 38.3%, compared with 38.2% in the prior quarter when a $16.5 million charge for excess purchase commitments reduced non-GAAP gross margins by 4.0%. Excluding the impact of the charge, non-GAAP gross profit margin in the fourth quarter of 2010 would have been 42.2%. Primary drivers for the decline in gross profit margin to 38.3% from 42.2% in the prior quarter were higher warranty and excess and obsolete inventory costs and lower overall product revenue and services margins.

Non-GAAP operating expenses for the first quarter of 2011 were $142.1 million, compared with $151.1 million in the prior quarter. Increased research and development expenses for products for the smart mobile Internet were offset by lower spending across the rest of the business.

Non-GAAP operating loss for the first quarter of 2011, driven by lower revenue and gross profit, was $18.7 million, compared with operating earnings of $5.7 million in the prior quarter.

Non-GAAP net loss in the first quarter of 2011, driven primarily by the overall decrease in revenue and gross margin, was $10.9 million or $0.03 per share (basic and diluted), compared with net earnings of $5.7 million or $0.02 per share (basic and diluted) in the prior quarter.

 

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TELLABS, INC.

RECONCILIATION OF NON-GAAP ADJUSTMENTS (1)

(Unaudited)

 

		First Quarter 2011												First Quarter 2010
In millions, except per-share data		As Reported				Adjustments				Non-GAAP				As Reported				Adjustments				Non-GAAP
Revenue
Products		$	272.4			$	—			$	272.4			$	318.5			$	—			$	318.5
Services			50.0				—				50.0				60.7				—				60.7
Total revenue			322.4				—				322.4				379.2				—				379.2
Cost of Revenue
Products (a)			159.5				(0.5	)			159.0				145.6				(0.4	)			145.2
Services (a)			40.6				(0.6	)			40.0				41.7				(0.5	)			41.2
Total cost of revenue			200.1				(1.1	)			199.0				187.3				(0.9	)			186.4
Gross Profit			122.3				1.1				123.4				191.9				0.9				192.8
Gross profit as a percentage of revenue			37.9	%			0.4	%			38.3	%			50.6	%			0.2	%			50.8	%
Gross profit as a percentage of revenue – products			41.4	%			0.2	%			41.6	%			54.3	%			0.1	%			54.4	%
Gross profit as a percentage of revenue – services			18.8	%			1.2	%			20.0	%			31.3	%			0.8	%			32.1	%
Operating Expenses
Research and development (a)			80.3				(2.6	)			77.7				69.2				(1.7	)			67.5
Sales and marketing (a)			44.7				(1.3	)			43.4				45.1				(1.1	)			44.0
General and administrative (a)			23.7				(2.7	)			21.0				24.8				(1.9	)			22.9
Intangible asset amortization (b)			5.2				(5.2	)			—				7.4				(7.4	)			—
Restructuring and other charges (c)			1.0				(1.0	)			—				10.0				(10.0	)			—
Total operating expenses			154.9				(12.8	)			142.1				156.5				(22.1	)			134.4
Operating (Loss) Earnings			(32.6	)			13.9				(18.7	)			35.4				23.0				58.4
Operating (loss) earnings as a percentage of revenue			-10.1	%			4.3	%			-5.8	%			9.3	%			6.1	%			15.4	%
Other Income
Interest income, net			3.3				—				3.3				3.9				—				3.9
Other (expense) income, net			(0.6	)			—				(0.6	)			2.7				—				2.7
Total other income			2.7				—				2.7				6.6				—				6.6
(Loss) Earnings Before Income Tax			(29.9	)			13.9				(16.0	)			42.0				23.0				65.0
Income tax benefit (expense) (e)			5.8				(0.7	)			5.1				3.6				(24.4	)			(20.8	)
Net (Loss) Earnings		$	(24.1	)		$	13.2			$	(10.9	)		$	45.6			$	(1.4	)		$	44.2
Weighted Average Shares Outstanding
Basic			363.0								363.0				384.7								384.7
Diluted			363.0								363.0				388.6								388.6
Net (Loss) Earnings Per Share
Basic		$	(0.07	)		$	0.04			$	(0.03	)		$	0.12			$	(0.01	)		$	0.11
Diluted		$	(0.07	)		$	0.04			$	(0.03	)		$	0.12			$	(0.01	)		$	0.11

 

(1)	Reconciliation of non-GAAP Adjustments

In addition to reporting financial results in accordance with U.S. generally accepted accounting principles (GAAP), Tellabs, Inc. has provided non-GAAP financial measures as additional information for its operating results. These measures have not been prepared in accordance with GAAP and may be different from measures used by other companies. Whenever we use non-GAAP financial measures, we designate these measures, which exclude the effect of certain charges, as “adjusted” and provide a reconciliation of non-GAAP financial measures to the most closely applicable GAAP financial measure. The non-GAAP financial measures eliminate certain items of expenses and losses from cost of revenue, operating expenses, other income and expenses, and income taxes. Management believes that this presentation allows investors to better evaluate the current operational and financial performance of our business and facilitate comparisons to historical results of operations. Management uses these measures for reviewing our financial results and for business planning and performance management. Management discloses this information publicly along with a reconciliation of the comparable GAAP amounts, to provide access to the detail and general nature of adjustments made to GAAP financial results. While some of these excluded items have been periodically reported in our statements of operations, including significant restructuring and other charges, their occurrence in future periods depends on future business and economic factors, among other evaluation criteria, and the occurrence of such events and factors may frequently be beyond the control of management.

 

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TELLABS, INC.

RECONCILIATION OF NON-GAAP ADJUSTMENTS (1)

(Unaudited)

 

		First Quarter 2011												Fourth Quarter 2010
In millions, except per-share data		As Reported				Adjustments				Non-GAAP				As Reported				Adjustments				Non-GAAP
Revenue
Products		$	272.4			$	—			$	272.4			$	350.3			$	—			$	350.3
Services			50.0				—				50.0				60.2				—				60.2
Total revenue			322.4				—				322.4				410.5				—				410.5
Cost of Revenue
Products (a)			159.5				(0.5	)			159.0				212.4				(0.4	)			212.0
Services (a)			40.6				(0.6	)			40.0				42.3				(0.6	)			41.7
Total cost of revenue			200.1				(1.1	)			199.0				254.7				(1.0	)			253.7
Gross Profit			122.3				1.1				123.4				155.8				1.0				156.8
Gross profit as a percentage of revenue			37.9	%			0.4	%			38.3	%			38.0	%			0.2	%			38.2	%
Gross profit as a percentage of revenue - products			41.4	%			0.2	%			41.6	%			39.4	%			0.1	%			39.5	%
Gross profit as a percentage of revenue - services			18.8	%			1.2	%			20.0	%			29.7	%			1.0	%			30.7	%
Operating Expenses
Research and development (a)			80.3				(2.6	)			77.7				82.9				(1.9	)			81.0
Sales and marketing (a)			44.7				(1.3	)			43.4				46.8				(1.2	)			45.6
General and administrative (a)			23.7				(2.7	)			21.0				26.7				(2.2	)			24.5
Intangible asset amortization (b)			5.2				(5.2	)			—				6.1				(6.1	)			—
Restructuring and other charges (c)			1.0				(1.0	)			—				—				—				—
Total operating expenses			154.9				(12.8	)			142.1				162.5				(11.4	)			151.1
Operating (Loss) Earnings			(32.6	)			13.9				(18.7	)			(6.7	)			12.4				5.7
Operating (loss) earnings as a percentage of revenue			-10.1	%			4.3	%			-5.8	%			-1.6	%			3.0	%			1.4	%
Other Income
Interest income, net			3.3				—				3.3				3.4				—				3.4
Other (expense) income, net (d)			(0.6	)			—				(0.6	)			(4.5	)			3.8				(0.7	)
Total other income (expense)			2.7				—				2.7				(1.1	)			3.8				2.7
(Loss) Earnings Before Income Tax			(29.9	)			13.9				(16.0	)			(7.8	)			16.2				8.4
Income tax benefit (expense) (e)			5.8				(0.7	)			5.1				(3.1	)			0.4				(2.7	)
Net (Loss) Earnings		$	(24.1	)		$	13.2			$	(10.9	)		$	(10.9	)		$	16.6			$	5.7
Weighted Average Shares Outstanding
Basic			363.0								363.0				365.9								365.9
Diluted			363.0								363.0				365.9								369.6
Net (Loss) Earnings Per Share
Basic		$	(0.07	)		$	0.04			$	(0.03	)		$	(0.03	)		$	0.05			$	0.02
Diluted		$	(0.07	)		$	0.04			$	(0.03	)		$	(0.03	)		$	0.05			$	0.02

 

(1)	Reconciliation of non-GAAP Adjustments

 

In addition to reporting financial results in accordance with U.S. generally accepted accounting principles (GAAP), Tellabs, Inc. has provided non-GAAP financial measures as additional information for its operating results. These measures have not been prepared in accordance with GAAP and may be different from measures used by other companies. Whenever we use non-GAAP financial measures, we designate these measures, which exclude the effect of certain charges, as “adjusted” and provide a reconciliation of non-GAAP financial measures to the most closely applicable GAAP financial measure. The non-GAAP financial measures eliminate certain items of expenses and losses from cost of revenue, operating expenses, other income and expenses, and income taxes. Management believes that this presentation allows investors to better evaluate the current operational and financial performance of our business and facilitate comparisons to historical results of operations. Management uses these measures for reviewing our financial results and for business planning and performance management. Management discloses this information publicly along with a reconciliation of the comparable GAAP amounts, to provide access to the detail and general nature of adjustments made to GAAP financial results. While some of these excluded items have been periodically reported in our statements of operations, including significant restructuring and other charges, their occurrence in future periods depends on future business and economic factors, among other evaluation criteria, and the occurrence of such events and factors may frequently be beyond the control of management.

 

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Footnotes to reconciliation of non-GAAP adjustments:

(a) The adjustments to cost of revenue, research and development, sales and marketing, and general and administrative expenses reflect equity-based compensation expense. We exclude these measures when reviewing financial results and for business planning and performance management. We believe that the exclusion of equity-based compensation expense allows for more accurate comparisons of operating results to our peer companies. In addition, we believe this non-cash GAAP measure is not indicative of our fundamental operating performance.

(b) We exclude amortization of intangible assets resulting from acquisitions to evaluate our continuing operational performance. The amortization of purchased intangible assets associated with acquisitions results in recording expense in our GAAP financial statements that were already expensed by the acquired company before the acquisition and for which we have not expended cash. We believe this non-cash GAAP measure is not indicative of our fundamental operating performance. Accordingly, we analyze the performance of operations without regard to such expenses.

(c) We exclude restructuring and other charges because we believe that they occur outside of the ordinary course of and are not related directly to the underlying performance of our fundamental business operations. We exclude these measures when reviewing financial results and for business planning and performance management. Although these events are reflected in our GAAP financials, these transactions may limit the comparability of our fundamental operations with prior and future periods.

(d) Other (expense) income, net includes charges to write-down long-term equity investments of $3.8 million in the fourth quarter of 2010. We exclude write-downs and gains on sales of long-term equity investments in partnerships and start-up technology companies because we believe that they are not related directly to the underlying performance of our working capital assets.

(e) We calculate a separate tax expense and effective tax rate for GAAP and for non-GAAP purposes. For non-GAAP purposes, we use a 32% effective tax rate which represents the projected, long term effective tax rate on non-GAAP pretax income.

 

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Off-Balance Sheet Arrangements

None.

Critical Accounting Policies

There were no material changes in our critical accounting policies during the quarter.

Outlook

We expect second-quarter 2011 revenue to be up in a range from $325 million to $345 million. We expect non-GAAP gross margin to be flat with the first quarter of 2011, plus or minus one or two points, depending on product and customer mix. We expect second-quarter non-GAAP operating expenses to be down slightly in the low $140 millions.

Forward-Looking Statements

This Management’s Discussion and Analysis and other sections of this Form 10-Q, including the statements under the caption “Outlook”, contain forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements reflect management’s expectations, estimates and assumptions, based on current and available information at the time the document was prepared. These forward-looking statements include, but are not limited to, statements regarding future events, plans, goals, objectives and expectations. The words “anticipate,” “believe,” “estimate,” “target,” “expect,” “predict,” “plan,” “possible,” “project,” “intend,” “likely,” “will,” “should,” “could,” “may,” “foreseeable,” “would” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and other factors that may cause our actual performance or achievements to be materially different from any future results, performance or achievements expressed or implied by those statements. Important factors that could cause our actual results to differ materially from those in forward-looking statements include, but are not limited to: customer concentration; successful expansion into adjacent markets with new and existing products and platforms; new product acceptance and profitability; our ability to compete with larger suppliers that can provide end to end solutions; overall negative economic conditions generally and disruptions in credit and capital markets, including specific impacts of these conditions on the telecommunications industry; financial condition of telecommunications service providers, equipment vendors and contract manufacturers, including the impact of any bankruptcies; availability of components and critical manufacturing equipment and capacity; the impact of customer and vendor consolidation; integration of a new business; product demand and industry capacity; competitive products and pricing; competitive pressures from new entrants to the telecommunications industry; initiatives to improve profitability that may have financial consequences, including further restructuring charges and the ability to realize anticipated savings under such cost-reduction initiatives; exiting businesses and product areas; impairment charges and other cost cutting initiatives and related charges and costs; manufacturing efficiencies; research and new product development; protection of and access to intellectual property, patents and technology; ability to attract and retain highly qualified personnel; foreign economic conditions, including currency rate fluctuations; the regulatory and trade environment; the impact of new or revised accounting rules or interpretations, including revenue recognition requirements; availability and terms of future acquisitions; divestitures and investments; uncertainties relating to synergies; charges and expenses associated with business combinations and other transactions; and other risks and future factors that may be detailed from time to time in the Company’s filings with the SEC. For a further description of such risks and future factors, see Item 1A of our most recently filed Form 10-K. Our actual future results could differ materially from those predicted in such forward-looking statements. In light of the foregoing risks, uncertainties and other factors, investors are advised not to rely on these forward-looking statements when making investment decisions. These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of our business. We undertake no obligation to publicly update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events or changes to future results over time. The foregoing discussion should be read in conjunction with the risk factors, financial statements and related notes and management’s discussion and analysis included in our Annual Report on Form 10-K for the year ended December 31, 2010.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of April 1, 2011, there were no material changes to the market risks disclosure, Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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Item 4. Controls and Procedures

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of disclosure controls and procedures as of April 1, 2011. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. There were no changes during the period covered by this Form 10-Q in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are subject to legal claims and litigation arising in the ordinary course of business, such as employment or intellectual property claims, including the matters described below. We are unable to determine the likelihood of an unfavorable outcome against us and are unable to reasonably estimate a range of loss, if any.

Makor Issues & Rights, Ltd. v. Tellabs, Inc. On June 18, 2002, a class action complaint was filed in the United States District Court of the Northern District of Illinois against Tellabs, Michael Birck (Chairman of the Board of Tellabs) and Richard Notebaert (former CEO, President and Director of Tellabs). Thereafter, eight similar complaints were also filed in the United States District Court of the Northern District of Illinois. All nine of these actions were subsequently consolidated, and on December 3, 2002, a consolidated amended class action complaint was filed against Tellabs, Mr. Birck, Mr. Notebaert, and certain other of our current or former officers and/or directors. The consolidated amended complaint alleged that during the class period (December 11, 2000-June 19, 2001) the defendants violated the federal securities laws by making materially false and misleading statements, including, among other things, allegedly providing revenue forecasts that were false and misleading, misrepresenting demand for our products, and reporting overstated revenue for the fourth quarter 2000 in our financial statements. Further, certain of the individual defendants were alleged to have violated the federal securities laws by trading our securities while allegedly in possession of material, non-public information about us pertaining to these matters. The consolidated amended complaint seeks unspecified restitution, damages and other relief.

On January 17, 2003, Tellabs and the other named defendants filed a motion to dismiss the consolidated amended class action complaint in its entirety. On May 19, 2003, the Court granted our motion and dismissed all counts of the consolidated amended complaint, while affording plaintiffs an opportunity to replead. On July 11, 2003, plaintiffs filed a second consolidated amended class action complaint against Tellabs, Messrs. Birck and Notebaert, and many (although not all) of the other previously named individual defendants, realleging claims similar to those contained in the previously dismissed consolidated amended class action complaint. We filed a second motion to dismiss on August 22, 2003, seeking the dismissal with prejudice of all claims alleged in the second consolidated amended class action complaint. On February 19, 2004, the Court issued an order granting that motion and dismissed the action with prejudice. On March 18, 2004, the plaintiffs filed a Notice of Appeal to the United States Federal Court of Appeal for the Seventh Circuit, appealing the dismissal. The appeal was fully briefed and oral argument was heard on January 21, 2005. On January 25, 2006, the Seventh Circuit issued an opinion affirming in part and reversing in part the judgment of the district court, and remanding for further proceedings. On February 8, 2006, defendants filed with the Seventh Circuit a petition for rehearing with suggestion for rehearing en banc. On April 19, 2006, the Seventh Circuit ordered plaintiffs to file an answer to the petition for rehearing, which was filed by the plaintiffs on May 3, 2006. On July 10, 2006, the Seventh Circuit denied the petition for rehearing with a minor modification to its opinion, and remanded the case to the district court. On September 22, 2006, defendants filed a motion in the district court to dismiss some (but not all) of the remaining claims. On October 3, 2006, the defendants filed with the United States Supreme Court a petition for a writ of certiorari seeking to appeal the Seventh Circuit’s decision. On January 5, 2007, the defendants’ petition was granted. The United States Supreme Court heard oral arguments on March 28, 2007. On June 21, 2007, the United States Supreme Court vacated the Seventh Circuit’s judgment and remanded the case for further proceedings. On November 1, 2007, the Seventh Circuit heard oral arguments for the remanded case. On January 17, 2008, the Seventh Circuit issued an opinion adhering to its earlier opinion reversing in part the judgment of the district court, and remanded the case to the district court for further proceedings. On February 24, 2009, the district court granted plaintiffs’ motion for class certification. On August 13, 2010, the Court granted in large part Tellabs’ motion for summary judgment. The parties have agreed to settle the lawsuit, which settlement is still subject to final court approval. If approved, all settlement amounts will be paid by Tellabs’ insurers.

Fujitsu Network Communications Inc. v. Tellabs, Inc. On January 28, 2008, Fujitsu Network Communications, Inc. and Fujitsu Limited filed a complaint in the United States District Court for the Eastern District of Texas against Tellabs in a case captioned Fujitsu Network Communications, Inc. and Fujitsu Limited v. Tellabs, Inc. and Tellabs Operations, Inc., Civil Action No. 6:08-cv-00022-LED. The complaint alleges infringement of U.S. Patent Nos. 5,526,163, 5,521,737, 5,386,418 and 6,487,686, and seeks unspecified damages including enhanced damages, as well as attorney fees and other remedies

 

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including injunctive relief. On March 21, 2008, Tellabs filed its answer, defenses and counterclaims in response to the complaint. A trial date had been set for May 10, 2010, in the Eastern District of Texas, however on July 7, 2009, the court granted Tellabs’ motion to transfer and issued an order transferring the action to the United States District Court for the Northern District of Illinois. On September 15, 2009, the Court in the Northern District of Illinois consolidated this action, for discovery purposes only, with the action instituted by Tellabs against Fujitsu in the Northern District of Illinois. On November 4, 2010, the Court dismissed with prejudice Fujitsu’s claim for infringement of Fujitsu’s U.S. Patent No. 6,487,686. In conjunction with the dismissal, Fujitsu signed a covenant not to sue Tellabs for infringement as to any claim of Fujitsu’s U.S. Patent No. 6,487,686, as to any Tellabs products as they currently exist or existed in the past. On March 31, 2011, the Court issued an Order denying a motion by Tellabs for summary judgment of invalidity based on indefiniteness of Fujitsu’s U.S. Patent No. 5,386,418, and granting a motion by Fujitsu for summary judgment for judicial correction of an error in asserted Claim 1 of the same patent as originally issued. The parties currently remain in the discovery phase, and a trial date has been set for January 17, 2012. The parties also await the Court’s issuance of a Markman ruling.

Tellabs Operations, Inc. v. Fujitsu Limited and Fujitsu Network Communications Inc. On June 11, 2008, Tellabs Operations, Inc. filed a complaint in the United States District Court for the Northern District of Illinois against Fujitsu Limited and Fujitsu Network Communications, Inc. in a case captioned Tellabs Operations, Inc. v. Fujitsu Limited and Fujitsu Network Communications, Inc. Civil Action No. 1:08-cv-3379. The complaint alleges infringement of Tellabs Operations, Inc.’s U.S. Patent No. 7,369,772, and seeks unspecified damages including enhanced damages, as well as attorney fees and other remedies including injunctive relief. On September 5, 2008, each of Fujitsu Limited and Fujitsu Network Communications, Inc. served its answer, defenses and counterclaims in response to the complaint. Fujitsu Limited also brought counterclaims against Tellabs, Inc. and Tellabs Operations, Inc. alleging infringement of two U.S. patents, namely U.S. Patent Nos. 5,533,006 and 7,227,681, seeking unspecified damages including enhanced damages, as well as attorney fees and other remedies including injunctive relief. On September 22, 2008, Tellabs Operations, Inc. filed its answer to the counterclaims of Fujitsu Network Communications, Inc., and also filed its counterclaims and reply to counterclaims of Fujitsu Limited. On that same date, Tellabs, Inc. filed its answer and counterclaims against Fujitsu Limited. On September 15, 2009, the Court in the Northern District of Illinois consolidated this action, for discovery purposes only, with the action filed by Fujitsu transferred to the Northern District of Illinois by the Eastern District of Texas. On March 31, 2011, the Court issued an Order granting Tellabs’ motion for summary judgment of invalidity of all claims of Fujitsu’s U.S. Patent No. 5,533,006. The parties currently remain in the discovery phase, and a trial date has been set for January 17, 2012. The parties also await the Court’s issuance of a Markman ruling.

Telcordia Technologies Inc. v. Tellabs, Inc. On May 4, 2009, Telcordia Technologies, Inc. filed a complaint against Tellabs in the United States District Court for the District of New Jersey in a case captioned Telcordia Technologies Inc. v. Tellabs, Inc., Civil Action No. 2:09-cv-02089. The complaint alleges infringement of U.S. Patent Nos. 4,893,306, 4,835,763 and Re. 36,633, and seeks unspecified damages including enhanced damages, as well as attorney fees and other remedies including injunctive relief. On July 27, 2009, Telcordia filed a first amended complaint adding Tellabs Operations, Inc. and Tellabs North America, Inc. as additional defendants. On September 1, 2009, Tellabs filed answers, defenses and counterclaims in response to the first amended complaint. On December 15, 2009, the Court granted Tellabs’ motion to transfer, which resulted in a transfer of the action to the United States District Court for the District of Delaware. The parties are in the early phases of discovery. A trial date has not yet been set.

Atwater Partners of Texas LLC v. AT&T, Inc. et al. On May 27, 2010, a complaint was filed in the United States District Court for the Eastern District of Texas against Tellabs and several other companies in a case captioned Atwater Partners of Texas LLC v. AT&T, Inc. et al., Civil Action No. 2:10-cv-00175. The complaint alleges infringement of U.S. Patent Nos. 6,490,296, 7,158,523, 7,161,953, 7,310,310, and 7,349,401, and seeks unspecified damages as well as interest, costs, expenses, attorney fees and other remedies including injunctive relief. Tellabs responded to the Complaint on August 6, 2010, denying Atwater’s allegations. A non-material financial settlement of this matter was reached between Tellabs and Atwater that resulted in a dismissal of Tellabs from the action with prejudice on March 24, 2011.

Lambda Optical Solutions, LLC v. Alcatel-Lucent SA, et al. On June 4, 2010, a complaint was filed in the United States District Court for the District of Delaware against Tellabs and several other companies in a case captioned Lambda Optical Solutions, LLC v. Alcatel-Lucent SA, et al., Civil Action No. 1:10-cv-00487-UNA. The complaint alleges infringement of U.S. Patent Nos. 6,973,229, and seeks unspecified damages including enhanced damages, as well as interest, costs, expenses, attorney fees and other remedies including injunctive relief. Tellabs was served with the Complaint on September 13, 2010. Tellabs responded to the Complaint on November 2, 2010, denying Lambda’s allegations. The parties are in the earliest phases of the litigation. No trial date has been set.

Apart from the matters described above, we are and in the future may be subject to various legal proceedings, claims and litigation arising in the ordinary course of business. Any legal proceedings, claims and litigation, whether current or future,

 

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and whether with or without merit, potentially can result in: costly litigation; diverting management’s time, attention and resources; delaying or halting product shipments or services delivery; requiring us to pay damages; requiring us to enter into royalty-bearing licensing arrangements or to obtain substitute technology of lower quality or higher costs; or otherwise imposing obligations or restrictions that could adversely affect our business, financial condition and operating results.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010. The risk factors described in our Annual Report could materially adversely affect our business, financial condition or future results. The risks described in our Annual Report are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently consider immaterial also may materially adversely affect our business, financial condition and/or operating results. There have been no other material changes to the risk factors included in our Annual Report for the year ended December 31, 2010.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Repurchases of Common Stock:

 

Period of Purchases		Total Number  of Shares Purchased				Average Purchase Price Per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs				Remaining Dollar Value of Shares Available to be Purchased Under the Programs (In millions)1
1/1/11 through 2/4/11			64,234			$	6.89				64,234			$	224.6
2/5/11 through 3/4/11			1,947			$	5.51				1,947			$	224.6
3/5/11 through 4/1/11			4,308			$	5.26				4,308			$	224.6
Total			70,489			$	6.75				70,489

 

1	The amounts in this column represent the remaining amounts under the current $600 million program described below. The Rule10b5-1 repurchase program described below does not have a repurchase amount limit; therefore, it is not included in the remaining value of shares.

We repurchase outstanding common stock under two programs authorized by our Board of Directors, the Rule 10b5-1 program and a repurchase program of up to $600 million of outstanding common stock. In addition, we purchase shares to cover withholding taxes on shares issued under employee stock plans.

Under the 10b5-1 program, we intend to continue to use cash generated by employee stock option exercises (other than those of Company officers and board members) to repurchase stock. We purchased $0.5 million (0.1 million shares) in the first quarter of 2011 under this program.

As of April 1, 2011, we purchased 56.6 million shares of our common stock under the $600 million repurchase program at a total cost of $375.4 million, leaving $224.6 million available to be purchased under this program. We did not purchase any shares under this program in the first quarter of 2011. We may change our repurchase activity and we provide no assurance that we will continue our repurchase activity in the future.

In addition, we purchased 0.3 million shares for $1.5 million in the first quarter of 2011 to cover withholding taxes on shares issued under employee stock plans.

We record repurchased shares as Treasury stock.

 

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Item 6. Exhibits

(A) Exhibits

 

31.1		CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Calculation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

 

*	Furnished and not filed

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

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