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Exhibit 13 (IMAGE) tellabs 2004 Annual Report Whats next?




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Tellabs Profile We deliver technology that transforms the way the world communicates. Tellabs
experts design, develop, deploy and support wireless and wireline network solutions. Our
comprehensive broadband portfolio enables carriers in more than 100 countries to succeed in the new
competitive environment. Tellabs (NASDAQ: TLAB) is part of the NASDAQ-100 Index. www.tellabs.com. Contents  2
    Letter to Stockholders from
President and CEO Krish Prabhu3
    Financial HighlightsOur financial position is among the
industrys strongest.6
    Questions for Krish PrabhuPresident and Chief Executive Officer
Krish Prabhu answers investors
frequently asked questions.8
    Whats Next at Home, at Work and on the GoOur leading-edge solutions help service
providers deliver whats next.14
    Tellabs Solutions and Applications16
    Managements Discussion and Analysis26
    Reports of Management & Independent
Registered Public Accounting Firm28
    Consolidated Financial Statements32
    Notes to Consolidated Financial Statements50
    11-Year Summary of Selected Financial Data52
    Board of Directors54
    Officers55
    Glossary56
    Investor Information Cover:Andrew Langille and his classmates
discover whats next in online learning through
Tellabs data solutions. Right:Tellabs solutions help Martin Mendez, Ivan
Fassione, Mariano Perez y Perez, Gonzalo Yazalde and
Ariel Pietrocola
of Pronto Esporte Clube stay in touch while their
soccer team is on the road.




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(IMAGE) People are communicating in ways never before imagined.
Tellabs grows with demand for whats next. Over 12 years household spending on communications has increased faster than any other spending category. (Source Most recent available from OECD, the Organisation for Economic Co-operation and Development
Worldwide data from Japan, United States, United Kingdom, and 22 other contries. TELLABS 2004 ANNUAL REPORT / 1




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(PHOTO OF KRISH PRABHU) 2004 marked a turning point for telecom and Tellabs. Dear Stockholders, Customers and Employees, In 2004, for the first time, people spent more money on mobile phone service than on
conventional phone service. For the first time, most U.S. homes connected to the Internet at
broadband speeds. And for the first time since 2000, our customers, the worlds leading providers
of telecom services, spent more than they did the previous year. Worldwide demand for telecom services, especially mobile and broadband, continues to grow. One
out of every four persons  double the number in 2000  now uses a mobile phone. Telecom service
providers are refocusing their capital spending to build next-generation networks. Their efforts
are focused on enhancing mobile service, offering higher bandwidth in the last mile access
network, and providing multiple services on a single network. Tellabs is well-positioned to grow in
these three areas as the industrys cycle of network upgrades unfolds. In January 2005, Tellabs marked its 30th anniversary. We enjoy long-standing relationships
with our customers, who have deployed billions of dollars worth of Tellabs equipment. We have
helped telecom service providers navigate through industry transitions from analog to digital,
copper to fiber, wireline to wireless, and circuits to packets. Today, we stand ready to deliver
whats next. 2




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Financial Highlights

Tellabs fiscal years ended December 31, 2004, and January 2, 2004. (In millions, except per-share and employee data)
    
    2004
    
    
    2003
    
    
    ChangeRevenue
    
    $
    1,232
    
    
    $
    980
    
    
    
    26
    %Gross profit
    
    $
    657
    
    
    $
    354
    
    
    
    86
    %Operating loss
    
    $
    (32
    )
    
    $
    (265
    )
    
    
    88
    %Loss before income taxes
    
    $
    (10
    )
    
    $
    (245
    )
    
    
    96
    %Net loss
    
    $
    (30
    )
    
    $
    (242
    )
    
    
    88
    %Loss per share
    
    $
    (0.07
    )
    
    $
    (0.58
    )
    
    
    88
    %Total cash, cash equivalents and marketable securities
    
    $
    1,116
    
    
    $
    1,123
    
    
    
    -1
    %Total assets
    
    $
    3,523
    
    
    $
    2,608
    
    
    
    35
    %Total liabilities
    
    $
    726
    
    
    $
    389
    
    
    
    87
    %Stockholders equity
    
    $
    2,797
    
    
    $
    2,219
    
    
    
    26
    %Net cash provided by operating activities
    
    $
    215
    
    
    $
    150
    
    
    
    43
    %Working capital
    
    $
    1,295
    
    
    $
    1,291
    
    
    
    < 1
    %Research and development expense
    
    $
    250
    
    
    $
    286
    
    
    
    -13
    %Return on average equity
    
    
    -1.2
    %
    
    
    -10.7
    %
    
    
    89
    %Weighted average shares outstanding
    
    
    420
    
    
    
    413
    
    
    
    2
    %Number of employees at year-end
    
    
    4,125
    
    
    
    3,515
    
    
    
    17
    %
 Tellabs 2004 results reflected a healthier telecom industry. After three years of declining sales, our revenue grew in 2004 by 20% to $1.2 billion
(excluding revenue from acquisitions; discussed later). We grew faster than the market by executing
well on our strategy to energize our core transport business.We helped our customers introduce
tomorrows capabilities into todays networks. For example, we introduced new features to help
locate mobile callers during emergencies. In 2004, Tellabs achieved its best-ever sales to mobile
service providers, who represented a third of our total revenue. It was not a perfect year, though. We had our share of problems as we outsourced manufacturing
of international products. The results were orders we could not fill and late deliveries to
customers. We have taken forceful action to remedy this problem, and we expect on-time delivery to
improve in the first half of 2005. Profound industry change is under way. That spells opportunity. The market for telecom services is a fierce battleground among telephone and cable TV
companies. Over the next 10 years, these companies will merge disparate voice, data and video
networks into a single, integrated network. These new multiservice networks will deliver a
complete, competitive menu TELLABS 2004 ANNUAL REPORT / 3




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of services that includes movies on demand, interactive gaming, high-speed Internet access,
VoIP (Voice over Internet Protocol) and more. Delivering such services will require much more bandwidth than is currently available in the
access portion of the network, which directly connects to homes and businesses. Telecom service
providers are spending more and more on building fiber access systems to reach neighborhoods and
homes. Analysts project that by 2009, the number of U.S. homes with access to fiber will grow
tenfold to 24 million. Fiber access is a golden opportunity for Tellabs strategyto expand into adjacent markets. In November, Tellabs acquired the U.S. leader in fiber access, Advanced Fibre Communications
(AFC). This acquisition strengthens Tellabs position as a strategic supplier to our largest
customers, such as Verizon and BellSouth. AFC brings us a portfolio of Fiber to the Home (FTTH) and
Fiber to the Curb (FTTC) equipment that we market as Tellabs FiberDirectSMsolutions.
Since fiber-access systems reside next to Tellabs transport equipment in networks, we have a unique
opportunity to design and deliver end-to-end access and transport solutions that are easier to
operate than current systems. At $1.6 billion, AFC is Tellabs largest acquisition to date. In 2005, our primary focus will
be to successfully integrate the people and operations of AFC into Tellabs. While we will continue
to control Tellabs overall operating expenses in 2005, we are shifting more of our R&D resources
towards the high-growth fiber access segment. In December we also acquired an Optical Networking
Terminal (ONT) company, Vinci Systems. This action brings to Tellabs a next-generation device that
connects fiber to homes more cost-effectively. The AFC and Vinci acquisitions generated certain one-time costs that caused Tellabs to report
a loss in 2004 of $30 million or 7 cents per share. While we hate to lose money in a year of
rebounding revenue, this short-term pain is the best way to position Tellabs in the high-growth
area of fiber access. We generated positive operating cash flow in 2004, ending the year with more than $1.1 billion
in cash and cash equivalents, despite the cash expended in our two acquisitions. In February 2005,
we announced plans to buy back up to $300 million in Tellabs shares, since we feel that the market
price for Tellabs stock does not accurately reflect our long-term prospects. With our current cash
position, repurchasing shares is a good way for us to enhance stockholder value. Tellabs still
retains the financial resources to carry out its growth strategies. 4




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As multiservice networks are built, the industry shift to packet technology continues. Running separate networks for data, voice and video is inefficient, but to combine these
services cost-effectively, telecom providers are continuing to transition from circuits to packets. Under Tellabs strategy to establish a presence in data, we now offer service providers a
unique transition path to multiservice networks. The Tellabs MultiservicePLuSSMsolution
helps service providers make this complex transition in a graceful, reliable and more
cost-effective manner. Tellabs 2004 data revenues reflect the start-up nature of this
business. We are making significant headway with customers.
More than 30 telecom service providers are now testing Tellabs
data solutions in their labs, and a dozen customers are deploy-
ing the Tellabs 8800 system in networks around the world.
Among our customers is the worlds largest telecom service
provider, NTT Communications of Japan, which is doubling its
deployment of the Tellabs 8800 system. In the United States,
Broadwing is finalizing the construction of a single converged
services network based on the Tellabs 8800 system. Tellabs
data solutions are well-suited to meet the needs of our
customers evolving networks. (PERFORMACE BAR GRAPH) During the past year, my first at Tellabs, I met and worked with many of our employees around
the world. Based on decades of industry experience, I must say that Tellabs has a hard-working,
talented team of employees who are dedicated to our customers success. We are grateful to our
employees for achieving so much in 2004. As industry changes unfold over the next decade, Tellabs
will continue as customers trusted partner, working side by side to manage the complexities of
evolving to next-generation networks. I am confident we have the people, the strategies and the
resources to do just that. It is the best way to ensure Tellabs long-term growth and success. Sincerely (-s- KRISH PRABHU) Krish Prabhu   TELLABS 2004 ANNUAL REPORT / 5




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Investors Frequently Asked Questions Tellabs President and CEO Krish Prabhu answers investors frequently asked questions. Q. How is your access strategy developing with the completion of the AFC acquisition? A. We finalized the AFC acquisition on November 30, and are focused on successfully integrating the
two companies to provide enhanced solutions to our customers. We also acquired Vinci Systems on
December 30, which brings us a third-generation Optical Networking Terminal (ONT) that complements
AFC products we now market as Tellabs FiberDirectSMsolutions. We continue to strengthen our relationships with both Verizon and BellSouth, two major North
American communications service providers. We also will work to strengthen our position as the
North American leader in fiber-access solutions. Q. What is the industry doing to provide fiber access to homes? A. Industry analysts predict that by 2009, about 24 million U.S. households will have the option of
fiber
access. Verizon, for whom Tellabs is the main provider of Fiber to the Home (FTTH) access
solutions, plans in 2005 to extend fiber access to at least 3 million households and businesses.
BellSouth, where Tellabs has an installed base of nearly 1 million lines of Fiber to the Curb
(FTTC) access solutions, may pass up to 3 million households with fiber access by year-end 2005. We
will continue to work with our customers to provide industry-leading fiber-access solutions and
implementation services. Q. What progress have you made on your three key strategies to energize the core business,
establish a presence in data and expand into adjacent markets? A. In 2004, we made solid progress on all three strategies. In our core business, we enhanced our transport solutions with new features that enable our
customers to deliver mobile and data services to businesses and consumers. We will continue to
enhance these products with the features that operators need to provide high-quality voice
services, deliver new data capabilities and handle increasing demand for network capacity. Our
year-over-year revenue growth demonstrates the success of this strategy. 6




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We gained traction in our data business. Our data solutions generated more than $17 million in
2004 revenue. Even more important for the long term, we set in motion more than 30 customer trials
and have a current pipeline of more than 100 opportunities worldwide. While the decision cycle for
data purchasing is long, we are confident of continuing progress during 2005. We acted on our strategy to expand into adjacent markets through the acquisitions of AFC and Vinci
Systems. Tellabs is now the U.S. leader in fiber-access solutions, which are key to enabling
telecom companies to offer a competitive menu of voice, data and video services. Q. What is your international strategy? A. As communications services migrate from place-centric to people-centric, the worldwide market
grows in importance. We are building on strong international customer relationships and a large installed
base of managed access equipment in more than 100 countries. We will foster these relationships to
provide a platform for growth in our new Ethernet, multiservice and next-generation wireless
solutions. In the longer term, as competition heats up in international markets, we also see
increasing potential for fiber-access solutions. Q. What will drive Tellabs future growth? A. Increasing demand for new, higher-speed data and video services over wireless and fixed networks
will drive our growth. The trends we see at work, at home and on the go are detailed on the next few
pages of this report. We are focused on providing the solutions our customers need to handle
constantly changing demands on their communications networks. TELLABS 2004 ANNUAL REPORT / 7




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(IMAGE) Through Tellabs FiberDirectSMsolutions, Ryley Conway, Nolan Conway,
Lyndsey Conway and Jessica Wolthman watch whats next in multimedia entertainment. Analysts forecast that by 2009, 24 million U.S. households will have access to fiber, up
tenfold from 2004. Cumulative U.S. Homes Passed and Subscribers In thousands (Source: KMI Research, August 2004.)




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Whats next at home? Today, you can save a trip to the music store by downloading music over the Internet.
Teens play video games with their peers around the world. Employees skip the commute and work from
home. So its no surprise that in 2004, for the first time, more than half of U.S. Internet users
connected from home with broadband links such as cable modems and Digital Subscriber Line (DSL)
service. Japan and Korea already have achieved even higher penetration levels of broadband to the
home. As a result of the AFC acquisition in late 2004, Tellabs now delivers cost-effective DSL
solutions, enabling telecom companies to provide service to millions of North American consumers
without building new networks. Tellabs cable telephony solution also delivers phone service to
hundreds of thousands of cable TV customers worldwide. Tellabs FiberDirectSMsolution speeds up the Internet. Hang on tight. Whats next? The blazing speed of a fiber-optic connection, direct to the neighborhood or to
the home, will deliver a host of new entertainment choices unavailable through todays broadband
connections. Analysts estimate that by 2009, fiber access will grow tenfold to reach some 24
million households in the United States alone. Through the acquisition of AFC, Tellabs now is the leading provider in the U.S. market for
fiber-based access. With more than a million lines connected, we have more experience deploying
fiber-access networks in the U.S. than anyone else. Tellabs MediaDirectSMsolution delivers sharp pictures plus more choices. Tellabs MediaDirectSMsolution enables telecom companies to outperform their
competitors by delivering new services with high reliability and increased bandwidth. This solution
delivers Internet Protocol television (IPTV) and Video on Demand (VoD), which offer razor-sharp
video, HDTV (High Definition TeleVision) and a wide array of program choices. The Tellabs
AdvancedVoiceSMsolution delivers a new, more affordable phone service called VoIP
(Voice over Internet Protocol). Verizon chose Tellabs as its first source for its Fiber to the Home initiative. And BellSouth
uses Tellabs access solutions to connect newly built neighborhoods. Stay tuned. This story is just beginning. TELLABS 2004 ANNUAL REPORT / 9




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(IMAGE) Growing demand for business data services creates opportunities for
Tellabs data solutions. Worldwide
Ethernet and Legacy
Data Services In billions of dollars (Source: Gartner  Forecast Fixed Public Network Services Worldwide 2002-2008; July 2004, Wm.
L. Hahn & Alex Winogradoff.) Tellabs data solutions enable David Utter to conduct real-time
business over the Internet with confidence his critical data will
reach its destination. 10




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Whats next at work? Communication is the lifeblood of business. Worldwide revenue from business data services
is growing by more than $10 billion every year. Businesses rely on communication networks for a
wide variety of voice, data, video and mobile applications, including critical, real-time financial
transactions. To meet this demand, telecom service providers must offer data services that are economical
and highly reliable. Many businesses plan to switch to more affordable, faster Ethernet services.
However, for critical business communication, traditional Ethernet networks often are not reliable
enough. Tellabs AssuredEthernetSMsolution delivers data with guaranteed reliability. Tellabs Ethernet solutions can deliver affordable data services with the level of reliability
that is required for todays business needs. Our wide range of solutions provides telecom service
providers with multiple choices for deploying high-speed services, including the ability to deliver
Ethernet over SONET (Synchronous Optical NETwork), SDH (Synchronous Digital Hierarchy), fiber and
DSL. In 2005, we will extend our successful international Ethernet-over-copper solutions to the
United States. This solution is tailored to fit the 80% of U.S. businesses that lack fiber access. The Tellabs solution is unique because it delivers new Ethernet services with the traditional
Quality of Service (QoS) that telecom service providers demand. Additionally, with the Tellabs
solution, telecom companies even can customize individual data services for each business customer. Tellabs MultiservicePLuSSMsolution uniquely blends existing and new data services. As new data services emerge, business customers need to exchange data over mixed networks.
Tellabs MultiservicePLuSSMsolution enables businesses to share information regardless
of network type. For example, a bank branch on a Frame Relay network needs to communicate with the
new bank headquarters, which uses a newer Ethernet network. With Tellabs solution, the bank branch
and headquarters can share data over their existing networks. If the bank decides to move the
branch to an Ethernet network, Tellabs MultiservicePLuSSMsolution enables seamless
migration, which prevents service interruptions, saves time and lowers costs. With other solutions,
in order for the two locations to share data, the branch would need to build a new Ethernet
network, incurring service interruptions and additional costs. With Tellabs, telecom service providers can deploy new data services in real time, without
disrupting current services. MCI uses this feature to tie Internet Service Providers (ISPs)
together so they can smoothly exchange Internet traffic. Tellabs enhanced its position in the data market in 2003 by acquiring Vivace Networks and the
Tellabs 8800 series. Today, the Tellabs 8800 series is deployed at NTT Communications, the largest
telecom company in the world. This platform is gaining acceptance worldwide as the next-generation
solution for delivering new Ethernet and IP services, as well as current Frame Relay and
Asynchronous Transfer Mode (ATM) services on converged networks. TELLABS 2004 ANNUAL REPORT / 11




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(IMAGE) In 2004, for the first time, people spent more money on mobile than on
traditional phone services worldwide. Services Revenue: Worldwide Mobile vs. Fixed (Source: Gartner  Forecast Global Telecommunications Market Take 3Q04; October 2004, Wm.
L. Hahn, et al.) 12




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Whats next on the go? One-fourth of the worlds population now communicates via a mobile phone. At 1.5 billion
users, the number of worldwide mobile subscribers has doubled since 2000. As mobile phones gain new
capabilities, people are:  
    sending more than 400 billion Short Message Service (SMS) messages per year
    taking digital photos and sharing them with friends and family
    reading newspapers, novels and other texts
    connecting to e-mail and the Internet
    viewing video clips of televised sports and news events. Whats next? New applications in areas such as gaming and streaming video are on the way. And
it will become more common for consumers to buy and pay for goods and services using a mobile phone. To support these bandwidth-hungry applications, mobile companies around the world are
migrating to next-generation networks that are designed to carry data and voice. This ongoing
migration will continue to fuel Tellabs growth in the wireless sector. The changing mix of voice,
data and video traffic in multiple formats drives demand for new solutions such as the Tellabs 8600
managed edge system and the Tellabs 8800 series, which help mobile service providers meet the
changing demands on their networks. Tellabs IntegratedMobileSMsolution enables mobile services around the world. About a third of Tellabs 2004 revenue came from the wireless market. In the U.S., all of the
leading wireless companies use equipment such as the Tellabs 5500 digital cross-connect system in
their transport networks. Many also deploy the Tellabs 3000 voice-quality enhancement series to
improve sound quality, thereby increasing call length and revenue. In international markets, Tellabs partners with Ericsson and Nokia to transport traffic in
wireless networks via the Tellabs 8100 and Tellabs 6300 systems. We also work directly with mobile
companies. For example, Beijing Zhengtong Network Telecommunications chose Tellabs
IntegratedMobileSMsolutions as part of the wireless network for the 2008 Olympics. In 2005, our wireless solutions will fit into a smaller space. Most wireless operators lease space for their network equipment, so floor space is at an
absolute premium. To meet this need, in 2005 we plan to introduce a new feature package for the
Tellabs 5500 system that saves space and reduces energy costs by tripling bandwidth capacity in the
same space. We also are integrating our voice-quality enhancement solution to fit inside the
Tellabs 5500 system, saving wireless operators even more space. TELLABS 2004 ANNUAL REPORT /
13




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Tellabs Solutions and Applications Solutions
    
    Benefits for Telecom Service ProvidersTellabs® AssuredEthernetSM
solutions
    
    Business demand for new Ethernet services is growing rapidly. Tellabs solutions:enable customized services with
    
    
    
    Enable simple, rapid deployment of cost-effective Ethernet servicesguaranteed delivery.
    
    
    
    Offer Quality of Service (QoS) guarantees in an IP/MPLS environment so
providers can protect
existing SLAs (Service Level
Agreements)
    
    Enable providers success over any network type so they can leverage
existing platforms and technology.Tellabs® MultiservicePLuSSM
solution
enables service providers to
combine
    
    Service providers need a cost-effective way to deliver new services with
the same QoS guarantees that apply to existing services.
Tellabs solutions:current ATM/FR services and
new
Ethernet and IP solutions on
the same platform.
    
    
    
    Enable new Ethernet or IP customers to communicate with existing Frame
Relay or ATM customers with a unique service interworking function
    
    Offer QoS guarantees for existing Frame Relay and ATM customers over
IP/MPLS networks.Tellabs® FiberDirectSM
solution is a
    
    Tellabs FiberDirect solutions:complete, simple and
cost-effective
way to deploy fiber access.
    
    
    
    Enable providers to quickly and economically transition from
copper-based networks to high-speed,
high-capacity fiber networks
    
    Bring together the variety of products and services needed to deploy
FTTx successfully
    
    Provide a comprehensive suite of advanced voice and broadband services
over multiple network architectures.Tellabs® IntegratedMobileSM
solutions
enable wireless operators to
migrate from 2G networks to 2.5G and 3G services
    
    In the evolving wireless market, service providers must operate more
efficiently and offer new 2.5G and
3G services to stay competitive. Tellabs solutions:without the expense of multiple technology overlays.
    
    
    
    Maximize use of existing networks by integrating new capabilities on
existing equipment
    
    Collapse multiple functions such as grooming and voice-quality
enhancement onto a single, scalable
platform with a common management
system.Tellabs® MediaDirectSMis a cost-
    
    In todays competitive environment, Tellabs MediaDirect helps service providers:effective solution that enables service
    
    
    
    Offer the triple play of voice,
video and dataproviders to deliver
advanced voice,
    
    
    
    Reduce customer churn and increase
revenueInternet, video and other
entertainment services.
    
    
    
    Deliver video services such as pay-per-view, Video on Demand, personal
video recording, and network
gaming  all packaged with voice and high-speed Internet services.Tellabs® AdvancedVoiceSM
solution
enables the seamless
migration of
voice and high-speed data
applications onto a single, packetized
    
    Service providers face competitive pressures and increased consumer
demand for faster, cheaper and
more advanced services. To combat these pressures and to meet subscriber
demands, Tellabs helps service providers:network.
    
    
    
    Converge voice and data traffic
onto a single network
    
    Deliver voice and broadband
services cost-effectively
    
    Implement converged network solutions at their own pace.Tellabs® UniversalDSLSM
provides a
complete solution,
delivering DSL
services to every subscriber.
    
    Growing demand for high-speed Internet access calls for a reliable,
field-proven solution that efficiently
delivers DSL services to every subscriber, regardless of location. With
this flexible DSL solution, service
providers can:
    
    Leverage their existing networks
    
    Minimize operating costs
    
    Deliver a comprehensive suite of
DSL services.Tellabs® ProfessionalServicesSM
    
    Tellabs ProfessionalServices helps service providers address these
critical business and competitive challenges:assists our customers in the planning,
    
    
    
    Increase revenues
    
     Reduce costsdesign, integration, deployment,
    
    
    
    Reduce network complexity
    
     Reduce time to marketsupport and ongoing
management
of Tellabs solutions.
    
    
    
    Improve network resilience and
reliability
    
     Reduce risk.
 14




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Examples of Customers
    
    Products
    
    CompetitorsBanverket Telenat, BSNL,
    
    Tellabs®1000 Multi-Service Access series,
    
    Alcatel, Cisco,MCI, NTT Communications,
    
    Tellabs®5500 digital cross-connect,
    
    Juniper NetworksTelekom Malaysia,
    
    Tellabs®6300 managed transport systems,Telenor, TeliaSonera
    
    Tellabs®7100 optical transport system, Tellabs®8100 managed
access system, Tellabs®8800 multi-service router seriesMCI,
    
    Tellabs®8800 multi-service router series
    
    Alcatel, Lucent,PacketExchange
    
    
    
    NortelBellSouth,
    
    Tellabs®1000 Multi-Service Access series,
    
    Alcatel, MotorolaPembroke Telephone,
    
    Tellabs®1100 Multi-Service Access seriesVerizonBeijing Zhengtong,
    
    Tellabs®3000 voice-quality enhancement systems,
    
    AlcatelChina Mobile, China Unicom,
    
    Tellabs®5320L digital cross-connect, Tellabs 5500 system,Ericsson, Nokia, TeliaSonera,
Verizon Wireless
    
    Tellabs 6300 systems, Tellabs 8100 system, Tellabs®8600 managed
edge system, Tellabs®8800 multi-service router series,Tellabs integrated voice productsBellSouth, Cap Rock Telephone Cooperative,
    
    Tellabs®1000 Multi-Service Access series, Tellabs®1200 Multi-Service
    
    MotorolaETEX Telephone Cooperative, Project Mutual
Telephone, Texas Lone Star Network, Twin Valley Telephone
    
    Aggregation series, Tellabs 7100
system, Tellabs®8800 multi-service router seriesSBC Communications;
    
    Tellabs®1000 Multi-Service Access series,
    
    Alcatel, Lucent,Suratel, a TVCable Ecuador Company;
    
    Tellabs®2300 telephony distribution system,
    
    NortelTeliaSonera
    
    Tellabs 7100 system, Tellabs®8800 multi-service router seriesSBC Communications
    
    Tellabs®1000 Multi-Service Access series,
    
    Alcatel, LucentTellabs®1200 Multi-Service Aggregation series,Tellabs 8100 systemBSNL, CTI, Eschelon Telecom, Inc.,
    
    Deployment services,
    
    Not applicableGlobal Crossing, J-COM, Movilnet,
    
    Professional services,Telefonica
    
    Support services,Training
 TELLABS 2004 ANNUAL REPORT / 15




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Managements Discussion and Analysis Introduction and Overview of Business Tellabs designs, develops, deploys and supports
products used in wireless and wireline networks
in almost 100 countries. More than two-thirds
of telephone calls and Internet sessions in the
United States and several other countries flow
through our equipment. Our product portfolio
includes solutions for next-generation
transport, Ethernet networks, multiservice
edge, next-generation mobile, fiber-based
access, advanced voice and video and DSL
(Digital Subscriber Line). We are focused on
three key strategies: energizing our core
business, establishing a presence in data and
expanding into adjacent markets. We generate revenue principally through the
sale of hardware and software, both as
stand-alone products and as elements of
integrated systems, to many of the worlds
largest and strongest telecommunications service
providers. In addition, we generate revenue by
providing installation and professional services
related primarily to our own products and
systems. Within North America we derive the majority
of our revenue from transport products,
principally digital cross-connect systems that
manage and route network traffic and combine,
consolidate and segregate signals to maximize
efficiency. Demand for these products is
sensitive to end-user demand for wireless
services, bandwidth, industry capacity
utilization and competing technologies. We also
generate revenue in North America from access
products. Demand for these products is driven by
the local telephone companies plans to deliver
triple-play (voice, data and video) services to
residential customers as a way to compete with
cable TV providers. According to industry
analysts, Tellabs has a market-leading position
in the U.S. bandwidth management and access
markets. Outside North America we earn the majority
of our revenue from managed access and transport
systems that control the flow of voice, data and
video across communications networks. Demand
comes primarily from two sources: business
services for voice and high-speed data and
network transport services for wireless
communications. Demand for these products is
sensitive to end-user demand for bandwidth,
industry capacity utilization and competing
technologies. In addition, we are a leading provider of
voice-quality enhancement solutions globally and
one of the top three providers of cable
telephony solutions worldwide. We also earn revenue from network
construction and other professional services.
Network construction revenue,
which comprises more than half of our
services revenue, arises primarily from sales of
our transport products in North America and
tends to lag product sales by
approximately one fiscal quarter. As a
result, it has tended to increase or decrease in
similar proportion to the increase or decrease in
revenue from those products. Professional
services offered by the company include network
deployment, traffic management, support services
and training. Another major source of services
revenue is support agreements related to our
managed access and transport systems outside
North America. The markets for our products have undergone
dynamic change over the last few years. Beginning
in 2001, carrier overcapacity, a softening
economy and other factors caused our customers to
significantly reduce their capital spending. The
impact on Tellabs was a dramatic decline in
revenue for each of the years 2001 through 2003
with year-over-year growth returning in 2004. As
these changes unfolded we were faced with excess
manufacturing capacity, excess inventories and a
cost structure that could not be supported by our
smaller revenue base. We responded by closing
manufacturing facilities, reducing global
head-count, consolidating office space, exiting
certain product lines and instituting cost
controls across the organization. We also
reviewed our product portfolio and cut back or
stopped development efforts on some products. In
addition, at the end of 2003, we moved to
outsource the majority of our remaining
manufacturing operations to third-party
electronics manufacturing services providers to
take advantage of their greater purchasing power
and other efficiencies. These actions caused us
to record material charges in 2001 through 2004
for excess and obsolete inventory and excess
purchase commitments, severance costs, facilities
shutdown costs, including accelerated
depreciation on certain manufacturing and office
building and equipment due to shortened useful
lives, and various contractual obligations. We
also recorded charges for other impaired and
surplus assets. Market stability began in 2003 and
continued in 2004 as carriers invested in their
networks at levels at or above 2003. This
stability enabled us to post year-over-year
revenue growth for the first time since fiscal
2000. However, change continues to be a
significant factor in our markets. Growing
demand for wireless services, including the new
3G services, is driving investment by both
wireless and wireline carriers. This shift helps
drive sales of our transport, VQE and managed
access products. In order to achieve our targeted synergies
following our acquisition of AFC, and to support
achievement of our strategic and financial goals,
we are currently reviewing our spending, asset
utilization and product development roadmap
opportunities to optimize revenue, improve asset
utilization and contain spending. We expect that
potential opportunities could include closing
facilities, reducing our 16




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##### 



workforce and realigning research and
development spending within our product
portfolio. Although we have not completed these
plans, it is likely that future implementation
of the plans could result in restructuring and
similar charges. Acquisitions On December 30, 2004, Tellabs acquired Vinci
Systems Inc. (Vinci), a privately held developer
of Optical Networking Terminals (ONTs) for Fiber
to the Premise (FTTP) access systems. Under the
terms of the agreement, we will pay up to $52.5
million in cash and Tellabs restricted stock
related to the acquisition of Vinci. This
acquisition enables us to deliver a more
cost-effective fiber access solution. On November 30, 2004, Tellabs acquired
Advanced Fibre Communications, Inc. (AFC), a
leading supplier of access products for
approximately $1.6 billion. Under the terms of
the merger, AFC stockholders received 0.504
shares of Tellabs common stock and $12.00 in cash
for each AFC share of common stock. We issued
approximately 44.8 million shares of our common
stock for the acquisition. We used our U.S.-based
cash and cash equivalents to satisfy the cash
portion of the purchase price. As a result of the
transaction, historical Tellabs stockholders own
approximately 90% of the combined company and
historical AFC stockholders own approximately
10%. In conjunction with the acquisition, Frank
Ianna, a director of AFC since February 2004 and
retired president of AT&T Network Services,
joined Tellabs board of directors. Our results
of operations for the fourth quarter and full
year 2004 include AFCs results for the one-month
period following the acquisition. Going forward
we will report revenue from AFCs and Vincis
products in a new revenue category called Access.
(See Note 4, Business Combinations,on page 37.) Our consolidated balance sheet at December
31, 2004, includes the estimated fair values of
the assets and liabilities of AFC and Vinci as
determined under the accounting rules for
purchase acquisitions. The amounts reflect our
best estimate of the fair values of the assets
and liabilities at that date, which are subject
to change as we complete the valuation and
purchase-accounting processes. As a result of our merger with AFC, we
became party to a multiyear agreement with
Verizon Services Group (Verizon) to be the
primary FTTP project vendor in providing the
central office and premises electronics required
for the delivery of telephone, data and video
services to customers homes or business
locations over fiber optic cable. Although the
overall contract is expected to be profitable,
gross margins are below Tellabs historical gross
margins. One component, the ONT, is sold
substantially below our current cost. Therefore,
the associated revenue and profitability are
affected by the timing and mix of components in
the deployment of FTTP systems and the mix of
customers. We expect to ship
significantly larger volumes of ONTs in 2005 than
in 2004 and that ONTs will constitute a larger
percentage of our overall revenue. If that does
occur, the impact would be lower overall gross
margins. We have an active remediation program in
place to address the profitability of the ONT
component. Over the next year we expect product
design changes, component price reductions and
increased production volumes to help improve
gross margins. In addition, Vinci is developing
a lower-cost ONT which will help improve the
overall FTTP gross margins. The other components
of the FTTP systems are expected to continue to
sell to customers at a profit. The Verizon agreement has several provisions
requiring penalties for failure to meet key
milestones by specified dates. Prior to its
acquisition by Tellabs, AFC failed to meet
certain milestones related to delivery of
products or features, which triggered the penalty
provisions. In total, AFC recorded $5.3 million
in penalties prior to being acquired by Tellabs. In June 2004 Verizon informed AFC that it
believed AFCs failure to meet certain
milestones and to deliver certain product
features under a corrective action plan
constituted a default and a breach of their
agreement. Verizon has reserved all of its legal
rights and remedies under the agreement, which
may include termination of the agreement without
the required advance notice, pursuing claims
against AFC and Tellabs for costs and other
damages caused by the breach, adjusting or
eliminating the exclusivity clause and canceling
previously placed orders. We could experience
additional penalties in the future if we fail to
comply with the remaining milestones. However,
Verizon has not terminated the contract and
continues to purchase products and services from
AFC and Tellabs, including FTTP systems. Results of Operations For 2004, we recorded a net loss of $29.8
million ($0.07 per share) compared with a net
loss of $241.6 million ($0.58 per share) in
2003 and a net loss of $313.1 million ($0.76
per share) in 2002. The year-over-year
improvements were driven by higher revenue,
lower restructuring and other charges, higher
gross margins and lower operating expenses
exclusive of restructuring and unusual charges. TELLABS 2004 ANNUAL REPORT / 17




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##### 



Revenue In 2004 we recategorized our product offerings into four areas to better reflect our business
dynamics: transport, managed access, broadband data and voice quality enhancement (VQE). In
December 2004, we added a fifth category, access, to incorporate the access products we obtained
through our acquisition of AFC and Vinci. 2004 vs.
    
    
    2003 vs.(In millions, except percentages)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2003
    
    
    2002Transport
    
    $
    588.2
    
    
    $
    419.4
    
    
    $
    579.1
    
    
    
    40
    %
    
    
    (28
    )%Managed Access
    
    
    331.0
    
    
    
    336.1
    
    
    
    455.0
    
    
    
    (2
    )%
    
    
    (26
    )%Voice Quality Enhancement
    
    
    84.3
    
    
    
    68.2
    
    
    
    103.7
    
    
    
    24
    %
    
    
    (34
    )%Access
    
    
    53.3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Broadband Data
    
    
    17.4
    
    
    
    6.4
    
    
    
    
    
    
    
    172
    %
    
    
    Services
    
    
    157.6
    
    
    
    150.3
    
    
    
    179.2
    
    
    
    5
    %
    
    
    (16
    )%Total
    
    $
    1,231.8
    
    
    $
    980.4
    
    
    $
    1,317.0
    
    
    
    26
    %
    
    
    (26
    )%
 Total revenue grew by 26% (20% excluding the
December 2004 revenue from AFC) in 2004 compared
with a 26% decline in 2003. Total 2004 revenue
was $1,231.8 million compared with $980.4 million
in 2003 and $1,317.0 million in 2002. Revenue
within North America amounted to $813.0 million
(66% of total revenue) in 2004 compared with
$597.8 million (61% of total revenue) in 2003 and
$916.4 million (70% of total revenue) in 2002.
International revenue was $418.8 million (34% of
total revenue) in 2004 compared with $382.6
million (39% of total revenue) in 2003 and $400.6
million (30% of total revenue) in 2002. Transport revenue for 2004 increased by
$168.8 million, or 40%, to $588.2 million from
$419.4 million in 2003. Transport revenue for
2003 decreased by $159.7 million, or 28%, from
$419.4 million in 2002. The improvement in 2004
was attributable to increased spending by
wireless carriers to meet growing capacity
requirements and to build out their networks to
provide new 3G services. We also experienced
increased orders from wireline carriers due to
increased end-user demand after a period of
restrained spending. The decline in 2003 was
attributable to the industrywide spending
curtailment that began in 2001. This category
includes the Tellabs®5300 and 5500
digital cross-connect systems, Tellabs®5500 NGX transport switch, Tellabs®6500 transport switch and Tellabs®7100 optical transport system. Managed access revenue remained relatively
constant at $331.0 million in 2004 compared with
$336.1 million in 2003, but declined by $118.9
million, or 26%, from $455.0 million in 2002.
This category includes the Tellabs®8100 managed access system, the
Tellabs®6300 managed transport system
and the Tellabs®2300 telephony
distribution system. The decline in revenue in
2003 was primarily attributable to a decline in
revenue from our Tellabs 2300 products as a
result of a change in business strategy by a
major customer. VQE revenue increased by $16.1 million, or
24%, in 2004 to $84.3 million from $68.2 million
in 2003. VQE revenue declined by $35.5 million,
or 34%, in 2003 from $103.7 million in 2002. As
with our transport products, the growth in 2004
was attributable to increased spending by
wireless carriers. This category includes the
Tellabs®3000 series of VQE products
and other products. Access revenue of $53.3 million in 2004
represents one month of revenue from our merger
with AFC at the end of November 2004. This
category includes the Tellabs®1000
Multi-Service Access systems. Broadband data
revenue more than doubled in 2004 to $17.4
million from $6.4 million in 2003, when Tellabs
had the product available for sale during the
last six months of the year. This category
includes the Tellabs®8800
multi-service router series and the Tellabs®8600 next-generation wireless aggregation
platform. Services revenue increased by $7.3 million,
or 5%, in 2004 to $157.6 million from $150.3
million in 2003, and it declined by $28.9
million, or 16%, in 2003 from $179.2 million in
2002. The decline in revenue from 2002 to 2003
was attributable to lower sales of products both
in the North America and international markets.
Revenue from Services did not recover in 2004 at
the same rate as product revenue because a larger
percentage of our product sales in North America
were of products that require less installation
or are more readily installed by our customers
without assistance from Tellabs. Gross Profit & Margin (In millions, except percentages)
    
    2004
    
    
    2003
    
    
    2002Gross Profit
    
    $
    657.0
    
    
    $
    354.0
    
    
    $
    486.5Gross Margin
    
    
    53.3
    %
    
    
    36.1
    %
    
    
    36.9
    %Product Gross Profit
    
    $
    612.2
    
    
    $
    317.1
    
    
    $
    440.1Product Margin
    
    
    57.0
    %
    
    
    38.2
    %
    
    
    38.7
    %Services Gross Profit
    
    $
    44.8
    
    
    $
    36.9
    
    
    $
    46.4Services Margin
    
    
    28.4
    %
    
    
    24.6
    %
    
    
    25.9
    %
 18




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##### 



Gross Profit Total gross profit was $657.0 million (53.3% of
revenue) in 2004 compared with $354.0 million
(36.1% of revenue) in 2003, and $486.5 million
(36.9% of revenue) in 2002. Unusual charges for
excess and obsolete inventories and excess
purchase commitments reduced gross profit by
$70.7 million (7.2% of revenue) in 2003 and by
$99.7 million (7.6% of revenue) in 2002. In
addition, in 2003 we incurred $23.7 million (2.4%
of revenue) of accelerated depreciation on our
U.S. manufacturing facility and equipment due to
our decision to outsource our manufacturing
operations. The impact of unusual charges on 2004
gross profit was not significant. Gross profit declined in 2003 compared
with 2002 due primarily to lower revenue. Gross
profit improved in 2004 due to higher revenue
compared with 2003, the absence of significant
unusual charges compared with 2003 and lower
product cost as a result of outsourcing our
manufacturing operations at the end of 2003. Gross margin improved in 2004 compared with
2003 due to the absence of significant unusual
charges (9.9%), lower manufacturing-related costs
(6.9%), improved margins on professional services
(0.7%) and overall product and services mix
(1.1%). The inclusion of access revenue and cost
of revenue for one month in 2004 reduced
full-year margins by 1.4% compared with 2003.
Gross margin declined slightly in 2003 compared
with 2002 due to the increased impact of
restructuring and inventory-related charges
(2.4%), offset by favorable product mix driven by
reduced sales of the Tellabs 6500 system, which
has significantly lower margins than our other
products (0.9%) and improved manufacturing and
services efficiencies (0.7%). Product Gross Profit Total product gross profit was $612.2 million
(57.0% of product revenue) in 2004 compared with
$317.1 million (38.2% of product revenue) in
2003, and $440.1 million (38.7% of product
revenue) in 2002. Unusual charges for excess and
obsolete inventories and excess purchase
commitments reduced product gross profit by $71.7
million (8.6% of product revenue) in 2003, and by
$99.7 million (8.8% of product revenue) in 2002.
In addition, in 2003 we incurred $23.7 million
(2.9% of product revenue) of accelerated
depreciation on our U.S. manufacturing facility
and equipment due to our decision to outsource
our manufacturing operations. Product gross profit improved in 2004 due to
higher product revenue compared with 2003, the
absence of significant unusual charges compared
with 2003 and 2002, and lower product cost as a
result of outsourcing our manufacturing
operations at the end of 2003. The impact of
unusual charges on 2004 product gross profit was
not significant. Product gross profit declined in
2003 due
primarily to lower product revenue compared
with 2002. Product gross margin improved in 2004
compared with 2003 due to the absence of
significant unusual charges (11.7%), lower
manufacturing-related costs (8.1%) and favorable
product mix and other (0.7%). The inclusion of
access product revenue and cost of product
revenue for one month in 2004 reduced full-year
product margins by 1.7% compared with 2003.
Product gross margin declined slightly in 2003
compared with 2002 due to the increased impact of
restructuring and inventory-related charges
(2.7%), offset by favorable product mix driven by
reduced sales of the Tellabs 6500 system, which
has significantly lower margins than our other
products (1.3%) and improved manufacturing
efficiencies due to outsourcing (0.9%). Services Gross Profit Total services gross profit was $44.8 million
(28.4% of services revenue) in 2004 compared with
$36.9 million (24.6% of services revenue) in
2003, and $46.4 million (25.9% of services
revenue) in 2002. Services gross profit improved
in 2004 due to higher services revenue compared
with 2003. Services gross profit declined in 2003
due primarily to lower services revenue compared
with 2002. Services gross margin improved in 2004
compared with 2003 due to labor efficiencies
achieved as a result of reduced headcount in our
services business. The inclusion of access
services revenue and cost of services revenue
for one month in 2004 reduced 2004 services
margins by 0.8%. Gross Margin Trend As previously discussed herein, we are obligated
to sell access products to Verizon under a supply
agreement that contains fixed selling prices.
While we anticipate this agreement to be
profitable, gross margins are below Tellabs
historical gross margins. We are working to
reduce the cost of these products through
internal development and by the acquisition of
Vinci. TELLABS 2004 ANNUAL REPORT / 19




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##### 



In addition, our total gross margin will continue to be subject to variability due to
product mix. Our gross margin is different for each product and services category and for each
product within a category because they are dependent on specific system configurations sold and
customer and geographic pricing differences. Under normal conditions, this variability has tended
to impact our gross margin in the range of 23% up or down. Going forward, we expect our total
gross margin will be in the low 40% range and to trend up through 2005. Operating Expenses Expense
    
    
    
    
    
    
    Percent of Revenue(In millions)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Sales and marketing
    
    $
    155.1
    
    
    $
    143.5
    
    
    $
    168.8
    
    
    
    12.6
    %
    
    
    14.6
    %
    
    
    12.8
    %Research and development
    
    
    250.3
    
    
    
    286.1
    
    
    
    335.2
    
    
    
    20.3
    %
    
    
    29.2
    %
    
    
    25.5
    %General and administrative
    
    
    81.5
    
    
    
    99.1
    
    
    
    129.0
    
    
    
    6.6
    %
    
    
    10.1
    %
    
    
    9.8
    %Subtotal
    
    
    486.9
    
    
    
    528.7
    
    
    
    633.0
    
    
    
    39.5
    %
    
    
    53.9
    %
    
    
    48.1
    %Restructuring and other charges
    
    
    14.1
    
    
    
    77.2
    
    
    
    169.0Purchased in-process R&D
    
    
    102.1
    
    
    
    
    
    
    
    5.4Intangible asset amortization
    
    
    17.8
    
    
    
    12.6
    
    
    
    8.8Asset impairment charge
    
    
    47.2
    
    
    
    
    
    
    
    Net loss on sale of real estate
    
    
    20.6
    
    
    
    
    
    
    
    Total Operating Expenses
    
    $
    688.7
    
    
    $
    618.5
    
    
    $
    816.2Headcount at end of year
    
    
    4,125
    *
    
    
    3,515
    
    
    
    4,828
   *Includes 1,084 employees at AFC and Vinci who joined Tellabs at the end of 2004. Total operating expenses increased to
$688.7 million in 2004 after declining to $618.5
million in 2003 from $816.2 million in 2002.
Total operating expenses for 2004 include $15.5
million of operating expenses from AFC (excluding
$89.0 million of purchased in-process research
and development charges) for the one-month period
following the merger in the fourth quarter of
2004. Spending on sales and marketing, R&D and
general and administrative declined in total by
$41.8 million, or 8%, from 2003 to 2004 and by
$104.3 million, or 16%, from 2002 to 2003. A significant portion of the improvements
resulted from lower expenses in headcount-related
areas such as benefits, travel and
telecommunications due to the reduction of our
global workforce. We also significantly reduced
spending on prototypes and we incurred lower
facilities costs due to having closed or vacated
a number of owned and leased facilities over the
periods. Sales and marketing expense increased in
2004 due to higher commissions and incentives on
higher sales volume compared with 2003. Restructuring and Other Charges During 2004 we recorded net restructuring
charges in operating expenses of $14.1
million compared with $77.2 million in 2003
and $169.0 million in 2002. (See Note 3,
Restructuring and Other Charges.) The charges
for 2004 included the following:  
    $15.4 million primarily for the closure of our research facility in Montreal,
Canada, in the first quarter of 2004, of which $9.4 million related to disposal of
fixed assets, $3.0 million related to
severance costs, $2.2 million related to
contractual obligations, and $0.8 million
related to facilities costs and other.
    $1.6 million for severance-related costs due to a reorganization of our
Denmark-based business.
    A net reversal of restructuring reserves in the amount of $2.9 million due to
changes in estimates of costs related to other restructurings initiated prior to 2004. The reorganization of our Denmark operations
is part of a plan to improve the profitability of
our operations at that location. As part of this
plan, in January 2005 we announced a further
reduction of approximately 80 employees at the
Denmark facility. We expect to record an
estimated $8.1 million of severance and related
expenses associated with those reductions during
2005, principally in the first quarter. It is
likely we will incur other unusual charges
related to the restructuring as we complete our
plan. However, we are currently unable to
estimate the magnitude or nature of those
charges. In January 2005, we also announced our
intention to reorganize our operations in
Finland, which will result in a headcount
reduction of approximately 70 positions. As a
result, we expect to record an estimated $3.6
million of charges for severance and related
expenses and other costs during 2005, principally
in the first quarter. It is possible we will
incur other unusual charges related to the
restructuring as we complete our plan. However,
we are currently unable to estimate the magnitude
or nature of those charges. 20




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##### 



We will also eliminate approximately 50
jobs at other U.S.-based facilities. We will
incur costs for severance-related benefits
related to these actions in 2005, primarily in
the first quarter. Purchased In-Process Research and Development During 2004 we charged $102.1 million to
operating expenses for the estimated fair value
of in-process research and development (IPR&D)
that we acquired in our acquisitions of AFC and
Vinci. IPR&D refers to the value of technology
under development that does not have an
alternative use outside of its value within the
acquired business. Generally accepted accounting
principles require that IPR&D be expensed in
whole at the time it is acquired. The value of
the IPR&D at AFC was approximately $89.0 million
of the total charges and was primarily
attributable to development of enhanced versions
of the companys Fiber to the Premise products.
The remainder, approximately $13.1 million, was
attributable to development at Vinci of Optical
Networking Terminals. The estimated fair values
of the IPR&D at both AFC and Vinci were
determined by using a discounted cash flow
analysis that incorporated estimates of the
amounts of costs remaining to complete the
development, the amount of revenue that would
result from the fully-developed technology and an
estimate of risk. Intangible Asset Amortization Amortization increased in 2004 to $17.8
million from $12.6 million in 2003 and $8.8
million in 2002. The increase in 2003 was
attributable to amortization of developed
technology acquired in our acquisition of
Vivace in 2003, and the increase in 2004 was
due to amortization of developed technology
acquired in our acquisitions of Vivace in 2003
and AFC in 2004. Asset Impairment Charge During the fourth quarter of 2004 we reviewed our
amortizable intangible assets for indicators of
impairment. We determined that impairment
indicators existed for our Tellabs 5500 NGX asset
group because actual and forecasted revenue for
that asset group was lower than expected. We
further determined that future undiscounted cash
flows would not be sufficient to support the
total carrying value of the asset group. We
therefore recorded an impairment charge of $47.2
million to reduce the carrying value of those
assets, principally amortizable intangibles, to
their fair value. We determined the fair value of
the assets by reference to the present value of
the cash flows attributable to those assets over
the remaining life of the intangibles, the
primary asset in the asset group. Net Loss on Sale of Real Estate During the fourth quarter of 2004, we sold an
administrative
and research and development facility in Denmark
and entered into a one-year lease for a portion
of the space. The sale resulted in a loss of
approximately $21.1 million. Other Income (Expense) (In millions)
    
    2004
    
    
    2003
    
    
    2002Interest income, net
    
    $
    26.9
    
    
    $
    24.2
    
    
    $
    29.9Other expense, net
    
    
    (5.4
    )
    
    
    (4.4
    )
    
    
    (28.0
    )Total
    
    $
    21.5
    
    
    $
    19.8
    
    
    $
    1.9
 Other expense, net includes impairment
charges to write down the carrying value of
certain cost-basis equity investments in start-up
technology companies. These charges, which arose
as a result of our normal review of long-lived
assets, were $11.2 million in 2004, $3.3 million
in 2003 and $29.6 million in 2002. Other expense,
net for 2004 includes a $6.6 million foreign
currency gain resulting from converting a portion
of our non-U.S. offshore cash from
Euro-denominated investments to investments
denominated in U.S. dollars. Income Taxes (In millions, except percentages)
    
    2004
    
    
    2003
    
    
    2002Income tax (expense)
benefit
    
    $
    (19.6
    )
    
    $
    3.1
    
    
    $
    14.7Effective tax rate
    
    
    192.2
    %
    
    
    (1.3
    )%
    
    
    (4.5
    )%
 Our tax expense increased in 2004 to $19.6
million from a tax benefit of $3.1 million in
2003 due to an increase in foreign taxes on
higher foreign source income. Our tax benefit
decreased to $3.1 million in 2003 from a benefit
of $14.7 million in 2002. The decrease in tax
benefit from 2002 to 2003 was due to a smaller
benefit on domestic losses, partially offset by
lower foreign taxes as a result of lower overall
foreign source income. Our tax expense for each of the years 2002
through 2004 has been unfavorably impacted by our
inability to record a tax benefit for all or a
portion of the domestic and foreign tax losses
and other unused tax benefits (referred to herein
as deferred tax assets) that we are carrying
forward to use on tax returns in future periods.
Generally, un-benefited tax assets increase tax
expense and decrease tax benefits in our results
of operations in the year they arise or in the
year we are required to record a valuation
allowance against them. TELLABS 2004 ANNUAL REPORT / 21




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##### 



At the end of 2003, we had $251.4
million of deferred tax assets for which no
benefit was recorded, that is, tax assets that
were offset by a valuation allowance. Because
AFC and Vinci together had significant deferred
tax liabilities, we reversed approximately
$187.2 million of the valuation allowance that
we had recorded against our pre-acquisition
deferred tax assets. We recorded the reversal of
valuation allowance as a reduction in goodwill
from those acquisitions. At the end of 2004, we
had approximately $38.9 million of deferred tax
assets for which no benefit was recorded. If we generate domestic pre-tax losses in
2005, such losses may not result in a tax benefit
if we determine that, based on our recent history
of losses and future projections of income, it is
more likely than not that such losses will not be
utilized (due to absence of tax liabilities).
That is, we would be required to record a
valuation allowance against the tax benefit
arising from those losses. If we generate
domestic pre-tax income in 2005, we would record
a tax benefit by reversing an amount of our
existing valuation allowance on U.S. deferred tax
assets equal to the income tax expense on the
income. After the valuation allowance is reduced
to zero, we would record a tax expense on
domestic pre-tax income arising thereafter at a
more normalized U.S. statutory rate. We cannot
reasonably estimate when such a level of domestic
pre-tax income would arise. Financial Condition, Liquidity and Capital Resources Our principal source of liquidity remains our
cash, cash equivalents and marketable securities,
which decreased by $6.8 million during 2004 to
$1,116.2 million. During 2004, we generated
$214.7 million of cash from operating activities
and we used $251.2 million in net cash for the
acquisitions of AFC and Vinci. We believe that
the current level of working capital,
particularly cash and marketable securities, is
sufficient to meet our normal operating
requirements for the foreseeable future. Further,
we believe that sufficient resources exist to
support our future growth and strategic needs.
Future available sources of working capital
include cash-on-hand, cash generated from future
operations, short-term or long-term financing,
equity offerings or any combination of these
sources. Our current policy is to retain our
earnings to provide funds for operating and
expanding our business. We do not anticipate
paying a cash dividend in the foreseeable future. On February 2, 2005, Tellabs announced
that its Board of Directors had authorized
the purchase of up
to $300.0 million in shares of the companys
outstanding common stock (approximately 9.5% of
the outstanding shares based on the closing price
on that date).
Purchases will be made from time to time in the
open
market or private transactions. Tellabs provides
no assurances as to the quantity of shares it
will purchase or the actual purchase prices. As
of February 28, 2005, we have purchased $118.7
million (16.5 million shares) of our common
stock. Cisco marketable securities As a result of our merger with AFC we acquired
the 10.6 million shares of Cisco Systems, Inc.
(Cisco), common stock that AFC owned as a
result of its investment in privately held Cerent
Corporation, which was acquired by Cisco in 1999.
The shares are presented as Other marketable
securities  Cisco stock in the current assets
portion of our balance sheet for the year ending
December 31, 2004. 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. The fair
value of those stock loans is reflected as a
current liability on our balance sheet for the
year ending December 31, 2004. The value of both
the asset and liability move in tandem with each
other since each is based upon the number of
shares we hold at the current stock price. In 2004, AFC received a private letter
ruling from the Internal Revenue Service holding
the use of borrowed shares to settle the hedge
contracts in 2003 did not require recognition of
a capital gain on the Cisco stock until the stock
loans are settled. Following issuance of the
ruling, AFC received a refund of $218.6 million
in federal and state income taxes that had
previously been paid in respect of the
transactions. Our balance sheet at December 31, 2004,
reflects the deferred tax liability that will be
due on the hedge contract gains upon termination
of the Cisco stock loans. Our agreement with the
lender of the stock has no defined date when we
must repay the loan, however, the loan is
callable at the discretion of the lender.
Further, we have no current intention to dispose
of the Cisco shares or otherwise take any actions
that would result in us having to pay the capital
gains tax on the stock. Although we do not have
any current intentions of unwinding this
transaction, if we did unwind this transaction,
we would use the proceeds from the sale of the
stock to pay off the stock loan. 22




---



##### 



Contractual Obligations The following table sets forth an overview of our known contractual obligations as of December 31,
2004, that will affect our liquidity and cash flows in future periods: Payments Due by PeriodLess than
    
    
    13
    
    
    35
    
    
    More than(In millions)
    
    Total
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    5 YearsOperating lease obligations
    
    $
    82.8
    
    
    $
    18.0
    
    
    $
    28.1
    
    
    $
    17.6
    
    
    $
    19.1Net operating lease obligations related to
restructuring activities
    
    
    36.8
    
    
    
    7.2
    
    
    
    12.1
    
    
    
    11.6
    
    
    
    5.9Purchase commitments to contract
manufacturers and suppliers
    
    
    267.8
    
    
    
    267.8
    
    
    
    
    
    
    
    
    
    
    
    Cisco stock loan*
    
    
    204.0
    
    
    
    204.0
    
    
    
    
    
    
    
    
    
    
    
    Cisco stock loan borrowing fees**
    
    
    8.9
    
    
    
    1.4
    
    
    
    3.4
    
    
    
    3.1
    
    
    
    1.0Total obligations
    
    $
    600.3
    
    
    $
    498.4
    
    
    $
    43.6
    
    
    $
    32.3
    
    
    $
    26.0
   *Our agreement with the lender of the stock has no defined date when we must repay the
loan, however, the loan is callable at the discretion of the lender.**For purposes of contractual
obligations disclosure, we used Ciscos average share price of $19.14 for the quarter ended
December 31, 2004, to determine the hypothetical value of the borrowing fees assuming the loans are
settled in 2010. We use several contract manufacturers
and suppliers to provide manufacturing services
for our products. During the normal course of
business, in order to reduce manufacturing lead
times and ensure adequate component supply, we
enter into agreements with certain contract
manufacturers and suppliers to enable them to
procure inventory based upon criteria defined by
us. Under these agreements, the maximum liability
for purchase commitments as of December 31, 2004,
was $267.8 million, of which $18.0 million was
accrued on the balance sheet. The Cisco stock loan borrowing fees are
partially based on Ciscos average share price at
the end of each quarter. Off-balance sheet arrangements None. Critical Accounting Policies The methods, estimates, and judgments that we use
in applying our accounting policies can have a
significant impact on the results we report in
the consolidated financial statements. Some of
these estimates require difficult and subjective
judgments, often as a result of the need to
estimate matters that are inherently uncertain.
For the reasons discussed below, we consider our
critical accounting estimates to be the allowance
for excess and obsolete inventory and excess
purchase commitments (collectively E&O), goodwill
valuation, the valuation allowance for deferred
tax assets, reserve requirements for lease
obligations on vacated facilities and the
valuation of amortizable intangible assets. We have discussed the development and
selection of these critical accounting policies
and estimates with the
Audit and Ethics Committee of Tellabs Board
of Directors. Excess & Obsolete Inventory and
Excess Purchase Commitments We determine our inventory cost using the
first-in, first-out method and we value our
inventory at the lower of cost or market, with
market determined by reference to current
replacement cost. We determine the amount of
inventory that is excess and obsolete and
purchase commitments in excess of requirements
using estimates of future demand for individual
components of raw materials and finished goods. To determine E&O, we compare our existing
inventory and inventory purchase commitments with
estimates of future product demand and usage
requirements. We consider quantities in excess of
two years expected usage to be excess and we
record a full valuation allowance for that
amount. For quantities that fall between one- and
two-years demand we use management judgment to
determine the appropriate E&O amount. We do not
record an allowance if the quantity is less than
one years forecasted demand. Because our visibility to future sales
volume and product mix is limited and actual
results can differ materially from our
estimates, charges for E&O can have a material
impact on our financial statements. Goodwill At December 31, 2004, we had approximately $1.1
billion of goodwill on our balance sheet, which
arose from acquisitions including the recent
acquisitions of AFC and Vinci. Accounting rules require that we evaluate
goodwill for impairment annually. Because we
report our operating results as a single segment
or reporting unit, we performed the impairment
test in 2004 by comparing the per-share market
price of our stock with our net book TELLABS 2004 ANNUAL REPORT / 23




---



##### 



value per share on our annual measurement
date in the fourth quarter. Because the market
price exceeded our net book value, we concluded
that our goodwill was not impaired. Therefore,
we did not perform additional impairment
testing or record an impairment charge. Segments are generally determined by the way
a company manages and measures its business, with
particular weight given to the manner in which
results of operations are reported internally and
the measures provided to, and used by, the
companys chief decision-maker. If facts were to
change such that we operated in multiple segments
rather than a single segment, then we would be
required to apportion our goodwill to each
segment, or part of a segment referred to as a
reporting unit, and conduct the impairment test
on a segment basis or reporting unit basis using
a fair value measurement that would not utilize
our stock price as a key indicator of value. We
cannot reasonably estimate if an impairment would
result from that process, or the amount of any
such impairment, because it would depend on the
number and configuration of segments or reporting
units, valuations of the underlying businesses,
and the amount of goodwill apportioned to each
segment or reporting unit. Valuation Allowance for Deferred Tax Assets Deferred tax assets arise when we record charges
or expenses in our financial statements that will
not be allowed as income tax deductions until
future periods. The term deferred tax assetalso
includes unused tax net operating losses and
unused tax credits that we are allowed to carry
forward to future years. Accounting rules permit
us to carry deferred tax assets on the balance
sheet at full value as long as it is more likely
than not the deductions, losses, or credits will
be used in the future. A valuation allowance must
be recorded against the deferred tax assets via a
charge to income tax expense if the test cannot
be met. The accounting rules state that a company
with a recent history of losses would have a
difficult, perhaps impossible, time supporting a
position that utilization of its deferred tax
assets was more likely than not to occur. Because of a recent history of losses we
determined that it was appropriate to maintain a
valuation allowance (approximately $38.9 million
at the end of 2004) against our domestic deferred
tax assets. We are currently not able to forecast when
an earnings improvement of sufficient size will
occur for us to reverse any of the remaining
valuation allowances that we have recorded. Restructuring Reserves  Leases At the end of 2004, we had $41.8 million of
remaining
reserves for lease obligations that arose from
facility closures that occurred in 2004 and prior
years. We determined the amount of the reserve
for each facility by calculating our outstanding
lease obligation, then reducing it by an estimate
of potential sublease income. We examine real
estate market conditions in each location where
we have a vacated facility and use input from
local real estate professionals to formulate an
estimate of potential sublease income. We review
our estimates quarterly and adjust our reserves
as necessary. We believe our estimate of
restructuring lease obligations is a critical
accounting estimate because it requires us to
make assumptions about matters that are highly
uncertain: real estate rental market conditions,
the length of time required to secure tenants,
the amount of tenant incentives and the potential
sublease income. Although the changes in our
reserves for restructuring lease obligations have
not been material in the past, it is possible
that future changes in estimates could have a
material impact on our financial statements. Intangible Assets At the end of 2004 we had $156.0 million of
amortizable intangible assets, primarily
purchased technology, on our balance sheet, which
arose primarily from our acquisitions in 2004 and
2003. We evaluate the carrying value of our
intangible assets for impairment whenever
indicators of impairment exist. If an impairment
indicator exists, we compare the sum of the
undiscounted future cash flows expected to result
from the intangibles, or asset group of which the
intangibles are a part, to our carrying value. If
the sum of the undiscounted future cash flows is
less than the carrying value, then we compare the
fair value of the asset group with our carrying
value to determine if an impairment charge is
required. The amount of impairment is calculated
by subtracting the fair value of the asset from
the carrying value of the asset. We believe that the accounting estimate
related to asset impairment is a critical
accounting estimate because it requires us to
make assumptions about future sales prices, sales
volumes and margins for our products, including
products that employ new technologies, and
uncertainties around customer acceptance, that
are highly uncertain. The amount of any such
impairment could be material to our financial
statements. 24




---



##### 



Strategy and Outlook We expect capital spending by our customers to be
stable globally in 2005 with growth in North
America. On a global basis, wireless carriers
will continue to build next-generation networks
to deliver new, data-oriented services. In North
America, we expect the regional Bell operating
companies to upgrade the access portion of their
networks with fiber technology as a means to
deliver broadband services to their customers. We
also expect that customers will begin to
accelerate spending on broadband data
infrastructure equipment globally. Tellabs has
products either currently available or in
development to take advantage of these
opportunities. In 2005, we will continue to focus on our
strategies to energize our core products,
establish a position in data and expand into
adjacent markets, specifically fiber access. In
addition, we are driving toward a business target
model that calls for us to achieve over time an
overall gross margin of 50% of revenue, operating
expenses of 30% of revenue (excluding unusual
charges), operating margins at 20% of revenue,
and 15% annual revenue growth. While we have
achieved and even exceeded these targets in the
past, we can not say when or if we will achieve
them again, given todays market conditions and
our product portfolio. Gross margin will be lower in 2005 than in
2004, reflecting the addition of AFC, whose
products have lower overall gross margins than
the traditional Tellabs products.
We expect overall gross profit margin to improve
through the course of 2005, as we begin to ship
the single-family ONTs we acquired from Vinci,
which have better gross margins than the ONTs
acquired from AFC. In addition, for the full year
2005, we expect that synergies associated with
the AFC acquisition will reduce overall cost of
revenue by $15 million, thus improving overall
gross margin performance toward our target. Our operating expenses will grow in 2005,
reflecting the acquisitions of AFC and Vinci. We
expect to reduce 2005 operating expenses by $30
million, compared with the full-year 2004 run
rate of Tellabs, AFC (including Marconi NAA) and
Vinci. We expect to achieve these savings through
a combination of synergies related to the AFC
acquisition, reducing fixed cost, especially
facilities, adjusting product roadmaps to match
market opportunities, and other cost containment
activities. Operating income is expected to be positive
in 2005, including restructuring and other
unusual charges discussed previously. In
connection with the restructuring actions taken
early this year, we expect to take a
restructuring charge to earnings in the first
quarter, as described earlier. It is possible
that we will take further charges in 2005 in
connection with cost-reduction activities and the
rationalization of our manufacturing supply
chain. TELLABS 2004 ANNUAL REPORT / 25




---



##### 



Managements Report on Internal Control over Financial Reporting Management of Tellabs, Inc., and subsidiaries
(the Company) is responsible for establishing
and maintaining adequate internal control over
financial reporting, as such term is defined in
the Securities Exchange Act of 1934 Rules
13a-15(f). Under the supervision and with the
participation of our management, including our
principal executive officer and principal
financial officer, we conducted an evaluation of
the effectiveness of the Companys internal
control over financial reporting as of December
31, 2004, as required by the Securities Exchange
Act of 1934 Rules 13a-15(c). In making this
assessment, we used the criteria set forth in the
framework in Internal ControlIntegrated
Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based
on our evaluation under the framework in Internal
ControlIntegrated Framework, our management
concluded that our internal control over
financial reporting was effective as of December
31, 2004. Our managements assessment of and
conclusion on the effectiveness of internal
control over financial reporting did not include
the internal controls of Advanced Fibre
Communications, Inc., which is included in the
2004 consolidated financial statements of the
Company and constituted approximately $1.1
billion and $800 million of total and net assets,
respectively, as of December 31, 2004, and $55
million of revenues for the year then ended.
Management did not assess the effectiveness of
internal control over financial reporting at this
entity
because the Company only recently acquired
this business on November 30, 2004. Our managements assessment of the
effectiveness of our internal control over
financial reporting as of December 31, 2004, has
been audited by Ernst & Young LLP, an independent
registered public accounting firm, as stated in
their report that appears on page 27. Ernst &
Young LLPs audit of internal control over
financial reporting of the Company also did not
include an evaluation of the internal control
over financial reporting of Advanced Fibre
Communications, Inc. -s- Michael J. Birck 
 -s- Krish Prabhu 
 -s- Timothy J. Wiggins) 
 March 10, 2005 Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of
Tellabs, Inc.: We have audited the accompanying
consolidated balance sheets of Tellabs, Inc., and
subsidiaries (the Company) as of December 31,
2004, and January 2, 2004, and the related
consolidated statements of operations,
stockholders equity and cash flows for each of
the three years in the period ended December 31,
2004. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits in accordance with
the standards of the Public Company Accounting
Oversight Board (United States). Those standards
require that we plan and perform the audit to
obtain reasonable assurance about whether the
financial statements are free of material
misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit
also includes assessing the accounting principles
used and significant estimates made by
management, as well as evaluating the overall
financial statement presentation. We believe that
our audits provide a reasonable basis for our
opinion. In our opinion, the financial statements
referred to above present fairly, in all material
respects, the consolidated financial position of
the Company at December 31, 2004, and January 2,
2004, and the consolidated results of their
operations and their cash flows for each of the
three years in the period ended December 31,
2004, in conformity with U.S. generally accepted
accounting principles. We also have audited, in accordance with the
standards of the Public Company Accounting
Oversight Board (United States), the
effectiveness of the Companys internal control
over financial reporting as of December 31, 2004,
based on criteria established in Internal Control
 Integrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway
Commission and our report dated March 10, 2005,
expressed an unqualified opinion thereon. (ERNST & YOUNG, LLP) 
 26




---



##### 



Report of Independent Registered Public Accounting
Firm on Internal Control over Financial Reporting To the Stockholders and Board of Directors of
Tellabs, Inc.: We have audited managements
assessment, included in the accompanying
Managements Report on Internal Control over
Financial Reporting , that  Tellabs, Inc., and
subsidiaries (the Company) maintained effective
internal control over financial reporting as of
December 31, 2004, based on criteria established
in Internal Control  Integrated Frameworkissued
by the Committee of Sponsoring Organizations of
the Treadway Commission (the COSO criteria). The
Companys management is responsible for
maintaining effective internal control over
financial reporting and for its assessment of the
effectiveness of internal control over financial
reporting. Our responsibility is to express an
opinion on managements assessment and an opinion
on the effectiveness of the companys internal
control over financial reporting based on our
audit. We conducted our audit in accordance with
the standards of the Public Company Accounting
Oversight Board (United States). Those standards
require that we plan and perform the audit to
obtain reasonable assurance about whether
effective internal control over financial
reporting was maintained in all material
respects. Our audit included obtaining an
understanding of internal control over financial
reporting, evaluating managements assessment,
testing and evaluating the design and operating
effectiveness of internal control, and
performing such other procedures as we
considered necessary in the circumstances. We
believe that our audit provides a reasonable
basis for our opinion. A companys internal control over financial
reporting is a process designed to provide
reasonable assurance regarding the reliability of
financial reporting and the preparation of
financial statements for external purposes in
accordance with generally accepted accounting
principles. A companys internal control over
financial reporting includes those policies and
procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately
and fairly reflect the transactions and
dispositions of the assets of the company; (2)
provide reasonable assurance that transactions
are recorded as necessary to permit preparation
of financial statements in accordance with
generally accepted accounting principles, and
that receipts and expenditures of the company are
being made only in accordance with authorizations
of management and directors of the company; and
(3) provide reasonable assurance regarding
prevention or timely detection of unauthorized
acquisition, use or disposition of the companys
assets that could have a material effect on the
financial statements. Because of its inherent limitations,
internal control over financial reporting may
not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness
to future periods are subject to the risk that
controls may become inadequate because of
changes in conditions, or that the degree of
compliance with the policies or procedures may
deteriorate. As indicated in the accompanying
Managements Report on Internal Control over
Financial Reporting, managements assessment of
and conclusion on the effectiveness of internal
control over financial reporting did not include
the internal controls of Advanced Fibre
Communications, Inc., which is included in the
2004 consolidated financial statements of the
Company and constituted approximately $1.1
billion and $800 million of total and net assets,
respectively, as of December 31, 2004, and $55
million of revenues for the year then ended.
Management did not assess the effectiveness of
internal control over financial reporting at this
entity because the Company only recently acquired
this business on November 30, 2004. Our audit of
internal control over financial reporting of the
Company also did not include an evaluation of the
internal control over financial reporting of
Advanced Fibre Communications, Inc. In our opinion, managements assessment that
the Company maintained effective internal control
over financial reporting as of December 31, 2004,
is fairly stated, in all material respects, based
on the COSO criteria. Also, in our opinion, the
Company maintained, in all material respects,
effective internal control over financial
reporting as of December 31, 2004, based on the
COSO criteria. We have also audited, in accordance with the
standards of the Public Company Accounting
Oversight Board (United States), the accompanying
consolidated balance sheets of the Company as of
December 31, 2004, and January 2, 2004, and the
related consolidated statements of operations,
stockholders equity and cash flows for each of
the three years in the period ended December 31,
2004, and our report dated March 10, 2005,
expressed an unqualified opinion thereon. (ERNST & YOUNG LLP) 
 TELLABS 2004 ANNUAL REPORT / 27




---



##### 



Consolidated Statements of Operations Year Ended
    
    
    Year Ended
    
    
    Year Ended(In millions, except per-share data)
    
    12/31/04
    
    
    1/2/04
    
    
    12/27/02RevenueProducts
    
    $
    1,074.2
    
    
    $
    830.1
    
    
    $
    1,137.8Services
    
    
    157.6
    
    
    
    150.3
    
    
    
    179.21,231.8
    
    
    
    980.4
    
    
    
    1,317.0Cost of RevenueProducts
    
    
    462.0
    
    
    
    513.0
    
    
    
    697.7Services
    
    
    112.8
    
    
    
    113.4
    
    
    
    132.8574.8
    
    
    
    626.4
    
    
    
    830.5Gross Profit
    
    
    657.0
    
    
    
    354.0
    
    
    
    486.5Operating ExpensesResearch and development
    
    
    250.3
    
    
    
    286.1
    
    
    
    335.2Sales and marketing
    
    
    155.1
    
    
    
    143.5
    
    
    
    168.8General and administrative
    
    
    81.5
    
    
    
    99.1
    
    
    
    129.0Restructuring and other charges
    
    
    14.1
    
    
    
    77.2
    
    
    
    169.0Asset impairment charge
    
    
    47.2
    
    
    
    
    
    
    
    Net loss on sale of real estate
    
    
    20.6
    
    
    
    
    
    
    
    Purchased in-process research and development
    
    
    102.1
    
    
    
    
    
    
    
    5.4Intangible asset amortization
    
    
    17.8
    
    
    
    12.6
    
    
    
    8.8688.7
    
    
    
    618.5
    
    
    
    816.2Operating Loss
    
    
    (31.7
    )
    
    
    (264.5
    )
    
    
    (329.7
    )Other Income (Expense)Interest income, net
    
    
    26.9
    
    
    
    24.2
    
    
    
    29.9Other expense, net
    
    
    (5.4
    )
    
    
    (4.4
    )
    
    
    (28.0
    )21.5
    
    
    
    19.8
    
    
    
    1.9Loss Before Income Tax
    
    
    (10.2
    )
    
    
    (244.7
    )
    
    
    (327.8
    )Income tax (expense) benefit
    
    
    (19.6
    )
    
    
    3.1
    
    
    
    14.7Net Loss
    
    $
    (29.8
    )
    
    $
    (241.6
    )
    
    $
    (313.1
    )Loss Per ShareBasic
    
    $
    (0.07
    )
    
    $
    (0.58
    )
    
    $
    (0.76
    )Diluted
    
    $
    (0.07
    )
    
    $
    (0.58
    )
    
    $
    (0.76
    )Weighted Average Shares Outstanding
    
    
    420.2
    
    
    
    413.1
    
    
    
    411.4
 The accompanying notes are an integral part of these statements. 28




---



##### 

\

Consolidated Balance Sheets (In millions, except share data )
    
    12/31/04
    
    
    1/2/04ASSETSCurrent AssetsCash and cash equivalents
    
    $
    292.9
    
    
    $
    245.9Investments in marketable securities
    
    
    823.3
    
    
    
    877.11,116.2
    
    
    
    1,123.0Other marketable securities  Cisco stock
    
    
    204.0
    
    
    
    Accounts receivable, net of returns and allowances of $16.6 and $5.4
    
    
    309.4
    
    
    
    196.7InventoriesRaw materials
    
    
    39.2

    
    
    
    12.5Work in process
    
    
    13.6
    
    
    
    4.1Finished goods
    
    
    63.6
    
    
    
    25.2116.4
    
    
    
    41.8Income taxes
    
    
    23.4
    
    
    
    22.7Miscellaneous receivables and other current assets
    
    
    50.0
    
    
    
    114.6Total Current Assets
    
    
    1,819.4
    
    
    
    1,498.8Property, Plant and EquipmentLand
    
    
    21.0
    
    
    
    26.7Buildings and improvements
    
    
    194.1
    
    
    
    227.7Equipment
    
    
    404.0
    
    
    
    389.2619.1
    
    
    
    643.6Accumulated depreciation
    
    
    (290.3
    )
    
    
    (327.8
    )328.8
    
    
    
    315.8Goodwill
    
    
    1,092.3
    
    
    
    552.3Intangible Assets, Net of Amortization
    
    
    156.0
    
    
    
    107.8Other Assets
    
    
    126.0
    
    
    
    132.8Total Assets
    
    $
    3,522.5
    
    
    $
    2,607.5LIABILITIES AND STOCKHOLDERS EQUITYCurrent LiabilitiesAccounts payable
    
    $
    96.3
    
    
    $
    47.8Accrued liabilitiesCompensation
    
    
    70.9
    
    
    
    34.9Payroll and other taxes
    
    
    11.4
    
    
    
    6.2Restructuring and other charges
    
    
    13.4
    
    
    
    64.8Cisco stock loan
    
    
    204.0
    
    
    
    Other
    
    
    128.2
    
    
    
    54.1Total Current Liabilities
    
    
    524.2
    
    
    
    207.8Long-Term Restructuring Liabilities
    
    
    33.0
    
    
    
    44.8Income Taxes
    
    
    117.1
    
    
    
    100.1Other Long-Term Liabilities
    
    
    51.0
    
    
    
    35.5Stockholders EquityPreferred stock: authorized 5,000,000 shares of $.01 par value;
no shares issued and outstanding
    
    
    
    
    
    
    Common stock: authorized 1,000,000,000 shares of $.01 par value;
466,910,981 and 417,859,719 shares issued, including treasury stock
    
    
    4.7
    
    
    
    4.2Additional paid-in capital
    
    
    1,145.9
    
    
    
    556.8Deferred compensation expense
    
    
    (21.8
    )
    
    
    (9.5
    )Treasury stock, at cost: 3,250,000 shares
    
    
    (129.6
    )
    
    
    (129.6
    )Total accumulated other comprehensive income
    
    
    125.9
    
    
    
    95.5Retained earnings
    
    
    1,672.1
    
    
    
    1,701.9Total Stockholders Equity
    
    
    2,797.2
    
    
    
    2,219.3Total Liabilities and Stockholders Equity
    
    $
    3,522.5
    
    
    $
    2,607.5
 The accompanying notes are an integral part of these statements. TELLABS 2004 ANNUAL REPORT / 29




---



##### 



Consolidated Statements of Stockholders Equity Year Ended
    
    
    Year Ended
    
    
    Year Ended(In millions)
    
    12/31/04
    
    
    1/2/04
    
    
    12/27/02Shares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Shares
    
    
    AmountCommon
StockBalance at beginning of year
    
    
    417.9
    
    
    $
    4.2
    
    
    
    415.4
    
    
    $
    4.1
    
    
    
    413.5
    
    
    $
    4.1Stock issued for business acquisitions
    
    
    46.7
    
    
    
    0.5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock issued for employee
stock programs
    
    
    2.3
    
    
    
    
    
    
    
    2.5
    
    
    
    0.1
    
    
    
    1.9
    
    
    
    Balance at end of year
    
    
    466.9
    
    
    
    4.7
    
    
    
    417.9
    
    
    
    4.2
    
    
    
    415.4
    
    
    
    4.1Additional Paid-In CapitalBalance at beginning of year
    
    
    
    
    
    
    556.8
    
    
    
    
    
    
    
    543.6
    
    
    
    
    
    
    
    496.0Stock issued for business acquisitions
    
    
    
    
    
    
    428.6
    
    
    
    
    
    
    
    2.4
    
    
    
    
    
    
    
    Fair value of options issued
in acquisitions
    
    
    
    
    
    
    143.6
    
    
    
    
    
    
    
    6.4
    
    
    
    
    
    
    
    42.9Restricted stock award activity
    
    
    
    
    
    
    8.0
    
    
    
    
    
    
    
    0.1
    
    
    
    
    
    
    
    (0.1
    )Stock options exercised
    
    
    
    
    
    
    8.9
    
    
    
    
    
    
    
    4.3
    
    
    
    
    
    
    
    4.8Balance at end of year
    
    
    
    
    
    
    1,145.9
    
    
    
    
    
    
    
    556.8
    
    
    
    
    
    
    
    543.6Deferred CompensationBalance at beginning of year
    
    
    
    
    
    
    (9.5
    )
    
    
    
    
    
    
    (19.3
    )
    
    
    
    
    
    
    (1.4
    )Deferred compensation from acquisitions
    
    
    
    
    
    
    (13.5
    )
    
    
    
    
    
    
    (1.4
    )
    
    
    
    
    
    
    (28.4
    )Amortization of deferred compensation
    
    
    
    
    
    
    5.5
    
    
    
    
    
    
    
    11.2
    
    
    
    
    
    
    
    10.5Restricted stock award activity
    
    
    
    
    
    
    (5.3
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of restricted stock awards
    
    
    
    
    
    
    1.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at end of year
    
    
    
    
    
    
    (21.8
    )
    
    
    
    
    
    
    (9.5
    )
    
    
    
    
    
    
    (19.3
    )Treasury StockBalance at beginning and end of year
    
    
    3.3
    
    
    
    (129.6
    )
    
    
    3.3
    
    
    
    (129.6
    )
    
    
    3.3
    
    
    
    (129.6
    )Accumulated Other Comprehensive
Income (Loss)Balance at beginning of year
    
    
    
    
    
    
    95.5
    
    
    
    
    
    
    
    (52.0
    )
    
    
    
    
    
    
    (160.1
    )Reclassification adjustment for gain
included in net earnings
    
    
    
    
    
    
    (1.4
    )
    
    
    
    
    
    
    (8.9
    )
    
    
    
    
    
    
    (7.1
    )Unrealized holding (loss) gain on
marketable securities, net of tax
    
    
    
    
    
    
    (3.1
    )
    
    
    
    
    
    
    4.9
    
    
    
    
    
    
    
    8.2Net unrealized holding (loss) gain
on marketable securities
    
    
    
    
    
    
    (4.5
    )
    
    
    
    
    
    
    (4.0
    )
    
    
    
    
    
    
    1.1Foreign currency translation
adjustment
    
    
    
    
    
    
    34.9
    
    
    
    
    
    
    
    151.5
    
    
    
    
    
    
    
    107.0Balance at end of year
    
    
    
    
    
    
    125.9
    
    
    
    
    
    
    
    95.5
    
    
    
    
    
    
    
    (52.0
    )Retained EarningsBalance at beginning of year
    
    
    
    
    
    
    1,701.9
    
    
    
    
    
    
    
    1,943.5
    
    
    
    
    
    
    
    2,256.6Net loss
    
    
    
    
    
    
    (29.8
    )
    
    
    
    
    
    
    (241.6
    )
    
    
    
    
    
    
    (313.1
    )Balance at end of year
    
    
    
    
    
    
    1,672.1
    
    
    
    
    
    
    
    1,701.9
    
    
    
    
    
    
    
    1,943.5Total Stockholders Equity
    
    
    
    
    
    $
    2,797.2
    
    
    
    
    
    
    $
    2,219.3
    
    
    
    
    
    
    $
    2,290.3
 The accompanying notes are an integral part of these statements. 30




---



##### 



Consolidated Statements of Cash Flow Year Ended
    
    
    Year Ended
    
    
    Year Ended(In millions)
    
    12/31/04
    
    
    1/2/04
    
    
    12/27/02Operating ActivitiesNet loss
    
    $
    (29.8
    )
    
    $
    (241.6
    )
    
    $
    (313.1
    )Adjustments to reconcile net loss to
net cash provided by operating activities:Depreciation and amortization
    
    
    82.3
    
    
    
    110.2
    
    
    
    142.6Purchased in-process research and development
    
    
    102.1
    
    
    
    
    
    
    
    5.4Restructuring and other charges
    
    
    11.7
    
    
    
    172.6
    
    
    
    268.7Asset impairment charge
    
    
    47.2
    
    
    
    
    
    
    
    Net loss on sale of real estate
    
    
    20.6
    
    
    
    
    
    
    
    Deferred income taxes
    
    
    11.6
    
    
    
    (14.9
    )
    
    
    110.0Deferred compensation amortization
    
    
    6.5
    
    
    
    11.2
    
    
    
    10.5(Gain) loss on sale of investments
    
    
    (1.4
    )
    
    
    4.0
    
    
    
    30.0Provision for doubtful accounts
    
    
    (0.9
    )
    
    
    (13.6
    )
    
    
    (25.4
    )Tax benefit associated with stock option exercises
    
    
    
    
    
    
    1.6
    
    
    
    2.0Net changes in assets and liabilities,
net of effects from acquisitions:Accounts receivable
    
    
    (48.7
    )
    
    
    47.1
    
    
    
    162.0Inventories
    
    
    (24.8
    )
    
    
    143.8
    
    
    
    113.2Miscellaneous receivables and other current assets
    
    
    65.8
    
    
    
    (87.1
    )
    
    
    (12.1
    )Other assets
    
    
    (9.1
    )
    
    
    2.0
    
    
    
    (32.3
    )Accounts payable
    
    
    13.0
    
    
    
    (34.1
    )
    
    
    9.2Restructuring and other charges
    
    
    (52.2
    )
    
    
    (84.2
    )
    
    
    (191.6
    )Other accrued liabilities
    
    
    10.9
    
    
    
    (16.9
    )
    
    
    (29.9
    )Income taxes
    
    
    18.1
    
    
    
    154.9
    
    
    
    (66.0
    )Long-term liabilities
    
    
    (8.2
    )
    
    
    (5.1
    )
    
    
    (5.4
    )Net Cash Provided by Operating Activities
    
    
    214.7
    
    
    
    149.9
    
    
    
    177.8Investing ActivitiesCapital expenditures
    
    
    (41.4
    )
    
    
    (17.2
    )
    
    
    (59.4
    )Disposals of property, plant and equipment
    
    
    31.5
    
    
    
    7.7
    
    
    
    25.3Payments for purchases of investments
    
    
    (1,318.8
    )
    
    
    (2,287.8
    )
    
    
    (697.0
    )Proceeds from sales and maturities of investments
    
    
    1,379.1
    
    
    
    2,009.8
    
    
    
    543.5Payments for acquisitions, net of cash acquired
    
    
    (244.3
    )
    
    
    (122.6
    )
    
    
    (291.7
    )Net Cash Used for Investing Activities
    
    
    (193.9
    )
    
    
    (410.1
    )
    
    
    (479.3
    )Financing ActivitiesProceeds from issuance of common stock under option plans
    
    
    8.9
    
    
    
    5.9
    
    
    
    2.8Payments of notes payable
    
    
    
    
    
    
    
    
    
    
    (8.8
    )Net Cash Provided by (Used for) Financing Activities
    
    
    8.9
    
    
    
    5.9
    
    
    
    (6.0
    )Effect of Exchange Rate Changes on Cash
    
    
    17.3
    
    
    
    46.6
    
    
    
    59.2Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    47.0
    
    
    
    (207.7
    )
    
    
    (248.3
    )Cash and Cash Equivalents at Beginning of Year
    
    
    245.9
    
    
    
    453.6
    
    
    
    701.9Cash and Cash Equivalents at End of Year
    
    $
    292.9
    
    
    $
    245.9
    
    
    $
    453.6Other InformationInterest paid
    
    $
    0.3
    
    
    $
    
    
    
    $
    1.4Income taxes (refunded) paid, net
    
    $
    (4.0
    )
    
    $
    (146.1
    )
    
    $
    23.9Issuance of common stock and options for acquisitions
    
    $
    576.0
    
    
    $
    
    
    
    $
    
 The accompanying notes are an integral part of these statements. TELLABS 2004 ANNUAL REPORT / 31




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##### 



Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies Nature of Business We operate as one business segment in the
design, assembly, marketing and servicing of a
diverse line of communications equipment used
in public and private networks worldwide. Principles of Consolidation Our consolidated financial statements include the
accounts of Tellabs and our subsidiaries. All
intercompany accounts and transactions have been
eliminated. Certain prior year amounts have been
reclassified to conform to the current year
presentation. Use of Estimates The preparation of the financial statements in
conformity with generally accepted accounting
principles requires us to make estimates and
assumptions that affect amounts reported in the
financial statements and accompanying notes.
Actual results could differ from those
estimates. Cash Equivalents We consider all highly liquid debt instruments
purchased with original maturities of three
months or less to be cash equivalents. Restricted Cash Restricted cash equivalents and marketable
securities of $20 million are included in other
assets. The cash equivalents and marketable
securities are held as collateral to back a
three-year bond posted for a U.S. customer
contract. Fair Value of Financial Instruments Our financial instruments consist of cash and
cash equivalents, accounts receivable, accounts
payable, marketable securities and cost-basis
investments. 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 quotes from
brokers or current rates offered for instruments
with similar characteristics. See discussion in
Note 7 regarding derivatives. Inventories Inventories are stated at the lower of cost
or market. Cost is determined by the
first-in, first-out method. Property, Plant and Equipment Property, plant and equipment is recorded at
cost. Depreciation is computed using both the
declining-balance and straight-line methods.
Buildings are depreciated over 25 to 40 years;
building improvements over 7 years; leasehold
improvements over the life of the lease,
currently 3 to 15 years; and equipment over 3 to
10 years. We evaluate property, plant and
equipment for impairment whenever events or
changes in circumstances indicate that the
carrying amount of an asset may not be fully
recoverable. Stock Options We are permitted under SFAS No. 123,
Accounting for Stock-Based Compensation, and
SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure  an
amendment of SFAS No. 123,to apply Accounting
Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees.
Accordingly, in most cases, no compensation cost
has been recognized for our fixed stock option
plan grants. If we had elected to recognize
compensation expense for our stock-based
compensation plans consistent with the methods
prescribed by SFAS No. 123, net loss and net loss
per share would have been changed to the pro
forma amounts shown below: (In millions, except per-share data)
    
    2004
    
    
    2003
    
    
    2002Net loss as reported
    
    $
    (29.8
    )
    
    $
    (241.6
    )
    
    $
    (313.1
    )Add: stock-based
employee compensation expense included
in reported net loss,
net of related tax effects
    
    
    6.5
    
    
    
    11.2
    
    
    
    10.5Less: Total stock-based
employee compensation
expense determined
under fair-value based
method for all grants,
net of related tax effects
    
    
    (62.0
    )
    
    
    (62.6
    )
    
    
    (129.6
    )Pro forma net loss
    
    $
    (85.3
    )
    
    $
    (293.0
    )
    
    $
    (432.2
    )Loss per
common shareAs reported
    
    $
    (0.07
    )
    
    $
    (0.58
    )
    
    $
    (0.76
    )Pro forma
    
    $
    (0.20
    )
    
    $
    (0.71
    )
    
    $
    (1.05
    )
 The fair value of options was estimated on the
date of grant using the Black-Scholes option
pricing model with the following
weighted-average assumptions for grants in 2004,
2003 and 2002: 32




---



##### 



2004
    
    
    2003
    
    
    2002Expected volatility
    
    
    70.8
    %
    
    
    73.4
    %
    
    
    72.2
    %Risk-free interest rate
    
    
    3.4
    %
    
    
    3.0
    %
    
    
    2.8
    %Expected life in years
    
    
    4.7
    
    
    
    5.1
    
    
    
    5.9Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
 The pro forma amounts disclosed above may not be
representative of future disclosures because the
estimated fair value of stock options is
amortized to expense over the vesting period, and
additional options may be granted in future
years. In addition, the Black-Scholes option
pricing model was developed for use in estimating
the fair value of traded options that have no
vesting restrictions and are fully transferable.
It requires the use of assumptions that are
subjective, such as the expected volatility of
the exercise price and the expected remaining
life of the option. Income Taxes We recognize deferred tax assets and liabilities
for the future tax consequences attributable to
differences between the financial statement
carrying amounts of existing assets and
liabilities and their respective tax bases at
enacted tax rates when such amounts are expected
to be realized or settled. Valuation allowances
are provided if, based on the weight of available
evidence, it is more likely than not that some or
all of the deferred tax assets will not be
realized. Goodwill Goodwill represents the excess of the cost of
businesses acquired over the fair market value of
identifiable net assets at the dates of
acquisition. We compare our market capitalization
to book value annually as an indicator of
potential impairment. Intangible Assets Our intangible assets are made up primarily of
purchased technology from acquisitions. These
assets are amortized over their estimated useful
lives and are reviewed for impairment when
indicators of impairment exist such as poor or
declining operating performance or cash flows. Revenue Recognition We recognize revenue when persuasive evidence of
an arrangement exists, delivery has occurred or
services have been rendered, the price or fee is
fixed or determinable, and collectibility is
reasonably assured, in accordance with the
guidance in the Securities and Exchange
Commission Staff Accounting Bulletin (SAB) No.
104, Revenue Recognition. Products The majority of our revenue comes from product
sales for which we recognize revenue either upon
shipment or upon
delivery to the customer, depending upon the
contractual delivery terms. Some of our customer agreements contain
acceptance clauses that grant the right to
return or exchange products that do not conform
to our published specifications. When we have
sufficient historical evidence that our products
meet the published specifications, we recognize
revenue upon shipment or upon delivery, and
treat any potential returns as warranties.
Otherwise, we recognize revenue when the
conditions of acceptance have been met. A few of our customer agreements grant the
right to return or exchange product based upon
subjective matters. We have established
sufficient historical evidence on rates of
return for most of our products to be able to
accrue for returns under the guidance of SFAS
No. 48, Revenue Recognition When Right of Return
Exists. We recognize revenue net of potential
returns upon shipment or upon delivery of
product to the customer. Some of our customer agreements are in the
form of distribution agreements, with
contractual rights of return, promotional
rebates, and other rebates and credits. We
recognize revenue net of estimated returns and
rebates, which are calculated based on
contractual provisions and historical evidence
of returns activity. Services We also recognize revenue for services
performed for customers. Most of our services
revenue relates to the installation of our
product at customer sites. Customers may
purchase installation services from us, install
our products themselves, or hire third parties
to perform the installation. Revenue for
installation services is recognized upon
completion. Revenue from maintenance and support
contracts is recognized ratably over the service
period. Other services revenue, including
training and other business support services, is
recognized upon completion. Earnings Per Share Earnings per share is based on the weighted
average number of shares (basic) and the weighted
average shares adjusted for assumed exercises of
stock options and vesting of restricted stock
(diluted). Earnings per share in periods of a net
loss is based solely on basic weighted average
number of shares under generally accepted
accounting principles. Foreign Currency Translation The financial statements of our foreign
subsidiaries are generally measured using the
local currency as the functional currency. In
such cases, assets and liabilities are
translated at exchange rates in effect at the
balance sheet date, and income and expenses are
translated at weighted average exchange rates
during the year. The effect of TELLABS 2004 ANNUAL REPORT / 33




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##### 



translating a subsidiarys stockholders
equity into U.S. dollars is recorded as a
cumulative translation adjustment in the equity
section of the Consolidated Balance Sheets. Foreign Currency Transactions Foreign currency transaction gains and losses
resulting from changes in exchange rates are
recognized in Other Income (Expense). Net gains
(losses) of $3.8 million, $(1.8) million and
$(5.9) million were recorded in 2004, 2003 and
2002, respectively. 2. New Accounting Pronouncements In December 2004, the Financial Accounting
Standards Board issued SFAS 123 (revised 2004),
Share-Based Payment, which is a revision of SFAS
123. SFAS 123(R) supersedes APB No. 25.
Generally, the approach in SFAS 123(R) is
similar to the approach described in SFAS 123.
However, beginning in our third quarter of 2005,
SFAS 123(R) requires all share-based payments to
employees, including grants of employee stock
options, to be recognized in the income
statement based on their fair values. Pro forma
disclosure is no longer an alternative. SFAS 123(R) must be adopted no later
than July 1, 2005. We expect to adopt SFAS
123(R) in the third quarter of 2005. SFAS 123(R) permits us to adopt its
requirements using one of two methods:  1.
    A modified prospective method in which
compensation cost is recognized beginning with
the effective date (a) based on the
requirements of SFAS 123(R) for all
share-based payments granted after the
effective date and (b) based on the
requirements of SFAS 123 for all awards
granted to employees prior to the effective
date of SFAS 123(R) that remain unvested on
the effective date.2.
    A modified retrospective method which
includes the requirements of the modified
prospective method described above, but also
permits entities to restate based on the
amounts previously recognized under SFAS 123
for purposes of pro forma disclosure either
(a) all prior periods presented or (b) prior
interim periods of the year of adoption. We have currently not determined which
method we will use. As permitted by SFAS 123, we currently
account for share-based payments to employees
using the APB No. 25 intrinsic value method and
therefore we usually do not recognize
compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)s
fair value method will have an impact on our
results of operations, although it will have no
incremental impact on our overall financial
position. 3. Restructuring and Other Charges During the fourth quarter of 2004, we recorded
restructuring charges for severance and related
costs of $1.6 million related to a reorganization
of our Denmark-based business. Our fourth-quarter
actions in Denmark are part of a plan to improve
the profitability of our international transport
switching business. As part of this plan, in
January 2005 we announced a further reduction of
approximately 80 employees at the Denmark
facility. In January 2005 we also announced our
intention to reorganize our operations in
Finland, which will result in a headcount
reduction of approximately 70 positions. This
plan to drive toward improved profitability also
includes headcount reductions on a smaller scale
in other locations throughout the world. As a
result of these actions, we expect to record
charges for severance and related costs and other
costs associated with these reductions during
2005, principally in the first quarter. Although we have not committed to any plans
other than those already announced, we believe
that it is possible that further plans, if
implemented, could result in further
restructuring and other charges for workforce
reductions, asset impairments, contractual and
other obligations (including facilities costs)
and inventory valuation. In 2003, management approved plans to
further restructure our operations due to
difficult market conditions in the
telecommunications industry. A major component of
the restructuring was the outsourcing of our
global manufacturing operations, which resulted
in work-force reductions of approximately 500
employees, facility closures, asset disposals and
the sale of the majority of our inventory to the
outsourcers. Additional restructuring activities
during 2003 included non-manufacturing work-force
reductions and facility closures. As a result of
these actions, we recorded charges for severance
and related costs, asset impairments and
accelerated depreciation on our manufacturing
facility in North America. We also recorded
charges for excess and obsolete inventories and
excess purchase commitments. Our manufacturing
operations in North America ceased at the end of
October 2003 and international manufacturing
operations ceased at the beginning of January
2004. We recorded restructuring and other charges
related to all of these activities in 2003 and
2004. In 2002, we approved plans to restructure our
operations, including a realignment of worldwide
inventory levels to match customer demand, which
resulted in the write-off of excess inventories and an
accrual for excess inventory purchase commitments;
workforce reductions; the closure and consolidation of
excess facilities, including manufacturing facilities in
Ronkonkoma, New York, and Shannon, 34




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##### 



Ireland, along with the write-off of related fixed assets; and an adjustment of the reserves
for excess leased facilities from our 2001 restructuring programs in light of current economic
conditions. Below is an analysis of the restructuring and other charges recorded during 2004, 2003 and
2002 by major income statement classification: Statements of OperationsClassificationDescription
    
    2004
    
    
    2003
    
    
    2002(In millions)Cost of revenue
    
    Disposal of property, plant and equipment
    
    $
    5.5
    
    
    $
    1.0
    
    
    $
    Inventory adjustments
    
    
    2.3
    
    
    
    49.4
    
    
    
    53.2Excess purchase commitments
    
    
    0.1
    
    
    
    23.2
    
    
    
    58.1Accelerated depreciation on buildings and equipment
    
    
    
    
    
    
    23.7
    
    
    
    Other obligations
    
    
    1.7
    
    
    
    
    
    
    
    Subtotal in Cost of Revenue
    
    
    9.6
    
    
    
    97.3
    
    
    
    111.3Reversal of excess purchase commitments accrual
    
    
    (12.0
    )
    
    
    (1.9
    )
    
    
    (11.6
    )Total in Cost of Revenue
    
    
    (2.4
    )
    
    
    95.4
    
    
    
    99.7Total in Gross Profit
    
    
    (2.4
    )
    
    
    95.4
    
    
    
    99.7Operating expenses
    
    Disposal of property, plant and equipment
    
    
    13.2
    
    
    
    22.6
    
    
    
    67.3Severance and related expenses
    
    
    6.6
    
    
    
    33.7
    
    
    
    51.3Consolidation of excess leased facilities
    
    
    1.9
    
    
    
    1.2
    
    
    
    44.7Accelerated depreciation on buildings and equipment
    
    
    
    
    
    
    24.8
    
    
    
    Other obligations
    
    
    2.4
    
    
    
    3.7
    
    
    
    12.6Subtotal in Operating Expenses
    
    
    24.1
    
    
    
    86.0
    
    
    
    175.9Proceeds from fixed asset disposals
in excess of estimates
    
    
    (5.2
    )
    
    
    (5.0
    )
    
    
    Reversal of excess leased facilities accrual
    
    
    (3.2
    )
    
    
    
    
    
    
    (0.7
    )Reversal of severance accruals
    
    
    (1.4
    )
    
    
    (1.4
    )
    
    
    (6.2
    )Reversal of accrual for other obligations
    
    
    (0.2
    )
    
    
    (2.4
    )
    
    
    Total in Operating Expenses
    
    
    14.1
    
    
    
    77.2
    
    
    
    169.0Total Restructuring and Other Charges
    
    $
    11.7
    
    
    $
    172.6
    
    
    $
    268.7
 Disposal of property, plant and equipment We recorded impairment charges of $18.7 million
in 2004 for property, plant and equipment to be
disposed of or held for sale. This charge is
composed of: $4.7 million for a loss on the sale
of our Bolingbrook manufacturing facilities; $7.7
million for the closure of our Montreal research
and development facility; $5.5 million for U.S.
research and development and manufacturing
assets; and $0.8 million for property, plant and
equipment sold to our manufacturing contractor as
part of our international manufacturing
outsourcing. We also received $5.2 million in
proceeds from the sale of property, plant and
equipment in excess of our original estimate. Our review of property, plant and equipment
needs during the restructuring activities
identified assets that would be sold or disposed.
We recorded a loss of $23.6 million in 2003
related to the disposal of this property, plant
and equipment. The property, plant and equipment
consisted primarily of manufacturing equipment,
lab and data equipment, and computer software.
This equipment was disposed of primarily by
conducting periodic open bid auctions with items
sold to the highest
bidders. In 2003, we reduced a reserve related to
the disposal of property, plant and equipment by
$5.0 million to reflect the receipt of sales
proceeds in excess of our original estimates. We recorded charges of $67.3 million in 2002
related to equipment and leasehold improvements
made excess by the closure of our manufacturing
facilities in New York and Ireland and the
consolidation of a number of smaller facilities. Severance and related expenses In the first half of 2004, we recorded
additional accruals for severance and related
costs of $5.0 million attributable to a change
in our estimate of the number of employees to be
terminated under our fourth-quarter 2003
restructuring plan and to severance and related
costs TELLABS 2004 ANNUAL REPORT / 35




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##### 



pertaining to the closure of our Montreal,
Canada, facility in the fourth quarter of 2003.
In December 2004, we recorded an accrual for
severance and related costs of $1.6 million
pertaining to the Denmark workforce reduction
approved toward the end of 2004. These charges
were partially offset by a $1.4 million reduction
of accruals for severance and related costs
pertaining to certain restructuring activities
that were initiated in 2003 and prior periods. As a result of the outsourcing of our
manufacturing operations and our goal to align
our employee levels with expected workforce
needs, we recorded charges totaling $33.7
million for severance pay and related costs for
the reduction of approximately 1,500 employees
worldwide in 2003. We also reversed $1.4 million
in severance accruals due to changes in the
estimated severance and related costs from prior
restructuring programs. In 2002, we reduced our workforce by
approximately 2,000 employees resulting in
severance and related charges of $51.3 million.
We also reversed $6.2 million of severance
reserves due to changes in our estimates of
severance costs for restructurings in prior
years. Inventory adjustments and excess purchase commitments In 2004, we accrued $2.3 million for the
revaluation of inventories related to
international manufacturing outsourcing, and
increased the accrual for North America purchase
commitments by $0.1 million. There was also a
$12.0 million reduction of the reserve for
excess purchase commitments in 2004 due to a
favorable settlement with a vendor. Due to a slowdown in customer spending
levels during 2003 and 2002, and a review of our
inventory levels during
outsourcing activities, we wrote down the
value of our inventories and related
non-cancelable inventory purchase commitments for
excess amounts. Included in product cost of goods
sold for 2003 were net charges of $70.7 million
related to the write-down of inventories and
accruals for non-cancelable inventory purchase
commitments. North American manufacturing
outsourcing resulted in a $7.4 million charge,
international manufacturing outsourcing resulted
in a $10.9 million charge, and $52.4 million was
recorded prior to manufacturing outsourcing to
write down excess and obsolete inventory and
accrue for non-cancelable inventory purchase
commitments. Net charges for 2002 were $53.2
million for excess and obsolete inventory and a
net $46.5 million for excess purchase
commitments. The inventory adjustments were
recorded as a reduction to inventory, while the
reserve for excess non-cancelable purchase
commitments was recorded to accrued restructuring
and other charges. Consolidation of excess leased facilities In 2004, we accrued $1.9 million for costs
associated with the consolidation of excess
leased facilities. This
amount included accruals for our Montreal
research and development office, which we
closed in the first quarter of 2004. There was
also a reduction of $3.2 million for excess
facilities accruals relating to final
settlement of obligations associated with
previously vacated facilities and favorable
subleasing activity in North America. Also as a result of the outsourcing of our
manufacturing operations, we recorded $1.2
million in charges related to the consolidation
of excess facilities in 2003. In 2002, we recorded $23.6 million net
charges for lease costs for facilities closures,
including our manufacturing facility in
Ronkonkoma, New York, two research facilities in
Virginia and numerous smaller offices. We also
recorded additional reserves of $20.4 million
for facilities vacated in prior years due to a
decline in the real estate sublease market. Accelerated depreciation on building and equipment During 2003, due to a change in the estimated
lives of certain buildings and equipment because
of the outsourcing of our North American
manufacturing operations, we recorded $48.5
million in accelerated depreciation on the
related buildings and equipment. Of this amount,
$23.7 million was charged to cost of revenue
during the year with the remaining $24.8 million
charged to operating expenses. Other obligations We accrued $2.4 million for contract termination
costs in 2004 because we failed to meet certain
contractual requirements related to volume usage.
In addition, we
accrued $1.7 million in wage transition charges
related to outsourcing our international
manufacturing operations. We also reduced a
previously established accrual of $0.2 million
for software licenses. In 2003, we recorded $3.7 million in
charges for other obligations that arose as a
direct result of our 2003 restructuring
activities. These charges represent
non-cancelable agreements for software
licenses that have been deemed excess due to
workforce reductions and product roadmap
changes. Charges for 2002 included $4.7 million to
write down the value of our facility in
Ireland, $4.3 million for repayment of local
incentive grants and $3.6 million for other
fees. Of the remaining $46.4 million accruals as
of December 31, 2004, $13.4 million is
classified as short-term as it is expected to
be paid in the next 12 months. The long-term
balance of $33.0 million will be paid over the
remaining terms of the facility leases, which
expire at various times through 2011. Of the $109.6 million accruals as of January
2, 2004, $64.8 million was classified as
short-term as it was expected to be paid in the
next 12 months. The long-term 36




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##### 



balance of $44.8 million was primarily related to excess facilities, and was expected to be
paid over the remaining lease terms through 2011. The following table displays our restructuring and other charges activity during 2004 and the
status of the reserves at December 31, 2004: Balance
    
    
    Additional
    
    
    Cash
    
    
    Non-Cash
    
    
    BalanceDescription of reserve
    
    1/2/04
    
    
    Reserves
    
    
    Activity
    
    
    Activity
    
    
    12/31/04(In millions)Consolidation of excess leased facilities
    
    $
    54.8
    
    
    $
    1.9
    
    
    $
    (12.1
    )
    
    $
    (2.8
    )
    
    $
    41.8Inventory write-offs
    
    
    
    
    
    
    2.3
    
    
    
    
    
    
    
    (2.3
    )
    
    
    Excess purchase commitments
    
    
    38.4
    
    
    
    0.1
    
    
    
    (20.6
    )
    
    
    (17.7
    )
    
    
    0.2Severance and related expenses
    
    
    13.5
    
    
    
    6.6
    
    
    
    (16.2
    )
    
    
    (1.9
    )
    
    
    2.0Disposal of property, plant and equipment
    
    
    
    
    
    
    18.7
    
    
    
    
    
    
    
    (18.7
    )
    
    
    Other obligations
    
    
    2.9
    
    
    
    4.1
    
    
    
    (2.8
    )
    
    

    (1.8
    )
    
    
    2.4$
    109.6
    
    
    $
    33.7
    
    
    $
    (51.7
    )
    
    $
    (45.2
    )
    
    $
    46.4
 The following table displays our restructuring and other charges activity during 2003 and the
status of the reserves at January 2, 2004: Balance
    
    
    Additional
    
    
    Cash
    
    
    Non-Cash
    
    
    BalanceDescription of reserve
    
    12/27/02
    
    
    Reserves
    
    
    Activity
    
    
    Activity
    
    
    1/2/04(In millions)Consolidation of excess leased facilities
    
    $
    81.8
    
    
    $
    1.2
    
    
    $
    (28.9
    )
    
    $
    0.7
    
    
    $
    54.8Inventory write-offs
    
    
    
    
    
    
    49.4
    
    
    
    
    
    
    
    (49.4
    )
    
    
    Excess purchase commitments
    
    
    30.0
    
    
    
    23.2
    
    
    
    (16.2
    )
    
    
    1.4
    
    
    
    38.4Severance and related expenses
    
    
    9.5
    
    
    
    33.7
    
    
    
    (29.1
    )
    
    
    (0.6
    )
    
    
    13.5Disposal of property, plant and equipment
    
    
    
    
    
    
    23.6
    
    
    
    
    
    
    
    (23.6
    )
    
    
    Accelerated depreciation
    
    
    
    
    
    
    48.5
    
    
    
    
    
    
    
    (48.5
    )
    
    
    Other obligations
    
    
    9.6
    
    
    
    3.7
    
    
    
    (10.0
    )
    
    
    (0.4
    )
    
    
    2.9$
    130.9
    
    
    $
    183.3
    
    
    $
    (84.2
    )
    
    $
    (120.4
    )
    
    $
    109.6
 4. Business Combinations On December 30, 2004, we acquired Vinci Systems,
a privately held developer of Optical Networking
Terminals for Fiber to the Premise access
systems. Under the terms of the agreement, we
will pay up to $52.5 million in cash and
restricted Tellabs stock related to the
acquisition of Vinci. This acquisition enables
us to deliver a more cost-effective fiber access
solution. In-process research and development
costs of $13.1 million related to this
acquisition were expensed in 2004 based on a
preliminary appraisal. On November 30, 2004, we acquired 100% of
the outstanding common stock of AFC, a leader in
access products, for 0.504 shares of our common
stock and $12.00 in cash for each AFC share, for
a total value of approximately $1.6 billion
($794.5 million, net of cash acquired) plus
liabilities assumed. We issued approximately 44.8
million shares of our common stock for the
acquisition, with the cash portion financed with
U.S.-based cash and cash equivalents, including
AFCs. AFCs products enable carriers to provide
voice, video and high-speed Internet access over
a single network infrastructure. By acquiring
AFC, Tellabs became the industry leader in the
broadband access market, a market in which
Tellabs had not previously been a significant
participant. In addition, Tellabs believes that
its international distribution channels and deep
relationships with regional Bell operating
companies will provide growth opportunities for
both Tellabs and AFC products not achievable as
stand-alone companies. Goodwill and intangible
assets from this acquisition were $537.4 million
and $185.2 million, respectively. The intangible
assets, excluding in-process research and
development, will be amortized on a
straight-line basis over a weighted average
amortization period of seven years. In-process
research and development costs of $89.0 million
were expensed in 2004. Components of the purchase price were as follows: (In millions)Cash paid to AFC stockholders
    
    $
    1,067.5Fair value of Tellabs common stock issued
    
    
    419.7Fair value of stock options converted
    
    
    143.6Acquisition costs
    
    
    7.91,638.7Deferred compensation
    
    
    (4.2
    )Purchase price
    
    $
    1,634.5
 TELLABS 2004 ANNUAL REPORT / 37




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##### 



The value of our common stock issued for
the acquisition was determined based on an
average of our stock price three days before and
three days after September 7, 2004, the date of
the revised merger agreement. The Black-Scholes
option valuation model was used to determine the
fair value of the Tellabs stock options
exchanged. The deferred compensation represents
the intrinsic value of the unvested AFC stock
options on the acquisition date, which will be
recognized over the remaining vesting period of
the options. The purchase price allocation for AFC has
not been finalized pending completion of
appraisals. A preliminary allocation of the
purchase price is as follows: (In millions)Cash, cash equivalents and
marketable securities
    
    $
    840.0Other marketable securities 
Cisco stock
    
    
    198.0Other current assets
    
    
    122.7Property, plant and equipment
    
    
    61.3Goodwill
    
    
    537.4Intangible assets: backlog/leasehold
estates/customer relationships
    
    
    28.2Intangible assets: Developed technology
    
    
    66.0Intangible assets: Trade name
    
    
    2.0Purchased in-process research and
development costs
    
    
    89.0Other long-term assets
    
    
    32.9Total assets
    
    
    1,977.5Cisco stock loan
    
    
    198.0Other current liabilities
    
    
    117.2Other long-term liabilities
    
    
    27.8Total liabilities
    
    
    343.0Purchase price
    
    $
    1,634.5
 The pro forma results of operations for
2004 and 2003 as though AFC had been acquired at
the beginning of the respective periods are as
follows: (Unaudited)Year ended
    
    
    Year ended(In millions, except per-share amounts)
    
    12/31/04
    
    
    1/2/04Revenue
    
    $
    1,665.9
    
    
    $
    1,498.5Net earnings (loss)
    
    
    46.4
    
    
    
    (236.7
    )Earnings (loss) per share  basic
    
    $
    0.10
    
    
    $
    (0.52
    )Earnings (loss) per share  diluted
    
    
    0.10
    
    
    
    (0.52
    )
 In June 2003, we acquired 100% of the
outstanding preferred and common stock of Vivace
Networks, Inc., a developer of flexible, high
performance multi-service routers, for $130.3
million ($122.6 million, net of cash
acquired) plus liabilities assumed. We
believe this acquisition brings two
complementary products that enable us to expand
into the high-growth global service provider
multi-service router market. Goodwill and
intangible assets from this acquisition were
$93.5 million and $37.5 million, respectively.
The intangible assets are being amortized over a
seven-year useful life using the straight-line
method. We have entered into an employee retention
incentive program which will award shares of our
stock worth $10.0 million to eligible employees
if certain employment targets are met over a
two-year timeframe. The cost of this program will
be recognized ratably over the two-year time
period. Components of the purchase price were as follows: (In millions)Cash paid to Vivace stockholders
    
    $
    124.6Fair value of stock options exchanged
    
    
    6.4Acquisition costs
    
    
    0.7131.7Deferred compensation
    
    
    (1.4
    )Purchase price
    
    $
    130.3
 The Black-Scholes option valuation model
was used to determine the fair value of the
Tellabs stock options exchanged. The deferred
compensation represents the intrinsic value of
the unvested Vivace stock options on the
acquisition date, which will be recognized
over the remaining vesting period of the
options. The allocation of the purchase price is as follows: (In millions)Goodwill
    
    $
    93.5Intangible assets subject to
amortizationdeveloped technology
    
    
    37.5Other assets
    
    
    16.7Total assets
    
    
    147.7Total liabilities
    
    
    17.4Purchase price
    
    $
    130.3
 In January 2002, we acquired 100% of the
outstanding voting stock of Ocular Networks, Inc.
(Ocular), a developer of optical solutions for
the metropolitan (metro) optical networking
market, for $323.0 million. We believed that by
acquiring Ocular it extended the addressable
market for our products within the metro optical
network. Oculars product offerings complement
our offerings by focusing on small to mid-size
tier 2 and 3 central offices, a market
opportunity that has previously not been
addressed by us. Goodwill and intangible assets
from this acquisition 38




---



##### 



were $267.1 million and $69.8 million,
respectively. The intangible asset is being
amortized over a 10-year useful life using the
straight-line method. In-process research and
development costs of $5.4 million were expensed
during
the first quarter of 2002. Components of the purchase price were as follows: (In millions)Cash paid to Ocular stockholders
    
    $
    278.5Fair value of stock options exchanged
    
    
    42.9Payable to former Ocular
restricted stockholders
    
    
    28.5Acquisition costs
    
    
    2.4352.3Deferred compensation
    
    
    (29.3
    )Purchase price
    
    $
    323.0
 The Black-Scholes option valuation model was
used to determine the fair value of the Tellabs
stock options exchanged. The deferred
compensation represents the intrinsic value of
the unvested Ocular stock options on the
acquisition date, which will be recognized over
the remaining vesting period of the options. Also
included in the purchase price was a payable of
$28.5 million to former holders of restricted
Ocular stock awards that were given to certain
key employees. On the acquisition date, the
restricted stock award holders exchanged these
awards for the right to receive $28.5 million in
cash, which we agreed to pay out either
immediately, if certain pre-defined conditions
were met, or over the original vesting period of
the awards. All of this liability has been paid
as of January 2, 2004. The allocation of the purchase price is as follows: (In millions)Goodwill
    
    $
    267.1Intangible assets subject to
amortizationdeveloped technology
    
    
    64.4Purchased in-process research
and development costs
    
    
    5.4Fair value of assets acquired
    
    
    8.2Total assets
    
    
    345.1Total liabilities
    
    
    22.1Purchase price
    
    $
    323.0
 These acquisitions were accounted for under
the purchase method of accounting. The operating
results of the businesses have been included in
the accompanying consolidated results of
operations from their date of acquisition. Pro
forma combined results of operations assuming
the acquisitions had occurred at the beginning
of the year are not presented for Vinci, Vivace
and Ocular as they would not differ materially
from reported results. In addition, we estimate
that $157.9 million of goodwill will be
deductible for tax purposes. 5. Goodwill and Intangible Assets During the first quarter of 2002, we adopted SFAS No. 142,
Goodwill and Other Intangible Assets.SFAS No.
142 eliminates the amortization of goodwill and
intangible
assets with indefinite useful lives. SFAS No. 142
requires that these assets be reviewed for
impairment at least annually. Intangible assets
with finite lives will continue to be amortized
over their estimated useful lives, which range
from approximately 1 year to 13 years, on a
straight-line basis. The weighted average
amortization period is 7 years for all intangible
assets, 6 years for developed technology, 12
years for customer relationships and backlog, 7
years for leasehold estates and less than 1 year
for trade names and trademarks. During the fourth quarter of 2004, we
recorded a charge of $47.2 million for the
impaired developed technology and other assets
related to the Tellabs 5500 NGX transport switch
product, which we acquired as part of the Ocular
acquisition, based on reduced cash flow
estimates. Of the total charge, $45.6 million was
to write off all of the remaining developed
technology asset. Also during the fourth quarter
of 2004, we wrote off all of the $102.1 million
based on the preliminary estimates of the value
of purchased in-process research and development
assets from our acquisitions of AFC and Vinci as
required by GAAP. TELLABS 2004 ANNUAL REPORT / 39




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##### 



The gross carrying amount and accumulated amortization of intangible assets subject to
amortization are as follows: (In millions)
    
    As of 12/31/04
    
    As of 1/2/04Gross
    
    
    Accumulated
    
    
    
    
    
    
    
    Gross
    
    
    AccumulatedAssets
    
    
    Amortization
    
    
    Net
    
    
    
    Assets
    
    
    Amortization
    
    
    NetDeveloped technology
    
    $
    153.5
    
    
    $
    26.6
    
    
    $
    126.9
    
    
    
    $
    124.9
    
    
    $
    17.1
    
    
    $
    107.8Customer relationships/backlog
    
    
    34.2
    
    
    
    0.8
    
    
    
    33.4
    
    
    
    
    
    
    
    
    
    
    
    
    Trade name/trademarks
    
    
    2.0
    
    
    
    0.4
    
    
    
    1.6
    
    
    
    
    
    
    
    
    
    
    
    
    Leasehold estates
    
    
    (6.0
    )
    
    
    (0.1
    )
    
    
    (5.9
    )
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    183.7
    
    
    $
    27.7
    
    
    $
    156.0
    
    
    
    $
    124.9
    
    
    $
    17.1
    
    
    $
    107.8
 The estimated amortization expense for each of the
next five years is as follows: (In millions)2005
    
    $
    37.02006
    
    $
    26.52007
    
    $
    22.62008
    
    $
    22.32009
    
    $
    18.7
 6. Investments Marketable securities are accounted for at market
prices, with the unrealized gain or loss, less
deferred income taxes, shown as a separate
component of stockholders equity. Realized gains
and losses are based on specific identification
of the security sold. At December 31, 2004, and
January 2, 2004, available-for-sale marketable
securities consisted of the following: Amortized
    
    
    Unrealized
    
    
    Market(In millions)
    
    Cost
    
    
    Gain/(Loss)
    
    
    Value2004U.S. government and
agency debt obligations
    
    $
    531.2
    
    
    $
    (3.2
    )
    
    $
    528.0Corporate debt
obligations
    
    
    187.1
    
    
    
    (1.6
    )
    
    
    185.5Foreign government
obligations
    
    
    64.4
    
    
    
    0.3
    
    
    
    64.7Preferred and
common stocks
    
    
    45.7
    
    
    
    (0.7
    )
    
    
    45.0Foreign bank obligations
    
    
    0.1
    
    
    
    
    
    
    
    0.1$
    828.5
    
    
    $
    (5.2
    )
    
    $
    823.32003U.S. government and
agency debt obligations
    
    $
    377.9
    
    
    $
    0.9
    
    
    $
    378.8Corporate debt
obligations
    
    
    253.2
    
    
    
    0.5
    
    
    
    253.7Foreign government
obligations
    
    
    172.2
    
    
    
    (0.6
    )
    
    
    171.6Preferred and
common stocks
    
    
    46.1
    
    
    
    1.6
    
    
    
    47.7Foreign bank obligations
    
    
    25.3
    
    
    
    
    
    
    
    25.3$
    874.7
    
    
    $
    2.4
    
    
    $
    877.1
 The contractual maturities of our
available-for-sale debt securities at December
31, 2004, are $103.9
million less than one year, $534.3 million
more than one year to three years and $140.2
million after three years. As a result of our acquisition of AFC we
acquired the 10.6 million shares of Cisco common
stock that AFC owned as a result of its
investment in privately held Cerent Corporation,
which was acquired by Cisco in 1999. The shares
are presented as Other marketable securities
Cisco stock in the current assets portion of our
balance sheet as of December 31, 2004. 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 hedge
contracts on the Cisco stock. The fair value of
those stock loans is reflected as a current
liability on our balance sheet as of December 31,
2004. The value of both the asset and liability
move in tandem with each other since each is
based upon the number of shares we hold at the
current stock price. There are fees associated
with the stock loan agreement which have been
approximately $1.0 million per year. In addition to the above investments, we
maintain investments in start-up technology
companies and partnerships that invest in
start-up technology companies. These investments are recorded in
Other Assets at cost. At
December 31, 2004, and January 2, 2004, these
investments totaled $5.8 million and $15.0
million, respectively. We conduct a quarterly review of each
investment in our portfolio, including
historical and projected financial performance,
expected cash needs and recent funding events.
Other-than-temporary impairments are recognized
if the market value of the investment is below
its cost basis for an extended period of time or
the issuer has experienced significant financial
declines or difficulties in raising capital to
continue operations. Other-than-temporary
impairments were $11.2 million for the year
ended December 31, 2004, $3.3 million for the
year ended January 2, 2004, and $29.6 million
for the year ended December 27, 2002. These
charges are 40




---



##### 



included in Other Expensein the
Consolidated Statements of Operations. 7. Derivative Financial Instruments We conduct business on a global basis in several
major currencies and are subject to risks
associated with fluctuating foreign exchange
rates. In response to this, we developed a
foreign currency exposure management policy with
the objective of mitigating financial exposure to
changing foreign exchange rates resulting from
nonfunctional currency receivables and payables
that are expected to be settled in one year or
less. We utilize derivatives, primarily foreign
currency forward contracts, to manage our foreign
currency exposure. We do not engage in hedging
specific individual transactions, but rather use
derivatives to manage overall exposure levels for
a specific currency. Gains and losses related to
these derivatives are recorded to the
Consolidated Statement of Operations each period. We enter into derivative foreign exchange
contracts only to the extent necessary to meet
our overall goal of minimizing nonfunctional
foreign currency exposures. We do not enter into
hedging transactions for speculative purposes. In accordance with SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities,
all forward exchange contracts are recorded on
the balance sheet at fair value. Forward foreign
exchange contracts receivable are included in
other current assets, while forward foreign
exchange contracts payable are included as part
of accrued liabilities in the Consolidated
Balance Sheet. Changes in the fair value of these
instruments are included in earnings, as part of
other income and expense, in the current period.
We had a net gain of $14.4 million, $17.0
million, and $5.5 million on forward exchange
contracts in 2004, 2003 and 2002, respectively.
Our current hedging practices do not qualify for
special hedge accounting treatment as prescribed
in SFAS No. 133 since hedges of existing assets
or liabilities that will be re-measured with
changes in fair value reported currently in
earnings are specifically excluded. Derivative financial instruments involve
elements of market and credit risk not recognized
in the financial statements. The market risk that
results from these instruments relates to changes
in the foreign currency exchange rates, which is
generally offset by movements 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 our derivative
contracts. We do not believe there is a
significant credit risk associated with our
hedging activities because the counterparties are
all large international financial institutions
with high credit ratings. In addition, we also
limit the aggregate notional amount of agreements
entered into with any one financial institution
in order to mitigate credit risk. Our net foreign currency exposure is
diversified among a broad number of currencies.
The notional amounts reflected in the table
that follows represent the
U.S. dollar values of the agreed-upon
amounts that will be delivered to a third party
on the agreed-upon date: Notional Valueof Forward
    
    
    Fair Value of(In millions)
    
    Contracts
    
    
    Forward ContractsForward contracts at December 31, 2004:Related forward contracts to sell foreign currencies for Euro
    
    $
    113.1
    
    
    $
    8.6Related forward contracts to buy foreign currencies for Euro
    
    
    8.5
    
    
    
    Related forward contracts to sell foreign currencies for Danish kroner
    
    
    8.9
    
    
    
    Related forward contracts to sell foreign currencies for British pound
    
    
    16.3
    
    
    
    Related forward contracts to sell foreign currencies for U.S. dollar
    
    
    19.7
    
    
    
    Related forward contracts to buy foreign currencies for U.S. dollar
    
    
    14.1
    
    
    
    Related forward contracts to buy foreign currencies for Thai baht
    
    
    1.4
    
    
    
    Total
    
    $
    182.0
    
    
    $
    8.6Forward contracts at January 2, 2004:Related forward contracts to sell foreign currencies for Euro
    
    $
    96.7
    
    
    $
    0.1Related forward contracts to buy foreign currencies for Euro
    
    
    1.3
    
    
    
    Related forward contracts to sell foreign currencies for Danish kroner
    
    
    5.8
    
    
    
    Related forward contracts to sell foreign currencies for British pound
    
    
    17.6
    
    
    
    (0.1
    )Related forward contracts to buy foreign currencies for British pound
    
    
    0.4
    
    
    
    Related forward contracts to buy foreign currencies for U.S. dollar
    
    
    3.9
    
    
    
    Related forward contracts to sell foreign currencies for U.S. dollar
    
    
    59.0
    
    
    
    Related forward contracts to buy foreign currencies for Brazilian reis
    
    
    0.4
    
    
    
    Related forward contracts to sell foreign currencies for Canadian dollar
    
    
    36.7
    
    
    
    .2Related forward contracts to buy foreign currencies for Thai baht
    
    
    3.1
    
    
    
    Total
    
    $
    224.9
    
    
    $
    0.2
    TELLABS 2004 ANNUAL
REPORT / 41




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##### 



8. Assets Held for Sale and Loss on Sale of Real Estate In 2003, as a result of a plan to consolidate facilities and reduce expenses, we
vacated one of our buildings in Vitikka, Finland, and began to actively market it
for sale. There was no loss recognized at the time the Vitikka facility qualified
as held for sale under FAS 144, as the net book value of $2.8 million was below
the market price less estimated costs to sell. We expect to locate a buyer and
complete a sale of the building in 2005. In 2003, we determined that the main manufacturing and office facility
located in Bolingbrook, Illinois, was no longer needed because we had committed to
outsource our North American manufacturing operations. As a result of that
decision, we changed the estimated useful life of the facility and recognized
additional depreciation expense of $38.4 million, bringing the net book value of
the asset to the fair value less cost to sell of $6.1 million. $24.8 million of
the additional depreciation expense was included in operating expenses, and $13.6
million was included in cost of revenue in our statement of operations for 2003.
In 2004, we determined that, due to excess capacity, we would sell the facility we
use for order assembly and shipment in Bolingbrook, Illinois, and lease back a
portion of the facility. As a result of this decision, we recognized a loss of
$4.7 million to write down the asset to the fair value less cost to sell of $9.2
million. This loss was included in cost of revenue in our statement of operations
for 2004. We sold both of the Bolingbrook, Illinois, facilities in a single
transaction in 2004. (See further discussion in Note 3.) As a result of prior
restructuring plans, we committed to sell facilities in Lisle, Illinois, and Round
Rock, Texas, with carrying amounts at the end of 2002 totaling $13.1 million. The
carrying value of the land, buildings and leasehold improvements approximated
their fair value less costs to sell, which was determined based on the quoted
market prices of similar assets; therefore, no impairment loss was recorded in
2002. In 2003, it was determined that neither property could be sold at the
current book value, and $4.8 million of impairment charges were recorded. In 2004,
a further impairment of the Round Rock facility was recorded for $0.8 million.
These impairment losses were included in operating expenses in our statements of
operations for 2003 and 2004. Both the Lisle, Illinois, and Round Rock, Texas,
facilities were sold in 2004. In addition, during the fourth quarter of 2004, we sold an
office building for a $21.1 million loss in Denmark and entered
into a one-year lease for a portion of the space. As of December 31, 2004, the total carrying value of
properties held for sale was $2.8 million, as only the Vitikka
property remains to be sold. As of January 2, 2004, the total
carrying value of properties held for sale was
$18.2 million. These balances are included in the Miscellaneous
Receivables and Other Current Assets in both of the
Consolidated Balance Sheets. 9. Product Warranties We offer warranties for all of our products. The specific terms
and conditions of those warranties vary depending upon the
product sold. We provide a basic limited warranty, including
parts and labor, for all products other than Access products for
a period ranging from 1 to 5 years. The basic limited warranty
for
Access products covers parts and labor for periods ranging from 1
to 10 years. Factors that enter into the estimate of our warranty
liability include the number of units shipped, historical and
anticipated rates of warranty claims, and cost per claim. We
periodically assess the adequacy of our recorded warranty
liabilities and adjust the amounts as necessary. On the
Consolidated Balance Sheets, the short-term portion of the
warranty reserve is included in Other Current Liabilities, while
the long-term portion is included in Other Long-Term Liabilities.
Our product warranty liabilities are as follows: (In millions)
    
    12/31/04
    
    
    1/2/04
    
    
    12/27/02Balance at beginning of year
    
    $
    19.5
    
    
    $
    13.9
    
    
    $
    14.4AFC warranty liability acquired
in acquisition
    
    
    24.8
    
    
    
    
    
    
    
    Accruals for product warranties
    
    
    6.3
    
    
    
    11.6
    
    
    
    8.5Settlements
    
    
    (9.4
    )
    
    
    (6.0
    )
    
    
    (9.0
    )Balance at end of year
    
    $
    41.2
    
    
    $
    19.5

    
    
    $
    13.9Balance sheet classification at end of yearOther current liabilities
    
    $
    21.2
    
    
    $
    6.4
    
    
    $
    6.2Other long-term liabilities
    
    
    20.0
    
    
    
    13.1
    
    
    
    7.7Total product warranty liabilities
    
    $
    41.2
    
    
    $
    19.5
    
    
    $
    13.9
 10. Employee Stock Plans At December 31, 2004, we had 15 stock-based compensation plans
with options still outstanding. Under these plans, we typically
grant options to purchase our common stock, or restricted shares,
at no less than 100% of the market price on the date granted.
Options and restricted shares granted in 2004 and 2003 generally
become exercisable on a cumulative basis at a rate of 20% on each
of the first two annual anniversaries and 60% on the third
anniversary of the grant date and have a maximum term of 10
years. Prior to 2003, options generally became exercisable on a
cumulative basis at a rate of 25% on each of the first through
fourth anniversaries of the grant date. AFC options that
converted to Tellabs options from the acquisition vest over three
to four years with a maximum term of 10 years. A total of
251,927,574 shares was authorized for grant under the plans of
which 42




---



##### 



39,087,402 remain available for grant. Certain plans also provide for the granting of stock
appreciation rights (SARs) in conjunction with, or independently of, the options under the plans.
The SARs are typically assigned 10-year terms. At December 31, 2004, there were 131,200 SARs
outstanding under the plans. At December 31, 2004, the exercise prices of our outstanding SARs
ranged from $4.07 to $70.06. A summary of the status of our option plans as of December 31, 2004, January 2, 2004, and
December 27, 2002, and of changes during the years ending on these dates is presented in the
following chart: 2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstandingbeginning of year
    
    
    41,240,918
    
    
    $
    19.35
    
    
    
    42,333,868
    
    
    $
    22.49
    
    
    
    37,926,204
    
    
    $
    30.95Granted/converted
    
    
    34,339,304
    *
    
    $
    10.93
    
    
    
    10,374,119
    
    
    $
    6.57
    
    
    
    16,781,435
    
    
    $
    5.23Exercised
    
    
    (2,331,337
    )
    
    $
    3.84
    
    
    
    (2,409,640
    )
    
    $
    2.57
    
    
    
    (2,144,053
    )
    
    $
    1.35Forfeited
    
    
    (6,037,615
    )
    
    $
    22.76
    
    
    
    (9,057,429
    )
    
    $
    23.31
    
    
    
    (10,229,718
    )
    
    $
    29.98Outstandingend of year
    
    
    67,211,270
    
    
    $
    15.28
    
    
    
    41,240,918
    
    
    $
    19.35
    
    
    
    42,333,868
    
    
    $
    22.49Exercisable at end of year
    
    
    40,415,004
    
    
    
    
    
    
    
    20,450,233
    
    
    
    
    
    
    
    17,278,637Available for grant
    
    
    39,087,402
    
    
    
    
    
    
    
    24,701,201
    
    
    
    
    
    
    
    25,688,260Weighted average fair value of
options granted during the year
    
    $
    5.49
    
    
    
    
    
    
    $
    4.15
    
    
    
    
    
    
    $
    4.31
    In 2004, 609,000 restricted shares were granted under this
program (including 103,000 shares relating to the AFC
acquisition). Compensation expense is recognized on a
straight-line basis over the vesting period and is based on the
market price of Tellabs stock on the date of grant. In addition to the plans discussed above, we maintain an
employee stock purchase plan. Under the plan, employees elect to
withhold a portion of their compensation to purchase our common
stock at fair market value. We match 15% of each employees
withholdings, which
increases their compensation for payroll tax purposes.
Compensation expense is recognized for the amount that we
contribute to the plan through our matching of participant
withholdings. We have a program to award shares of our common stock to
employees in recognition of their past service. Each full-time
employee who has worked for a continuous 5-, 10-, 15-, 20-, 25-
or 30-year period is awarded 10, 15, 25, 50, 75 or 100 shares,
respectively. When an employee stock award is granted,
compensation expense is charged for the fair market value of the
shares issued. TELLABS 2004 ANNUAL REPORT / 43




---



##### 



Options outstanding and exercisable as of December 31, 2004, by price range are as follows: Outstanding
    
    
    
    
    
    ExercisableWeightedAverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedNumber
    
    
    Remaining
    
    
    Average
    
    
    Number
    
    
    AverageRange of
    
    Outstanding
    
    
    Contractual
    
    
    Exercise
    
    
    Exercisable
    
    
    ExerciseExercise Prices
    
    As of 12/31/2004
    
    
    Life
    
    
    Price
    
    
    As of 12/31/2004
    
    
    Price$  0.03- $ 6.50
    
    
    10,669,370
    
    
    
    7.0
    
    
    $
    5.15
    
    
    
    6,467,435
    
    
    $
    4.66$  6.56- $12.60
    
    
    35,762,471
    
    
    
    8.0
    
    
    $
    9.08
    
    
    
    15,640,620
    
    
    $
    9.46$12.69- $20.35
    
    
    10,343,719
    
    
    
    5.5
    
    
    $
    16.18
    
    
    
    8,362,786
    
    
    $
    16.35$20.42- $27.75
    
    
    3,058,883
    
    
    
    4.5
    
    
    $
    24.37
    
    
    
    3,046,389
    
    
    $
    24.37$29.25- $34.28
    
    
    426,799
    
    
    
    5.3
    
    
    $
    31.52
    
    
    
    400,072
    
    
    $
    31.47$35.11- $42.57
    
    
    322,848
    
    
    
    5.3
    
    
    $
    39.53
    
    
    
    295,951
    
    
    $
    39.56$45.06- $50.31
    
    
    2,195,789
    
    
    
    5.8
    
    
    $
    49.91
    
    
    
    1,770,360
    
    
    $
    49.81$51.69- $58.50
    
    
    539,663
    
    
    
    4.8
    
    
    $
    53.54
    
    
    
    539,663
    
    
    $
    53.54$59.25- $65.63
    
    
    3,801,803
    
    
    
    5.2
    
    
    $
    61.75
    
    
    
    3,801,803
    
    
    $
    61.75$70.06- $70.63
    
    
    89,925
    
    
    
    5.1
    
    
    $
    70.46
    
    
    
    89,925
    
    
    $
    70.4667,211,270
    
    
    
    7.0
    
    
    $
    15.28
    
    
    
    40,415,004
    
    
    $
    19.09
 11. Employee Benefit and Retirement Plans Our employees may voluntarily participate in the Tellabs Advantage Program and
upon meeting eligibility requirements, we will match (dollar-for-dollar) up to
the first 4% (from July 1, 2003 - December 31, 2004) or 3% (from January 1, 2003
- June 30, 2003) of the employees compensation. Both employee and employer
contributions are immediately vested. The investment election for the employees
contribution is employee-driven and our match follows this election. In
addition, the employee may elect to change this investment election and
reallocate assets on a daily basis. Although the Tellabs Stock Fund is one of
several funds offered to participants, at no time do we direct the investment of
an employees contribution or our match into any one fund offered under the
program. We maintain similar plans for the benefit of eligible employees at our
Finland and Denmark subsidiaries. Until July 1, 2003, we contributed to a retirement plan under the program
consisting of a money purchase plan and a profit-sharing plan for which, upon
meeting eligibility requirements, all employees become eligible participants.
Each quarter, we contributed an amount equal to 5% of a participants quarterly
salary, subject to the terms set forth in the program. This quarterly
contribution was entirely funded by us. Of the 5% contribution, 4.5% was
deposited into a money purchase plan and invested per the participants
direction into the funds offered under the program with the exception of the
Tellabs Stock Fund. The participant may not direct any portion of this 4.5% into
the Tellabs Stock Fund. Participants were allowed to change their money purchase
plan investment elections at any time and may continue to reallocate the
investments among the same funds available under the program (with the exception
of the Tellabs Stock Fund) on a daily basis. Contributions to the profit-sharing
plan were suspended as of July 1, 2003. The investment of the remaining 0.5% of this quarterly 5% contribution
(10% of our retirement contribution) was deposited into the profit-sharing plan
and was directed by us into the Tellabs Stock Fund and still may not be
reallocated unless the participant is age 55 or older. Contributions to the
profit-sharing plan were suspended as of July 1, 2003. Effective July 1, 2003, we instituted a Discretionary Company
Contribution. This contribution is declared by the Board of Directors and is
funded entirely by us. The amount of the contribution is based on a percent of
pay for a specific period as declared by the Board. All full-time active
employees are immediately eligible to receive this contribution and the
investment of these funds follows the participants elections on file for the
program. This contribution is immediately vested. The Board of Directors
declared a 2% contribution for the third and fourth quarters of 2003 and for
each quarter of 2004. Our contributions to these programs were $18.8 million, $25.9 million and
$22.9 million for 2004, 2003 and 2002, respectively. We provide a deferred income plan that permits certain officers and
management employees to defer portions of their compensation. All deferrals
prior to September 2, 2001, are guaranteed a fixed return. In September 2001,
the plan was amended to offer multiple investment funds whose investment returns
are based on market performance; therefore, all deferrals on or after September
2, 2001, also 44




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##### 



can be transferred into the amended plan and invested in the new fund options.
Funds invested prior to September 2, 2001, also can be transferred into the
amended plan. The deferred income obligation is included in Other Long-Term
Liabilities and adjusted, with a corresponding charge (or credit) to compensation
expense, to reflect changes in the fair value of the amount owed to the employee.
We fund any payments from the deferred income plan from our investment in
corporate-owned life insurance policies. The cash surrender value of such
policies is recorded in Other Assets. We maintain a defined-benefit retiree medical plan. Under the plan, which was
implemented in 1999, we provide qualified retirees with a subsidy to offset
their medical costs and allow the retirees to participate in the
Company-sponsored healthcare plan. In 2004, no contribution was made and in 2003
and 2002, $2.0 million and $2.4 million were contributed, respectively, to our
defined-benefit retiree medical plan. The following table summarizes plan assets, obligations, and assumptions of
the retiree medical plan as of December 31, 2004 and December 31, 2003: (In millions)
    
    2004
    
    
    2003Change in benefit obligationAccumulated postretirement
benefit obligation at
beginning of year
    
    $
    8.6
    
    
    $
    7.9Service cost
    
    
    0.7
    
    
    
    0.9Interest cost
    
    
    0.5
    
    
    
    0.5Plan amendments
    
    
    
    
    
    
    Actuarial (gain) loss
    
    
    (1.1
    )
    
    
    1.6Benefits paid
    
    
    (0.3
    )
    
    
    (0.3
    )AFC acquisition
    
    
    2.7
    
    
    
    Curtailment
    
    
    
    
    
    
    (2.0
    )Accumulated postretirement
benefit obligation at end of year
    
    $
    11.1
    
    
    $
    8.6Change in plan assetsAssets at fair value at
beginning of year
    
    $
    8.5
    
    
    $
    6.4Return on plan assets
    
    
    0.1
    
    
    
    0.1Company contributions
    
    
    
    
    
    
    2.0Benefits paid
    
    
    
    
    
    
    Assets at fair value at end of year
    
    $
    8.6
    
    
    $
    8.5
 (In millions)
    
    2004
    
    
    2003Reconciliation of (accrued)
prepaid costFunded status of the plan
    
    $
    (2.5
    )
    
    $
    (0.1
    )Unrecognized prior service cost
    
    
    1.5
    
    
    
    1.6Unrecognized net loss
    
    
    0.4
    
    
    
    1.2(Accrued) prepaid cost
    
    $
    (0.6
    )
    
    $
    2.7Components of net periodic
benefit costService cost
    
    $
    0.7
    
    
    $
    0.9Interest cost
    
    
    0.5
    
    
    
    0.5Expected return on assets
    
    
    (0.4
    )
    
    
    (0.4
    )Amortization of:Unrecognized prior service cost
    
    
    
    
    
    
    0.2Net periodic postretirement
benefit cost
    
    $
    0.8
    
    
    $
    1.2Additional costs due to restructure
Special termination benefits
    
    
    
    
    
    
    0.2Total cost for the year
    
    $
    0.8
    
    
    $
    1.4
 We incurred additional costs of $0.2 million in 2003 for certain extra
benefits paid to terminated or retired employees. We expect to contribute $0.8
million to our retiree medical plan in 2005. We amortize the prior service cost using a straight-line method over the
average remaining years of service to full eligibility for benefits of the active
retiree medical plan participants. Weighted average assumptions
    
    2004
    
    
    2003Discount rate used to
determine benefit costs
    
    
    6.00
    %
    
    
    6.75
    %Discount rate used to determine
benefit obligation
    
    
    6.00
    %
    
    
    6.00
    %Expected long-term rate of
return on assets
    
    
    5.00
    %
    
    
    5.00
    %
 There is no trend rate assumption required for this plan, because all
liabilities are related to a fixed-dollar subsidy, and are not related to medical
claims. Therefore, any change in future medical inflation trends or assumptions
will have no effect on the liabilities of this plan. The plans assets are invested 100% in fixed-income securities. Historical
markets are studied and long-term historical relationships between equities and
fixed-income are preserved consistent with the widely accepted capital market
principle that assets with higher volatility generate a greater return over the
long run. Current market factors such as inflation and interest rates are
evaluated before long-term capital market assumptions are determined. The TELLABS 2004 ANNUAL REPORT / 45




---



##### 



long-term portfolio return is established via a building block approach with
proper consideration of diversification and rebalancing. Peer data and historical
returns are reviewed to check for reasonableness and appropriateness. The following table presents estimated future benefit payments for the
retiree medical plan as of December 31, 2004: (In millions)2005
    
    $
    0.32006
    
    
    0.32007
    
    
    0.32008
    
    
    0.32009
    
    
    0.420102014
    
    
    2.4
 12. Income Taxes Components of the companys (loss) earnings before income taxes are as follows: Year Ended
    
    
    Year Ended
    
    
    Year Ended(In millions)
    
    12/31/04
    
    
    1/2/04
    
    
    12/27/02Domestic source
    
    $
    (47.3
    )
    
    $
    (250.8
    )
    
    $
    (330.2
    )Foreign source
    
    
    37.1
    
    
    
    6.1
    
    
    
    2.4Loss before
income tax
    
    $
    (10.2
    )
    
    $
    (244.7
    )
    
    $
    (327.8
    )
 The provision for income tax (expense) benefit consists of the
following: Year Ended
    
    
    Year Ended
    
    
    Year Ended(In millions)
    
    12/31/04
    
    
    1/2/04
    
    
    12/27/02Current:Federal
    
    $
    0.6
    
    
    $
    5.7
    
    
    $
    132.3State
    
    
    (0.4
    )
    
    
    (0.4
    )
    
    
    1.4Foreign
    
    
    (8.2
    )
    
    
    (17.1
    )
    
    
    (26.2
    )(8.0
    )
    
    
    (11.8
    )
    
    
    107.5Deferred:Federal
    
    
    
    
    
    
    
    
    
    
    (89.1
    )State and foreign
    
    
    (11.6
    )
    
    
    14.9
    
    
    
    (3.7
    )(11.6
    )
    
    
    14.9
    
    
    
    (92.8
    )Income tax
(expense) benefit
    
    $
    (19.6
    )
    
    $
    3.1
    
    
    $
    14.7
 Deferred tax assets (liabilities) for 2004 and 2003 are composed of the
following: Ending Balance
    
    
    Ending Balance(In millions)
    
    12/31/04
    
    
    1/2/04Deferred tax assetsNOL and tax credit
carryforwards
    
    $
    177.6
    
    
    $
    195.6Inventory reserves
    
    
    14.4
    
    
    
    22.2Accrued liabilities
    
    
    35.5
    
    
    
    11.6Deferred compensation plan
    
    
    7.9
    
    
    
    7.9Deferred employee
benefit expenses
    
    
    13.4
    
    
    
    5.0Fixed assets and depreciation
    
    
    
    
    
    
    10.4Restructuring accruals
    
    
    17.5
    
    
    
    36.2Amortizable intangibles
    
    
    2.0
    
    
    
    Unrealized loss on
marketable securities
    
    
    2.1
    
    
    
    Other
    
    
    
    
    
    
    5.8Gross deferred tax assets
    
    
    270.4
    
    
    
    294.7Deferred tax liabilitiesAmortizable intangibles
    
    
    
    
    
    
    (25.3
    )Unrealized gain on
marketable securities
    
    
    (198.1
    )
    
    
    (1.0
    )Fixed assets and depreciation
    
    
    (21.4
    )
    
    
    Other
    
    
    (4.3
    )
    
    
    (0.7
    )Gross deferred tax liabilities
    
    
    (223.8
    )
    
    
    (27.0
    )Valuation allowance
    
    
    (38.9
    )
    
    
    (251.4
    )Net deferred tax asset
    
    $
    7.7
    
    
    $
    16.3
 46




---



##### 



Federal income taxes at the statutory rate are reconciled with the companys
income tax provision as follows: Year Ended
    
    
    Year Ended
    
    
    Year Ended(In percentages)
    
    12/31/04
    
    
    1/2/04
    
    
    12/27/02Statutory U.S.
income tax rate
    
    
    (35.0
    )%
    
    
    (35.0
    )%
    
    
    (35.0
    )%State income tax,
net of federal benefits
    
    
    4.1
    
    
    
    1.4
    
    
    
    1.7Research and
development credit
    
    
    
    
    
    
    
    
    
    
    (0.7
    )Foreign earnings taxed
at different rates
    
    
    91.6
    
    
    
    0.4
    
    
    
    9.0Loss on investment
in securities
    
    
    
    
    
    
    (2.5
    )
    
    
    (Loss) gain on investment in
subsidiary
    
    
    
    
    
    
    0.6
    
    
    
    (5.1
    )Valuation allowance on
net deferred
tax assets
    
    
    (267.9
    )
    
    
    30.8
    
    
    
    25.4Assessments related
to prior year
tax matters
    
    
    17.8
    
    
    
    2.8
    
    
    
    Write-off of in-process
research and
development
    
    
    352.2
    
    
    
    
    
    
    
    Nondeductible stock
compensation expense
    
    
    33.9
    
    
    
    
    
    
    
    Other, net
    
    
    (4.5
    )
    
    
    0.2
    
    
    
    0.2Effective income
tax rate
    
    
    192.2
    %
    
    
    (1.3
    )%
    
    
    (4.5
    )%
 The net deferred income tax asset decreased from $16.3 million at January 2,
2004, to $7.7 million at December 31, 2004. The $8.6 million change in the net
deferred tax balance is primarily attributable to utilization of net operating
losses in foreign jurisdictions. Our net deferred tax asset includes a deferred
tax liability of $198.1 million representing taxes that will be due on certain
hedge contract gains upon termination of our Cisco stock loans. Deferred Tax Valuation Allowance SFAS No. 109,
Accounting for Income Taxes, requires that a valuation allowance
be established when it is more likely than not that all or a portion of a
deferred tax asset will not be realized. Prior to December 27, 2002, we
established valuation allowances only for future tax benefits from certain state
net operating losses, credits with relatively short carryforward periods, and
certain foreign net operating losses. At December 27, 2002, we determined it
appropriate to establish a full valuation
allowance against our remaining net U.S. deferred tax assets. For the year ended
December 31, 2004, we continued to maintain a full valuation allowance on our
net U.S. deferred tax assets. Until an appropriate level of profitability is
attained, we expect to continue to record a full valuation allowance on our net
deferred tax assets related to future U.S. and certain non-U.S. tax benefits. During 2004, the valuation allowance maintained against our net U.S.
deferred tax asset was reduced as a result of deferred tax liabilities of
$177.2 million and $9.9 million recorded in accounting for the purchase of AFC
and Vinci. The reduction in the valuation allowance was credited against
goodwill recorded with respect to these acquisitions, and did not impact our
tax expense. Summary of Carryforwards We have carryforward U.S. federal and state net operating losses and research and
development credits. The value of these assets decreased from $174.4 million as
of January 2, 2004, to $165.4 million as of December 31, 2004. This decrease was
primarily attributable to utilization of net operating losses in 2004. The state
net operating loss carryforwards and credits will expire at various dates between
2005 and 2023, a majority of which will expire between 2012 and 2023. The federal
net operating loss and R&D tax credit carryforwards will expire at various dates
between 2020 and 2023. We have net operating loss carryforwards relating to certain non-U.S.
subsidiaries for which a full valuation allowance has been previously
established. The value of these assets was $9.6 million at December 31, 2004,
compared with $9.4 million at January 2, 2004. We also have net operating losses
relating to other non-U.S. subsidiaries for which deferred tax assets exist that
are not reduced by a valuation allowance. The value of these assets was $2.6
million at December 31, 2004, compared with $11.8 million at January 2, 2004. The
non-U.S. net operating loss carryforwards will expire at various dates between
2005 and 2013. Investment in Foreign Operations Deferred U.S. income taxes and foreign withholding taxes are not provided on the
undistributed cumulative earnings of foreign subsidiaries because such earnings
are considered to be permanently reinvested in those operations. The
undistributed cumulative earnings of foreign subsidiaries that are considered
permanently reinvested outside the U.S. were $664.5 million at December 31, 2004. The American Jobs Creation Act of 2004 (the AJCA), signed into law in
October 2004, includes a provision that allows Tellabs to elect to claim a
special one-time dividend received deduction with respect to a qualifying cash
repatriation from its foreign subsidiaries. We are evaluating TELLABS 2004 ANNUAL REPORT / 47




---



##### 



the potential benefits of making this election with respect to a cash
repatriation of between $0 and $600.0 million. We expect to complete our
evaluation subsequent to enactment of anticipated Technical Corrections
legislation. Through the end of 2004, preliminary estimates indicate that Tellabs
would owe approximately $70.0 million in U.S. income tax if $600.0 million in
cash were repatriated by its foreign subsidiaries under the provisions of the
AJCA as enacted. Audits We are subject to tax examinations and potential assessments in various
jurisdictions. During 2004 we reached a settlement with the IRS in connection
with their examination of our 1998-2000 tax years, resulting in an $8.5 million
tax benefit. The IRS is currently examining our federal income tax returns for
2001 through 2003. We do not expect the outcome of these examinations to have a
material effect on our consolidated results of operations, consolidated financial
position or cash flow. 13. Product Group and Geographical Information We manage our business in one operating segment. Consolidated revenue by
current product group designations is as follows: (In millions)
    
    2004
    
    
    2003
    
    
    2002Transport
    
    $
    588.2
    
    
    $
    419.4
    
    
    $
    579.1Managed Access
    
    
    331.0
    
    
    
    336.1
    
    
    
    455.0Voice-Quality
Enhancement
    
    
    84.3
    
    
    
    68.2
    
    
    
    103.7Access
    
    
    53.3
    
    
    
    
    
    
    
    Broadband Data
    
    
    17.4
    
    
    
    6.4
    
    
    
    Services
    
    
    157.6
    
    
    
    150.3
    
    
    
    179.2Total
    
    $
    1,231.8
    
    
    $
    980.4
    
    
    $
    1,317.0
 During 2004, revenue from a single customer accounted for 27% of
consolidated revenue. During 2003, revenue from a single customer accounted
for 21% of consolidated revenue. During 2002, revenue from a single customer
accounted for 17% of consolidated revenue, and a second customer accounted
for 11% of consolidated revenue. Consolidated revenue by country, based on the location of our customers, is
as follows: (In millions)
    
    2004
    
    
    2003
    
    
    2002United States
    
    $
    797.0
    
    
    $
    588.8
    
    
    $
    904.3Other geographic
areas
    
    
    434.8
    
    
    
    391.6
    
    
    
    412.7Total
    
    $
    1,231.8
    
    
    $
    980.4
    
    
    $
    1,317.0
 Long-lived assets by country are as follows: (In millions)
    
    2004
    
    
    2003United States
    
    $
    1,558.0
    
    
    $
    921.3Finland
    
    
    102.7
    
    
    
    119.4Denmark
    
    
    16.0
    
    
    
    51.2Other geographic
areas
    
    
    9.3
    
    
    
    16.9Total
    
    $
    1,686.0
    
    
    $
    1,108.8
 14. Operating Lease Commitments We have a number of operating lease agreements primarily involving office space,
buildings and office equipment. These leases are non-cancelable and expire on
various dates through 2014. As of December 31, 2004, future minimum lease
commitments under non-cancelable leases are as follows: (In millions)2005
    
    $
    18.02006
    
    
    15.42007
    
    
    12.72008
    
    
    9.62009
    
    
    8.02010 and thereafter
    
    
    19.1Total minimum lease payments
    
    $
    82.8
 Total future minimum lease payments have not been reduced by $3.8 million of
future sublease payments to be received under non-cancelable subleases. Total
rental expense for the years ended December 31, 2004, January 2, 2004, and
December 27, 2002, was approximately $10.0 million, $15.0 million and $16.5
million, respectively. 48




---



##### 



15. Earnings Per Share The following chart sets forth the computation of loss per share: (In millions, except per-share data)
    
    2004
    
    
    2003
    
    
    2002Numerator:Net loss
    
    $
    (29.8
    )
    
    $
    (241.6
    )
    
    $
    (313.1
    )Denominator:Denominator for basic loss per share 
weighted average shares outstanding
    
    
    420.2
    
    
    
    413.1
    
    
    
    411.4Effect of dilutive securities:Employee stock options and awards
    
    
    
    
    
    
    
    
    
    
    Denominator for diluted loss per share 
adjusted weighted average shares outstanding
and assumed conversions
    
    
    420.2
    
    
    
    413.1
    
    
    
    411.4Loss per share, basic and diluted
    
    $
    (0.07
    )
    
    $
    (0.58
    )
    
    $
    (0.76
    )
 Under GAAP, dilutive securities are not included in the computation of
diluted earnings per share when a company is in a net loss position. Diluted
weighted average shares outstanding were 424.7 million, 416.7 million and 414.9
million in 2004, 2003 and 2002, respectively. 16. Quarterly Financial Data (unaudited) Selected quarterly financial data for 2004 and 2003 are as follows: (In millions, except per-share data)
    
    First Quarter
    
    
    Second Quarter
    
    
    Third Quarter
    
    
    Fourth Quarter12004Revenue
    
    $
    263.8
    
    
    $
    304.3
    
    
    $
    284.3
    
    
    $
    379.4Gross profit
    
    $
    150.5
    
    
    $
    174.8
    
    
    $
    153.1
    
    
    $
    178.6Net earnings (loss)
    
    $
    13.4
    
    
    $
    49.6
    
    
    $
    45.9
    
    
    $
    (138.7
    )Earnings (loss) per share 
basic and diluted
    
    $
    0.03
    
    
    $
    0.12
    
    
    $
    0.11
    
    
    $
    (0.32
    )2003Revenue
    
    $
    222.5
    
    
    $
    234.1
    
    
    $
    244.5
    
    
    $
    279.3Gross profit
    
    $
    93.5
    
    
    $
    44.5
    
    
    $
    93.2
    
    
    $
    122.8Net loss
    
    $
    (42.9
    )
    
    $
    (110.7
    )
    
    $
    (64.8
    )
    
    $
    (23.2
    )Loss per share 
basic and diluted
    
    $
    (0.10
    )
    
    $
    (0.27
    )
    
    $
    (0.16
    )
    
    $
    (0.06
    )
   1
    
    The fourth quarter of 2004 includes the following pre-tax charges:
Purchased in-process research and development charges of $102.1 million;
asset impairment charges of $47.2 million; a net loss on the sale of real
estate of $20.6 million; and a $11.2 million impairment charge for the
write-down of certain start-up investments. The per-share computation for the year is a separate, annual calculation.
Accordingly, the sum of the quarterly per share amounts do not necessarily equal
the per share amounts for the year. 17. Subsequent Event On February 2, 2005, our Board of Directors authorized the purchase of up to
$300 million in shares of our outstanding common stock. Purchases of common
shares may be made from time-to-time in the open market or in private
transactions and will be recorded as treasury stock. As of February 28, 2005, we
have purchased $118.7 million (16.5 million shares) of our common stock. TELLABS 2004 ANNUAL REPORT / 49




---



##### 



11-Year Summary of Selected Financial Data (Unaudited) (In millions, except per-share, employee and stockholder data)
    
    20044
    
    
    2003
    
    
    2002
    
    
    2001Statement of Operations DataRevenue
    
    $
    1,231.8
    
    
    $
    980.4
    
    
    $
    1,317.0
    
    
    $
    2,199.7Gross profit
    
    $
    657.0
    
    
    $
    354.0
    
    
    $
    486.5
    
    
    $
    763.2Operating (loss) profit
    
    $
    (31.7
    )
    
    $
    (264.5
    )
    
    $
    (329.7
    )
    
    $
    (279.4
    )(Loss) earnings before income taxes and
cumulative effect of change in
accounting principle
    
    $
    (10.2
    )
    
    $
    (244.7
    )
    
    $
    (327.8
    )
    
    $
    (244.8
    )(Loss) earnings before cumulative effect
of change in accounting principle
    
    $
    (29.8
    )
    
    $
    (241.6
    )
    
    $
    (313.1
    )
    
    $
    (182.0
    )Net (loss) earnings
    
    $
    (29.8
    )
    
    $
    (241.6
    )
    
    $
    (313.1
    )
    
    $
    (182.0
    )(Loss) earnings per share before
cumulative effect of change in
accounting principle  diluted 1
    
    $
    (0.07
    )
    
    $
    (0.58
    )
    
    $
    (0.76
    )
    
    $
    (0.44
    )(Loss) earnings per share  diluted 1
    
    $
    (0.07
    )
    
    $
    (0.58
    )
    
    $
    (0.76
    )
    
    $
    (0.44
    )Weighted average shares
outstanding  diluted 1
    
    
    420.2
    
    
    
    413.1
    
    
    
    411.4
    
    
    
    409.6Balance Sheet DataTotal assets
    
    $
    3,522.5
    
    
    $
    2,607.5
    
    
    $
    2,705.7
    
    
    $
    2,865.8Total liabilities
    
    $
    725.3
    
    
    $
    388.2
    
    
    $
    415.4
    
    
    $
    400.2Stockholders equity
    
    $
    2,797.2
    
    
    $
    2,219.3
    
    
    $
    2,290.3
    
    
    $
    2,465.6Other InformationNet cash provided by operating activities
    
    $
    214.7
    
    
    $
    149.9
    
    
    $
    177.8
    
    
    $
    419.3Working capital
    
    $
    1,295.2
    
    
    $
    1,291.1
    
    
    $
    1,359.2
    
    
    $
    1,625.1Long-term debt
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    3.4Research and development expenditures 2
    
    $
    250.3
    
    
    $
    286.1
    
    
    $
    340.6
    
    
    $
    422.7Return on average equity
    
    
    1.2
    %
    
    
    10.7
    %
    
    
    13.2
    %
    
    
    7.1
    %Stock price at year-end
    
    $
    8.59
    
    
    $
    8.36
    
    
    $
    7.43
    
    
    $
    15.79Number of employees at year-end
    
    
    4,125
    
    
    
    3,515
    
    
    
    4,828
    
    
    
    7,334Number of stockholders 3
    
    
    8,035
    
    
    
    6,659
    
    
    
    6,397
    
    
    
    5,845
   1
    
    Restated to reflect two-for-one stock splits in 1999, 1996, 1995 and 1994, and a three-for-two stock split in 1993.2
    
    2004 and 1996 research and development expenditures do not include purchased in-process research and
development costs of $102.1 and $74.7 million, respectively.3
    
    Represents the number of stockholders at the record date for the next annual meeting of stockholders.4
    
    Includes the acquisition of AFC in November 2004.5
    
    We adopted SAB 101 Revenue Recognition in Financial Statements in 2000 which is shown as a change in accounting
principle. 50




---



##### 



20005
    
    
    1999
    
    
    1998
    
    
    1997
    
    
    1996
    
    
    1995
    
    
    1994$
    3,387.4
    
    
    $
    2,322.4
    
    
    $
    1,706.1
    
    
    $
    1,280.9
    
    
    $
    925.4
    
    
    $
    680.5
    
    
    $
    524.7$
    1,835.4
    
    
    $
    1,382.3
    
    
    $
    1,000.0
    
    
    $
    761.3
    
    
    $
    533.4
    
    
    $
    376.2
    
    
    $
    280.8$
    995.0
    
    
    $
    731.8
    
    
    $
    484.4
    
    
    $
    379.8
    
    
    $
    183.6
    
    
    $
    168.8
    
    
    $
    106.0$
    1,109.4
    
    
    $
    802.1
    
    
    $
    577.7
    
    
    $
    417.2
    
    
    $
    190.3
    
    
    $
    175.6
    
    
    $
    104.2$
    760.0
    
    
    $
    549.7
    
    
    $
    391.5
    
    
    $
    275.5
    
    
    $
    127.6
    
    
    $
    123.3
    
    
    $
    76.2$
    730.8
    
    
    $
    549.7
    
    
    $
    391.5
    
    
    $
    275.5
    
    
    $
    127.6
    
    
    $
    123.3
    
    
    $
    76.2$
    1.82
    
    
    $
    1.32
    
    
    $
    0.96
    
    
    $
    0.69
    
    
    $
    0.32
    
    
    $
    0.32
    
    
    $
    0.20$
    1.75
    
    
    $
    1.32
    
    
    $
    0.96
    
    
    $
    0.69
    
    
    $
    0.32
    
    
    $
    0.32
    
    
    $
    0.20418.4
    
    
    
    417.0
    
    
    
    408.9
    
    
    
    401.1
    
    
    
    393.1
    
    
    
    387.6
    
    
    
    362.7$
    3,073.1
    
    
    $
    2,354.6
    
    
    $
    1,651.9
    
    
    $
    1,250.1
    
    
    $
    786.8
    
    
    $
    581.0
    
    
    $
    407.4$
    445.5
    
    
    $
    307.1
    
    
    $
    247.4
    
    
    $
    257.9
    
    
    $
    158.2
    
    
    $
    127.1
    
    
    $
    104.2$
    2,627.6
    
    
    $
    2,047.5
    
    
    $
    1,404.5
    
    
    $
    992.2
    
    
    $
    628.6
    
    
    $
    453.9
    
    
    $
    303.2$
    426.1
    
    
    $
    452.2
    
    
    $
    239.3
    
    
    $
    219.1
    
    
    $
    185.5
    
    
    $
    103.0
    
    
    $
    114.7$
    1,910.0
    
    
    $
    1,511.4
    
    
    $
    1,054.9
    
    
    $
    685.0
    
    
    $
    374.7
    
    
    $
    283.9
    
    
    $
    148.0$
    2.9
    
    
    $
    9.4
    
    
    $
    3.3
    
    
    $
    3.1
    
    
    $
    2.9
    
    
    $
    3.9
    
    
    $
    4.9$
    412.4
    
    
    $
    311.0
    
    
    $
    224.1
    
    
    $
    171.9
    
    
    $
    113.7
    
    
    $
    86.5
    
    
    $
    68.731.3
    %
    
    
    31.8
    %
    
    
    32.7
    %
    
    
    34.0
    %
    
    
    23.6
    %
    
    
    32.6
    %
    
    
    29.9
    %$
    56.50
    
    
    $
    64.19
    
    
    $
    34.28
    
    
    $
    27.38
    
    
    $
    19.75
    
    
    $
    9.25
    
    
    $
    6.978,643
    
    
    
    7,068
    
    
    
    5,073
    
    
    
    4,394
    
    
    
    3,418
    
    
    
    2,814
    
    
    
    2,5655,367
    
    
    
    5,504
    
    
    
    4,371
    
    
    
    3,725
    
    
    
    3,035
    
    
    
    2,685
    
    
    
    1,832
 TELLABS 2004 ANNUAL REPORT / 51




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##### 



Board of Directors (PHOTO OF MICHAEL J. BIRCK) Michael J. Birck,67, chairman and co-founder Tellabs. Chairman since 2000,
chief executive officer 2002-2004, chief executive officer and president 1975-2000.
Director of engineering at Wescom Inc. 1968-1975. Director, Molex Incorporated,
Illinois Tool Works. M.S.E.E., New York University; B.S.E.E., Purdue University. Tellabs director since 1975. (PHOTO OF BO HEDFORS) Bo Hedfors,61, founder and president of Hedfone Consulting, Inc. (telecom and
Internet consulting), since 2002. President, global wireless infrastructure business
at Motorola 1998-2002. President and CEO of Ericsson, Inc., 1994-1998; chief
technology officer of LM Ericsson 1990-1993; president
of Honeywell Ericsson Development Co. 1984-1986.
Director, Openwave Systems, Inc., SwitchCore AB.
M.S.E.E., Chalmers University of Technology. Tellabs
director since 2003. (PHOTO OF MELLODY L. HOBSON) Mellody L. Hobson,35, president and director of Ariel Capital Management,
LLC/Ariel Mutual Funds since 2000. Senior vice president and director of marketing at
Ariel Capital Management, Inc. 1994-2000; vice president of marketing at Ariel
Capital Management, Inc. 1991-1994. A.B., Princeton University,
Woodrow Wilson School. Tellabs director since 2002.
(Will not stand for re-election in 2005.) (PHOTO OF FRANK LANNA) Frank lanna, 55, president of AT&T Network Services 1998-2003. Various executive and senior
management positions at AT&T 1990-1998; various management and staff positions at AT&T 1972-1998.
M.S.E.E., Massachusetts Institute of Technology; B.E.E.E., Stevens Institute of Technology. Tellabs
director since 2004. (PHOTO OF FRED A. KREHBIEL) Fred A. Krehbiel, 63, chief executive
officer of Molex Incorporated since
2004; co-chairman of the board since
1999; co-chief executive officer
1999-2001; chief executive officer
1988-1999; chairman of the board
1993-1999. Director, DeVry, Inc.,
W.W. Grainger. B.A., Lake Forest College.
Tellabs director since 1985. Board of Director Structure and Process Tellabs is managed by and under the direction of its board of directors. Each director who is not an officer of the Company is paid an annual retainer of
$30,000 plus a fee of $1,500 and expenses for each board of director meeting attended in
person and $1,000 for each substantive telephonic board of director meeting. Committee members receive a fee of $1,000 for each committee meeting attended in person
and $500 for each substantive telephonic committee meeting. In addition, the chairperson of
the audit and ethics committee receives an annual retainer of $4,000. Commencing in 2005,
the annual retainer will increase to $8,000 for the chairperson of the audit and ethics
committee and the chairs of the compensation and nominating and governance committees shall
receive an annual retainer of $4,000. The board has an audit and ethics committee, a nominating and governance
committee and a compensation committee. Members of the audit and ethics committee are Michael Lavin  Chairman, Melody
Hobson, Fred Krehbiel and William Souders. Nominating and governance committee members are Jan Suwinski  Chairman, Bo
Hedfors, Michael Lavin and Stephanie Pace Marshall. Compensation committee members are William Souders  Chairman, Melody
Hobson, Stephanie Pace Marshall and Jan Suwinski. Effective as of the 2005 annual meeting, Bo Hedfors will replace Mellody Hobson on the
audit and ethics committee and Frank lanna will replace Ms. Hobson on the compensation
committee. 52




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##### 



(PHOTO OF MICHAEL E. LAVIN) Michael E. Lavin,59, Midwest area managing partner KPMG LLP 1993-2002; partner
1977-2002; various management and staff positions 1967-1976. Director, Peoples
Energy Corporation. B.B.A., University of Wisconsin. Tellabs director since 2003. (PHOTO OF STEPHANIE PACE MARSHALL) Stephanie Pace Marshall, Ph.D.,59,
founding president of Illinois Mathematics and Science Academy since 1986.
Ph.D., Loyola University; M.A., University of Chicago; B.A., Queens College. Tellabs
director since 1996. (PHOTO OF KRISH A. PRABHU) Krish A. Prabhu,50, president and chief executive officer of Tellabs since 2004. Partner,
Morgenthaler Ventures 2001-2004. Chief operating officer of Alcatel Telecom 1999-2001; chief
executive officer of Alcatel USA 1997-1999; various senior management positions at Alcatel
1991-1997; various management and research and development positions at Rockwell Network
Transmission Division (now Alcatel) 1984-1991. Ph.D. and M.S.E.E., University of Pittsburgh; M.S.,
Indian Institute of Technology; B.S., Bangalore University. Tellabs director since 2004. (PHOTO OF WILLIAM F. SOUDERS) William F. Souders,76, chairman and chief executive officer of Emery Air Freight
Corporation 1988-1989; executive vice president and director at Xerox Corporation
1974-1986. B.A., Lake Forest College. Tellabs director since 1990. (PHOTO OF JAN H. SUWINSKI) Jan H. Suwinski,63, professor of Business and Operations, Cornell University, Johnson Graduate
School of Management since 1997; executive vice president of OptoElectronics Group, Corning
Incorporated 1990-1996; various executive and operations positions, 1965-1990. Director, Thor
Industries, Inc., Ohio Casualty Group. M.B.A. and B.M.E., Cornell University. Tellabs director
since 1997. TELLABS 2004 ANNUAL REPORT
/53




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Officers (PHOTO OF MICHAEL J. BRICK) Michael J. Birck,67, chairman and co-founder. Chairman since 2000, chief executive officer
2002-2004, chief executive officer and president 1975-2000. Director of engineering at Wescom Inc.
1968-1975; director, Molex Incorporated, Illinois Tool Works. M.S.E.E., New York University;
B.S.E.E., Purdue University. Tellabs director since 1975. (PHOTO OF KRISH A. PRABHU) Krish A. Prabhu,50, president and chief executive officer since 2004. Partner, Morgenthaler
Ventures 2001-2004. Chief operating officer of Alcatel Telecom 1999-2001; chief executive officer
of Alcatel USA 1997-1999; various senior management positions at Alcatel 1991-1997; various
management and research and development positions at Rockwell Network Transmission Division (now
Alcatel) 1984-1991. Ph.D. and M.S.E.E., University of Pittsburgh; M.S., Indian Institute of
Technology; B.S., Bangalore University. Tellabs director since 2004. (PHOTO OF JOHN M. BROTS) John M. Brots,45, executive vice president, supply chain management since 2005.
Vice president of supply chain management 2004. Vice president of North American
operations from 2000-2003; various positions from 1988-2003. Various positions at
Tracor, Inc., Sperry Aerospace and
Gulton Aerospace from 1983-1988. M.B.A., St. Edwards
University; B.S., Cameron University. (PHOTO OF CARL A. DE WILDE) Carl A. DeWilde,57, executive vice president, access products since 2004. Chief
operating officer and chief technology officer at Xtera Communications 2000-2004.
Senior vice president of development at Fujitsu Network Communications 1992-2000;
various positions at Alcatel 1990-1992;
various positions at Siemens 1980-1990. B.S.E.E.,
Hogeschool Zeeland. (PHOTO OF J. THOMAS GRUENWALD) J. Thomas Gruenwald,57, executive vice president, broadband networking products since 2004.
Senior vice president of operations at Tellabs International 2002-2004; various engineering and
executive positions 1991-2002. Various positions at AT&T Bell Laboratories 1978-1990. Ph.D. and
M.S., Purdue University; B.S., University of Cincinnati. (PHOTO OF JEAN K. HOLLEY) Jean K. Holley,45, executive vice president and chief information officer since 2005. Senior
vice president and chief information officer 2004. Chief information officer at USG Corp from
1998-2003. Various positions at Waste Management from 1989-1998. M.S., Illinois Institute of
Technology; B.S., University of Missouri-Rolla. (PHOTO OF  DANIEL P. KELLY) Daniel P. Kelly,43, executive vice president, core products since 2004. Various
engineering and executive positions 1985-2004. M.B.A., University of Chicago;
M.S.E.E. and B.S.E.E., University of Notre Dame. (PHOTO OF  STEPHEN M. MC CARTHY) Stephen M. McCarthy,50, executive vice president of global customer sales and
service since 2004. Various engineering and executive positions at Tellabs
1999-2004. Senior vice president of Automatic Data Processings (ADP) major accounts
central division 1997-1998. Various positions at
Ameritech 1989-1997. M.B.A., DePaul University; B.S.,
University of Illinois. (PHOTO OF  VICTORIA L. PERRAULT) Victoria L. Perrault,51, executive vice president of human resources since 2004.
Various positions at AFC 1996-2004. Director of human resources at Aegon USA
1993-1996. J.D., University of California, Hastings College of the Law; B.A.,
University of California at Berkeley. (PHOTO OF JAMES M. SHEEHAN) James M. Sheehan,42, general counsel, executive vice president and secretary since
2002. Vice president and deputy general counsel 2000-2002; director and assistant
general counsel 1995-2000. J.D., University of Illinois College of Law; B.S.,
University of Illinois. (PHOTO OF TIMOTHY J. WIGGINS) Timothy J. Wiggins,48, executive vice president and chief financial officer since 2003. Executive
vice president and chief financial officer at Chicago Bridge & Iron Company, N.V. 1996-2001;
various senior positions at Fruehauf Trailer Corporation and Autodie Corporation 1988-1996; senior
manager at Deloitte, Haskins and Sells (now Deloitte & Touche), 1979-1988. Certified Public
Accountant; B.S., Michigan State University. 54




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##### 



Glossary 2G Wireless  Digital wireless networks
that carry voice and low-speed data. 2.5G Wireless  2G wireless networks that can be
upgraded to carry 3G traffic in the future. 3G Wireless  Wireless networks built for
digital voice and high-speed data. Access  Equipment that provides a connection
between end-customer locations and service
provider central offices. ATM
(Asynchronous Transfer Mode)  High - speed
transmission technology. A high-bandwidth,
low-delay, packet-like switching and multiplexing
technique. Backbone  The main high-capacity paths within a
communications network. Bandwidth  The carrying capacity of a communications channel. Broadband  A high-bandwidth fiber optic, coaxial
or hybrid line with more capacity than a standard
voice-grade phone line, capable of carrying
numerous voice, data and video channels at once. Circuit  A connection between two points on a
communications network. Connectivity  Network capability that enables
different devices to communicate with each other. Data  Typically, network traffic other than
voice. Increasingly, voice is encoded and
transported as data. Digital  Digital systems transport information in
the binary 1s and 0s format, like computer code, to
improve clarity and quality. Digital cross-connect system  A specialized
high-speed data channel switch, which connects
transmission paths based on network needs (rather
than call by call). Digital cross-connects manage
and route network traffic, and combine,
consolidate and segregate signals to maximize
efficiency. DSL (Digital Subscriber Line)  A high-speed
Internet connection to a home or business delivered
over copper. Ethernet  A data network standard to connect
computers, printers, workstations, terminals
and servers. Ethernet-over-SDH/Ethernet-over-SONET  Industry
standards that enable Ethernet data traffic to be
easily carried over SDH or SONET networks. Fiber to the Premise, Curb or Neighborhood (FTTx)
 Fiber optic cable deployed directly to homes and
neighborhoods to deliver broadband communications
services. Fiber optic cable  High-capacity cable that
transmits communications along a glass fiber using
laser light. Frame Relay  Data-oriented switching interface
standard that transmits bursts of data over Wide
Area Networks (WANs). Gigabit Ethernet  A high-speed, standardized data
format used to implement wide area data networks. HDTV (High Definition TeleVision)  A television
standard that delivers better quality picture and
sound. Internet  The worlds largest
decentralized network of computers and
network servers. Intranet  A private computer network based on Internet protocols. IP (Internet protocol)  Common name given to a
set of rules that enable cooperating computers to
share information across a network. IPTV (Internet Protocol Television)  Technology
that enables video and other entertainment
services over two-way broadband networks. MultiProtocol Label Switching (MPLS)  A packet
switching standard that assigns multiple traffic
types within a data stream levels of priority to
implement Quality of Service (QoS). Multiservice or Multi-service  Transportation
of a variety of communications services at once
(e.g., ATM, Ethernet or IP). Network  A system of equipment and
connections for the transmission of signals
that carry voice, data and/or video. Optical Network Terminal (ONT)  A device
that closes an optical circuit at a residence,
business or neighborhood. Optical transmission  A technology that
transmits signals as light over fiber optic
cable. Packet  Data organized into a certain format
for transmission over a communications network. Quality of Service (QoS)  Measurement of the
integrity of traffic moving across a network,
especially important for real-time transmissions
such as financial transactions or video services. SDH (Synchronous Digital Hierarchy) 
Transport format for transmitting high-speed
digital information over fiber optic facilities
outside of North America, comparable to SONET. Service Level Agreement (SLA)  An agreement
between an end user and a service provider that
establishes metrics for Quality of Service (QoS)
and measures the service provided to ensure the
agreement is met. SONET (Synchronous Optical NETwork)  Transport
format for sending high-speed digital signals
through fiber optics in North America, comparable
to SDH. Switch  A device that establishes and routes
communications paths. Transport  The process of moving voice, data or
video across communications networks. VPN (Virtual Private Network)  A connection
that enables businesses to securely transmit
their own voice, data and/or video traffic over
a public network (e.g., owned by a phone
company or Internet service provider) at a
lower cost than a dedicated private network. VoD (Video on Demand)  A service that enables
end users to watch any video program at any time. VoIP (Voice over Internet Protocol)  The
transmission of voice traffic over data or
Internet links. Voice-quality enhancement  A technique that
isolates and filters out unwanted signals and
sounds such as echo and background noise to
improve sound quality. Wireless  Mobile networks that use radio rather than cables. Wireline  Networks that use cables rather than radio. TELLABS 2004 ANNUAL REPORT /
55




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##### 



Information for Our Investors Ownership
Structure and
Investor Rights
Stockholder class and voting
rights: All Tellabs stockholders
are entitled to one vote for
each share held. Only
stockholders of record as of
Feb. 22, 2005, the record date
for the annual meeting
determined by the board of
directors, are entitled to
receive notice of, to attend and
to vote at the annual meeting. Votes cast in person or by
proxy at the annual meeting of
stockholders will be tabulated
by the inspectors of election
appointed for the meeting who
determine whether a quorum, a
majority of the shares entitled
to be voted, is present. Stockholders Owning More than
5% of the Companys shares:
AXA Financial, Inc.
Michael J. Birck Stockholder
Logistics
If you have a question for the
board of directors, would like
to make a stockholder proposal
or nominate a director for the
board, contact Jim Sheehan,
Tellabs general counsel,
executive vice president and
secretary at +1.630.798.8800. For inclusion in the Companys proxy statement for the Tellabs 2006 Annual Meeting of Stockholders,
proposals of stockholders must be received by Jim Sheehan, Secretary of the Company, no later than
Nov. 19, 2005. To nominate one or more directors for consideration at the 2006 annual meeting, a stockholder must
provide notice of the intent to make such nomination(s) by personal delivery or by mail to the
Secretary of the Company, no later than Nov. 19, 2005. The Companys bylaws set specific
requirements that such written notice must satisfy. Copies of those requirements will be sent to
any stockholder upon written request. Code
of Ethics, Certificate of Incorporation and Bylaws
Tellabs adopted a code of ethics applicable to its officers, directors and employees. Tellabs
Integrity Policy, certificate of incorporation and bylaws are available online at
tellabs.com/investors. Important
Dates for Stockholders
(Dates subject to change) First
Quarter 2005
Record Date: Tuesday, February
22 Earnings Call: Wednesday,
April 20 (7:30 a.m. Central time)
Annual Meeting: Thursday,
April 21 Second
Quarter 2005
Earnings Call: Tuesday,
July 26 (7:30 a.m. Central
time) Third
Quarter 2005
Earnings Call: Tuesday, October
25 (7:30 a.m. Central time) Were
Here to Help You
You can contact Tom Scottino
in Investor Relations at
+1.630.798.3602. You also can
get investor information
online at
tellabs.com/investors. Transfer
Agent
Computershare Investor Services
serves as the stock transfer
agent for Tellabs. If you need
to transfer stock, change
ownership, report lost or
stolen certificates, or change
your address, please contact
Computershare Investor Services
at +1.312.360.5389. Common Stock Market Data 2004
    
    
    2003High
    
    
    
    Low
    
    
    
    High
    
    
    
    LowFirst Quarter
    
    
    11.37
    
    
    
    8.05
    
    
    
    9.73
    
    
    
    5.07Second Quarter
    
    
    10.02
    
    
    
    7.63
    
    
    
    8.74
    
    
    
    5.26Third Quarter
    
    
    10.32
    
    
    
    7.40
    
    
    
    8.28
    
    
    
    5.85Fourth Quarter
    
    
    9.59
    
    
    
    7.87
    
    
    
    8.80
    
    
    
    6.77
 56




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##### 



Requests
for Information
Additional information is
available without charge. For
additional copies of annual
reports, 10-Ks, 10-Qs or other
financial information, please
contact:  
 Stock
Trading Information
Tellabs stock is traded in the
United States, listed on the
NASDAQ Stock Market under the
symbol TLAB. It appears in most
daily newspaper stock tables as
Tellabs. Tellabs is a component
of the NASDAQ-100 Index and the
Standard & Poors 500 Index. Trademarks
All trademarked, servicemarked
or registered trademark product
names used herein are the
property of Tellabs or one of
its affiliates in the United
States and/or in other
countries. All other product or
company names used herein may be
the property of their respective
companies. Annual
Meeting
The 2005 Annual Meeting of
Stockholders will be held at 2
p.m. Central time on Thursday,
April 21, 2005, at: The Signature Room at
Seven Bridges
6440 Double Eagle Drive
Woodridge, III. 60517
U.S.A. Doors will open at 1 p.m. Internet users can hear a
simultaneous live webcast of
the annual meeting at
tellabs.com. Electronic
Voting
As an added convenience,
stockholders can vote their
proxy by mail or via the
Internet at proxyvote.com. Independent
Registered
Public Accounting Firm
Ernst & Young LLP,
Chicago, Illinois U.S.A. The
Tellabs Foundation
The Tellabs Foundation supports
nonprofit organizations in the
priority areas of education,
environment and health. For an
annual report on corporate and
foundation community activities,
contact Meredith Hilt at
meredith.hilt@tellabs.com. Worldwide
Locations
Please visit tellabs.com and see
the Tellabs Locations section
for the most up-to-date,
complete information on Tellabs
global presence. The Contact
Us page also provides easy
access to the right people. For Information:
In Asia Pacific
Phone: +65.6336.7611
Fax: +65.6336.7622 In Europe, Middle East
and Africa Phone: +44.870.238.4700
Fax: +44.870.238.4851 In Latin America and Caribbean
Phone: +1.954.839.2800
Fax: +1.954.839.2828 In North America
Phone: +1.630.798.8800
Fax: +1.630.798.2000 How to Reach Us
One Tellabs Center
1415 West Diehl Road
Naperville, IL 60563 U.S.A.
Phone: +1.630.798.8800
Fax: +1.630.798.2000
tellabs.com (LOGO)
    
    Report printed entirely on recycled paper. This
report costs $1.60 per copy, less than half the cost
of the average annual report.
(C)2005 Tellabs, Inc. All rights reserved. Printed in U.S.A.
 On the back cover: Tellabs
FiberDirect solution gives Gary
Good and Dean
Hawkins blazing speed that
provides their edge in online
gaming. TELLABS 2004 ANNUAL REPORT




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(IMAGE)