**Exhibit 13**
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TELLABS PROFILE

 

Tellabs works withcommunications service providers worldwide to advancethe networks that bring the Internet to you.Our broadband solutions make theInternet instant, intelligent and indispensable. Tellabs (NASDAQ: TLAB) is part of the NASDAQ-100 Index and theS&P 500. www.tellabs.com

 

Wherethe growth is.

 

**TechnologyAdoption by U.S. Households**

*In millions*

 

 

(Source: TheState of Consumers and Technology: Benchmark 2005, Forrester Research, Inc.,July 2005)

 

*Growing demand for mobile and broadband Internet services is driving**telecom service providers to advance theirnetworks with Tellabs solutions.*

 

CONTENTS
| ** ** | ** **                                                                   | ** ** |
|------------|------------------------------------------------------------------------------|------------|
| **1**      | **Financial  Highlights**                                                    |       |
|       |                                                                         |       |
| **2**      | **Letter to  Stockholders From President and CEO Krish Prabhu**              |       |
|       |                                                                         |       |
| **5**      | **President  and CEO Krish Prabhu Answers Investors’ Questions**        |       |
|       |                                                                         |       |
| **6**      | **Tellabs  Makes the Internet Instant, Intelligent and Indispensable**       |       |
|       |                                                                         |       |
| **14**     | **Tellabs  Solutions and Applications**                                      |       |
|       |                                                                         |       |
| **16**     | **Management’s  Discussion and Analysis**                               |       |
|       |                                                                         |       |
| **26**     | **Reports  of Management and Independent Registered Public Accounting Firm** |       |
|       |                                                                         |       |
| **28**     | **Consolidated  Financial Statements**                                       |       |
|       |                                                                         |       |
| **32**     | **Notes to  Consolidated Financial Statements**                              |       |
|       |                                                                         |       |
| **50**     | **11-years  Summary of Selected Financial Data**                             |       |
|       |                                                                         |       |
| **52**     | **Directors**                                                                |       |
|       |                                                                         |       |
| **54**     | **Officers**                                                                 |       |
|       |                                                                         |       |
| **56**     | **Glossary**                                                                 |       |
|       |                                                                         |       |
| **58**     | **Investor  Information**                                                    |       |

 

On the cover: The growingpopularity of handheld devices spurs telecom service providers to advance theirnetworks so that you can more quickly download Internet content such aspodcasts — including Tellabs’ investor conference calls.

 

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FINANCIALHIGHLIGHTS

 

Tellabsfiscal years ended December 30, 2005, and December 31, 2004.

 
| **(In millions, except per-share and employee data)**   | ** ** | **2005**   | ** ** | **2004** | ** ** | **Change** | ** ** |
|---------------------------------------------------------|------------|------------|------------|----------|------------|------------|------------|
|                                                    | ** ** | ** ** |       |     |       |       |       |
| Revenue                                                 | ** ** | **$**      | **1,883**  |     | $          | 1,232      |       | 53 | % |
| Gross profit                                            | ** ** | **$**      | **855**    |     | $          | 657        |       | 30 | % |
| Operating  earnings (loss)                              | ** ** | **$**      | **189**    |     | $          | (32        | )          | N/M |   |
| Earnings  (loss) before income taxes                    | ** ** | **$**      | **213**    |     | $          | (10        | )          | N/M |   |
| Net earnings  (loss)                                    | ** ** | **$**      | **176**    |     | $          | (30        | )          | N/M |   |
| Earnings  (loss) per share                              | ** ** | **$**      | **0.39**   |     | $          | (0.07      | )          | N/M |   |
| Total cash,  cash equivalents and marketable securities | ** ** | **$**      | **1,190**  |     | $          | 1,116      |       | 7 | % |
| Total assets                                            | ** ** | **$**      | **3,515**  |     | $          | 3,545      |       | -1 | % |
| Total  liabilities                                      | ** ** | **$**      | **700**    |     | $          | 748        |       | -6 | % |
| Stockholders’  equity                              | ** ** | **$**      | **2,815**  |     | $          | 2,797      |       | 1 | % |
| Net cash  provided by operating activities              | ** ** | **$**      | **258**    |     | $          | 215        |       | 20 | % |
| Working  capital                                        | ** ** | **$**      | **1,348**  |     | $          | 1,299      |       | 4 | % |
| Research and  development expense                       | ** ** | **$**      | **344**    |     | $          | 250        |       | 37 | % |
| Return on  average stockholders’ equity            | ** ** | **6.3**    | **%**      | -1.2     | %          | N/M        |       |
| Weighted  average shares outstanding                    | ** ** | **455**    | ** ** | 420      |       | 8          | %          |
| Number of  employees at year-end                        | ** ** | **3,609**  | ** ** | 4,125    |       | -13        | %          |
| Total  stockholder return                               | ** ** | **27**     | **%**      | 2        | %          | N/M        |       |
|                                                    | ** ** | ** ** |       |     |       |       |       |
| N/M = Not  meaningful                                   |       |       |       |     |       |       |       |

 

**2005 TotalStockholder Return**

*%, as ofDecember 30, 2005*

 

 

*Tellabs’2005 total return to stockholders exceeded competitors’.*

 

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**Tellabsgrows as we make the Internet more instant, intelligent and indispensable.**

 

**DearStockholders, Customers and Employees,**

 

**As I writethis, the Internet is hard at work informing, entertaining and connecting some1 billion people****around the world.**It is being used to watch videos, listen to music, share photos, stayabreast of breaking news andmuch, much more. But after 37 years, the Internet is rapidly approaching middleage. To truly unleash itspotential, the Internet needs an upgrade.

 

For starters, it’s too slow.You may have noticed that whenyou download music or a movie, you wait. And wait. And wait some more.

 

It doesn’t have to be thatway. Today in Keller, Texas,consumers don’t wait for the Internet. It’sinstant. Using Tellabs’ fiber-access technology,Verizon delivers the Internet at speeds up to 30 Mbps (megabits per second). At that speed, you candownload a two-hour, DVD-quality movie in about the time it takes to pop some popcorn and dim thelights — never mind making the trip to the video store.

 

Verizon hasextended fiber access to 3 million homes in New York, Florida, Virginia, Texasand other states, and plans to reach an additional 3 million homes in 2006.BellSouth uses Tellabs’ fiber-access technology to bring the instant Internetto 1.2 million homes in its territory. But fiber access does more than justenable people to surf the Internet at incredible speeds — it also empowersservice providers to deliver a fully integrated package of digital voice andvideo services.

 

Tellabs’ new ROADM (reconfigurable optical add/dropmultiplexer) technology helps make this possible.Residing deep in the heart of the Internet,ROADM adds bandwidth as needed to keep up with demand. If there is a sudden spike in Internettraffic, service providers are able to meet it instantly, without affecting the quality of their services.

 

Here’s another challengewith the Internet: It’s not intelligent. Today, the Internet has no way ofknowing that your phone call isurgent, but the spam sent to your inbox is not. Again, it doesn’t have to be thatway. By using Tellabs’ data technology, your Internet can become intelligent.It can know that live calls andvideoconferences must get through now, while e-mails can wait until later. Inthe future, the intelligent Internetwill even personalize your services, giving you exactly what you want, the wayyou want it, when you want it.

 

Let me offer a thirdchallenge with the Internet: It is not portable at the speeds you need. Eventhough more than 2 billionpeople carry mobile phones and handheld devicestoday, only a small fraction ofthem use mobile Internet access. And most of them only do so at dial-up speeds.I’ll say it again: It doesn’thave to be that way. As new 3G and 4G wireless networks roll out with Tellabs’transport and data technologies,your mobile phone will be able to access the Internet at vastly higher speeds.By combining speed with mobility, Tellabs makes the Internet indispensable.

 

**TheInternet’s challenges are Tellabs’ growth opportunities.**The fact that today’s consumers aren’t satisfiedwith yesterday’s Internet is a tremendous opportunity for Tellabs. We provide the technology to

 

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| upgrade the Internet and  enhance the communications  networks that deliver it. And we are working with service providers around the world to do exactly that. Our goal is to  deliver an Internet that is  instant, intelligent and indispensable  — one that is much better suited  for today’s users. That’s what customers want. That’s where the growth is. And that’s where Tellabs is making its mark.

 

**Tellabs’  2005 revenue grew 53%, driven**  **by customer demand.**We grew faster than the overall telecom equipment market by  executing well against our  three key growth strategies: 

 

*to  expand into adjacent markets, to energize our transport business and to  enlarge our presence in data.* |                                                          |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | **Krish  Prabhu,**President  and Chief Executive Officer |

 

**Tellabs nowleads the U.S. fiber-access market.**Our strategic acquisition of AFC in November 2004 propelled Tellabs to first place in the U.S.fiber-access market. As we integrated AFC over the past year, we strengthened our relationships with keycustomers. In the process, we achieved four quarters of access revenues that each exceeded AFC’s best-everquarter as a stand-alone company. For 2005, Tellabs’ access revenue grew 29%, compared with the 2004access revenues of AFC and Tellabs combined.

 

With the AFC acquisition,Tellabs inherited a major challenge: AFC was losing money on its opticalnetwork terminals (ONTs),devices that deliver video, high-speed Internet and phone services to homes.We addressed this challenge in December2004 when we acquired Vinci Systems and its ONT technology. A year later, margins are improving, andTellabs has shipped hundreds of thousands of ONTs. We have turned a challenge into an opportunity.

 

Our future growth in fiberaccess will be driven by demand from service providers gearing up todeliver the “triple-play” of voice, data andvideo services. We are perfectly positioned to seize this opportunity. Bandwidth is the key, and ournew fiber-access systems will be capable of delivering data to homes at speeds of up to 100 Mbps, morethan triple the highest speeds available today.

 

**Wirelesscustomers drove growth in transport.**More than one-third of the world’s wireless calls flow through networks owned by Tellabs customers.Our 2005 transport revenue was the highest in four years, and more than half of that came from wirelesscustomers.

 

To ensure that we continueto grow with this key market, we constantly reinvent our flagship Tellabs® 5500 digital cross-connect system. Recently, we introduced a number ofnew features for our wireless customersthat handle data, enable emergency calls and improve voice quality. Sales ofthe Tellabs® 5500 system grew 10% in 2005. As ourcustomers migrate to new 3G wireless services like mobile video and Internet, their transport networks willneed to double or triple in capacity over the next few years. That’s another opportunity for us, one thatwill drive further growth in our transport business.

 

In international markets, weare focused on enabling wireless customers’ migration to 3G services.

 

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One key to 3G is the Tellabs® 8600 managed edgesystem, deployed by Vodafone Hungary and Vodacom South Africa. Another is the new Tellabs® 6325 edge node, theworld’s smallest fully featured Multiservice Provisioning Platform (MSPP), which is rapidly winning acceptance amongwireless operators worldwide.

 

**Datarevenue more than tripled to $60 million.**Tellabs entered the data market in 2003through the Vivace acquisition.Since then, we have added internal research and development resources to betteraddress the needs of this importantmarket. Last year saw strong progress as we extended our data deployments into the realm of wireless andcable TV. Today, we serve data customers and networks in Europe, Asia, Australia, Africa and NorthAmerica. The key to our growth is the Tellabs® MultiservicePLuSSM solution,which helps service providers deliver a more intelligent Internet.

 

**Tellabsinvestors earned a 27% total return in 2005.**Tellabs’ stock outperformed most others inour sector. That performancereflected our strong focus on fundamentals. One is organic revenue growth,which compares Tellabs 2005 revenuewith the full 2004 revenues of Tellabs, AFC and Vinci Systems. By that measure, Tellabs revenue grew 13%year over year.

 

We anticipate that ourrevenue momentum will continue in 2006. To improve operating income, we will remainfocused on growing revenue, increasing gross margins and holding the line onoperating expenses.

 

I am confidentthat Tellabs has the right strategy, the right technology and the right peopleto grow with our customers in the years ahead. Our confidence is reflected intwo share repurchase plans authorized by our board of directors. Under a $300million buyback plan announced early in 2005, Tellabs invested $193 millionduring the year to repurchase 24.4 million shares, or about 5.4% of sharesoutstanding. In January 2006, the board authorized an additional $100 millionshare repurchase plan.

 

Above all, oursteady progress in 2005 and the strong potential that exists for our businessin 2006 and beyond is a reflection of our employees. I want to thank them fortheir hard work, their dedication and their commitment to make the Internetinstant, intelligent and indispensable. Their talents make a real differencefor service providers, consumers and businesses around the world. We value andappreciate their contributions.

 

Sincerely,

 

 

**KrishPrabhu**

President and CEO

 

February 27, 2006

 

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Tellabs President and CEOKrish Prabhu answers investors’ questions.

 

**Q. Wherewill future growth come from?**

 

A. People around the worldare placing new demandson,and expecting new services from, the Internet. So service providers have begun a new cycle of capital spending on network upgrades to meettheir customers’ demands. Whilethe growth of the Internet benefitsthe telecom industry, it especially benefits Tellabs. That’s because our solutions fit the problems that service providers need to fix at theInternet’s “choke points.”

 

For example, today you candownload TV showstowatch on a PC or mobile phone. But even with broadband connections such as DSL or cable modems, many downloads take too long,sometimes twice as long as theTV show itself. Tellabs enables serviceproviders to make such downloads quicker, so that a two-hour, DVD-quality movie downloads in just a few minutes. Tellabs enablesservice providers to deliver:

 

• the instant Internet, with Tellabs’fiber-access and transportsolutions to provide more bandwidthand speed to the home

 

• the intelligent Internet, with Tellabs’ datasolutions to assure the capacity,quality and reliability neededfor live video and phone calls

 

• the indispensable Internet, with Tellabs’transport and data solutions to provide mobility at high speed through new 3G technology.

** **

**Q. What progresshas tellabs made in data?**

 

A. Tellabs entered themultiservice data market in2003through the acquisition of Vivace and the launch of internal developments. In 2004, we generated $17 million in data revenue.Revenue more than tripled to $60million in 2005, so we are onthe right path. Today Tellabs’ data solutions power wireline, wireless and cable TV networks on five continents.

 

To further grow data revenuein 2006, we aredevelopingstandard feature sets that support serviceproviders’ needs to deliver new services a round the world. Service providers choose the Tellabs® MultiservicePLuSSM and Tellabs®IntegratedMobileSM solutionsfor a variety of applications,including:

 

• delivery of business data services such asEthernet

 

• delivery of new 3G wireless services 

 

• convergence of existing and new datanetworks

 

• convergence of mobile and fixed networks

 

• “triple-play” services for consumers, which delivervoice, data and video to phones, PCs and TVs.

 

**Q. As thetelecom equipment industry consolidates, will Tellabs do another acquisition?**

 

A. When there’s a goodopportunity to create valueforcustomers and stockholders, Tellabs will be an acquirer. In considering acquisitions we are most selective.

 

Two types of acquisitionsmake sense for Tellabs,andwe did one of each type in late 2004. A large acquisition can transform the overall business and add to its growth potential by enablingTellabs to better meet customerneeds, as AFC did. A small acquisitioncan fill a technology gap and speed our time to market, as Vinci Systems’ ONT technology did.

 

Now, AFC and Vinci have beensuccessfullyintegratedinto Tellabs. Together they have propelled Tellabs to a leading position in U.S. fiber access, creating new opportunities for Tellabs togrow where customers are focusingtheir current spending.

 

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**Tellabsmakes the Internet more instant, intelligent and indispensable**

 

The Internet informs,entertains and connects 1 billion people worldwide, but today consumers expecteven more. Increasingly, theywant an Internet that’s instant, intelligent and indispensable.

 

That’s especially true forthe Echo Boomers, the children of the Baby Boomers born between the early1980s and mid-1990s. Some 250million Echo Boomers around the world are reshaping the face of the Internet. The Echo Boomers grew up with theInternet at their fingertips, cable TV at home and mobile phones in their pockets. Sophisticated anddemanding users, more than half of U.S. Echo Boomers create digital content and upload it to theInternet.

 

To meetconsumers’ expectations, communications service providers have begun a newcycle of network upgrades. They are investing to fix specific Internetbottlenecks, all of which represent growth opportunities for Tellabs. That putsTellabs where the growth is.

 
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**The instantInternet is growing**

 

Internet trafficin North America and Europe doubled last year, and that growth will accelerateas more video comes through the Internet. Although many consumers use broadbandInternet access, the problem is: When it’s time to download a TV show, it’sagonizingly slow. Slow speeds stem from capacity constraints, both in theconnection to the home and in service provider networks. The Tellabs®DynamicHomeSMsolution breaks those bottlenecks to deliver the instant Internet.

 

**Tellabs’fiber access delivers the instant Internet**

 

Tellabs powers a new Verizonnetwork called FiOS, which reaches 3 million U.S. homes in New York,Massachusetts, Virginia, Texas, Florida andother states. The Tellabs® 1000fiber-to-the-premises (FTTP) systemconnects a fiber-optic cable directly to the home — delivering hundreds of TVchannels, phone service andInternet access at speeds up to 30 Mbps, the fastest speed available for U.S.homes today. In Verizon’s firstmarket for video services, Keller, Texas, 20% of households subscribed toVerizon video services in thefirst few months.

 

BellSouth uses Tellabs® 1100 fiber-to-the-curb(FTTC) systems. In FTTC, fiber reaches within 500 feet of homes, with copper making the finalconnection to homes. BellSouth’s FTTC network reaches 1.2 million homes with phone and Internet services. In2006, BellSouth plans to test video services over FTTC.

 

The Tellabs® 1300 fiber-to-the-node(FTTN) system extends fiber to within 5,000 feet of homes.

 

Tellabs now leads the NorthAmerican market for fiber access, according to industry analysts. In 2006,we will introduce new technologythat triples fiber-access speeds to 100 Mbps. New optical network terminals (ONTs) will deliver FTTP tomultiple-tenant buildings.

 

**New ROADMtechnology enables the instant Internet**

 

During 2005, the Tellabs® 7100 optical transportsystem proved instrumental when a major service provider needed to reroute traffic around hurricane-strickenfacilities.

 

In late 2005, Tellabsincorporated a new technology called ROADM (reconfigurable optical add/dropmultiplexer) into the Tellabs® 7100 system. ROADMinstantly adds capacity when and where it’s needed. A large U.S. service provider has selected Tellabs to provide this added capacity to enable the instant Internet.

 
| **Fiber  access delivers the instant Internet**                                                                                                    |
|----------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                         |
|                                                                                                                                                    |
|                                                                                                                                               |
| *Tellabs  offers three choices in fiber access, FTTP, FTTC and FTTN, to fit customers’  needs for delivering voice, data and video services.* |

 

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**Theintelligent Internet is growing**

 

Once, the Internet carried atrickle of e-mail and Web pages. Now, with a surging torrent of musicdownloads,business data,videoconferences, voice calls, TV shows and movies, the Internet needs moreintelligence:

 

• to sort through traffic, prioritize it alland send live traffic first

 

• to assure high-quality, reliable connectionsfor phone calls and video

 

• to enable disparate data formats to worktogether well.

 

The Tellabs® MultiservicePLuSSM solutionadds these capabilities to make the Internet intelligent. Telstra, the largest service provider inAustralia, is among the service providers who have chosen this solution for their networks.

 

**Businessesdepend on the intelligent Internet**

 

Businesses use different,disparate data services called Frame Relay, Asynchronous Transfer Mode(ATM) and Ethernet. Uniquely, the Tellabs® MultiservicePLuSSM solutionenables all of these services to workwell together. Using this capability, Tellabs’ customers have combined as manyas three separate data networksinto a single network, lowering costs.

 

Ethernet is thefastest-growing data service, but it’s not known for reliability. Tellabs® AssuredEthernetSMsolution elevates Ethernet reliabilitywith the highest Quality of Service (QoS) available. Tellabs is among the first companies certified by the MetroEthernet Forum for “carrier-grade” Ethernet. To address specific Ethernet needs, customers choose from a widerange of transport and managed access products designed for use around the world.

 

As conventional phone callsevolve into voice over InternetProtocol (VoIP) calls, a large U.S. service provider is deploying theTellabs® MultiservicePLuSSM solutionto assure the quality and reliability that its customers expect.

 

Businessescannot afford service interruptions. Tellabs’ customers need to providebusinesses with notice of planned service interruptions well in advance. Toreduce such needs, we introduced Tellabs® ServiceAssuredSMupgrades,an innovative feature that keeps service on even during a software upgrade.

 

**Theintelligent Internet delivers the consumer “triple play”**

 

Serviceproviders are preparing to deliver the “triple play” of voice, video and dataservices to homes. The same intelligence that assure s reliable business dataservices is built into the Tellabs® DynamicHomeSMsolution,so that consumers see and hear the quality they expect on their TVs, PCs andphones.

 
| **Global  businesses use a mix of**  **traditional and new data services**  *$ in billions*                       |
|----------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                       |
|                                                                                                                                  |   |
|                                                                                                                             |
| (Source: Gartner Dataquest  – Worldwide Fixed  Telecom  Market Retail Data Services Revenue 2003-2009; July 2005) |
|                                                                                                                             |
| *Tellabs  enables traditional and*  *new data services to work*  *together through the  intelligent*  *Internet.* |

 

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**TheInternet is growing indispensable**

 

Consumers want to use theInternet every where. Worldwide, more than 2 billion people carry mobilephones, but few use a mobileInternet service. Why? It’s too slow.

 

That’s why mobile serviceproviders are migrating to new 3G networks and expanding their transportnetworks to deliver Internet andvideo services to subscribers. At the same time, providers need to optimize transportcosts, which can amount to a third of their overall costs. Tellabs meets thesechallenges to make the mobileInternet indispensable.

 

**Tellabstransport and data solutions deliver the mobile Internet**

 

More thanone-third of the world’s wireless calls are made on networks owned by Tellabs’customers. Now, new wireless devices retrieve and send e-mail, surf the Web,play music and games, take photos and videos, and display live or recorded TVshows. These new mobile applications drive explosive demand for bandwidth inmobile service providers’ radio transport networks. While a typical 2G cellsite transports 6 to 7 Mbps of traffic, new 3G sites will double and eventuallytriple that volume of traffic.

 

In 2005, more than half ofTellabs’ transport revenue came from wireless service providers. Usingthe Tellabs® IntegratedMobileSM solution,wireless providers are rolling out new services faster and more cost-effectively:

 

• Vodafone Hungary and Vodacom South Africachose the Tellabs® 8600managed edge system with theTellabs® 8000network manager to upgrade to 3G technology.

 

• U.S. customers’ demand for T-1 data-lineequivalents on Tellabs® 5500digital cross-connects increased15% in 2005. New wireless features handle data, enable emergency 911 mobilecalls and improve voice quality.

 

**Tellabsmakes the mobile Internet more efficient**

 

In 2006, we are introducingnew ways to improve wirelesstransport networks:

 

• In North America, the Tellabs® 8800 multiservice routerseries will handle a mix of mobile services in new 3G switching offices, working hand in hand with the Tellabs® 5500 system.

 

• Outside North America, we introduced the newTellabs® 6325 edge node, the world’s smallest fully featuredMultiservice Provisioning Platform (MSPP). It enables operators such as GoldenTelecom of Ukraine to simplify networks and speed new service launches.

 
| **Data and  video drive growth in 3G wireless**

*$ in  billions*                                                                 |
|----------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                   | ** ** |
|                                                                                                                                        |   |
|                                                                                                                                   |   |
| (Source: Gartner Dataquest  – “Forecast: Mobile Services, Worldwide,  2000-2009.” Tole Hart, et al. Oct. 10, 2005) |
|                                                                                                                                   |   |
| *New 3G  wireless networks add data and video*  *traffic to voice, making  the mobile Internet*  *indispensable.*            |

 

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Tellabs Solutions andApplications 

 
| **WHAT END USERS WANT**                                                     | ** **                                                                                                                                           | **SOLUTIONS**                                                                                                                                                                                     | ** ** | **BENEFITS FOR  SERVICE PROVIDERS**                                                           | ** ** |
|-----------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                                                                  | ** **                                                                                                                                           | ** **                                                                                                                                                                                        | ** ** | ** **                                                                                    | ** ** |
| Video on demand   Interactive gaming   Music downloads                      | ** **                                                                                                                                           | **Tellabs**® **DynamicHome**SM solution enables superior  service delivery with unsurpassed flexibility and delivery guarantees.                                                   |       | •  Quality guarantees for delivery of high-quality video, voice and data services.       |       |
|                                                                        | •  Fast migration to new Video on Demand (VoD), Internet Protocol Television  (IPTV) and High-Definition Television (HDTV) services.            |                                                                                                                                                                                              |
|                                                                        |                                                                                                                                                 |                                                                                                                                                                                              |       |                                                                                          |       |
| Video on demand   Interactive gaming   Mobile Internet   Music downloads    | ** **                                                                                                                                           | **Tellabs**® **Integrated Mobile**SM solutions  enable wireless operators to migrate from 2G networks to 2.5G, 3G and beyond without  the expense of multiple technology overlays. |       | •  Future - proof solutions for today’s mobile service and beyond.                  |       |
|                                                                        | •  Minimize total cost of ownership through network convergence.                                                                                |                                                                                                                                                                                              |
|                                                                        | •  Enable mobile operators to converge on a packet-based network.                                                                               |                                                                                                                                                                                              |
|                                                                        |                                                                                                                                                 |                                                                                                                                                                                              |       |                                                                                          |       |
| Service compatibility   Reliable data   IP Virtual Private   Networks (VPN) | ** **                                                                                                                                           | **Tellabs**® **MultiservicePLuS**SM solution  enables service providers to combine current ATM and Frame Relay services with  new Ethernet and IP services on a single platform.   |       | •  Quality guarantees for existing Frame Relay and ATM customers over IP/MPLS  networks. |       |
|                                                                        | •  Enables new Ethernet or IP customers to communicate with existing ATM or Frame  Relay customers with a unique service-interworking function. |                                                                                                                                                                                              |
|                                                                        |                                                                                                                                                 |                                                                                                                                                                                              |       |                                                                                          |       |
| Reliable Ethernet   Faster connections   Delivery guarantees                | ** **                                                                                                                                           | **Tellabs**® **AssuredEthernet**SM solutions  enable the delivery of customized, guaranteed Ethernet services.                                                                     |       | •  Quickly deploy simple, cost-effective Ethernet services.                              |       |
|                                                                        | •  Offers QoS guarantees in an IP/MPLS environment to protect existing Service  Level Agreements (SLAs).                                        |                                                                                                                                                                                              |
|                                                                        | •  Makes Ethernet services successful over any network type to better leverage  existing platforms and technology.                              |                                                                                                                                                                                              |
|                                                                        |                                                                                                                                                 |                                                                                                                                                                                              |       |                                                                                          |       |
| Fast service turn-up   New 3G services   High availability                  | ** **                                                                                                                                           | **Tellabs  Global Services**advanced solutions** **optimize today’s networks and seamlessly  migrate to advanced networks.                                                    | ** ** | •  Increase revenues.                                                                    |       |
|                                                                        | •  Reduce costs.                                                                                                                                |                                                                                                                                                                                              |
|                                                                        | •  Reduce network complexity.                                                                                                                   |                                                                                                                                                                                              |
|                                                                        | •  Reduce time to market.                                                                                                                       |                                                                                                                                                                                              |
|                                                                        | • Improve  network resilience and reliability.                                                                                                  |                                                                                                                                                                                              |
|                                                                        | •  Reduce risk.                                                                                                                                 |                                                                                                                                                                                              |
|                                                                        |                                                                                                                                                 |                                                                                                                                                                                              |       |                                                                                          |       |
|                                                                             |                                                                                                                                                 |

 

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| **EXAMPLES OF CUSTOMERS**                                                                                                                                                      | ** ** | **TELLABS  PRODUCTS / SERVICES**                           | ** ** | **PRIMARY  COMPETITOR S** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|---------------------------|
| ** **                                                                                                                                                                     | ** ** | ** **                                                 | ** ** | ** **                |
| BellSouth, Charles  Pointe/TelAtlantic,                                                                                                                                        |       | Tellabs® 1000  multiservice access series        |       | Alcatel                   |
| Verizon                                                                                                                                                                        |       | Tellabs® 1100  multiservice access series        |       |                      |
|                                                                                                                                                                           |       | Tellabs® 1300  Ethernet access system            |       |                      |
|                                                                                                                                                                           |       | Tellabs® 1600  optical network terminal series   |       |                      |
|                                                                                                                                                                           |       | Tellabs® 7100  optical transport system          |       |                      |
|                                                                                                                                                                           |       | Tellabs® 8800  multiservice router series        |       |                      |
|                                                                                                                                                                           |       |                                                       |       |                      |
| Beijing Zhengtong, China  Mobile,  China Unicom, Cingular, Ericsson,  Golden Telecom, Nokia, TeliaSonera, T-Mobile,  Verizon Wireless, Vodafone Hungary,  Vodacom South Africa |       | Tellabs® 3000  voice-quality enhancement systems |       | Alcatel,                  |
| Tellabs® 5500  digital cross-connect system                                                                                                                          |       | Lucent,                                                    |
| Tellabs® 6300  managed transport system                                                                                                                              |       | Nortel                                                     |
| Tellabs® 8100  managed access system                                                                                                                                 |       |                                                       |
| Tellabs® 8600  managed edge system                                                                                                                                   |       |                                                       |
| Tellabs® 8800  multiservice router series                                                                                                                            |       |                                                       |
| Tellabs® integrated  voice products                                                                                                                                  |       |                                                       |
|                                                                                                                                                                           |       |                                                       |       |                      |
| Broadwing,   Telstra,   MCI (now Verizon)                                                                                                                                      |       | Tellabs® 8800  multiservice router series        |       | Alcatel                   |
|                                                                                                                                                                           |       |                                                       |       |                      |
| Banverket Telenat, BSNL,  NTT Communications,  Telekom Malaysia,  TeliaSonera                                                                                                  |       | Tellabs® 5500  digital cross-connect system      |       |                      |
| Tellabs® 6300  managed transport system                                                                                                                              | Cisco,     |
| Tellabs® 7100  optical transport system                                                                                                                              | Juniper    |
| Tellabs® 8100  managed access system                                                                                                                                 |       |
| Tellabs® 8800  multiservice router series                                                                                                                            |       |
|                                                                                                                                                                           |       |                                                       |       |                      |
| BSNL, Cingular, CTI,  Eschelon Telecom, Inc., Global Crossing,  J-COM, Movilnet, Telefonica                                                                                    |       | Deployment, professional and  support services;            |       | Cisco,                    |
| Training                                                                                                                                                                       | Juniper,   |
|                                                                                                                                                                           | Lucent     |

 

15

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**Management’sDiscussion and Analysis**

**Introductionand Overview of Business**

 

Tellabs designs, develops,deploys and supportstelecommunicationsnetworking products around the world.Our product portfolio includes solutions for wireline and wireless transport, access networking,broadband data, optical transportand voice-quality enhancement.

 

We generate revenueprincipally through the sale oftelecommunications products, both as stand-alone products and as elements of integratedsystems, to many of the world’slargest telecommunications service providers.In addition, we generate revenue by providing installation and professional services related primarily to our own products and systems.

 

In North America we derivethe majority of our productrevenuefrom transport products, principally digital cross-connect systems that manageand route network traffic andcombine, consolidate and segregate signals to maximize efficiency; and access products that support the delivery of voice, data and video services toresidences and businesses overcopper wire and fiber-optic cable. Demandfor transport products is driven by end-user demand for wireline and wireless services, bandwidth, industry capacity utilization, serviceprovider capital expenditurebudgets and competing technologies. Demand for access products is driven by consumer demand for voice, data and video services and thecompetition among traditionaltelecommunications companies and cable service operators to be the sole source provider of voice, data and video services (referred to as the “tripleplay”). According to industryanalysts, Tellabs has a market-leading position in the U.S. transport and access markets.

 

Outside North America, weearn the majority of ourproductrevenue from managed access and transport systems that control the flow of voice and data across communications networks. Demand is drivenprimarily by business servicesfor voice and high-speed data, and networktransport services for wireless communications. Demand for these products is driven by end-user demand for bandwidth, industry capacity utilization,service provider capitalexpenditure budgets and competing technologies.

 

Globally, we earn servicesrevenue from networkconstruction,support agreements and other professional services. Network construction revenue, which is more than half of services revenue, arisesprimarily from sales of ourtransport products in North America and tends to lag product sales by approximately one fiscalquarter. Revenue from supportagreements arises primarily from sales of our managed access and transport systems, with approximately half coming from outside ofNorth America. Other professionalservices offered by the company include network deployment, traffic management and training.

 

The markets for our productshave undergone dynamicchangeover the last few years. Beginning in 2001, carrier overcapacity, a softening economy and otherfactors caused our customers toreduce their capital spending significantly.The impact on Tellabs was a dramatic decline in revenue for each of the years 2001 through 2003. In addition, we had manufacturingovercapacity, excess inventoriesand a cost structure that could not be supported by our smaller revenue base. We responded by closing manufacturing facilities, reducingglobal headcount, consolidatingoffice space, exiting certain productlines and instituting cost controls across the organization. We also reviewed our product portfolio and cut back or stopped development efforts onsome products. In addition, atthe end of 2003, we moved to outsourcethe majority of our remaining manufacturing operations to third-party electronics manufacturing services providers to take advantage of theirgreater purchasing power andother efficiencies. These actions causedus to record material charges in 2001 through 2005 for excess and obsolete inventory and excess purchase commitments, severance costs,facilities shutdown costs,including accelerated depreciation on certain manufacturing and office buildings and equipment due to shortened useful lives, and variouscontractual obligations. We alsorecorded charges for other impaired and surplus assets.

 

Market stability began in2003 and continued in 2004and2005 as service providers invested in their networks at levels at or above 2003. This stabilityenabled us to post year-over-yearrevenue growth in 2004 for the first time since fiscal 2000. Growing demand for wireless services, including third-generation (3G)services, drove capitalinvestments by both wireless and wireline service providers and helped drive sales of ourtransport and managed accessproducts.

 

Revenue growth wasbroad-based in 2005. Webenefitedfrom increasing wireless and data traffic by selectively enhancing our transport and managed access products with new features. In addition, wecontinued to address new,evolving growth opportunities with our broadband data networking and access products. Our acquisition of Advanced Fibre Communications,Inc. (AFC), was a significantpart of our revenue growth in 2005as its sales grew sequentially each quarter during the year. Additionally, through ouracquisition of Vinci Systems,Inc., (Vinci) and the introduction of its optical network terminal (ONT) product, we weresuccessful at reducing the costof such product to close to breakeven.

 

For 2006, we will continue tofocus on maximizing thesynergiesfrom our integration of AFC and continue to

 

16

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review our spending, assetutilization and productdevelopmentroadmap opportunities to optimize revenue, improve asset utilization and contain spending.

 

**Acquisitions**

 

On December 30, 2004, Tellabsacquired Vinci, aprivatelyheld developer of ONTs for Fiber-to-the-Premises (FTTP) access systems, for up to $52.5 million in cash and Tellabs restricted stock. Of the $52.5million, $34.0 million was paidthrough 2005, with the remainder expectedto be paid in 2006. Acquiring Vinci’s ONT technology enabled us to deliver a more cost-effective fiber-access solution. We accounted for thisacquisition under the purchasemethod and recorded the final adjustmentsto the purchase price in 2005.

 

On November 30, 2004, Tellabsacquired AFC, aleadingsupplier of access products, for approximately $1.6 billion. Under the terms of the acquisition, AFC stockholders received 0.504 shares of Tellabscommon stock and $12.00 in cashfor 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 tosatisfy the cash portion of thepurchase price. As a result of the transaction,at the acquisition date, historical Tellabs stockholders owned approximately 90% of the combined company and historical AFC stockholders owned approximately10%. In conjunction with the acquisition, Frank Ianna, a director of AFC and retired president of AT&T Network Services, joined the Tellabsboard of directors. Our resultsof operations for the fourth-quarter and full-year 2004 include AFC’s results for the one-month period following the acquisition. We reportAFC’s and Vinci’s products in therevenue category called access.We accounted for this acquisition under the purchase method and recorded the final adjustments to the purchase price in 2005.

 

As a result of ouracquisition of AFC, we became partyto a multiyear agreement with Verizon Services Group (Verizon) to be the primary FTTP projectvendor in providing the centraloffice and premises electronics requiredfor the delivery of telephone, data and video services to customers’ homes or business locations over fiber-optic cable. Although we expect theoverall contract to beprofitable, gross margins are below Tellabs’ historical gross margins. One component, the ONT, had been sold substantially below current costthrough the third quarter of2005, when we introduced a new version of the ONT from Vinci with a cost close to breakeven.

 

We have an ongoing program tocontinue to improvetheprofitability of the ONT. We expect product design changes, lower cost versions, component pricereductions and increasedproduction volumes to continue to improve gross margins for the ONT. We expect to continue to sell other components of the FTTP systems at aprofit.

 
| **Quarterly  Revenue**                                                        |
|-------------------------------------------------------------------------------|
| *$ in  millions*                                                         |
| * *                                                                      |
| * *                                                                      |
| * *                                                                      |
| *Tellabs  revenue grew 53% in 2005 as the company returned to profitability.* |

 
| **2005  Revenue Distribution**                                                                                 |
|----------------------------------------------------------------------------------------------------------------|
| *Percent*                                                                                                      |
|                                                                                                           |
|                                                                                                                |
|                                                                                                           |
| *2005 was  Tellabs’ first full year to include access products, which generated 33% of  overall revenue.* |

 

 

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**Results ofOperations**

 

For 2005, we hadnet earnings of $175.8 million ($0.39 per share) compared with a net loss of$29.8 million ($0.07 per share) in 2004 and a net loss of $241.6 million ($0.58per share) in 2003. The year-over-year improvements were driven by higherrevenue and lower operating expenses as a percentage of revenues.

 

*Revenue*

 
| **In millions, except percentages** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | *** *** | **2005 vs.  2004** | ** ** | **2004 vs.  2003** | *** *** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|--------------|--------------------|------------|--------------------|--------------|
| Transport                           |       | $        | 637.9      |     | $          | 597.9    |         | $                  | 419.4      | * *           | *7*          | *%* | *4.3* | *%* |
| Access                              |       | 617.0    |       | 53.3     |       | —   | * *     | *N/M*              | * *   | *N/M*              | * *     |
| Managed Access                      |       | 364.8    |       | 331.0    |       | 336.1    | * *     | *10*               | *%*        | *(2*               | *)%*         |
| Broadband  Data                     |       | 60.3     |       | 17.4     |       | 6.4      | * *     | *N/M*              | * *   | *172*              | *%*          |
| Voice-Quality  Enhancement          |       | 36.3     |       | 74.6     |       | 68.2     | * *     | *(51*              | *)%*       | *9*                | *%*          |
| Services                            |       | 167.1    |       | 157.6    |       | 150.3    | * *     | *6*                | *%*        | *5*                | *%*          |
| Total                               |       | $        | 1,883.4    |     | $          | 1,231.8  |         | $                  | 980.4      | * *           | *53*         | *%* | *26* | *%* |

 

N/M – Not meaningful.

 

Total revenue grew by 53% in2005 compared with a26%increase in 2004 (20% excluding the December 2004 revenue from AFC). Total 2005 revenue was $1,883.4 million compared with $1,231.8million in 2004 and $980.4million in 2003. Revenue in North Americaamounted to $1,419.4 million (75% of total revenue) in 2005 compared with $813.0 million (66% of total revenue) in 2004 and $597.8 million(61% of total revenue) in 2003.International revenue was $464.0million (25% of total revenue) in 2005 compared with $418.8 million (34% of total revenue) in 2004 and $382.6 million (39% of total revenue) in 2003.

 

The increase in transportrevenue in 2005 and 2004camefrom increased spending by North American wireless service providers to meet growing capacity requirements and to build out their networksto provide 3G services. Shipmentsto our North American wireless customersaccounted for approximately 55% of all transport revenue in 2005, compared with 50% in 2004 and 38% in 2003. Approximately 69% of 2005revenue from widebandcross-connect products, which constitute the majority of transport revenue, came from port-card growth on our installed base, with the balanceconsisting of new systems, systemexpansions and software upgrades.This mix compares with 76% in 2004 and 69% in 2003. We shipped approximately 7.3 million T-1 equivalents in 2005 compared with 6.4 millionin 2004 and 3.7 million in 2003.The transport category includes theTellabs® 5300and Tellabs® 5500digital cross-connect systems,Tellabs® 5500NGX transport switch, Tellabs® 6500 transport switch andTellabs® 7100optical transport system.

 

Fiscal 2005 was the firstfull year of revenue fromAFCin our results. The importance of access in our 2005 growth is highlighted by the fact that accessrevenue increased in each quarterof the year. Approximately half thisrevenue was for fiber-to-the-premises and fiber-to the-curb deployments, withmost of the balance coming fromcopper-based access solutions. The access category includes the Tellabs® 1000 multiservice accesssystem, Tellabs® 1100 multiservice accesssystem and Tellabs® 1600 optical networkterminal (ONT) series.

 

The 2005 increase in managedaccess revenuewas dueprimarily to strength in sales of our managed transport systems and managed access systems driven by Ethernet-over-SDH applications and 3Gwireless network build-outs.Revenue for 2004 compared with 2003was relatively flat. The managed access category includes the Tellabs® 8100managed access system, theTellabs® 6300managed transport system and the Tellabs® 2300 telephonydistribution system.

 

Revenue from our broadbanddata products (whichincludesthe Tellabs® 8800multiservice router series and theTellabs® 8600managed edge system) has grown sincewe introduced them in the second half of 2003. We continued to add new customers in 2005, with our customer base now including wireline andwireless service providers aswell as cable TV operators.

 

Voice-Quality Enhancement(VQE) revenue decreasedfrom2004 to 2005. Across the industry, VQE is migrating from a technology that is sold as stand-alone products to a technology that is integratedinto transport, switching andother products. In fact, we have integrated voice-quality capability into our Tellabs® 5500 digital cross-connect system. Therefore, beginning in2006, we will include all VQErevenue in the transport category. The increase in VQE revenue from 2003 to 2004 was attributable to increased spending by wirelessservice

 

18

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providers. The VQE categoryprimarily includes theTellabs® 3000 series of VQEproducts.

 

Services revenue increasedfrom 2004 to 2005 as aresultof higher product sales. Services revenue from 2003 to 2004 was relatively flat as a larger percentage of our 2004 products in North America requiredless installation or wereinstalled by our customers without assistancefrom Tellabs.

 

*Gross Profit & Margin*

 
| **In millions, except percentages** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gross Profit                        |       | $        | 855.0      |     | $          | 657.0    |       | $ | 354.0 |   |
| Gross Margin                        |       | 45.4     | %          | 53.3     | %          | 36.1     | %          |
| Product  Gross Profit               |       | $        | 807.5      |     | $          | 602.1    |       | $ | 317.1 |   |
| Product  Margin                     |       | 47.0     | %          | 56.1     | %          | 38.2     | %          |
| Services  Gross Profit              |       | $        | 47.5       |     | $          | 54.9     |       | $ | 36.9 |   |
| Services  Margin                    |       | 28.4     | %          | 34.8     | %          | 24.6     | %          |

 

*GrossMargin*

 

When we acquired AFC in thefourth quarter of 2004,itsaccess products and related services had average gross margins that were substantially below the average for Tellabs products and services. Althoughthe access product category hadan overall margin below Tellabs averagemargin, one component, the Tellabs 610x ONT (optical network terminal for FTTP applications), had a cost that was substantially in excess of itsselling price. However, beginningin the third quarter of 2005, a portion of our ONT revenue came from shipments of a new ONT, the Tellabs 611 ONT, which has a cost close tobreakeven.

 

Negative margins from salesof ONTs and the inclusionofother access products were the principal drivers of the decrease in our overall gross margin in 2005compared with 2004 (9.2percentage points). The impact was offset partially by higher margins from products in the transport category (2.3 percentage points). During theperiods presented, there werewide variances in our product and servicesgross margins due to a number of unusual items. In 2003 we incurred significant charges for excess and obsolete inventories and excess purchasecommitments that did not recur in2004 and 2005. Our gross margin in 2003 also was burdened by significant additional depreciation charges due to our decision to outsource ourmanufacturing operations andclose facilities. These unusual charges were the key reasons for the differences between our consolidated gross margin of 36.1% in 2003 and the 53.3%gross margin in 2004. Theylikewise account for the difference in product gross margins for those periods.

* *

*ProductGross Margin*

 

Product margins declined from2004 to 2005 primarilydueto the inclusion of the lower margin access products (10.5 percentage points), partially offset bylower manufacturing costs for ourtransport products (2.6 percentage points).Product gross margin improved in 2004 compared with 2003 due to the absence of significant unusual charges (11.7 percentage points), lowermanufacturing-related costs (8.1percentage points) and favorable product mix and other (0.7 percentage points). The inclusion of access product revenue and related costs forone month in 2004 reducedfull-year 2004 product margins by 1.7percentage points compared with 2003.

* *

*ServicesGross Margin*

 

The decrease in servicesgross margin in 2005 comparedwith 2004 was due to the addition of access-product related services in 2005 (8.2 percentagepoints) and higher materialcosts. Services gross margin improved in 2004 compared with 2003 due to labor efficiencies achieved as a result of reduced headcount inour services business. Theinclusion of access services revenue and the related costs for one month in 2004 reduced 2004 services margin by 0.8 percentage pointscompared with 2003.

* *

*GrossMargin Trend*

 

Our total gross margin willcontinue to be subject tovariabilitydue to product mix. Our gross margins are different for each product and services category and for each product within a category because theydepend on specific systemconfigurations sold and customer and geographic pricing differences. Under normal conditions, this variability has tended to affect ourgross margin in the range of 2 to3 percentage points up or down. In addition, since acquiring AFC near the end of 2004, our gross margin from the sale of ONTs reduced ouroverall gross margin. However, wehave been successful in bringing the cost of our ONT to near breakeven by the end of 2005. We will continue our efforts to reduce the costof ONTs through internaldevelopment and cost of parts savings.

 

19

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*Operating Expenses*

 
| ** **                      | ** ** | **Expense** | ** **  | **Percent of Revenue** | ** ** |
|---------------------------------|------------|-------------|-------------|------------------------|------------|
| **In millions**                 | ** ** | **2005**    | ** **  | **2004**               | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Research and development        |       | $           | 344.0       |                   | $          | 250.3 |   | $ | 286.1 |   | 1 8.3 | % | 20.3 | % | 29.2 | % |
| Sales and marketing             |       | 175.5       |        | 155.1                  |       | 143.5 |   | 9.3 | % | 12.6 | % | 14.6 | % |
| General and administrative      |       | 95.6        |        | 81.5                   |       | 99.1 |   | 5.1 | % | 6.6 | % | 10.1 | % |
|                            |       |        |        |                   |       |   |   |   |   |   |   |   |   |
| Subtotal                        |       | 615.1       |        | 486.9                  |       | 528.7 |   | 32.7 | % | 39.5 | % | 53.9 | % |
|                            |       |        |        |                   |       |   |   |   |   |   |   |   |   |
| Intangible asset amortization   |       | 36.0        |        | 17.8                   |       | 12.6 |   |   |   |   |   |   |   |
| Restructuring and other charges |       | 12.9        |        | 14.1                   |       | 77.2 |   |   |   |   |   |   |   |
| Purchased in-process R&D    |       | 2.2         |        | 102.1                  |       | — |   |   |   |   |   |   |   |
| Asset impairment charge         |       | —      |        | 47.2                   |       | — |   |   |   |   |   |   |   |
| Net loss on sale of real estate |       | —      |        | 20.6                   |       | — |   |   |   |   |   |   |   |
| Total Operating Expenses        |       | $           |  666.2 |                   | $          |  688.7 |   | $ |  618.5 |   |   |   |   |   |   |   |
| Headcount at end of year        |       | 3,609       |        | 4,125                  | (1)        | 3,515 |   |   |   |   |   |   |   |
|                                 |            |             |             |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) Includes 1,084 employees at AFC and Vinci who joined Tellabsat the end of 2004.

 

The increase in research anddevelopment, sales andmarketing,and general and administrative expenses from 2004 to 2005 is due primarily to the inclusion of approximately $184.0 million in operatingexpenses from AFC and Vinci for2005 compared with $15.5 million of AFC operating expenses included in 2004. In 2005, we set a target to realize $30.0 million inoperating expense reductions,based on the combined 2004 operating expense of Tellabs, AFC (including entities it acquired in 2004) and Vinci. By year-end, we realizedmore than $50.0 million in totaloperating expense reductions.

 

The total of research anddevelopment, sales andmarketing,and general and administrative expenses decreased from 2003 to 2004 due to lower expenses in headcount-related areas such as benefits,travel and telecommunications aswe reduced our global workforce. Wealso significantly reduced spending on prototypes and incurred lower facilities costs due to closingor vacating a number of owned andleased facilities over the periods. Sales and marketing expense increased in 2004 due to higher commissions and incentives on highersales volume compared with 2003.

* *

*IntangibleAsset Amortization*

 

The increase in amortizationfrom 2003 through 2005 isdueto the amortization of developed technology acquired in our acquisitions of AFC and Vinci in late2004. We adjusted intangibleassets in 2005 for the final allocation of the purchase price of these acquisitions.

 

*Restructuringand Other Charges*

 

Restructuring and othercharges were $12.9 million in2005, $14.1 million in 2004 and $77.2 million in 2003. These charges continue to decrease as ourpreviously announcedrestructuring and other activities wind down. The charges in 2003 relate to outsourcing of our global manufacturing operations, which resulted in aworkforce reduction ofapproximately 500 employees, facility closures and asset disposals. Additional restructuring activities in 2003 included non-manufacturing workforcereductions and facility closures.As a result of these actions, we recordedcharges for severance and related costs, asset impairments and accelerated depreciation due to a change in the useful lives of buildings andequipment because of theoutsourcing of our North American manufacturingoperations.

* *

*PurchasedIn-Process Research and Development*

 

The charge to in-processresearch and developmentexpense(IPR&D) was for the estimated fair value of IPR&D that we acquired when we purchased AFC and Vinci. IPR&D refers to the value oftechnology under development thatdoes not have an alternative use outside of its value within the acquired business. Generally accepted accounting principles requires thatIPR&D be expensed in whole atthe time it is acquired. The value of the IPR&D at AFC was $89.0 million of the total charges and primarily was attributable to developmentof enhanced versions of thecompany’s FTTP products. The remainder was attributable to development of ONTs at Vinci. We determined the estimated fair values of theIPR&D at both AFC and Vinciby using a discounted cash-flow analysis that incorporates estimates of the amounts of costs

 

20

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remaining to complete thedevelopment, the amount ofrevenuethat would result from the fully developed technology and an estimate of risk. The IPR&D amount in 2005 is due to the finalization of thepurchase price allocation forthese two acquisitions.

 

*AssetImpairment Charge*

 

In 2004, we determined thatimpairment indicatorsexistedfor our Tellabs® 5500NGX switch asset group becauseactual and forecasted revenue for that group were lower than expected. We further determined that future undiscounted cash flows would not besufficient to support the totalcarrying value of the asset group. We therefore recorded an impairment charge of $47.2 million to reduce the carrying value of those assets,principally amortizableintangibles, to their fair value. We determined the fair value of the assets by reference to the present value of the cash flows attributable to thoseassets over the remaining life ofthe intangibles, the primary asset in the asset group.

 

*Net Loss onSale of Real Estate*

 

In 2004 we sold anadministrative and research anddevelopment facility in Denmark, which resulted in a loss of approximately $21.1 million.

** **

*Other Income*

 
| **In millions**       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest  income, net |       | $        | 28.3       |     | $          | 26.9     |       | $ | 24.2 |   |
| Other  expense, net   |       | (4.0     | )          | (5.4     | )          | (4.4     | )          |
| Total                 |       | $        | 24.3       |     | $          | 21.5     |       | $ | 19.8 |   |

 

*Otherexpense, net* in 2005 includes $1.8 million of lossesfrom the sale of short-term investments, driven by the repatriation of cash inthe fourth quarter; $4.0 million in income from a long-term investmentpurchased by a publicly traded entity; and a net $4.0 million loss from foreigncurrency transaction gains or losses made up of $19.3 million in gains from theimpact of foreign currency transactions offset by $23.3 million in losses onforward foreign exchange contracts. Other expense, net also includes impairmentcharges to write down the carrying value of certain cost-basis equityinvestments in start-up technology companies and other long-term equity investments.These charges were $4.8 million in 2005, $11.2 million in 2004 and $3.3 millionin 2003. *Other expense, net* in 2004 also includesa $6.6 million foreign currency gain resulting from converting a portion of ouroffshore cash from Euro-denominated investments to investments denominated inU.S. dollars.

 

*Income Taxes*

 
| **In millions, except percentages** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income tax  (expense)benefit        |       | $        | (37.3      | )        | $          | (19.6    | )          | $ | 3.1 |   |
| Effective  income tax rate          |       | 17.5     | %          | 192.2    | %          | (1.3     | )%         |
|                                     |            |          |            |          |            |          |            |  |  |  |

 

Our tax expense increased in2005 to $37.3 million,comparedwith tax expense of $19.6 million in 2004. The increase is due principally to a tax expense of $15.4 million associated with our repatriationof $600 million under theAmerican Jobs Creation Act of 2004(AJCA) and an increase in foreign taxes on higher foreign source income. The increase is offsetby $10.1 million attributable tothe reversal of reserves due tothe expiration of the applicable statute of limitations to a potential claim in a foreign jurisdiction.Our tax expense increased to$19.6 million in 2004 from a benefit of $3.1 million in 2003, due to an increase in foreign taxes on higher foreign source income.

 

Our tax expense for 2003 and2004 was impactedunfavorablyby our inability to record a tax benefit for all or a portion of the domestic and foreign taxlosses and other unused taxbenefits (referred to herein as deferred tax assets). Generally, un-benefited deferred tax assets increase tax expense and decrease tax benefits in ourresults of operations in the yearthey arise or in the year we are requiredto accrue a valuation allowance against them.

 

In 2005 we re-evaluated theneed to maintain avaluationallowance on our net deferred tax assets under the rules of SFAS 109. Based on this evaluation, which included a review of recent profitability andprojections of futureprofitability, we concluded that a full valuation allowance against our net domestic deferredtax assets was no longernecessary. At December 30, 2005, we continued to maintain a valuation allowance of $14.2 million against deferred tax assetsrelated to foreign net operatinglosses.

** **

**FinancialCondition, Liquidity and Capital Resources**

 

Our principal source ofliquidity is our cash, cashequivalentsand marketable securities. A significant portion of our cash historically has been provided by operations outside of the United States, withsignificant tax implications torepatriate these funds for domestic use. However, the AJCA created a one-time incentive for U.S. corporations to repatriate this foreigncapital by providing an 85%dividends-received deduction with respectto qualifying dividends. In 2005, we repatriated approximately $600 million of existing foreign cash under the AJCA. Since we intend to continue toreinvest

 

21

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unrepatriated foreignearnings outside the United Statesfor the foreseeable future, we have not recognized any U.S. tax expense on those earnings.

 

In 2005, we generated $258.4million of cash fromoperatingactivities and purchased $192.6 million (24.4 million shares) of our common stock under our $300.0 million stock repurchase plan, whichwas authorized by our Board ofDirectors in early 2005. In January2006, our Board of Directors authorized the repurchase of up to $100.0 million in shares of our outstanding common stock. We intend to usecash generated by employee stockoption exercises (other than thoseof company officers and the Board of Directors) to purchase stock under this separate plan.

 

We believe that the currentlevel of working capital,particularlycash and marketable securities, is sufficient to meet our normal operating requirements for the foreseeable future. Further, we believe thatsufficient resources exist tosupport our future growth and strategic needs. Future available sources of working capital include cash-on-hand, cash generated from futureoperations, short-term orlong-term financing, equity offerings or any combination of these sources. Our current policy is to retain our earnings to provide funds foroperating and expanding ourbusiness. We do not anticipate paying a cash dividend in the foreseeable future.

 

**ContractualObligations**

 

The following table setsforth an overview of our contractual obligations as of December 30, 2005, thatwill affect ourliquidityand cash flows in future periods:

 
| ** **                                                           | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------|------------|
| **In millions**                                                      | ** ** | **Total**                  | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More than  5 Years** | ** ** |
| Operating lease obligations                                          |       | $                          | 86.5       |   | $ | 18.7 |   | $ | 30.1 |   | $ | 17.9 |   | $ | 19.8 |   |
| Net operating lease obligations related to restructuring  activities |       | 29.7                       |       | 5.7 |   | 12.1 |   | 9.8 |   | 2.1 |   |
| Purchase commitments to contract manufacturers  and suppliers        |       | 261.8                      |       | 261.8 |   | — |   | — |   | — |   |
| Cisco stock loan(1)                                                  |       | 180.8                      |       | 180.8 |   | — |   | — |   | — |   |
| Cisco stock loan borrowing fees(2)                                   |       | 7.8                        |       | 1.5 |   | 3.0 |   | 2.5 |   | 0.8 |   |
| Total obligations                                                    |       | $                          | 566.6      |   | $ | 468.5 |   | $ | 45.2 |   | $ | 30.2 |   | $ | 22.7 |   |

 

----

(1)Our agreement with thelender of the stock has no defined date when we must repay the loan; however,the loan is callable at the discretion of the lender.

 

(2)For purposes of contractualobligations disclosure, we used Cisco’s average share price of $17.12 for thequarter ended December 30, 2005, to determine the hypothetical value of the borrowing fees assuming the loans aresettled in 2011.

 

We use several contractmanufacturers and suppliers toprovide manufacturing services for our products. During the normal course of business, to reducemanufacturing lead times andensure adequate component supply, we enter into agreements with certain contract manufacturers and suppliers to enable them to procureinventory based upon criteriadefined by us. Under these agreements, the maximum liability for purchase commitments as of December 30, 2005, was $261.8 million, ofwhich $17.4 million was accruedon the balance sheet.

 

The Cisco stock loanborrowing fees that are recordedin the financial statements each period are based partially on Cisco’s average share price at the end ofeach quarter.

 

**Off-BalanceSheet Arrangements**

 

None.

 

**CriticalAccounting Policies**

 

The methods, estimates and judgmentsthat we use inapplyingour accounting policies can have a significant impact on the results we report in the consolidated financial statements. Some of these estimatesrequire difficult and subjectivejudgments, often as a result of theneed to estimate matters that are inherently uncertain. For the reasons discussed below, we consider our critical accounting estimates to be theallowance for excess and obsoleteinventory and excess purchase commitments(collectively E&O), goodwill valuation, the valuation of amortizable intangible assets, reserve requirements for lease obligations on vacatedfacilities, the valuation ofdeferred tax assets, the estimate of warranty liability and income taxes.

 

22

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We have discussed thedevelopment and selection ofthese critical accounting policies and estimates with the Audit and Ethics Committee of our Board ofDirectors.

 

*Excess& Obsolete Inventory and Excess Purchase Commitments*

 

We determine our inventory costusing the first-in, first-outmethod, and we value our inventory at the lower of cost or market, with market determined byreference to current replacementcost. We determine the amount of inventorythat is excess and obsolete (E&O) and purchase commitments in excess of requirements usingestimates of future demand forindividual components of raw materialsand finished goods.

 

To determine E&O, wecompare our existing inventoryand inventory purchase commitments with estimates of future product demand and usage requirements.We consider quantities in excessof two years’ expected usage tobe excess and we record a full valuation allowance for that amount. For quantities that fall betweenone- and two-years’ demand, weuse management judgment to determinethe appropriate E&O amount. We do not record an allowance if the quantity is less than one year’s forecasted demand.

 

Because our visibility tofuture sales volume andproductmix 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*

 

Accounting rules require thatwe evaluate goodwill forimpairmentannually. Because we report our operating results as a single segment or reporting unit, we performed the impairment test in 2005 by comparing theper-share market price of ourstock with our net book value per share on our annual measurement date in the fourth quarter. Because the market price exceeded our net bookvalue, we concluded that ourgoodwill was not impaired. Therefore, we did not perform additional impairment testing or record an impairment charge.

 

*IntangibleAssets*

 

Our intangible assets consistprimarily of purchasedtechnology,which arose primarily from our acquisitions in 2004 and 2003.

 

We evaluate the carryingvalue of our intangible assetsfor impairment whenever indicators of impairment exist. If an impairment indicator exists, we comparethe sum of the undiscountedfuture cash flows expected to result from the intangibles, or asset group of which the intangibles are a part, with our carryingvalue. If the sum of theundiscounted future cash flows is less than the carrying value, then we compare the fair value of the asset group with our carrying value todetermine if an impairment chargeis required. We calculate the amount of impairment by subtracting the asset’s fair value from its carrying value.

 

We believe that theaccounting estimate related toasset impairment is a critical accounting estimate because it requires us to make assumptions thatare highly uncertain, including:future sales prices, sales volumesand margins for our products, including products that employ new technologies, and uncertainties around customer acceptance. The amount of any suchimpairment could be material to our financialstatements.

 

*ValuationAllowance for Deferred Tax Assets*

 

Deferred tax assets arisewhen we record charges orexpensesin our financial statements that will not be allowed as income-tax deductions until future periods. The term deferred tax asset also includesunused tax net operating lossesand unused tax credits that we are allowedto carry forward to future years. Accounting rules permit us to carry deferred tax assets on thebalance sheet at full value aslong as it is “more likely than not” the deductions, losses or credits will be used in the future. A valuation allowance must be recordedagainst the deferred tax assetsvia a charge to income tax expenseif the test cannot be met.

 

Through the quarter endedSeptember 30, 2005, wemaintaineda valuation allowance against our domestic deferred tax assets. In the quarter ended December 30, 2005, we re-evaluated the need to maintain avaluation allowance on our netdeferred tax assets under the rules of SFAS 109. Based on this evaluation, which included a review of recent profitability and projectionsof future profitability, weconcluded that a full valuation allowance against our net U.S. deferred tax assets is no longer necessary. At December 30, 2005, we continuedto maintain a valuation allowanceof $14.2 million against deferredtax assets related to tax benefits from certain non-U.S. net operating losses.

 

23

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*WarrantyCosts*

 

We provide warranties for allof our products, with termsandconditions that vary by product. We provide a basic limited warranty, including parts and labor,for all products other thanaccess products for periods that generallyrange from 90 days to 5 years. The basic limited warranty for access products covers parts and labor for periods that generally range from 2years to 6 years. We recordwarranty expense in cost of revenue on the consolidated statement of operations. We estimate our warranty liability by applying historicalwarranty return rates and costsper claim to the number of units shipped that are still within their warranty period. In addition, when we judge that a particular warranty claimwill involve costs that are outof the ordinary, we separately estimatethe costs for that claim and record the amount as an additional warranty expense for the period in which we determine we have a liability. Theseestimates require us to makeassumptions about matters that are highly uncertain, including future rates of product failure; repair costs, including availability of materials;shipping and handling; andde-installation and re-installation costs at our customers’ sites, among others. Consequently, the changes in our warranty reserves could bematerial from period to period.

 

*RestructuringReserves – Leases*

 

Our restructuring reservesconsist of lease obligations thatarose from facility closures. We determined the amount of the reserve for each facility by calculatingour outstanding lease obligation,then reducing it by an estimate of potentialsublease income. We examine real-estate market conditions in each location where we have a vacated facility. We use input from local real-estateprofessionals to formulate anestimate of potential sublease income. We review our estimate quarterly and adjust our reserves as necessary. We believe our estimate ofrestructuring lease obligationsis a critical accounting estimate because it requires us to make assumptions about matters that are highly uncertain: real-estate rental marketconditions, the length of timerequired to secure tenants, the amount of tenant incentives and the potential sublease income. Although the changes in our reserves forrestructuring lease obligationshave not been material in the past, it is possible that future changes in estimates could have a material impact on our financial statements.

 

*IncomeTaxes*

 

We conduct business and fileincome tax returns innumeroustax jurisdictions around the world. Having a global business requires us to interpret tax laws that are often vague and uncertain, and to makejudgments about the applicationof those laws when we prepare our tax returns. When we calculate income tax expense and the related tax liabilities and assets for ourconsolidated financialstatements, we use estimates of the amount of income, deductions and credits that we believe are allowable under local tax laws, and thatshould be allowed by taxauthorities if our tax returns are audited. However, tax authorities may disagree on the amounts of income, deductions and credits that areallowed to be included in thosetax returns. This discrepency could result in paying additional taxes or receiving a refund of previously paid taxes.

 

Because we are a large,multinational corporation, theUnited States Internal Revenue Service generally audits each of our federal income tax returns. Theyare currently auditing our taxreturns for the years 2001 through 2003 and have not yet completed their audit. We anticipate that the IRS will submit the results of theaudit to us in the first half of2006. Although we believe any increase to our tax expense that might result from the audit would not have a material impact on our financialstatements, we cannot provideassurance that a material adjustment, positive or negative, will not result.

 

24

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**Strategy andOutlook**

 

We expect capital spending byour customers in 2006tobe stable internationally with growth in North America. On a global basis, wireless operators willcontinue to build next-generationnetworks to deliver new, data-oriented services. In North America, we expect the regional Bell operating companies to continue to upgrade theaccess portion of their networkswith fiber technology to deliver broadbandservices to their customers. We also expect that customers will begin to upgrade the transport portion of their networks with next-generation opticaltechnology. Globally, we expectthat customers will begin to accelerate spending on broadband data infrastructure equipment. Tellabs believes that it has products eithercurrently available or indevelopment to address these opportunities.

 

In 2006, we will continue tofocus on our strategies toenergizeour transport products, enlarge our presence in data and expand into adjacent markets, specifically fiber access. In addition, we are driving toward abusiness target model to achieveover time an overall gross margin of50% of revenue, operating expenses of 30% of revenue (excluding unusual charges), operating margins at 20% of revenue, and 15% annual revenuegrowth. While we have achievedand even exceeded these targets inthe past, we cannot say when or if we consistently will achieve them again, given today’s marketconditions and our productportfolio and services.

 

Expensing stock options willincrease our cost-of-goodssoldand operating expenses in 2006. For the first quarter, we expect stock-option expense to be approximately $10.0 million.

 

We also expect higher incometax expense in 2006.Wehave exhausted the financial statement benefit of the net loss carryforwards that limited our taxeson domestic operations throughout2005. We expect that our effective taxrate for the first-quarter and the entire year 2006 will be approximately 35%.

 

25

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**Management’sReport 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 Rule 13a-15(f) of theSecurities Exchange Act of 1934,as amended. Under the supervision andwith the participation of our management, including our principal executive officer and principalfinancial officer, we conductedan evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 30, 2005, as required by Rule13a-15(c) of the SecuritiesExchange Act of 1934, as amended. In making this assessment, we used the criteria set forth in the framework in *Internal Control – Integrated Framework* issued by the Committee of SponsoringOrganizations of the TreadwayCommission. Based on our evaluation under the framework in *Internal Control –Integrated Framework*, our management concluded that our internalcontrol over financial reportingwas effective as of December 30, 2005. 

 

Our management’s assessmentof the effectivenessofour internal control over financial reporting as of December 30, 2005, has been audited by Ernst& Young LLP, an independentregistered public accounting firm,as stated in its report that appears on page 27.

 

 

Michael J. Birck

Chairman of the Board

 

 

Krish Prabhu

President and

Chief Executive Officer

 

 

Timothy J. Wiggins

Executive Vice President and

Chief Financial Officer

 

February 28, 2006

 

**Report ofIndependent Registered Public Accounting Firm**

 

To the Stockholders and Boardof Directors of Tellabs, Inc.:

 

We have audited theaccompanying consolidated balancesheets of Tellabs, Inc., and subsidiaries (the “Company”) as of December 30, 2005, and December 31, 2004,and the related consolidatedstatements of operations, stockholders’equity and cash flows for each of the three years in the period ended December 30, 2005. These financial statements are the responsibility ofthe Company’s management. Ourresponsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits inaccordance with thestandardsof the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance aboutwhether the financial statements are free of material misstatement. An audit includes examining, ona test basis, evidence supportingthe amounts and disclosures in thefinancial statements. An audit also includes assessing the accounting principles used and significantestimates made by management, aswell as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financialstatements referred toabovepresent fairly, in all material respects, the consolidated financial position of the Company at December30, 2005, and December 31, 2004,and the consolidated results oftheir operations and their cash flows for each of the three years in the period ended December 30, 2005, in conformity with U.S. generallyaccepted accounting principles.

 

We also have audited, inaccordance with the standardsof the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financialreporting as of December 30, 2005, based on criteria established in *InternalControl – Integrated**Framework*issuedby the Committee of Sponsoring Organizationsof the Treadway Commission and our report dated February 28, 2006, expressed an unqualified opinion thereon.

 

Ernst & Young, LLP

Chicago, Illinois

February 28, 2006

 

26

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**Report ofIndependent Registered Public Accounting Firm on Internal Control over FinancialReporting**

 

To the Stockholders and Boardof Directors of Tellabs, Inc.:

 

We have audited management’sassessment, included intheaccompanying *Management’s Report on Internal**Control overFinancial Reporting*, thatTellabs, Inc., and subsidiaries (the“Company”) maintained effective internal control over financial reporting as of December 30, 2005, based on criteria established in *Internal Control –**Integrated Framework*issued by the Committee of Sponsoring Organizations of the TreadwayCommission (the COSO criteria).The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of theeffectiveness of internal controlover financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’sinternal control over financialreporting based on our audit.

 

We conducted our audit inaccordance with thestandardsof the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance aboutwhether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining anunderstanding of internal controlover financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internalcontrol, and performing suchother procedures as we considered necessaryin the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal controlover financial reporting is aprocess designed to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of financialstatements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reportingincludes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions ofthe assets of the company; (2)provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, andthat receipts and expenditures ofthe company are being made only inaccordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timelydetection of unauthorizedacquisition, use, or disposition of the company’s assets that could have a material effect on the financialstatements.

 

Because of its inherentlimitations, internal controlover financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or proceduresmay deteriorate.

 

In our opinion, management’sassessment that theCompanymaintained effective internal control over financial reporting as of December 30, 2005, is fairly stated, in all material respects, based on theCOSO criteria. Also, in ouropinion, the Company maintained, inall material respects, effective internal control over financial reporting as of December 30, 2005,based on the COSO criteria.

 

We also have audited, inaccordance with the standardsof the Public Company Accounting Oversight Board (United States), the accompanying consolidatedbalance sheets of the Company asof December 30, 2005, and December31, 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in theperiod ended December 30, 2005,and our report dated February 28, 2006,expressed an unqualified opinion thereon.

 

Ernst & Young, LLP

Chicago, Illinois

February 28, 2006

 

27

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**ConsolidatedStatements of Operations**

 
| **In millions, except per-share  data**                           | ** ** | **Year Ended  12/30/05** | ** **  | **Year Ended  12/31/04** | ** ** | **Year Ended  1/2/04** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------|-------------|--------------------------|------------|------------------------|------------|
| **Revenue**                                                       | ** ** | ** **               |        |                     |       |                   |       |
| Products                                                          | ** ** | **$**                    | **1,716.3** |                     | $          | 1,074.2                |       | $ | 830.1 |   |
| Services                                                          | ** ** | **167.1**                |        | 157.6                    |       | 150.3                  |       |
| ** **                                                        |       | **1,883.4**              |        | 1,231.8                  |       | 980.4                  |       |
| **Cost of Revenue**                                               | ** ** | ** **               |        |                     |       |                   |       |
| Products                                                          | ** ** | **908.8**                |        | 472.1                    |       | 513.0                  |       |
| Services                                                          | ** ** | **119.6**                |        | 102.7                    |       | 113.4                  |       |
| ** **                                                        |       | **1,028.4**              |        | 574.8                    |       | 626.4                  |       |
| **Gross Profit**                                                  | ** ** | **855.0**                |        | 657.0                    |       | 354.0                  |       |
| ** **                                                        | ** ** | ** **               |        |                     |       |                   |       |
| **Operating Expenses**                                            | ** ** | ** **               |        |                     |       |                   |       |
| Research and development                                          | ** ** | **344.0**                |        | 250.3                    |       | 286.1                  |       |
| Sales and marketing                                               | ** ** | **175.5**                |        | 155.1                    |       | 143.5                  |       |
| General and administrative                                        | ** ** | **95.6**                 |        | 81.5                     |       | 99.1                   |       |
| Intangible asset amortization                                     | ** ** | **36.0**                 |        | 17.8                     |       | 12.6                   |       |
| Restructuring and other charges                                   | ** ** | **12.9**                 |        | 14.1                     |       | 77.2                   |       |
| Purchased in-process research and  development                    | ** ** | **2.2**                  |        | 102.1                    |       | —                 |       |
| Asset impairment charge                                           | ** ** | **—**               |        | 47.2                     |       | —                 |       |
| Net loss on sale of real estate                                   | ** ** | **—**               |        | 20.6                     |       | —                 |       |
| ** **                                                        |       | **666.2**                |        | 688.7                    |       | 618.5                  |       |
| **Operating Earnings (Loss)**                                     | ** ** | **188.8**                |        | (31.7                    | )          | (264.5                 | )          |
| **Other Income**                                                  | ** ** | ** **               |        |                     |       |                   |       |
| Interest income, net                                              | ** ** | **28.3**                 |        | 26.9                     |       | 24.2                   |       |
| Other expense, net                                                | ** ** | **(4.0**                 | )           | (5.4                     | )          | (4.4                   | )          |
| ** **                                                        |       | **24.3**                 |        | 21.5                     |       | 19.8                   |       |
| **Earnings (Loss) Before Income Tax**                             | ** ** | **213.1**                |        | (10.2                    | )          | (244.7                 | )          |
| Income tax (expense) benefit                                      | ** ** | **(37.3**                | )           | (19.6                    | )          | 3.1                    |       |
| **Net Earnings (Loss)**                                           | ** ** | **175.8**                |        | $                        | (29.8      | )                      | $          | (241.6 | ) |
| ** **                                                        | ** ** | ** **               |        |                     |       |                   |       |
| **Net Earnings (Loss) Per Share**                                 | ** ** | ** **               |        |                     |       |                   |       |
| Basic                                                             | ** ** | **$**                    | **0.39**    |                     | $          | (0.07                  | )          | $ | (0.58 | ) |
| Diluted                                                           | ** ** | **$**                    | **0.39**    |                     | $          | (0.07                  | )          | $ | (0.58 | ) |
| **Weighted Average Shares Outstanding**                           | ** ** | ** **               |        |                     |       |                   |       |
| Basic                                                             | ** ** | **449.9**                |        | 420.2                    |       | 413.1                  |       |
| Diluted                                                           | ** ** | **454.5**                |        | 420.2                    |       | 413.1                  |       |
|                                                              |       |                     |        |                     |       |                   |       |
| The accompanying notes are an integral part  of these statements. |       |                     |        |                     |       |                   |       |

 

28

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**ConsolidatedBalance Sheets**

 
| **In millions, except share data**                                                                                                     | ** ** | **12/30/05** | ** **  | **12/31/04** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------|-------------|--------------|------------|
| **ASSETS**                                                                                                                             |       |         |        |         |       |
| **Current Assets**                                                                                                                     |       |         |        |         |       |
| Cash and cash equivalents                                                                                                              | ** ** | **$**        | **880.8**   |         | $          | 292.9 |   |
| Investments in marketable securities                                                                                                   | ** ** | **308.9**    |        | 823.3        |       |
| ** **                                                                                                                             |       | **1,189.7**  |        | 1,116.2      |       |
| Other marketable securities — Cisco stock                                                                                         | ** ** | **180.8**    |        | 204.0        |       |
| Accounts receivable, net of returns and  allowances of $8.4 and $14.8                                                                  | ** ** | **319.4**    |        | 309.4        |       |
| Inventories                                                                                                                            |       |         |        |         |       |
| Raw materials                                                                                                                          | ** ** | **28.3**     |        | 39.2         |       |
| Work in process                                                                                                                        | ** ** | **11.7**     |        | 13.6         |       |
| Finished goods                                                                                                                         | ** ** | **69.1**     |        | 63.6         |       |
| ** **                                                                                                                             |       | **109.1**    |        | 116.4        |       |
| Income taxes                                                                                                                           | ** ** | **15.9**     |        | 38.9         |       |
| Miscellaneous receivables and other current  assets                                                                                    | ** ** | **58.1**     |        | 50.0         |       |
| **Total Current Assets**                                                                                                               | ** ** | **1,873.0**  |        | 1,834.9      |       |
| **Property, Plant and Equipment**                                                                                                      |       |         |        |         |       |
| Land                                                                                                                                   | ** ** | **20.3**     |        | 21.0         |       |
| Buildings and improvements                                                                                                             | ** ** | **190.5**    |        | 194.1        |       |
| Equipment                                                                                                                              | ** ** | **403.2**    |        | 404.0        |       |
| ** **                                                                                                                             |       | **614.0**    |        | 619.1        |       |
| Accumulated depreciation                                                                                                               | ** ** | **(313.9**   | )           | (290.3       | )          |
| ** **                                                                                                                             |       | **300.1**    |        | 328.8        |       |
| **Goodwill**                                                                                                                           | ** ** | **1,111.9**  |        | 1,092.3      |       |
| **Intangible Assets, Net of Amortization**                                                                                             | ** ** | **117.2**    |        | 156.0        |       |
| **Other Assets**                                                                                                                       | ** ** | **112.7**    |        | 133.1        |       |
| **Total Assets**                                                                                                                       | ** ** | **$**        | **3,514.9** |         | $          | 3,545.1 |   |
| ** **                                                                                                                             | ** ** | ** **   |        |         |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                          |       |         |        |         |       |
| **Current Liabilities**                                                                                                                |       |         |        |         |       |
| Accounts payable                                                                                                                       | ** ** | **$**        | **97.1**    |         | $          | 96.3 |   |
| Accrued compensation                                                                                                                   | ** ** | **83.8**     |        | 70.3         |       |
| Restructuring and other charges                                                                                                        | ** ** | **7.2**      |        | 13.4         |       |
| Income taxes                                                                                                                           | ** ** | **28.9**     |        | 15.9         |       |
| Cisco stock loan                                                                                                                       | ** ** | **180.8**    |        | 204.0        |       |
| Other accrued liabilities                                                                                                              | ** ** | **127.4**    |        | 136.1        |       |
| **Total Current Liabilities**                                                                                                          | ** ** | **525.2**    |        | 536.0        |       |
| **Long-Term Restructuring Liabilities**                                                                                                | ** ** | **24.0**     |        | 33.0         |       |
| **Income Taxes**                                                                                                                       | ** ** | **95.9**     |        | 127.9        |       |
| **Other Long-Term Liabilities**                                                                                                        | ** ** | **55.1**     |        | 51.0         |       |
| ** **                                                                                                                             | ** ** | ** **   |        |         |       |
| **Stockholders’ Equity**                                                                                                          |       |         |        |         |       |
| Preferred stock: authorized 5,000,000  shares of $.01 par value; no shares issued and outstanding                                      | ** ** | **—**   |        | —       |       |
| Common stock: authorized 1,000,000,000  shares of $.01 par value; 477,045,901 and 466,910,981 shares issued,  including treasury stock | ** ** | **4.8**      |        | 4.7          |       |
| Additional paid-in capital                                                                                                             | ** ** | **1,238.7**  |        | 1,145.9      |       |
| Deferred compensation expense                                                                                                          | ** ** | **(10.9**    | )           | (21.8        | )          |
| Treasury stock, at cost: 27,661,859 and  3,250,000 shares                                                                              | ** ** | **(322.8**   | )           | (129.6       | )          |
| Retained earnings                                                                                                                      | ** ** | **1,847.9**  |        | 1,672.1      |       |
| Accumulated other comprehensive income                                                                                                 | ** ** | **57.0**     |        | 125.9        |       |
| **Total Stockholders’ Equity**                                                                                                    | ** ** | **2,814.7**  |        | 2,797.2      |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                    | ** ** | **$**        | **3,514.9** |         | $          | 3,545.1 |   |

 

The accompanying notes are an integral partof these statements.

 

29

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**ConsolidatedStatements of Stockholders’ Equity**

 
| ** **                                                                                                                                | ** ** | **Year Ended  12/30/05** | ** ** | **Year Ended  12/31/04** | ** **  | **Year Ended  1/2/04** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|-------------|------------------------|------------|
| **In millions**                                                                                                                           |       | **Shares**               | ** ** | **Amount**               | ** **  | **Shares**             | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| **Common Stock**                                                                                                                          | ** ** | ** **               | ** ** | ** **               | ** **  | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of year                                                                                                              | ** ** | **466.9**                | ** ** | **$**                    | **4.7**     |                   | 417.9      |   | $ | 4.2 |   | 415.4 |   | $ | 4.1 |   |
| Stock issued for employee stock programs                                                                                                  | ** ** | **10.1**                 | ** ** | **0.1**                  |        | 2.3                    |       | — |   | 2.5 |   | 0.1 |   |
| Stock issued for business acquisitions                                                                                                    | ** ** | **—**               | ** ** | **—**               |        | 46.7                   |       | 0.5 |   | — |   | — |   |
| Balance at end of year                                                                                                                    | ** ** | **477.0**                | ** ** | **4.8**                  |        | 466.9                  |       | 4.7 |   | 417.9 |   | 4.2 |   |
|                                                                                                                                      | ** ** | ** **               | ** ** | ** **               |        |                   |       |   |   |   |   |   |   |
| **Additional Paid-In Capital**                                                                                                            |       |                     |       |                     |        |                   |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                                                              | ** ** | ** **               |       | **1,145.9**              |        |                   |       | 556.8 |   |   |   | 543.6 |   |
| Stock options exercised                                                                                                                   | ** ** | ** **               |       | **83.2**                 |        |                   |       | 8.9 |   |   |   | 4.3 |   |
| Restricted stock award activity                                                                                                           | ** ** | ** **               |       | **7.3**                  |        |                   |       | 8.0 |   |   |   | 0.1 |   |
| Stock purchase plan activity                                                                                                              | ** ** | ** **               |       | **2.3**                  |        |                   |       | — |   |   |   | — |   |
| Stock issued for business acquisitions                                                                                                    | ** ** | ** **               |       | **—**               |        |                   |       | 428.6 |   |   |   | 2.4 |   |
| Fair value of options issued in  acquisitions                                                                                             | ** ** | ** **               |       | **—**               |        |                   |       | 143.6 |   |   |   | 6.4 |   |
| Balance at end of year                                                                                                                    | ** ** | ** **               |       | **1,238.7**              |        |                   |       | 1,145.9 |   |   |   | 556.8 |   |
|                                                                                                                                      | ** ** | ** **               |       | ** **               |        |                   |       |   |   |   |   |   |   |
| **Deferred Compensation**                                                                                                                 |       |                     |       |                     |        |                   |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                                                              | ** ** | ** **               |       | **(21.8**                | )           |                   |       | (9.5 | ) |   |   | (19.3 | ) |
| Amortization of deferred compensation                                                                                                     | ** ** | ** **               |       | **10.9**                 |        |                   |       | 5.5 |   |   |   | 11.2 |   |
| Amortization of restricted stock awards                                                                                                   | ** ** | ** **               |       | **5.4**                  |        |                   |       | 1.0 |   |   |   | — |   |
| Restricted stock award activity                                                                                                           | ** ** | ** **               |       | **(5.4**                 | )           |                   |       | (5.3 | ) |   |   | — |   |
| Deferred compensation from acquisitions                                                                                                   | ** ** | ** **               |       | **—**               |        |                   |       | (13.5 | ) |   |   | (1.4 | ) |
| Balance at end of year                                                                                                                    | ** ** | ** **               |       | **(10.9**                | )           |                   |       | (21.8 | ) |   |   | (9.5 | ) |
|                                                                                                                                      | ** ** | ** **               |       |                     |        |                   |       |   |   |   |   |   |   |
| **Treasury Stock**                                                                                                                        |       |                     |       |                     |        |                   |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                                                              | ** ** | **3.3**                  | ** ** | **(129.6**               | )           | 3.3                    |       | (129.6 | ) | 3.3 |   | (129.6 | ) |
| Purchases                                                                                                                                 | ** ** | **24.4**                 | ** ** | **(193.2**               | )           | —                 |       | — |   | — |   | — |   |
| Balance at end of year                                                                                                                    | ** ** | **27.7**                 | ** ** | **(322.8**               | )           | 3.3                    |       | (129.6 | ) | 3.3 |   | (129.6 | ) |
|                                                                                                                                      | ** ** | ** **               | ** ** | ** **               |        |                   |       |   |   |   |   |   |   |
| **Retained Earnings**                                                                                                                     |       |                     |       |                     |        |                   |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                                                              | ** ** | ** **               |       | **1,672.1**              |        |                   |       | 1,701.9 |   |   |   | 1,943.5 |   |
| Net earnings (loss)                                                                                                                       | ** ** | ** **               |       | **175.8**                |        |                   |       | (29.8 | ) |   |   | (241.6 | ) |
| Balance at end of year                                                                                                                    | ** ** | ** **               |       | **1,847.9**              |        |                   |       | 1,672.1 |   |   |   | 1,701.9 |   |
|                                                                                                                                      | ** ** | ** **               |       | ** **               |        |                   |       |   |   |   |   |   |   |
| **Accumulated Other Comprehensive Income (Loss)**                                                                                    |       |                     |       |                     |        |                   |       |   |   |   |   |   |   |
| Balance at beginning of year                                                                                                              | ** ** | ** **               |       | **125.9**                |        |                   |       | 95.5 |   |   |   | (52.0 | ) |
| Reclassification adjustment for loss (gain)  included in net earnings                                                                     | ** ** | ** **               |       | **2.5**                  |        |                   |       | (1.4 | ) |   |   | (8.9 | ) |
| Unrealized holding (loss) gain on  marketable securities, net of tax benefit of $2.1 in 2005 and 2004, and a tax  expense of $1.0 in 2003 | ** ** | ** **               |       | **(3.1**                 | )           |                   |       | (3.1 | ) |   |   | 4.9 |   |
| Net unrealized holding loss on marketable  securities                                                                                     | ** ** | ** **               |       | **(0.6**                 | )           |                   |       | (4.5 | ) |   |   | (4.0 | ) |
| Foreign currency translation adjustments                                                                                                  | ** ** | ** **               |       | **(68.3**                | )           |                   |       | 34.9 |   |   |   | 151.5 |   |
| Balance at end of year                                                                                                                    | ** ** | ** **               |       | **57.0**                 |        |                   |       | 125.9 |   |   |   | 95.5 |   |
| **Total Stockholders’ Equity**                                                                                                       | ** ** | ** **               |       | **$**                    | **2,814.7** |                   |       |   | $ | 2,797.2 |   |   |   | $ | 2,219.3 |   |

 

The accompanying notes are an integral partof these statements.

 

30

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**ConsolidatedStatements of Cash Flow**

 
| **In millions**                                            | ** ** | **Year Ended  12/30/05** | ** ** | **Year Ended  12/31/04** | ** ** | **Year Ended  1/2/04** | ** ** |
|------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|------------------------|------------|
| **Operating Activities**                                   |       |                     |       |                     |       |                   |       |
| Net earnings (loss)                                        | ** ** | **$**                    | **175.8**  |                     | $          | (29.8                  | )          | $ | (241.6 | ) |
| Adjustments to reconcile net earnings  (loss) to           |       |                     |       |                     |       |                   |       |
| net cash provided by operating activities:                 |       |                     |       |                     |       |                   |       |
| Depreciation and amortization                              | ** ** | **126.1**                |       | 82.3                     |       | 110.2                  |       |
| Deferred compensation amortization                         | ** ** | **16.3**                 |       | 6.5                      |       | 11.2                   |       |
| Deferred income taxes                                      | ** ** | **(15.6**                | )          | 11.6                     |       | (14.9                  | )          |
| Tax benefit associated with stock option  exercises        | ** ** | **14.0**                 |       | —                   |       | 1.6                    |       |
| Restructuring and other charges                            | ** ** | **12.9**                 |       | 11.7                     |       | 172.6                  |       |
| Purchased in-process research and  development             | ** ** | **2.2**                  |       | 102.1                    |       | —                 |       |
| Asset impairment charge                                    | ** ** | **—**               |       | 47.2                     |       | —                 |       |
| Net loss on sale of real estate                            | ** ** | **—**               |       | 20.6                     |       | —                 |       |
| Net changes in assets and liabilities,                     |       |                     |       |                     |       |                   |       |
| net of effects from acquisitions:                          |       |                     |       |                     |       |                   |       |
| Accounts receivable                                        | ** ** | **(15.0**                | )          | (49.6                    | )          | 33.5                   |       |
| Inventories                                                | ** ** | **7.0**                  |       | (24.8                    | )          | 143.8                  |       |
| Miscellaneous receivables and other current  assets        | ** ** | **3.2**                  |       | 65.8                     |       | (87.1                  | )          |
| Other assets                                               | ** ** | **(11.2**                | )          | (9.1                     | )          | 2.0                    |       |
| Accounts payable                                           | ** ** | **(15.5**                | )          | 13.0                     |       | (34.1                  | )          |
| Restructuring and other charges                            | ** ** | **(24.2**                | )          | (52.2                    | )          | (84.2                  | )          |
| Other accrued liabilities                                  | ** ** | **(27.6**                | )          | 9.5                      |       | (12.9                  | )          |
| Income taxes                                               | ** ** | **9.4**                  |       | 18.1                     |       | 154.9                  |       |
| Other long-term liabilities                                | ** ** | **0.6**                  |       | (8.2                     | )          | (5.1                   | )          |
| **Net Cash Provided by Operating Activities**              | ** ** | **258.4**                |       | 214.7                    |       | 149.9                  |       |
| **Investing Activities**                                   |       |                     |       |                     |       |                   |       |
| Capital expenditures                                       | ** ** | **(61.8**                | )          | (41.4                    | )          | (17.2                  | )          |
| Disposals of property, plant and equipment                 | ** ** | **15.6**                 |       | 31.5                     |       | 7.7                    |       |
| Payments for purchases of investments                      | ** ** | **(661.9**               | )          | (1,318.8                 | )          | (2,287.8               | )          |
| Proceeds from sales and maturities of  investments         | ** ** | **1,180.4**              |       | 1,379.1                  |       | 2,009.8                |       |
| Payments for acquisitions, net of cash  acquired           | ** ** | **—**               |       | (244.3                   | )          | (122.6                 | )          |
| **Net Cash Provided by (Used for) Investing  Activities**  | ** ** | **472.3**                |       | (193.9                   | )          | (410.1                 | )          |
| **Financing Activities**                                   |       |                     |       |                     |       |                   |       |
| Proceeds from issuance of common stock  under option plans | ** ** | **71.6**                 |       | 8.9                      |       | 5.9                    |       |
| Repurchase of common stock                                 | ** ** | **(193.2**               | )          | —                   |       | —                 |       |
| **Net Cash (Used for) Provided by Financing  Activities**  | ** ** | **(121.6**               | )          | 8.9                      |       | 5.9                    |       |
| **Effect of Exchange Rate Changes on Cash**                | ** ** | **(21.2**                | )          | 17.3                     |       | 46.6                   |       |
| **Net Increase (Decrease) in Cash and Cash Equivalents**   | ** ** | **587.9**                |       | 47.0                     |       | (207.7                 | )          |
| **Cash and Cash Equivalents at Beginning of  Year**        | ** ** | **292.9**                |       | 245.9                    |       | 453.6                  |       |
| **Cash and Cash Equivalents at End of Year**               | ** ** | **$**                    | **880.8**  |                     | $          | 292.9                  |       | $ | 245.9 |   |
| **Other Information**                                      |       |                     |       |                     |       |                   |       |
| Interest paid                                              | ** ** | **$**                    | **2.3**    |                     | $          | 0.3                    |       | $ | — |   |
| Income taxes paid (refunded), net                          | ** ** | **$**                    | **11.8**   |                     | $          | (4.0                   | )          | $ | (146.1 | ) |
| Issuance of common stock and options for  acquisitions     | ** ** | **$**                    | **—** |                     | $          | 576.0                  |       | $ | — |   |

 

The accompanying notes are an integral partof these statements.

 

31

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**Notes toConsolidated Financial Statements**

 

**1. Summaryof Significant Accounting Policies**

 

**Nature ofBusiness**

 

We operate as one segment inthe design, assembly,marketingand servicing of a diverse line of communications equipment used in public and private networks worldwide.

 

**Principlesof Consolidation**

 

Our consolidated financialstatements include theaccountsof Tellabs and our subsidiaries. All intercompany accounts and transactions have been eliminated. We have reclassified certainprior-year amounts to conform tothe current-year presentation.

 

**Use ofEstimates**

 

The preparation of thefinancial statements in conformitywith generally accepted accounting principles requires us to make estimates and assumptions that affectamounts reported in the financialstatements and accompanying notes.Actual results could differ from those estimates.

 

**CashEquivalents**

 

We consider all highly liquiddebt instrumentspurchasedwith original maturities of three months or less to be cash equivalents.

** **

**RestrictedCash**

 

Restricted cash equivalentsand marketable securitiesof$20.0 million are included in Other Assets in 2004. The cash equivalents and marketable securitieswere held as collateral to back athree-year bond posted for a U.S.customer contract. The restriction for these assets was removed in 2005, so they were reclassfied to Cash and Cash Equivalents.

 

**Fair Valueof Financial Instruments**

 

Our financial instrumentsconsist of cash and cashequivalents,accounts receivable, accounts payable, marketable securities, cost-basis investments and derivatives. The carrying value of the cashand cash equivalents, accountsreceivable and accounts payable arereasonable estimates of their fair value because of their short-term nature. We determine the fairvalue of marketable securitiesand derivatives based on quotes frombrokers or current rates offered for instruments with similar characteristics. See discussion in Note 7 regarding derivatives.

 

**AccountsReceivable Returns and Allowances**

 

Our reserve for returns andallowances is based on ourassessmentof the collectibility of customer accounts. We regularly review the allowance by considering factors such as credit, the age of theaccounts receivable balances, thecurrent economic conditions thatmay affect a customer’s ability to pay and historical experience.

 

**Inventories**

 

We determine our inventorycost using the first-in,first-outmethod and we value our inventory at the lower of cost or market, with market determined by reference to current replacement cost. We determinethe amount of inventory that is excessand obsolete using estimates offuture demand for individual componentsof raw materials and finished goods.

** **

**Property,Plant and Equipment**

 

We record property, plant andequipment at cost. Wecomputedepreciation using both the declining-balance and straight-line methods. Buildings are depreciated over 25 to 40 years; building improvementsover 7 years; leaseholdimprovements 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 orchanges in circumstances indicatethat the carrying amount of anasset may not be fully recoverable.

** **

**StockOptions**

 

We account for stock-basedcompensation under theintrinsicvalue outlined in Accounting Principles Board Opinion No. 25, *Accounting for StockIssued to**Employees*.Accordingly, no compensation cost has been recognized for its stockcompensation arrangements. If thecost for our compensation plans hadbeen determined consistent with SFAS No. 123,  *Accounting for Stock-Based Compensation*, our net

 

32

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earnings and net earnings pershare would havechangedto the pro forma amounts indicated below:

 
| **In millions, except  per-share data**                                                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net earnings (loss) as reported                                                                                                                |       | $        | 175.8      |     | $          | (29.8    | )          | $ | (241.6 | ) |
| Add: Stock-based employee compensation  expense included in reported net earnings (loss), net of related tax effects                           |       | 10.3     |       | 6.5      |       | 11.2     |       |
| Less: Total stock-based employee  compensation expense determined under fair-value based method for all grants,  net of related tax effects(1) |       | (18.9    | )          | (62.0    | )          | (62.6    | )          |
| Pro forma net earnings (loss)                                                                                                                  |       | $        | 167.2      |     | $          | (85.3    | )          | $ | (293.0 | ) |
| Net earnings (loss) per common share                                                                                                           |       |     |       |     |       |     |       |   |   |   |
| As reported                                                                                                                                    |       | $        | 0.39       |     | $          | (0.07    | )          | $ | (0.58 | ) |
| Pro forma basic and diluted                                                                                                                    |       | $        | 0.37       |     | $          | (0.20    | )          | $ | (0.71 | ) |

 

----

(1) The pro forma effect recorded in 2005 includesa tax benefit of $62.7 million,of which $35.6 million represents the release of a valuation allowance maintained against the deferred taxbenefit on stock-based employeecompensation expense recorded in 2004 and 2003.

 

We estimated the fair valueof options on the date ofgrantusing the Black-Scholes option pricing model with the following weighted-average assumptions:

 
| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected  volatility     |       | 51.9     | %          | 70.8     | %          | 73.4     | %          |
| Risk-free  interest rate |       | 3.9      | %          | 3.4      | %          | 3.0      | %          |
| Expected  life in years  |       | 4.0      |       | 4.7      |       | 5.1      |       |
| Expected  dividend yield |       | 0.0      | %          | 0.0      | %          | 0.0      | %          |

 

The pro forma amountsdisclosed above may not berepresentativeof future disclosures for several reasons. For instance, the estimated fair value of stock options is amortized to expense over the vesting periodand additional options may begranted in future years. In addition,beginning in the first quarter of 2006, we will begin expensing options based on methods prescribed under SFAS 123(R).

 

**Income Taxes**

 

We recognize deferred taxassets and liabilities for thefuture tax consequences attributable to differences between the financial statement carryingamounts of existing assets andliabilities and their respective tax basis at enacted tax rates when such amounts are expected to be realized or settled. We providevaluation allowances if, based onthe weight of available evidence, itis more likely than not that some or all of the deferred tax assets will not be realized.

 

**Goodwill**

 

Goodwill represents theexcess of the cost of businessesacquired over the fair market value of identifiable net assets at the dates of acquisition. We compareour market capitalization withbook value annually as an indicator of potential impairment.

 

**IntangibleAssets**

 

Our intangible assets aremade up primarily of purchasedtechnology from acquisitions. We amortize these assets over their estimated useful lives and reviewthem for impairment whenindicators of impairment exist, such as poor or declining operating performance or cash flows.

** **

**RevenueRecognition**

 

We recognize revenue whenpersuasive evidence of anarrangementexists, delivery has occurred or services have been rendered, the price or fee is fixed or determinable, andcollectibility 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 revenuecomes from product sales. Werecognize revenue either upon shipment or delivery to the customer, depending upon the contractualdelivery terms.

 

Some of our customeragreements contain acceptanceclauses that grant the right to return or exchange products that do not conform to our publishedspecifications. When we havesufficient historical evidence that our products meet the published specifications, we recognize revenue upon shipment or delivery, and record anypotential returns as warranties.Otherwise, we recognize revenue whenthe conditions of acceptance have been met.

 

A few of our customeragreements grant the right toreturn or exchange product based upon subjective matters. We have established sufficient historicalevidence on rates of return formost of our products to be able to accrue for returns under the guidance of SFAS No. 48, *Revenue*

 

33

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*RecognitionWhen Right of Return Exists*. We recognize revenue,net of potential returns, upon shipment or upon delivery of product to the customer.

 

Some of our customeragreements are in the form ofdistribution agreements, with contractual rights of return, promotional rebates, and other rebates andcredits. We recognize revenue netof estimated returns and rebates, whichare calculated based on contractual provisions and historical evidence of returns activity.

 

*Services*

 

We also recognize revenue forservices performed forcustomers.Most services revenue relates to product installation at customer sites. Customers may purchase installation services from us, install ourproducts themselves or hire thirdparties to perform the installation. We recognize revenue for installation services upon completion. 

 

We recognize revenue frommaintenance and supportcontractsratably over the service period. We recognize other services revenue, including training and other business support services, upon completion.

** **

**Earnings PerShare**

 

We base earnings per share onthe weighted averagenumberof common shares (basic) and the weighted average common shares adjusted for assumed exercises of stock options and vesting of restrictedstock (diluted). We base earningsper share in periods of a net loss solely on basic weighted average number of common shares under generally accepted accountingprinciples.

** **

**ForeignCurrency Translation**

 

We generally measure thefinancial statements of ourforeignsubsidiaries using the local currency as the functional currency. In such cases, we translate assets and liabilities at exchange rates in effect at thebalance sheet date, and wetranslate revenue and expenses at weighted average exchange rates during the year. We record the gain or loss from translating a subsidiary’sstockholders’ equity into U.S.dollars as a cumulative translation adjustment in the equity section of the Consolidated BalanceSheets.

** **

**ForeignCurrency Transactions**

 

We recognize foreign currencytransaction gains and lossesresulting from changes in exchange rates in *Other Expense,**Net*.We recorded net (losses) gains of $(4.0) million in 2005, $3.8 million in 2004 and $(1.8) millionin 2003.

** **

**2. NewAccounting Pronouncements**

 

In December 2004, theFinancial Accounting StandardsBoard (FASB) issued Statement No. 123 (revised 2004),  *Share-Based Payment*(SFAS 123(R)), which requires the measurement and recognition of compensationexpense for all stock-basedcompensation payments. This statement supersedes our current accounting under APB 25. In March 2005, the Securities and ExchangeCommission issued StaffAccounting Bulletin (SAB) No. 107 relating to the adoption of SFAS 123(R). We will adopt SFAS 123(R) at the beginning of 2006 using the modifiedprospective method. We expect the adoption of SFAS 123(R) and SAB No. 107 to result in an additional pre-taxexpense of $30.3 million in 2006plus an amount that has not been determinedfor options granted in 2006.

 

In June 2005, the FASB issuedSFAS No. 154,*Accounting Changes and Error Corrections*, which supersedes APB Opinion No. 20, *AccountingChanges*, and SFAS No.3, *Reporting Accounting Changes in Interim**FinancialStatements*. This new standardrequires retrospectiveapplication to prior periods’ financial statements of a voluntary change in accounting principle unless impracticable. This statement alsorequires that a change indepreciation, amortization or depletion method for long-lived, non-financial assets be treated as a change in accounting estimate affected by a change inaccounting principle. SFAS No.154 is effective for accounting changesand corrections of errors made in fiscal years beginning after December 15, 2005. We adopted this statement on December 31, 2005.

 

Also in June 2005, the FASBissued FSP 143-1,*Accounting for Electronic Equipment Waste Obligations*, whichaddresses the accounting for obligations associated with Directive 2002/96/EC on Waste Electricaland Electronic Equipment (the“Directive”) adopted by the EuropeanUnion. The Directive obligates a commercial user to incur costs associated with the retirement of a specified asset that qualifies as historical wasteequipment effective August 13,2005. FSP 143-1 requires commercial users to apply the provisions of SFAS 143, *Accountingfor**ConditionalAsset Retirement Obligations*,and the related FASBInterpretation No. 47, *Accounting forConditional**Asset Retirement Obligations*, to their obligations associated with historical waste. FSP 143-1took effect on the later of thefirst reporting period ending after June 8, 2005, or the date of the adoption of the law by the applicable European Union member. Inconjunction with the Directive,we have accrued amounts that we believe are adequate as of December 30, 2005. These accruals did not have a material impact on our financialstatements. As of December 30,2005, certain of the member states had not adopted or issued their implementation guidance. In addition, similar legislation has been or maybe enacted in other countries,including the United States, Canada, Mexico, China and Japan.

 

34

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**3. Restructuringand Other Charges**

 

In the fourth quarter of 2004and first quarter of 2005,weinitiated plans to improve profitability by reducing the combined annual expenditures of Tellabs andAFC by $30 million in 2005 andbeyond, and by realizing an additional$15 million in annual expense savings from other sources, primarily operating expenses. To reach these goals, we reorganized our operations in Denmark andFinland, and reduced headcount ona smaller scale in other locations. Implementation of these plans, which is substantially complete, resulted in workforce reductions,facility closures and assetdisposals. We recorded charges in both 2004 and 2005 of $16.7 million related to these plans. During the second half of 2005, we made minor adjustmentsto prior accruals to reflectcurrent expectations. Excluding restructuringcharges, we achieved cost savings from these plans beginning in the first quarter of 2005. By the end of 2005, we had achieved the goals of theseplans. If we incur any additionalcharges for our previous restructuring plans, we do not expect them to be material.

 

In 2003, management approvedplans to restructure ouroperationsdue to difficult market conditions in the telecommunications industry. A major component of the restructuring was the outsourcing of ourglobal manufacturing operations,which resulted in workforce reductionsof approximately 500 employees, facility closures, asset disposals and the sale of the majority of our inventory to outsourcers. Additionalrestructuring activities during2003 included non-manufacturing workforce reductions and facility closures. As a result of these actions, we recorded charges for severance and relatedcosts, asset impairments,accelerated depreciation on our manufacturing facility in North America, excess and obsolete inventories and excess purchase commitments. Ourmanufacturing operations in NorthAmerica ceased in October 2003, and international manufacturing operations ceased in January 2004. We recorded restructuring and othercharges related to all of theseactivities in 2003 and 2004.

 

The following tablesummarizes restructuring and othercharges recorded for the plans mentioned above, as well as adjustments to reserves recorded for priorrestructurings:

 
| **In millions**                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Severance  and other termination benefits              |       | $        | 12.4       |     | $          | 5.2      |       | $ | 32.3 |   |
| Facility and  other exit costs                         |       | —   |       | 12.2     |       | 68.3     |       |
| Inventory  adjustments and excess purchase commitments |       | —   |       | (9.6     | )          | 70.7     |       |
| Other  obligations                                     |       | 0.5      |       | 3.9      |       | 1.3      |       |
| Total  restructuring and other charges                 |       | $        | 12.9       |     | $          | 11.7     |       | $ | 172.6 |   |
| Total of  above items in cost of revenue               |       | $        | —     |     | $          | (2.4     | )          | $ | 95.4 |   |
| Total of  above items in operating expenses            |       | $        | 12.9       |     | $          | 14.1     |       | $ | 77.2 |   |

 

**Severanceand other termination benefits**

 

Severance and other terminationbenefits in 2005include$11.8 million for staff reductions in Denmark and Finland and severance of $0.6 million attributable to outsourcing our North American prototype lab.

 

In the first half of 2004, werecorded additionalaccrualsfor severance and related costs of $5.0 million as we changed our estimates of the number of employees to be terminated under our fourth-quarter 2003restructuring plan and of severance and related costs pertaining to the closure of our Montreal,Canada, facility in the fourthquarter of 2003. In December 2004, we recorded an accrual for severance and related costs of $1.6 million pertaining to the Denmarkworkforce reduction, which wasapproved toward the end of 2004. Thesecharges were offset partially by a $1.4 million reduction of accruals for severance and related costs pertaining to certain restructuring activitiesthat we initiated in 2003 andprior periods.

 

As a result of outsourcingmanufacturing operationsandaligning employee levels with expected workforce needs, we recorded charges totaling $33.7 million for severance pay and related costs, as we laidoff approximately 1,500 employeesworldwide in 2003. We alsoreversed $1.4 million in severance accruals due to changes in the estimated severance and relatedcosts from prior restructuringprograms.

** **

**Facility andother exit costs**

 

Facility and other exit costsin 2005 include $2.9 millionfor equipment disposals in Denmark and Finland and a $2.9 million reduction of prior restructuringaccruals for excess leased facilities,primarily due to favorable subleasing.

 

35

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Facility and other exit costsinclude impairmentchargesof $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 thesale of our Bolingbrookmanufacturing facilities; $7.7 million for the closure of our Montreal research and development facility; $5.5 million for U.S. research and developmentand manufacturing assets and $0.8million for property, plant andequipment sold to our manufacturing contractor as part of our international manufacturingoutsourcing. We also received$5.2 million in proceeds from the sale of property, plant and equipment in excess of our original estimate. Also included in facility and otherexit costs is $1.9 million forcosts associated with the consolidation of excess leased facilities. This amount included accruals for our Montreal research and developmentoffice, which we closed in the firstquarter of 2004. We reduced excess facilitiesaccruals by $3.2 million in a final settlement of obligations associated with previously vacatedfacilities and favorablesubleasing activity in North America.

 

During 2003, due to a changein the estimated livesofcertain buildings and equipment because we outsourced our North American manufacturing operations, we recorded $48.5 million in accelerateddepreciation on the relatedbuildings and equipment. Of this amount, $23.7 million was charged to cost of revenue during the year and $24.8 million was charged tooperating expenses. We alsorecorded a loss of $23.6 million relatedto the disposal of property, plant and equipment consisting primarily of manufacturing equipment, lab and data equipment, and computer software. Wedisposed of this equipmentprimarily by conducting periodic open-bid auctions with items sold to the highest bidders. During the year we also reduced a reserve related tothe disposal of property, plantand equipment by $5.0 million to reflectthe receipt of sales proceeds in excess of our original estimates. In addition, as a result of the outsourcing of our manufacturing operations,we recorded $1.2 million incharges related to the consolidation of excess facilities.

 

**Inventoryadjustments and excess purchase commitments**

 

In 2004, we accrued $2.3million for the revaluation ofinventories related to international manufacturing outsourcing, and increased the accrual for North American purchasecommitments by $0.1 million. We reduced the reserve for excess purchase commitments in 2004 by $12.0 million, due to a favorable settlementwith a vendor.

 

Due to a slowdown in customerspending levels during2003and 2002, and a review of our inventory levels during outsourcing activities, we wrote down the value of our inventories and related non-cancelableinventory purchase commitmentsfor excess amounts. Included in productcost 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 purchasecommitments. We recorded theinventory adjustments as a reductionto inventory, and recorded the reserve for excess non-cancelable purchase commitments to accrued restructuring and other charges.

 

**Otherobligations**

 

In 2005, the charge to otherobligations is for non-cancelablesoftware licenses due to headcount reductions in Denmark and Finland.

 

In 2004, we accrued $2.4million for contract terminationcosts because we failed to meet certain contractual requirements related to volume usage. Inaddition, we accrued $1.7 millionin wage transition charges related to outsourcing our international manufacturing operations. We also reduced a previously establishedaccrual of $0.2 million forsoftware licenses.

 

In 2003, we recorded $3.7million in charges forotherobligations that arose as a direct result of our 2003 restructuring activities. These chargesrepresent non-cancelable agreementsfor software licenses that were deemedexcess due to workforce reductions and product roadmap changes.

 

We expect to pay the currentportion of accruals forrestructuringand other charges within 12 months, so it is classified as a current liability on the Consolidated Balance Sheets. The long-term portion of theaccruals consists of the long-termportion of facility leases, which weexpect to pay over the remaining terms of the leases that expire at various times through 2011.

 

36

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The following tablessummarize our restructuring and other charges activity during 2005 and 2004 andthe status of the reserves at the related year-end:

 
| **In millions**                                        | ** ** | **Balance at  12/31/04** | ** ** | **Charges** | ** ** | **Cash  Payments** | ** ** | **Non-Cash  Settlements  and Other  Activities (****1)** | ** ** | **Balance at  12/30/05** | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|-------------|------------|--------------------|------------|----------------------------------------------------------|------------|--------------------------|------------|
| Facility and other exit costs                          |       | $                        | 41.8       |        | $          | —             |       | $                                                        | (9.1       | )                        | $          | (3.0 | ) | $ | 29.7 |   |
| Severance and other termination benefits               |       | 2.0                      |       | 12.4        |       | (12.3              | )          | (0.6                                                     | )          | 1.5                      |       |
| Inventory adjustments and excess purchase  commitments |       | 0.2                      |       | —      |       | —             |       | (0.2                                                     | )          | —                   |       |
| Other obligations                                      |       | 2.4                      |       | 0.5         |       | (2.8               | )          | (0.1                                                     | )          | —                   |       |
| Total                                                  |       | $                        | 46.4       |        | $          | 12.9               |       | $                                                        | (24.2      | )                        | $          | (3.9 | ) | $ | 31.2 |   |

 
| **In millions**                                        | ** ** | **Balance at  1/2/04** | ** ** | **Charges/  (Reversals)** | ** ** | **Cash  Payments** | ** ** | **Non-Cash  Settlements  and Other  Activities (****1)** | ** ** | **Balance at  12/31/04** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|--------------------|------------|----------------------------------------------------------|------------|--------------------------|------------|
| Facility and other exit costs                          |       | $                      | 54.8       |                      | $          | 12.2               |       | $                                                        | (12.1      | )                        | $          | (13.1 | ) | $ | 41.8 |   |
| Severance and other termination benefits               |       | 13.5                   |       | 5.2                       |       | (16.2              | )          | (0.5                                                     | )          | 2.0                      |       |
| Inventory adjustments and excess purchase  commitments |       | 38.4                   |       | (9.6                      | )          | (20.6              | )          | (8.0                                                     | )          | 0.2                      |       |
| Other obligations                                      |       | 2.9                    |       | 3.9                       |       | (2.8               | )          | (1.6                                                     | )          | 2.4                      |       |
| Total                                                  |       | $                      | 109.6      |                      | $          | 11.7               |       | $                                                        | (51.7      | )                        | $          | (23.2 | ) | $ | 46.4 |   |

 

----

(1) Non-Cash Settlements and Other Activities include the effectsof currency translation on balances, write-downs of property, plant andequipment to be disposed, and other changes in the reserve balance that do notflow through the income statement.

 

**4.Acquisitions**

 

On December 30, 2004, weacquired Vinci, a privatelyhelddeveloper of optical network terminals for fiber-to-the-premises accesssystems, for $52.5 million in cash andrestricted Tellabs stock. This acquisition enabled us to deliver a more cost-effective fiber-accesssolution. In 2004, we expensedin-process research and development costs of $13.1 million related to this acquisition based on a preliminary appraisal. In 2005, weexpensed an additional $2.2million of in-process research and developmentcosts based on the final allocation of the purchase price. 

 

On November 30, 2004, weacquired 100% of theoutstandingcommon 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. The totalvalue of the acquisition wasapproximately $1.6 billion ($794.5 million, net of cash acquired) plus liabilities assumed. We issued approximately 44.8 million shares of Tellabscommon stock for the acquisition,with the cash portion financed withU.S.-based cash and cash equivalents, including AFC’s. AFC’s products enable service providers to deliver voice, video and high-speed Internet accessover a single networkinfrastructure. By acquiring AFC, Tellabs became the industry leader in the broadband fiber-access market, a market in which Tellabs previously had notbeen a significant participant.Tellabs believes that its deep relationshipswith telecom service providers will provide growth opportunites for both Tellabs and AFC products that were not achievable as stand-alonecompanies.  Goodwill from this acquisition was $559.2million and intangible assetswere $185.2 million. We are amortizing intangible assets, excluding in-process research and development, on a straight-line basis over aweighted average amortizationperiod of 7 years. We expensed in-processresearch and development costs of $89.0 million in 2004.

 

Components of the purchaseprice follow:

 
| **In millions**                            | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|
| Cash paid to  AFC stockholders             |       | $          | 1,067.5    |   |
| Fair value  of Tellabs common stock issued |       | 419.7      |       |
| Fair value  of stock options converted     |       | 143.6      |       |
| Acquisition  costs                         |       | 7.9        |       |
|                                       |       | 1,638.7    |       |
| Deferred  compensation                     |       | (4.2       | )          |
| Purchase  price                            |       | $          | 1,634.5    |   |

 

During 2005, we madeadjustments to the AFCpurchaseprice of $13.8 million for costs to exit facilities, and costs for employee severance andrelocation (exit costs). Inaddition, we made adjustments of $7.9 million related to other assets and liabilities assumed in the acquisition. During 2005, the accrual for exitcosts was

 

37

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charged $15.4 million,leaving a remaining balance of $10.0 million at December 30, 2005. We expect to complete the remaining exit activities within thenext year.  

 

The value of our common stockissued for theacquisitionwas determined based on an average of our stock price three days before and three days after September 7, 2004, the date of the revisedacquisition agreement. We usedthe Black-Scholes option valuation modelto determine the fair value of the Tellabs stock options exchanged. The deferred compensation represents the intrinsic value of the unvested AFC stockoptions on the acquisition date,which is being amortized over the remainingvesting period of the options.  

 

The allocation of thepurchase price follows:

 
| **In millions**                                                      | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|
| Cash, cash  equivalents and marketable securities                    |       | $          | 840.0      |   |
| Other  marketable securities – Cisco stock                      |       | 198.0      |       |
| Other  current assets                                                |       | 126.1      |       |
| Property,  plant and equipment                                       |       | 64.0       |       |
| Goodwill                                                             |       | 559.2      |       |
| Intangible  assets: backlog/leasehold estates/customer relationships |       | 28.2       |       |
| Intangible  assets: developed technology                             |       | 66.0       |       |
| Intangible  assets: trade name                                       |       | 2.0        |       |
| Purchased  in-process research and development costs                 |       | 89.0       |       |
| Other  long-term assets                                              |       | 32.9       |       |
| Total assets                                                         |       | 2,005.4    |       |
| Cisco stock  loan                                                    |       | 198.0      |       |
| Other  current liabilities                                           |       | 145.0      |       |
| Other  long-term liabilities                                         |       | 27.9       |       |
| Total  liabilities                                                   |       | 370.9      |       |
| Purchase  price                                                      |       | $          | 1,634.5    |   |

 

The pro forma results ofoperations for 2004 and2003,as though AFC were acquired at the beginning of the respective periods, follow:

 
| ** **                                 | ** ** | **(Unaudited)**          | ** ** |
|--------------------------------------------|------------|--------------------------|------------|
| **In millions,  except per-share amounts** | ** ** | **Year ended  12/31/04** | ** ** | **Year ended  1/02/04** | ** ** |
| Revenue                                    |       | $                        | 1,665.9    |   | $ | 1,498.5 |   |
| Net 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 acquired100% of the outstanding preferred and common stock of Vivace Networks, Inc. (Vivace),a developer of flexible, high-performance multi service routers, for $130.3million ($122.6 million, net of cash acquired) plus liabilities assumed. Webelieve this acquisition brought two complementary products that enabled us toexpand into the high-growth multiservice router market. Goodwill from thisacquisition was $93.5 million and intangible assets were $37.5 million. We areamortizing the intangible assets over a 7-year useful life using thestraight-line method.

 

We entered into an employeeretention incentive program that awarded shares of our stock worth $10.0million to eligible employees. The cost of this program was recognized ratablyover a 2-year time period.

 

Components of the purchaseprice follow:

 
| **In millions**                        | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|
| Cash paid to  Vivace stockholders      |       | $          | 124.6      |   |
| Fair value  of stock options exchanged |       | 6.4        |       |
| Acquisition  costs                     |       | 0.7        |       |
|                                   |       | 131.7      |       |
| Deferred  compensation                 |       | (1.4       | )          |
| Purchase  price                        |       | $          | 130.3      |   |

 

We used the Black-Scholesoption valuation model to determine the fair value of the Tellabs stock optionsexchanged. The deferred compensation represents the intrinsic value of theunvested Vivace stock options on the acquisition date, which will be recognizedover the remaining vesting period of the options.

 

The allocation of thepurchase price follows:

 
| **In millions**                                                      | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|
| Goodwill                                                             |       | $          | 93.5       |   |
| Intangible  assets subject to amortization—developed technology |       | 37.5       |       |
| Other assets                                                         |       | 16.7       |       |
| Total assets                                                         |       | 147.7      |       |
| Total  liabilities                                                   |       | 17.4       |       |
| Purchase  price                                                      |       | $          | 130.3      |   |

 

We accounted for theseacquisitions under the purchase method of accounting. We included the operatingresults of the businesses in the accompanying consolidated results ofoperations from their date of acquisition. Pro forma combined results ofoperations assuming the acquisitions had occurred at the beginning of the yearare not presented for Vinci and Vivace, because they would not differmaterially from reported results. In addition, we estimate that $158.8 millionof goodwill from these acquisitions will be deductible for tax purposes.

 

38

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**5. Goodwilland Intangible Assets**

 

Goodwill changed during 2004and 2005 due to acquisitions and currency translation adjustments. Thefollowing table reconciles goodwill from 1/2/04 to 12/30/05:

 
| **In millions** | ** ** | **Balance at  1/2/04** | ** ** | **Additions** | ** ** | **Currency  Translation  Adjustments** | ** ** | **Balance at  12/31/04** | ** ** | **Additions** | ** ** | **Currency  Translation  Adjustments** | ** ** | **Balance at  12/30/05** | ** ** |
|-----------------|------------|------------------------|------------|---------------|------------|----------------------------------------|------------|--------------------------|------------|---------------|------------|----------------------------------------|------------|--------------------------|------------|
| Goodwill        |       | $                      | 552.3      |          | 537.4      |                                   | $          | 2.6                      |       | $             | 1,092.3    |                                   | $          | 23.5                     |       | $ | (3.9 | ) | $ | 1,111.9 |   |
|                 |            |                        |            |               |            |                                        |            |                          |            |               |            |                                        |            |                          |            |  |  |  |  |  |  |

 

We amortize our intangibleassets with finite lives on a straight-line basis over their estimated usefullives, which range from approximately 1 year to 13 years. Amortizable intangibleassets acquired in our acquisitions of AFC and Vinci in 2004 had a weightedaverage amortization period of 7 years, with a weighted average amortization periodof 6 years for $89.8 million in developed technology, 12 years for $34.2million in customer relationships and backlog, 7 years for ($6.0) million inleasehold estates and less than 1 year for $2.0 million in trade names andtrademarks.

 

During the fourth quarter of2004, we recorded a charge of $47.2 million for the impaired developed technologyand other assets related to the Tellabs 5500® NGXtransport switch product acquired as part of the Ocular acquisition, based onreduced cash-flow estimates. Of the total charge, $45.6 million was to write offall of the remaining developed technology asset.

 

The gross carrying amount andaccumulated amortization of intangible assets subject to amortization are asfollows:

 
| ** **                      | ** ** | **As of 12/30/05** | ** ** | **As of 12/31/04**            | ** ** |
|---------------------------------|------------|--------------------|------------|-------------------------------|------------|
| **In millions**                 | ** ** | **Gross  Assets**  | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Gross  Assets** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Developed  technology           |       | $                  | 151.1      |                          | $          | 57.1 |   | $ | 94.0 |   | $ | 153.5 |   | $ | 26.6 |   | $ | 126.9 |   |
| Customer  relationships/backlog |       | 34.2               |       | 5.9                           |       | 28.3 |   | 34.2 |   | 0.8 |   | 33.4 |   |
| Trade  name/trademarks          |       | 2.0                |       | 2.0                           |       | — |   | 2.0 |   | 0.4 |   | 1.6 |   |
| Leasehold  estates              |       | (6.0               | )          | (0.9                          | )          | (5.1 | ) | (6.0 | ) | (0.1 | ) | (5.9 | ) |
| Total                           |       | $                  | 181.3      |                          | $          | 64.1 |   | $ | 117.2 |   | $ | 183.7 |   | $ | 27.7 |   | $ | 156.0 |   |

 

The estimated amortizationexpense for each of the next 5 years follows: 

 
| **In millions** | ** ** | ** ** | ** ** |
|-----------------|------------|------------|------------|
| 2006            |       | $          | 26.6       |   |
| 2007            |       | 22.3       |       |
| 2008            |       | 22.0       |       |
| 2009            |       | 18.4       |       |
| 2010            |       | 7.8        |       |
|                 |            |            |            |  |

 

39

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**6.Investments**

 

We account for marketablesecurities at market prices, with the unrealized gain or loss, less deferredincome taxes, shown as a separate component of stockholders’ equity. We baserealized gains and losses on specific identification of the security sold. AtDecember 30, 2005, and December 31, 2004, available-for-sale marketablesecurities consisted of the following:

 
| **In millions**                             | ** ** | **Amortized   Cost** | ** ** | **Unrealized   Gain/(Loss)** | ** ** | **Market   Value** | ** ** |
|---------------------------------------------|------------|----------------------|------------|------------------------------|------------|--------------------|------------|
| **2005**                                    |       |                 |       |                         |       |               |       |
| U.S. government and agency debt obligations |       | $                    | 202.8      |                         | $          | (3.1               | )          | $ | 199.7 |   |
| Corporate debt obligation                   |       | 66.6                 |       | (1.0                         | )          | 65.6               |       |
| Preferred and common stocks                 |       | 44.8                 |       | (1.2                         | )          | 43.6               |       |
|                                        |       | $                    | 314.2      |                         | $          | (5.3               | )          | $ | 308.9 |   |
| **2004**                                    |       |                 |       |                         |       |               |       |
| U.S. government and agency debt obligations |       | $                    | 531.2      |                         | $          | (3.2               | )          | $ | 528.0 |   |
| Corporate debt obligations                  |       | 187.1                |       | (1.6                         | )          | 185.5              |       |
| Foreign government obligations              |       | 64.4                 |       | 0.3                          |       | 64.7               |       |
| Preferred and common stocks                 |       | 45.7                 |       | (0.7                         | )          | 45.0               |       |
| Foreign bank obligations                    |       | 0.1                  |       | —                       |       | 0.1                |       |
|                                        |       | $                    | 828.5      |                         | $          | (5.2               | )          | $ | 823.3 |   |

 

Of our available-for-saledebt securities at December 30, 2005, $157.2 million have contractualmaturities of less than 12 months and $108.1 million have contractual maturitiesgreater than 12 months. As of December 30, 2005, the unrealized loss forsecurities with a final maturity date of less than 12 months was $2.2 million, andthe unrealized loss for securities with a final maturity of greater than 12months was $1.9 million.

 

The unrealized losses in ourfixed-income investments were caused by interest-rate increases. Because the declinein market value is attributable to changes in interest rates and not creditquality, and because we can and intend to hold those investments until arecovery of fair value, we do not consider those investments to be impaired atDecember 30, 2005.

 

As a result of the AFCacquisition, we acquired 10.6 million shares of Cisco common stock that AFC ownedas a result of its investment in privately held Cerent Corporation, which wasacquired by Cisco in 1999. The shares are presented in the current assets sectionof our balance sheet as of December 30, 2005.  In 2000, AFC entered into two three-year hedgecontracts, pledging all of the Cisco stock to secure the obligations under thecontracts. When the hedge contracts matured in 2003, AFC entered into stockloan agreements with a lender, borrowing 10.6 million shares of Cisco stock tosettle hedge contracts on the Cisco stock. The fair value of those stock loansis reflected as a current liability on our balance sheet as of December 30, 2005.The value of both the asset and liability move in tandem with each other sinceeach is based upon the number of shares we hold at the current stock price. Annualfees associated with the stock loan agreement have been approximately $1.3million.

 

In addition to the aboveinvestments, we maintain investments in start-up technology companies and partnershipsthat invest in start-up technology companies. We recorded these investments in *Other Assets*at cost. These investmentstotaled $13.8 million at December 30, 2005, and $12.5 million at December 31,2004.

 

We conduct a quarterly reviewof each investment in our portfolio, including historical and projectedfinancial performance, expected cash needs and recent funding events. Werecognize other-than-temporary impairments if the market value of theinvestment is below its cost basis for an extended period of time or if theissuer has experienced significant financial declines or difficulties inraising capital to continue operations. Other-than temporary impairments were$4.8 million for the year ended December 30, 2005, which includes a loss of $0.5million from currency translation adjustments related to the sale of a foreigninvestment. Other-than-temporary impairments were $11.2 million for the yearended December 31, 2004, and $3.3 million for the year ended January 2, 2004.In 2005, we recorded $4.0 million in income from a long-term investment becausethe underlying company was purchased by a publicly traded entity. Theimpairment charges and income are included in *OtherExpense, Net*in the Consolidated Statements of Operations.

 

**7.Derivative Financial Instruments**

 

We conduct business on aglobal basis in several major currencies and are subject to risks associatedwith fluctuating foreign exchange rates. In response to this risk, we developeda foreign currency exposure management policy to mitigate financial exposure tochanging foreign exchange rates resulting from nonfunctional currency receivablesand payables that are expected to be settled in one year or less. In 2005, weexpanded our policy to include hedging of currency exposures anticipated within

 

40

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the year. We used foreigncurrency forward contracts and a limited number of currency options to manageour foreign currency exposure. We enter into derivative foreign exchangecontracts only to the extent necessary to meet our overall goal of minimizingnonfunctional foreign currency exposures. We do not enter into hedging transactionsfor speculative purposes.

 

*Non-designatedHedges*

 

We do not engage in hedgingspecific individual transactions when addressing currency risks associated withnonfunctional monetary assets and liabilities that are re-measured throughincome. Instead, we use derivatives to manage overall exposure levels forspecific currencies. In accordance with SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*, we record all related forward foreign exchange contractson the balance sheet at fair value. Forward foreign exchange contractsreceivable are included in *Miscellaneous Receivablesand Other Current Assets*, while forward foreign exchange contractspayable are included as part of *OtherAccrued Liabilities*in the Consolidated Balance Sheets. Changes inthe fair value of these instruments are included in earnings as part of *Other Expense, Net*. We had a net loss onforward foreign exchange contracts of $23.3 million in 2005, a net gain of$14.4 million in 2004 and a net gain of $17.0 million in 2003.

 

*Cash FlowHedges*

 

In 2005, we identified andquantified currency risks associated with European operations where operationsand product costs were denominated in Euros and the related revenue wasdenominated in U.S. dollars. To mitigate some of this risk, we entered intoforward and option currency contracts designated as cash flow hedges. Throughoutthe year, we conducted effectiveness tests on derivatives designated as cashflow hedges on a spot to spot basis (excluding time value), with the time-valueportion recorded in *Other Expense*,*Net*. We reclassified theeffective gains and losses accumulated in *AccumulatedOther Comprehensive Income to Operating Expenses*when the hedgedtransaction was recognized in earnings. We reclassified all derivative-hedgedexposures for periods less than 12 months and all of our $0.7 million lossaccumulated in *Accumulated Other Comprehensive Income to OperatingExpenses* by our 2005 year-end. We did not hold any derivativesdesignated as cash flow hedges at year-end.

 

Derivative financialinstruments involve elements of market and credit risk not recognized in thefinancial statements. The market risk that results from these instrumentsrelates to changes in foreign currency exchange rates, which are generallyoffset by changes in the value of the underlying assets or liabilities beingheld. Credit risk relates to the risk of nonperformance by a counterparty to oneof our derivative contracts. We do not believe there is a significant creditrisk associated with our hedging activities because the counterparties are alllarge international financial institutions with high credit ratings. Inaddition, we also limit the aggregate notional amount of agreements enteredinto with any one financial institution to mitigate credit risk.

 

41

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Our net foreign currencyexposure is diversified among a broad number of currencies. The notionalamounts reflected in the following table represent the U.S. dollar values ofthe agreed-upon amounts that will be delivered to a third party on theagreed-upon date:

 
| **In millions**                                                         | ** ** | **Notional Value of  Forward Contracts** | ** ** | **Fair Value of  Forward Contracts** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------|------------|--------------------------------------|------------|
| Forward  contracts at December 30, 2005:                                |       |                                     |       |                                 |       |
| Related  forward contracts to sell foreign currencies for Euro          |       | $                                        | 125.9      |                                 | $          | — |   |
| Related  forward contracts to buy foreign currencies for Euro           |       | 8.3                                      |       | —                               |       |
| Related  forward contracts to sell foreign currencies for Danish kroner |       | 7.1                                      |       | —                               |       |
| Related  forward contracts to sell foreign currencies for British pound |       | 13.6                                     |       | —                               |       |
| Related  forward contracts to sell foreign currencies for U.S. dollar   |       | 28.4                                     |       | —                               |       |
| Related  forward contracts to buy foreign currencies for U.S. dollar    |       | 4.3                                      |       | —                               |       |
| Related  forward contracts to buy foreign currencies for Thai baht      |       | 3.3                                      |       | —                               |       |
| Total                                                                   |       | $                                        | 190.9      |                                 | $          | — |   |
|                                                                    |       |                                     |       |                                 |       |   |   |
| Forward  contracts at December 31, 2004:                                |       |                                     |       |                                 |       |
| Related  forward contracts to sell foreign currencies for Euro          |       | $                                        | 113.1      |                                 | $          | 8.6 |   |
| Related  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      |                                 | $          | 8.6 |   |

 

Pursuant to our policy, we entered into mostof the above contracts immediately prior to the respective year-ends.Accordingly, the carrying value of such contracts at December 30, 2005, andDecember 31, 2004, approximates fair value.

 

**8. ProductWarranties**

 

We provide warranties for allof our products. The specific terms and conditions of those warranties varydepending upon the product sold. We provide a basic limited warranty, includingparts and labor, for all products except access products, for periods generallyranging from 90 days to 5 years. The basic limited warranty for access productscovers parts and labor for periods generally ranging from 2 to 6 years.

 

Our estimate of warrantyliability involved many factors, including the number of units shipped,historical and anticipated rates of warranty claims, and cost per claim. Weperiodically assess the adequacy of our recorded warranty liability and adjustthe amounts as necessary. We classify the portion of our warranty liabilitythat we expect to incur in the next 12 months as a current liability. We classifythe portion of our warranty liability that we expect to incur more than 12months in the future as a long-term liability. Our product warranty liabilitiesare as follows:

 
| **In millions**                                 | ** ** | **12/30/05** | ** ** | **12/31/04** | ** ** | **1/2/04** | ** ** |
|-------------------------------------------------|------------|--------------|------------|--------------|------------|------------|------------|
| Balance at  beginning of year                   |       | $            | 41.2       |         | $          | 19.5       |       | $ | 13.9 |   |
| Accruals for  product warranties issued         |       | 37.0         |       | 6.3          |       | 11.6       |       |
| Settlements                                     |       | (29.0        | )          | (9.4         | )          | (6.0       | )          |
| AFC warranty  liability acquired in acquisition |       | —       |       | 24.8         |       | —     |       |
| Balance at  end of year                         |       | $            | 49.2       |         | $          | 41.2       |       | $ | 19.5 |   |
|                                            |       |         |       |         |       |       |       |   |   |   |
| Balance  sheet classification at end of year    |       |         |       |         |       |       |       |
| Other  accrued liabilities                      |       | $            | 27.9       |         | $          | 21.2       |       | $ | 6.4 |   |
| Other  long-term liabilities                    |       | 21.3         |       | 20.0         |       | 13.1       |       |
| Total  product warranty liabilities             |       | $            | 49.2       |         | $          | 41.2       |       | $ | 19.5 |   |

 

**9. EmployeeStock Plans**

 

In 2004, our shareholdersapproved the Tellabs, Inc. Incentive Compensation Plan, which provides for the grantof short-term and long-term incentive and other stock and cash awards. Weauthorized a total of 39,139,977 shares for grant under the plan, of which 27,761,668remain available for grant under the plan.

 

42

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Under this plan andpredecessor plans, we typically grantthese awards at market value on the date of grant.

 

*StockOption and Stock Appreciation Rights*

* *

Options granted in 2005generally become exercisableratably over 36 months from the date of grant. Options granted in 2004 and 2003 generally becomeexercisable on a cumulative basisat a rate of 20% on each of the firsttwo annual anniversaries and 60% on the third anniversary of the grant date, with a maximum term of 10 years. AFC options that converted toTellabs options from theacquisition vest over 3 to 4 years with a maximum term of 10 years.

 

The following is a summary ofthe status of our optionplansas of December 30, 2005, December 31, 2004,  andJanuary 2, 2004, and of changes during the years ending on these dates:

 
| ** **                                                      | ** ** | **2005**   | ** ** | **2004**                               | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                                                            |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Outstanding—beginning of year                              |       | 67,211,270 |       | $                                      | 15.28      |       | 41,240,918 |   | $ | 19.35 |   | 42,333,868 |   | $ | 22.49 |   |
| Granted/converted                                               |       | 6,964,030  |       | $                                      | 8.70       |       | 34,339,304 | (1) | $ | 10.93 |   | 10,374,119 |   | $ | 6.57 |   |
| Exercised                                                       |       | (9,355,189 | )          | $                                      | 7.41       |       | (2,331,337 | ) | $ | 3.84 |   | (2,409,640 | ) | $ | 2.57 |   |
| Forfeited/expired                                               |       | (9,499,846 | )          | $                                      | 14.62      |       | (6,037,615 | ) | $ | 22.76 |   | (9,057,429 | ) | $ | 23.31 |   |
| Outstanding—end of year                                    |       | 55,320,265 |       | $                                      | 15.90      |       | 67,211,270 |   | $ | 15.28 |   | 41,240,918 |   | $ | 19.35 |   |
|                                                            |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Exercisable at end of year                                      |       | 37,458,198 |       | $                                      | 19.50      |       | 40,415,004 |   | $ | 19.09 |   | 20,450,233 |   | $ | 27.92 |   |
| Available for grant                                             |       | 27,761,668 |       |                                   |       | 39,087,402 |       |   |   | 24,701,201 |   |   |   |
|                                                            |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Weighted average fair value of options  granted during the year |       | $          | 3.85       |                                   |       |       | $          | 5.49 |   |   |   | $ | 4.15 |   |   |   |
|                                                                 |            |            |            |                                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) AFC stock options as of the acquisition datewere converted into 29,728,119 Tellabs stock options with a weighted averageexercise price of $11.19.

 

Options outstanding andexercisable as of December 30, 2005, by price range are as follows:

 
| ** **                                 | ** ** | **Outstanding**                           | ** ** | **Exercisable**                                     | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------------------|------------|
| **Range of  Exercise Prices**              | ** ** | **Number  Outstanding  As of 12/30/2005** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable  As of 12/30/2005** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $ 0.03 –  $  5.79 |       |                                      | 1,346,126  |                                                | 5.1        |   | $ |   2.84 |   | 1,237,770 |   | $ |   2.71 |   |
| $ 5.92 –  $  6.50 |       |                                      | 6,248,703  |                                                | 6.5        |   | $ |   6.05 |   | 4,375,778 |   | $ |   6.04 |   |
| $ 6.56 –  $  8.25 |       |                                      | 7,681,445  |                                                | 7.6        |   | $ |   6.86 |   | 2,998,342 |   | $ |   6.95 |   |
| $ 8.27 –  $  8.67 |       |                                      | 6,729,855  |                                                | 8.8        |   | $ |   8.64 |   | 1,676,167 |   | $ |   8.60 |   |
| $ 8.68 –  $ 9.10       |       |                                      | 3,558,900  |                                                | 6.7        |   | $ |   8.77 |   | 2,765,583 |   | $ |   8.76 |   |
| $ 9.12 –  $10.20            |       |                                      | 4,647,958  |                                                | 8.4        |   | $ |   9.49 |   | 1,397,743 |   | $ |   9.57 |   |
| $10.21 –  $12.05                      |       |                                      | 5,719,325  |                                                | 7.3        |   | $ | 10.92 |   | 3,851,923 |   | $ | 10.86 |   |
| $12.11 –  $14.31                      |       |                                      | 3,237,238  |                                                | 4.3        |   | $ | 13.35 |   | 3,007,999 |   | $ | 13.35 |   |
| $14.43 –  $23.23                      |       |                                      | 7,985,468  |                                                | 4.8        |   | $ | 17.47 |   | 7,981,646 |   | $ | 17.47 |   |
| $23.63 –  $70.63                      |       |                                      | 8,165,247  |                                                | 4.2        |   | $ | 49.78 |   | 8,165,247 |   | $ | 49.78 |   |
|                                       |       | 55,320,265                                |       | 6.4                                                 |       | $ | 15.90 |   | 37,458,198 |   | $ | 19.50 |   |

 

43

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Certain plans also providefor the granting of stockappreciationrights (SARs) in conjunction with, or independently of, the options under the plans. The SARs typically are assigned 10-year terms. AtDecember 30,  2005, there were 82,209 SARs outstanding underthe plans. At December 30, 2005,the exercise prices of outstandingSARs ranged from $4.07 to $70.06. The weighted average price of the 16,720 SARs granted in 2005 was $8.38.

 

*RestrictedStock*

 

We granted 944,984 restrictedshares in 2005, 609,066  restricted shares in 2004 (including 102,816shares relating to the AFCacquisition) and 20,000 restricted sharesin 2003 under this program. We generally recognize compensation expense on a straight-line basis over the vesting period of generally 1 to 3years, based on the market priceof Tellabs stock on the date of grant.Compensation expense was $5.4 million in 2005,  $1.0million in 2004 and no expense in 2003. The weighted average price of restricted stock granted in 2005 was $8.44.

 

*StockPurchase Plan*

 

Under the 2005 Tellabs, Inc.,Employee Stock PurchasePlan,employees can elect to withhold a portion of their compensation to purchase our common stock at85%  of the fair market value on date of purchase. We sold 222,478 shares of common stock under this planin 2005, with 9,777,522 sharesstill available for purchase atDecember 30, 2005. The weighted average purchase price of shares purchased under the plan in 2005  was$8.13.

 

**10. EmployeeBenefit and Retirement Plans**

 

*401(k)Plans*

 

Our employees may participatein the 401(k) plan portionofthe Tellabs Advantage Program. Upon meeting eligibility requirements, we will match(dollar-for-dollar) up to the first4% (from July 1, 2003 – December 30, 2005) or 3% (from January 1, 2003 – June 30, 2003) of the employee’s percentage contribution. Both employee andemployer contributions are vestedimmediately. On July 1, 2003,  we instituted a Discretionary CompanyContribution. This contributionis 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 specificperiod as declared by the Board.All 401(k) eligible employees actively employed on the last business day of the declared period immediately are eligible to receive thiscontribution. The investment ofthese funds follows the participants’ elections on file for theprogram. This contribution vests immediately. The Board of Directors declared a2%  contribution for the third and fourth quarters of 2003, for each quarter of 2004 and for the full year of2005. We maintain similar plansfor the benefit of eligible employees at our Finland and Denmark subsidiaries.

 

Our contributions to theseprograms were $24.3 millionin2005, $18.8 million in 2004 and $25.9 million in 2003.

 

*DeferredIncome Plan*

 

We provide a Deferred IncomePlan that permits certainofficersand management employees to defer portions of their compensation. All deferrals prior to September 2, 2001, are guaranteed a fixed return. InSeptember 2001,  we amended the plan to offer multipleinvestment funds whose returnsare based on market performance. All deferrals on or after September 2, 2001, can be transferred into the amended plan and investedin the new fund options. Fundsinvested prior to September 2, 2001, also can be transferred into the amendedplan. The deferred incomeobligation of $29.1 million is included in  *Other Long-Term Liabilities*and adjusted, with a corresponding charge (or credit) tocompensation expense, to reflectchanges in the fair value of the amount owed to the employee. We fund any payments by the Deferred Income Plan from our investment incorporate-owned life insurancepolicies. The cash surrender value of such policies is recorded in *Other Assets*.

 

*RetireeMedical Plan*

 

We maintain a defined-benefitRetiree Medical Plan.  Under the plan, we provide qualified retireeswith a subsidy to offset theirmedical costs and allow the retirees to participate in the Company-sponsored healthcare plan.  Wemade no contributions in 2005 or 2004. We currently do not anticipate making a contribution to theplan in 2006.

 

44

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The following tablesummarizes benefit obligations,plan assets and funded status of the Retiree Medical Plan measured as of December 31, 2005, andDecember 31, 2004:

 
| **In millions**                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Change  in benefit obligation**                                   |       |     |       |     |       |
| Accumulated  postretirement benefit obligation at beginning of year |       | $        | 11.1       |     | $          | 8.6 |   |
| Service cost                                                        |       | 1.1      |       | 0.7      |       |
| Interest  cost                                                      |       | 0.6      |       | 0.5      |       |
| Actuarial  gain                                                     |       | (0.4     | )          | (1.1     | )          |
| Benefits  paid                                                      |       | (0.2     | )          | (0.3     | )          |
| AFC  acquisition                                                    |       | —   |       | 2.7      |       |
| Curtailment                                                         |       | (1.0     | )          | —   |       |
| Accumulated  postretirement benefit obligation at end of year       |       | $        | 11.2       |     | $          | 11.1 |   |
|                                                                |       |     |       |     |       |
| **Change  in plan assets**                                          |       |     |       |     |       |
| Assets at  fair value at beginning of year                          |       | $        | 8.6        |     | $          | 8.5 |   |
| Return on  plan assets                                              |       | 0.3      |       | 0.1      |       |
| Assets at  fair value at end of year                                |       | $        | 8.9        |     | $          | 8.6 |   |
|                                                                |       |     |       |     |       |
| **Reconciliation  of (accrued) prepaid cost**                       |       |     |       |     |       |
| Funded  status of the plan                                          |       | $        | (2.3       | )        | $          | (2.5 | ) |
| Unrecognized  prior service cost                                    |       | 1.3      |       | 1.5      |       |
| Unrecognized  net loss                                              |       | 0.2      |       | 0.4      |       |
| Accrued cost                                                        |       | $        | (0.8       | )        | $          | (0.6 | ) |

 

The plan’s assets were investedin short-term fixed-income securities at December 31, 2005, and December 31,2004

 

The following tablesummarizes components of netperiodic benefit cost of the retiree medical plan for the years ended December 31, 2005, 2004 and 2003:

 
| **In millions**                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Components  of net periodic benefit cost**                      |       |     |       |     |       |     |       |
| Service cost                                                      |       | $        | 1.1        |     | $          | 0.7      |       | $ | 0.9 |   |
| Interest  cost                                                    |       | 0.6      |       | 0.5      |       | 0.5      |       |
| Expected  return on assets                                        |       | (0.4     | )          | (0.4     | )          | (0.4     | )          |
| Amortization  of unrecognized prior service cost                  |       | 0.1      |       | —   |       | 0.2      |       |
| Net periodic  postretirement benefit cost                         |       | $        | 1.4        |     | $          | 0.8      |       | $ | 1.2 |   |
| Curtailment                                                       |       | (1.0     | )          | —   |       | —   |       |
| Additional  costs due to restructure special termination benefits |       | —   |       | —   |       | 0.2      |       |
| Total cost  for the year                                          |       | $        | 0.4        |     | $          | 0.8      |       | $ | 1.4 |   |

 

The curtailment of $1.0million in 2005 is dueprimarilyto the termination of employees related to our acquisition of AFC. In 2003, we incurred additional costs of $0.2 million for certain extra benefitspaid to terminated or retiredemployees. We amortize the prior servicecost using a straight-line method over the average remaining years of service to full eligibilityfor benefits of the activeRetiree Medical Plan participants.

 

The following tablesummarizes the weighted-averageassumptions used to determine benefit costs and benefit obligations for the years ended December 31,2005,  2004 and 2003:

 
| **Weighted average assumptions**          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount  rate used to determine benefit costs      |       | 6.00     | %          | 6.00     | %          | 6.75     | %          |
| Discount  rate used to determine benefit obligation |       | 6.00     | %          | 6.00     | %          | 6.00     | %          |
| Expected  long-term rate of return on assets        |       | 5.00     | %          | 5.00     | %          | 5.00     | %          |

 

There is no trend rateassumption 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 futuremedical inflation trends or assumptions will not affect the liabilities of this plan.

 

We study historical marketsand preserve long-termhistoricalrelationships between equities and fixed-income securities consistent with the widely accepted capital market principle that assets with highervolatility generate a greaterreturn over the long run. We evaluate current market factors such as inflation and interest rates before

 

45

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determining long-term capitalmarket assumptions. Thelong-termportfolio return is established via a building block approach with proper consideration ofdiversification and rebalancing.We review peer data and historical returns to check for reasonableness and appropriateness.

 

The following table presentsestimated futurebenefitpayments for the Retiree Medical Plan as of December 31, 2005:

 
| **In millions** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|
| 2006                 |       | $          | 0.3        |   |
| 2007                 |       | 0.3        |       |
| 2008                 |       | 0.3        |       |
| 2009                 |       | 0.4        |       |
| 2010                 |       | 0.4        |       |
| 2011–2015       |       | 3.2        |       |
|                      |            |            |            |  |

 

**11. IncomeTaxes**

 

Components of earnings (loss)before income taxes areasfollows:

 
| **In millions**               | ** ** | **Year Ended  12/30/05** | ** ** | **Year Ended  12/31/04** | ** ** | **Year Ended  1/2/04** | ** ** |
|------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| Domestic  source                   |       | $                             | 140.1      |                          | $          | (47.3                       | )          | $ | (250.8 | ) |
| Foreign  source                    |       | 73.0                          |       | 37.1                          |       | 6.1                         |       |
| Earnings  (loss) before income tax |       | $                             | 213.1      |                          | $          | (10.2                       | )          | $ | (244.7 | ) |

 

The provision for income tax(expense) benefitconsistsof the following:

 
| **In millions**               | ** ** | **Year Ended  12/30/05** | ** ** | **Year Ended  12/31/04** | ** ** | **Year Ended  1/2/04** | ** ** |
|------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| Current:                           |       |                          |       |                          |       |                        |       |
| U.S. Federal                       |       | $                             | (15.3      | )                             | $          | 0.6                         |       | $ | 5.7 |   |
| State                              |       | (0.8                          | )          | (0.4                          | )          | (0.4                        | )          |
| Foreign                            |       | (22.0                         | )          | (8.2                          | )          | (17.1                       | )          |
|                               |       | (38.1                         | )          | (8.0                          | )          | (11.8                       | )          |
| Deferred:                          |       |                          |       |                          |       |                        |       |
| U.S. Federal and state             |       | (1.0                          | )          | —                        |       | —                      |       |
| Foreign                            |       | 1.8                           |       | (11.6                         | )          | 14.9                        |       |
|                               |       | 0.8                           |       | (11.6                         | )          | 14.9                        |       |
| Total income tax (expense) benefit |       | $                             | (37.3      | )                             | $          | (19.6                       | )          | $ | 3.1 |   |

 

Deferred taxassets (liabilities) for 2005 and 2004 consist of the following:

 
| **In millions**                             | ** ** | **Ending Balance  12/30/05** | ** ** | **Ending Balance  12/31/04** | ** ** |
|--------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| **Deferred  tax assets**                         |       |                              |       |                              |       |
| Net operating loss and tax credit  carryforwards |       | $                                 | 147.3      |                              | $          | 177.6 |   |
| Accrued liabilities                              |       | 29.4                              |       | 35.5                              |       |
| Inventory reserves                               |       | 22.9                              |       | 14.4                              |       |
| Deferred employee benefit expenses               |       | 12.3                              |       | 13.4                              |       |
| Restructuring accruals                           |       | 11.3                              |       | 17.5                              |       |
| Deferred compensation plan                       |       | 11.0                              |       | 7.9                               |       |
| Amortizable intangibles                          |       | —                            |       | 2.0                               |       |
| Unrealized loss on marketable securities         |       | 2.1                               |       | 2.1                               |       |
| Other                                            |       | 7.0                               |       | —                            |       |
| Gross deferred tax assets                        |       | 243.3                             |       | 270.4                             |       |
|                                             |       |                              |       |                              |       |
| **Deferred  tax liabilities**                    |       |                              |       |                              |       |
| Unrealized gain on marketable securities         |       | $                                 | (197.2     | )                                 | $          | (198.1 | ) |
| Fixed assets and depreciation                    |       | (4.9                              | )          | (21.4                             | )          |
| Amortizable intangibles                          |       | (3.5                              | )          | —                            |       |
| Other                                            |       | —                            |       | (4.3                              | )          |
| Gross deferred tax liabilities                   |       | (205.6                            | )          | (223.8                            | )          |
| Valuation  allowance                             |       | (14.2                             | )          | (38.9                             | )          |
| Net deferred  tax asset                          |       | $                                 | 23.5       |                              | $          | 7.7 |   |

 

The net deferred income taxasset increased from$7.7million at December 31, 2004, to $23.5 million at December 30, 2005. The $15.8 million change is attributable primarily to the utilization ofdomestic and foreign netoperating losses and the release of the domestic deferred tax valuation allowance. Our net deferred tax asset includes a deferred taxliability of $198.2 millionrepresenting taxes that will be due on certain hedge contract gains upon termination of our Cisco stock loans.

 

46

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Federal income taxes at thestatutory rate are reconciledwith the company’s income tax provision as follows:

 
| **In percentages**                                                     | ** ** | **Year Ended  12/30/05** | ** ** | **Year Ended  12/31/04** | ** ** | **Year Ended  1/2/04** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| Statutory  U.S. income tax rate                                             |       | 35.0                          | %          | (35.0%                        | )          | (35.0%                      | )          |
| Valuation  allowance on net deferred tax assets                             |       | (18.4                         | )          | (267.9                        | )          | 30.8                        |       |
| Research and  development credit                                            |       | (4.0                          | )          | —                        |       | —                      |       |
| Tax on  repatriated foreign earnings under the AJCA of 2004, net of credits |       | 7.2                           |       | —                        |       | —                      |       |
| Assessments  related to prior year tax matters                              |       | 1.9                           |       | 17.8                          |       | 2.8                         |       |
| Foreign  earnings taxed at different rates                                  |       | (5.4                          | )          | 91.6                          |       | 0.4                         |       |
| Write-off of  in-process research and development                           |       | 0.4                           |       | 352.2                         |       | —                      |       |
| Nondeductible  stock compensation expense                                   |       | 0.4                           |       | 33.9                          |       | —                      |       |
| State income  tax, net of federal benefits                                  |       | 0.3                           |       | 4.1                           |       | 1.4                         |       |
| Loss on  investment in securities                                           |       | —                        |       | —                        |       | (2.5                        | )          |
| Gain on  investment in subsidiary                                           |       | —                        |       | —                        |       | 0.6                         |       |
| Other, net                                                                  |       | 0.1                           |       | (4.5                          | )          | 0.2                         |       |
| Effective  income tax rate                                                  |       | 17.5                          | %          | 192.2                         | %          | (1.3%                       | )          |

 

*DeferredTax Valuation Allowance*

 

During the year endedDecember 30, 2005, we re-valuated the need to maintain a valuation allowanceon our net deferred tax assetsunder the rules of SFAS 109.Based on this evaluation, which included a review of recent profitability and projections of future profitability, we concluded that a fullvaluation allowance against ournet U.S. deferred federal tax assets is no longer required since it is more likely than not that all of the deferred tax asset will be realized. AtDecember 30,  2005, we continued to maintain a valuationallowance of $14.2 millionagainst deferred tax assets related to tax benefits from certain state and non-U.S. net operating losses.

 

*Summary ofCarryforwards*

 

The balance of our operatinglease and tax credit carryforwardsdecreased from $165.4 million at December 31,  2004,to $147.3 million at December 30, 2005. This decrease was attributable primarily to the utilization of net operating losses in 2005. The state netoperating loss carryforwards andcredits will expire at various dates between 2006 and 2024, most between 2013 and 2024. The federal net operating loss andR&D tax credit carryforwardswill expire at various dates between 2021 and 2025.

 

We have net operating losscarryforwards relating tocertainnon-U.S. subsidiaries for which a full valuation allowance was previously established. The value of these assets was $12.3 million at December 30, 2005,  comparedwith $9.6 million at December 31, 2004. Of these amounts, $5.9 million will expire in 2006 if not utilized, and the remainder will carry forwardindefinitely.

 

*Investmentin Foreign Operations*

 

Deferred U.S. income taxesand foreign withholding taxesare not provided on the undistributed cumulative earnings of foreign subsidiaries because such earningsare considered to be permanentlyreinvested in those operations. The undistributed cumulative earnings of foreign subsidiaries that are considered permanently reinvestedoutside the United States were$270.7 million at December 30,  2005. Upon repatriation of these earnings, wewould be subject to U.S. incometax, net of available foreign tax credits.At December 30, 2005, the estimated amount of this unrecognized deferred tax liability on permanently reinvested foreign earnings, based on currentexchange rates and assuming weare able to utilize foreign tax credits,is approximately $38.0 million.

 

The American Jobs CreationAct of 2004 (AJCA) createdaone-time incentive for U.S. corporations to repatriate foreign earnings by providing an 85% dividendsreceived deduction with respectto qualifying dividends. In 2005, we recorded an income tax expenseof $15.4 million associated withour decision to repatriate $600 million under the AJCA. We completed this repatriation in the fourth quarter using existing foreign cashbalances.

 

*Audits*

 

We are subject to taxexaminations and potentialassessmentsin various jurisdictions. The Internal Revenue Service is auditing our federal income tax returns for 2001 through 2003. We anticipatethat the IRS will submit theresults of this audit to Tellabs in the first half of 2006. We believe any increase to our tax

 

47

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expense for those years thatmight result from the auditwouldnot materially impact our financial statements.  However,we cannot provide assurance that a material adjustment, positive or negative, will not result.

 

**12. ProductGroup and Geographical Information**

 

We manage our business in onesegment. Consolidatedrevenueby current product group designations follows:

 
| **In millions**       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Transport                  |       | $        | 637.9      |     | $          | 597.9    |       | $ | 419.4 |   |
| Access                     |       | 617.0    |       | 53.3     |       | —   |       |
| Managed  Access            |       | 364.8    |       | 331.0    |       | 336.1    |       |
| Broadband  Data            |       | 60.3     |       | 17.4     |       | 6.4      |       |
| Voice-Quality  Enhancement |       | 36.3     |       | 74.6     |       | 68.2     |       |
| Services                   |       | 167.1    |       | 157.6    |       | 150.3    |       |
| **Total**                  |       | $        | 1,883.4    |     | $          | 1,231.8  |       | $ | 980.4 |   |

 

In 2005, revenue from twocustomers accounted for24%and 16% of consolidated revenue. In 2004 and 2003, revenue from a single customer accounted for 27% and 21% of consolidated revenue.Consolidated revenue by country,based on customer location, follows:

 
| **In millions**    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
| United  States          |       | $        | 1,400.1    |     | $          | 797.0    |       | $ | 588.8 |   |
| Other  geographic areas |       | 483.3    |       | 434.8    |       | 391.6    |       |
| **Total**               |       | $        | 1,883.4    |     | $          | 1,231.8  |       | $ | 980.4 |   |

 

Long-lived assets by countryfollow:

 
| **In millions**    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| United  States          |       | $        | 1,494.5    |     | $          | 1,549.1 |   |
| Finland                 |       | 74.6     |       | 91.3     |       |
| Other  geographic areas |       | 20.7     |       | 25.3     |       |
| **Total**               |       | $        | 1,589.8    |     | $          | 1,665.7 |   |

 

**13.Operating Lease Commitments**

 

We have a number of operatinglease agreements primarilyinvolvingoffice space, buildings and office equipment.  Theseleases are non-cancelable and expire on various dates through 2023. As of December 30, 2005, future minimum lease commitments under non-cancelableleases are as follows:

 
| **In millions**          | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| 2006                          |       | $          | 18.7       |   |
| 2007                          |       | 16.7       |       |
| 2008                          |       | 13.4       |       |
| 2009                          |       | 11.1       |       |
| 2010                          |       | 6.8        |       |
| 2011 and  thereafter          |       | 19.8       |       |
| Total  minimum lease payments |       | $          | 86.5       |   |

 

Total future minimum leasepayments have notbeenreduced by $4.5 million of future sublease payments to be received under non-cancelable subleases.  Totalrental expense was $21.5 million for 2005, $10.0 million for 2004 and $15.0 million for 2003.

 

**14. StockRepurchase Plans**

 

In January 2006, our Board ofDirectors authorizedthepurchase of up to $100.0 million in shares of our outstanding common stock. We intend to usecash generated by employee stockoption exercises (other than thoseof company officers and the Board of Directors) to purchase stock under this separate plan. Wewill record these repurchasedshares as treasury stock.

 

In February 2005, our Boardof Directors authorizedthepurchase of up to $300.0 million in shares of our outstanding common stock. We may purchasecommon stock from time to time onthe open market or in private transactionsand record purchases as treasury stock. As of December 30, 2005, we purchased $192.6 million (24.4 million shares) of our common stockunder this plan.

 

48

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**15. EarningsPer Share**

 

The following chart setsforth the computation of net earnings (loss) per share:

 
| **In millions, except per-share data**                                                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Numerator:                                                                                                                          |       |     |       |     |       |     |       |
| Net earnings (loss)                                                                                                                 |       | $        | 175.8      |     | $          | (29.8    | )          | $ | (241.6 | ) |
| Denominator:                                                                                                                        |       |     |       |     |       |     |       |
| Denominator for basic net earnings (loss)  per share – weighted average shares outstanding                                     |       | 449.9    |       | 420.2    |       | 413.1    |       |
| Effect of dilutive securities:                                                                                                      |       |     |       |     |       |     |       |
| Employee stock options and awards                                                                                                   |       | 4.6      |       | —   |       | —   |       |
| Denominator for diluted net earnings (loss)  per share – adjusted weighted average shares outstanding and assumed  conversions |       | 454.5    |       | 420.2    |       | 413.1    |       |
| Net earnings (loss) per share, basic                                                                                                |       | $        | 0.39       |     | $          | (0.07    | )          | $ | (0.58 | ) |
| Net earnings (loss) per share, diluted                                                                                              |       | $        | 0.39       |     | $          | (0.07    | )          | $ | (0.58 | ) |

 

Under GAAP, dilutivesecurities are not included in the computation of diluted earnings per sharewhen a company is in a net loss position. Diluted weighted average sharesoutstanding were 424.7 million in 2004 and 416.7 million in 2003. The number ofanti-dilutive securities excluded from the weighted average shares outstandingcomputation was 38.2 million in 2005 and 37.0 million in 2004.

 

**16.Quarterly Financial Data (unaudited)**

 

Selected quarterly financialdata for 2005 and 2004 is as follows:

 
| **In millions, except per-share data** | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter(****1)** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|--------------------------------|------------|
| **2005**                                                   |       |                   |       |                    |       |                   |       |                           |       |
| Revenue                                                    |       | $                      | 435.6      |                    | $          | 462.5                  |       | $                              | 463.9      |   | $ | 521.4 |   |
| Gross profit                                               |       | $                      | 181.9      |                    | $          | 207.2                  |       | $                              | 217.7      |   | $ | 248.2 |   |
| Net earnings                                               |       | $                      | 0.7        |                    | $          | 41.1                   |       | $                              | 41.9       |   | $ | 92.1 |   |
| Earnings per  share –                                 |       |                   |       |                    |       |                   |       |                           |       |
| Basic                                                      |       | $                      | 0.00       |                    | $          | 0.09                   |       | $                              | 0.09       |   | $ | 0.21 |   |
| Diluted                                                    |       | $                      | 0.00       |                    | $          | 0.09                   |       | $                              | 0.09       |   | $ | 0.20 |   |
|                                                       |       |                   |       |                    |       |                   |       |                           |       |
| **2004**                                                   |       |                   |       |                    |       |                   |       |                           |       |
| Revenue                                                    |       | $                      | 263.8      |                    | $          | 304.3                  |       | $                              | 284.3      |   | $ | 379.4 |   |
| Gross profit                                               |       | $                      | 150.5      |                    | $          | 174.8                  |       | $                              | 153.1      |   | $ | 178.6 |   |
| Net 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 | ) |

 

----

(1)   The fourth quarter of 2004 includes the following pre-tax charges:purchased in-process research and development charges of $102.1 million; asset impairmentcharges of $47.2 million; a net loss on the sale of real estate of $20.6million; and a $11.2 million impairment charge for the write-down of certainlong-term investments.

 

The per-share computation forthe year is a separate, annual calculation. Accordingly, the sum of the quarterlyper-share amounts does not necessarily equal the annual per-share amount.

 

49

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**11-YearSummary of Selected Financial Data (Unaudited)**

 
| **In millions, except per-share, employee  and stockholder data**              | ** ** | **2005** | ** ** | **2004(4)** | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------|------------|-------------|------------|------------|------------|------------|------------|
| **Statement of Operations Data**                                                                             |       |     |       |        |       |       |       |       |       |
| Revenue                                                                                                      |       | $        | 1,883.4    |        | $          | 1,231.8    |       | $          | 980.4      |   | $ | 1,317.0 |   |
| Gross profit                                                                                                 |       | $        | 855.0      |        | $          | 657.0      |       | $          | 354.0      |   | $ | 486.5 |   |
| Operating profit (loss)                                                                                      |       | $        | 188.8      |        | $          | (31.7      | )          | $          | (264.5     | ) | $ | (329.7 | ) |
| Earnings (loss) before income taxes and cumulative effect of change in  accounting principle                 |       | $        | 213.1      |        | $          | (10.2      | )          | $          | (244.7     | ) | $ | (327.8 | ) |
| Earnings (loss) before cumulative effect of change in accounting  principle                                  |       | $        | 175.8      |        | $          | (29.8      | )          | $          | (241.6     | ) | $ | (313.1 | ) |
| Net earnings (loss)                                                                                          |       | $        | 175.8      |        | $          | (29.8      | )          | $          | (241.6     | ) | $ | (313.1 | ) |
| Net earnings (loss) per share before cumulative effect of change in  accounting principle – diluted (1) |       | $        | 0.39       |        | $          | (0.07      | )          | $          | (0.58      | ) | $ | (0.76 | ) |
| Net earnings (loss) per share – diluted (1)                                                             |       | $        | 0.39       |        | $          | (0.07      | )          | $          | (0.58      | ) | $ | (0.76 | ) |
| Weighted average shares outstanding – diluted (1)                                                       |       | 454.5    |       | 420.2       |       | 413.1      |       | 411.4      |       |
|                                                                                                         |       |     |       |        |       |       |       |       |       |
| **Balance Sheet Data**                                                                                       |       |     |       |        |       |       |       |       |       |
| Total assets                                                                                                 |       | $        | 3,514.9    |        | $          | 3,545.1    |       | $          | 2,607.5    |   | $ | 2,705.7 |   |
| Total liabilities                                                                                            |       | $        | 700.2      |        | $          | 747.9      |       | $          | 388.2      |   | $ | 415.4 |   |
| Stockholders’ equity                                                                                    |       | $        | 2,814.7    |        | $          | 2,797.2    |       | $          | 2,219.3    |   | $ | 2,290.3 |   |
|                                                                                                         |       |     |       |        |       |       |       |       |       |
| **Other Information**                                                                                        |       |     |       |        |       |       |       |       |       |
| Net cash provided by operating activities                                                                    |       | $        | 258.4      |        | $          | 214.7      |       | $          | 149.9      |   | $ | 177.8 |   |
| Working capital                                                                                              |       | $        | 1,347.8    |        | $          | 1,298.9    |       | $          | 1,291.1    |   | $ | 1,359.2 |   |
| Long-term debt                                                                                               |       | $        | —     |        | $          | —     |       | $          | —     |   | $ | — |   |
| Research and development expenditures (2)                                                                    |       | $        | 344.0      |        | $          | 250.3      |       | $          | 286.1      |   | $ | 340.6 |   |
| Return on average equity                                                                                     |       | 6.3      | %          | –1.2   | %          | –10.7 | %          | –13.2 | %          |
| Stock price at year-end                                                                                      |       | $        | 10.90      |        | $          | 8.59       |       | $          | 8.36       |   | $ | 7.43 |   |
| Number of employees                                                                                          |       | 3,609    |       | 4,125       |       | 3,515      |       | 4,828      |       |
| Number of stockholders (3)                                                                                   |       | 8,262    |       | 8,035       |       | 6,659      |       | 6,397      |       |

 

----

(1)   Restatedto reflect two-for-one stock splits in 1999, 1996, 1995 and 1994.

(2)   Researchand development expenditures do not include purchased in-process research anddevelopment costs of $2.2 million in 2005, $102.1 million in 2004 and $74.7million in 1996.

(3)   Representsthe number of stockholders at the record date for the next annual meeting ofstockholders.

(4)   Includesthe acquisition of AFC in November 2004.

(5)   Weadopted SAB 101, *Revenue Recognition inFinancial Statements,*in 2000, which is shown as a change inaccounting principle.

 

50

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| **In millions, except per-share, employee  and stockholder data**              | ** ** | **2001**   | ** ** | **2000(5)** | ** ** | **1999**   | ** ** | **1998**   | ** ** | **1997**   | ** ** | **1996**   | ** ** | **1995**   | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **Statement of Operations Data**                                                                             | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                                      |       | $          | 2,199.7    |        | $          | 3,387.4    |       | $          | 2,322.4    |       | $          | 1,706.1    |       | $          | 1,280.9    |   | $ | 925.4 |   | $ | 680.5 |   |
| Gross profit                                                                                                 |       | $          | 763.2      |        | $          | 1,835.4    |       | $          | 1,382.3    |       | $          | 1,000.0    |       | $          | 761.3      |   | $ | 533.4 |   | $ | 376.2 |   |
| Operating profit (loss)                                                                                      |       | $          | (279.4     | )           | $          | 995.0      |       | $          | 731.8      |       | $          | 484.4      |       | $          | 379.8      |   | $ | 183.6 |   | $ | 168.8 |   |
| Earnings (loss) before income taxes and cumulative effect of change in  accounting principle                 |       | $          | (244.8     | )           | $          | 1,109.4    |       | $          | 802.1      |       | $          | 577.7      |       | $          | 417.2      |   | $ | 190.3 |   | $ | 175.6 |   |
| Earnings (loss) before cumulative effect of change in accounting  principle                                  |       | $          | (182.0     | )           | $          | 760.0      |       | $          | 549.7      |       | $          | 391.5      |       | $          | 275.5      |   | $ | 127.6 |   | $ | 123.3 |   |
| Net earnings (loss)                                                                                          |       | $          | (182.0     | )           | $          | 730.8      |       | $          | 549.7      |       | $          | 391.5      |       | $          | 275.5      |   | $ | 127.6 |   | $ | 123.3 |   |
| Net earnings (loss) per share before cumulative effect of change in  accounting principle – diluted (1) |       | $          | (0.44      | )           | $          | 1.82       |       | $          | 1.32       |       | $          | 0.96       |       | $          | 0.69       |   | $ | 0.32 |   | $ | 0.32 |   |
| Net earnings (loss) per share – diluted (1)                                                             |       | $          | (0.44      | )           | $          | 1.75       |       | $          | 1.32       |       | $          | 0.96       |       | $          | 0.69       |   | $ | 0.32 |   | $ | 0.32 |   |
| Weighted average shares outstanding – diluted (1)                                                       |       | 409.6      |       | 418.4       |       | 417.0      |       | 408.9      |       | 401.1      |       | 393.1      |       | 387.6      |       |
|                                                                                                         |       |       |       |        |       |       |       |       |       |       |       |       |       |       |       |
| **Balance Sheet Data**                                                                                       |       |       |       |        |       |       |       |       |       |       |       |       |       |       |       |
| Total assets                                                                                                 |       | $          | 2.865.8    |        | $          | 3,073.1    |       | $          | 2,354.6    |       | $          | 1,651.9    |       | $          | 1,250.1    |   | $ | 786.8 |   | $ | 581.0 |   |
| Total liabilities                                                                                            |       | $          | 400.2      |        | $          | 445.5      |       | $          | 307.1      |       | $          | 247.4      |       | $          | 257.9      |   | $ | 158.2 |   | $ | 127.1 |   |
| Stockholders’ equity                                                                                    |       | $          | 2,465.6    |        | $          | 2,627.6    |       | $          | 2,047.5    |       | $          | 1,404.5    |       | $          | 992.2      |   | $ | 628.6 |   | $ | 453.9 |   |
|                                                                                                         |       |       |       |        |       |       |       |       |       |       |       |       |       |       |       |
| **Other Information**                                                                                        |       |       |       |        |       |       |       |       |       |       |       |       |       |       |       |
| Net cash provided by operating activities                                                                    |       | $          | 419.3      |        | $          | 426.1      |       | $          | 452.2      |       | $          | 239.3      |       | $          | 219.1      |   | $ | 185.5 |   | $ | 103.0 |   |
| Working capital                                                                                              |       | $          | 1,625.1    |        | $          | 1,910.0    |       | $          | 1,511.4    |       | $          | 1,054.9    |       | $          | 685.0      |   | $ | 374.7 |   | $ | 283.9 |   |
| Long-term debt                                                                                               |       | $          | 3.4        |        | $          | 2.9        |       | $          | 9.4        |       | $          | 3.3        |       | $          | 3.1        |   | $ | 2.9 |   | $ | 3.9 |   |
| Research and development expenditures (2)                                                                    |       | $          | 422.7      |        | $          | 412.4      |       | $          | 311.0      |       | $          | 224.1      |       | $          | 171.9      |   | $ | 113.7 |   | $ | 86.5 |   |
| Return on average equity                                                                                     |       | -7.1%      |       | 31.3        | %          | 31.8       | %          | 32.7       | %          | 34.0       | %          | 23.6       | %          | 32.6       | %          |
| Stock price at year-end                                                                                      |       | $          | 15.79      |        | $          | 56.50      |       | $          | 64.19      |       | $          | 34.28      |       | $          | 27.38      |   | $ | 19.75 |   | $ | 9.25 |   |
| Number of employees                                                                                          |       | 7,334      |       | 8,643       |       | 7,068      |       | 5,073      |       | 4,394      |       | 3,418      |       | 2,814      |       |
| Number of stockholders (3)                                                                                   |       | 5,845      |       | 5,367       |       | 5,504      |       | 4,371      |       | 3,725      |       | 3,035      |       | 2,685      |       |

 

51

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**Boardof Directors**

 

 

**LindaBeck,**42, executive vice president and general managerof business solutions at EarthLink since 2005. Executive vice president ofoperations 2000–2005; vice president of engineering at MindSpring 1999–2000.Various management positions at Netcom 1996–1999; Sybase 1994–1996; Amdahl1992–1994; GTE 1987–1992. M.B.A., St. Mary’s College; B.S., Iowa StateUniversity. Tellabs director since 2006.

 

 

**Michael J.Birck,**68, chairmanand co-founder of Tellabs.Chairman since 2000, chiefexecutive officer 2002–2004,chief executive officer andpresident 1975–2000. Director, MolexIncorporated, Illinois Tool Works. M.S.E.E.,New York University; B.S.E.E.,Purdue University. Tellabs directorsince 1975.

 

 

**Bo Hedfors,**62, founder and president of Hedfone Consulting, Inc. (telecom and Internet consulting) since 2002. President, global wireless infrastructurebusiness at Motorola 1998–2002. Presidentand CEO of Ericsson, Inc. 1994–1998;chief technology officer of LMEricsson 1990–1993. Director, OpenwaveSystems, Inc., SwitchCore AB. M.S.E.E., Chalmers University of Technology. Tellabs director since 2003.

 

 

**Frank Ianna,**56, president ofAT&T Network Services1998–2003. Various executive andsenior management positions atAT&T 1990–1998; various managementand staff positions at AT&T1972–1998. M.S.E.E., MassachusettsInstitute of Technology; B.E.E.E.,Stevens Institute of Technology.Tellabs director since 2004.

 

 

**Fred A.Krehbiel,**64,co-chairman of Molex Incorporated since 1999. Co-chief executive officer1999–2001; chairman of the board 1993–1999; vice chairman and chief executiveofficer 1988–1993. Director, DeVry, Inc. B.A., Lake Forest College. Tellabsdirector since 1985.

 

 

**Michael E.Lavin,**60, Midwestarea managing partner KPMG LLP 1993–2002.Partner 1977–2002. Director,Peoples Energy Corporation andSPSS Inc. B.B.A., University of Wisconsin.Tellabs director since 2003. 

 

**Board of Directors Structure andProcess**

 

Tellabsis managed by and under the direction of its Board of Directors.

 

Eachdirector 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 meetingattended in person and $1,000 for each substantive telephonic board ofdirectors meeting. Each director receives equity compensation as described inTellabs 2006 proxy statement.

 

Committeemembers receive a fee of $1,000 for each committee meeting attended in personand $500 for each substantive telephonic committee meeting. In addition, thechairperson of the audit and ethics committee receives an annual retainer of$8,000. The chairs of the compensation committee and the nominating andgovernance committee receive an annual retainer of $4,000.

 

Theboard has an audit and ethics committee, a nominating and governance committeeand a compensation committee.

 

Membersof the audit and ethics committee are Michael Lavin — Chairman, Bo Hedfors,William Souders and Jan Suwinski.

 

Nominatingand governance committee members are Stephanie Pace Marshall — Chairman, LindaBeck, Bo Hedfors, Fred Krehbiel and Michael Lavin.

 

Compensationcommittee members are William Souders — Chairman, Frank Ianna, Stephanie PaceMarshall and Jan Suwinski.

 

52

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**StephaniePace Marshall, Ph.D.,**60,founding president of Illinois Mathematicsand Science Academy since 1986.Ph.D., Loyola University; M.A.,University of Chicago; B.A., QueensCollege. Tellabs director since 1996.

 

 

**Krish A.Prabhu,**51, presidentand chief executive officer ofTellabs since 2004. Partner,Morgenthaler Ventures 2001–2004.Chief operating officer of AlcatelTelecom 1999–2001; chief executiveofficer of Alcatel USA 1997–1999;various senior management positionsat Alcatel 1991–1997. Director,Freescale Semiconductor, Inc. Ph.D. and M.S.E.E., University of Pittsburgh; M.S., Indian Institute of Technology; B.S., Bangalore University.Tellabs director since 2004.

 

 

**William F.Souders,**77, chairmanand chief executive officer ofEmery Air Freight Corporation1988–1989. Executive vicepresident and director at XeroxCorporation 1974–1986. B.A., LakeForest College. Tellabs director since1990. 

 

 

**Jan H.Suwinski,**64,professor of Business and Operations, Cornell University, Johnson GraduateSchool of Management since 1997. Executive vice president of OptoElectronicsGroup, Corning Incorporated 1990–1996. Director, Thor Industries, Inc., OhioCasualty Group. M.B.A. and B.M.E., Cornell University. Tellabs director since1997.

 

53

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**Officers**

 

 

**Michael J.Birck,**68, chairmanand co-founder. Chairman since2000, chief executive officer2002–2004, chief executiveofficer and president 1975–2000.Director, Molex Incorporated,Illinois Tool Works. M.S.E.E.,New York University; B.S.E.E.,Purdue University. Tellabs directorsince 1975.

 

 

**Krish A.Prabhu,**51, presidentand chief executive officer since2004. Partner, MorgenthalerVentures 2001–2004. Chief operatingofficer of Alcatel Telecom1999–2001; chief executive officerof Alcatel USA 1997–1999; varioussenior management positions at Alcatel1991–1997. Director, Freescale Semiconductor,Inc. Ph.D. and M.S.E.E., University of Pittsburgh; M.S., Indian Institute of Technology; B.S., Bangalore University. Tellabs director since2004.

 

 

**John M.Brots,**45, executivevice president, global operationssince 2005. Vice president ofsupply chain management 2004;vice president of North Americanoperations 2000–2003; variousoperations and managementpositions 1988–2003. M.B.A., St.Edwards University; B.S., CameronUniversity.

 

 

**Carl A.DeWilde,**58, executivevice president, broadbandproducts since 2005; executivevice president, access productssince 2004. Chief operating officerand chief technology officer at XteraCommunications 2000–2004. Seniorvice president of development atFujitsu Network Communications 1992–2000;various senior management positions at Alcatel 1990–1992. B.S.E.E., Hogeschool Zeeland.

 

 

**J. ThomasGruenwald,**58,executive vice president,corporate strategy and chieftechnology officer since 2005. Seniorvice president, operations atTellabs International 2002–2004; seniorvice president, broadband access1999–2004; various engineering andmanagement positions 1991–1999. Ph.D.and M.S., Purdue University; B.S. University of Cincinnati.

 

 

**Jean K.Holley,**46, executivevice president and chiefinformation officer since 2005.Senior vice president and chiefinformation officer 2004. Chief informationofficer at USG Corp. from 1998–2003.Various positions at Waste Managementfrom 1989–1998. M.S., IllinoisInstitute of Technology; B.S., Universityof Missouri–Rolla.

 

54

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**Daniel P.Kelly,**44, executivevice president, transportproducts since 2004. Variousengineering and management positions1985–2004. M.B.A., University ofChicago; M.S.E.E. and B.S.E.E.,University of Notre Dame.

 

 

**Stephen M.McCarthy,**51,executive vice president, globalsales and service since 2004.Various engineering and executivepositions at Tellabs 1999–2004.Senior vice president of AutomaticData Processing’s (ADP) majoraccounts central division 1997–1998.Various executive positions atAmeritech 1989–1997. Various sales and management positions at IBM 1976–1989. M.B.A., DePaul University; B.S., University ofIllinois.

 

 

**James M.Sheehan,**43, chiefadministrative officer since2005. General counsel andsecretary 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.

 

 

**Timothy J.Wiggins,**49, executivevice president and chieffinancial officer since 2003.Executive vice president and chieffinancial officer at Chicago Bridge & Iron Company, N.V. 1996–2001; various senior financial and operating management positions at Fruehauf Trailer Corporation and Autodie Corporation 1988–1996. Certified Public Accountant; B.S., Michigan State University.

 

55

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**Glossary**

 

2G Wireless — Digitalwireless networks that carry voice and low-speed data.

 

2.5G Wireless— Software andhardware overlays on a 2G network that provide faster speeds and better servicefor voice and data.

 

3G Wireless — Wirelessnetworks built for digital voice and high-speed data, including video.

 

4G Wireless— The futuregeneration of wireless networks, which will provide high-speed servicesuniversally.

 

Access — Equipment that providesa connection between service providers’ central offices and homes, businessesand other end-user locations.

 

ATM (Asynchronous TransferMode) — A high-speed, high-bandwidth transmission technology that carries datatraffic in fixed-size cells.

 

Bandwidth — The carryingcapacity of a communications channel.

 

Broadband — A high-bandwidthfiber optic, coaxial or hybrid line with more capacity than a voice-grade phoneline (64 kilobits per second), which is capable of carrying numerous voice,data and video channels at once.

 

Carrier-grade Ethernet—Industry standards for Ethernet services that enable service providers torapidly create services, smoothly scale up to speed of 10 Gbps (gigabits persecond), offer robust service level agreements and flexibly support varioustypes of traffic.

 

Circuit — A connectionbetween two points on a communications network.

 

Connectivity — Networkcapability that enables different devices to communicate with each other.

 

Data — Any network trafficother than voice phone calls. Increasingly, phone calls and video are encodedand transported as data.

 

Digital — Systems thattransport information in the binary1s and 0s format, like computer code, to improve clarity and quality.

 

Digital Cross-Connect — Aspecialized high-speed datachannelswitch that connects transmission paths based on network needs (rather than call by call). Digital cross-connects manage and re route networktraffic, and combine, consolidateand segregate signals to maximizeefficiency.

 

DSL (Digital Subscriber Line)— A broadband, high-speedInternetconnection to a home or business delivered over copper wires.

 

Echo Boomers— The generationborn between the early1980sand the mid-1990s, children of the Baby Boomers. There are 250 million Echo Boomers worldwide, who are heavy users of broadband Internet services.

 

Ethernet— A data networkstandard to connect computers, printers, workstations, terminals and servers.

 

FTTC, FTTN, FTTP (Fiber tothe Curb, Fiber to the Node,Fiber to the Premises) — Fiber-optic cable extended directly to homes or neighborhoods to deliverbroadband communicationsservices, including voice, data and video.

 

Fiber-Optic Cable —High-capacity cable that transmits communications along a glass fiber usinglaser light.

 

Frame Relay — Switchinginterface standard that transmits bursts of data over wide-areas networks(WANs).

 

Gbps (gigabits per second) —A way to measure data transfer speeds across a network. A gigabit is onethousand million bits of data.

 

HDTV (High-Definition Television)— A standard designed to deliver sharper pictures and better-quality sound fortelevisions.

 

Internet —The world’s largestdecentralized network of computers and network servers.

 

IP (Internet Protocol) —Rules that enable cooperating computers to share information across a network.

 

IPTV (Internet ProtocolTelevision) — Technology that enables video and other entertainment servicesover two way broadband networks.

 

Mbps (megabits per second) —A way to measure data transfer speeds across a network. A megabit is 1 millionbits of data.

 

Metro Ethernet Forum— Anon-profit organization of service providers, equipment companies and otherswith the mission of accelerating worldwide adoption of carrier-class Ethernetnetworks and services.

 

Mobile — Wirelesscommunications networks that use radio frequencies rather than cables.

 

56

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MSPP (MultiserviceProvisioning Platform) — A system that consolidates the number of separatedevices needed to provide transport, switching and routing services.

 

MPLS (MultiProtocol LabelSwitching) — A packetswitching standard that assigns levels of priority tomultiple traffic types within a data stream to assure quality of service (QoS).

 

Multiplexing — Transmittingtwo or more signals over a single communications channel.

 

Multiservice — Handlesvarious communications services at once, such as ATM, Ethernet and IP.

 

Multiservice Router — Anetwork switch that handles both data and the real-time transmission of videoand voice with high reliability and quality.

 

Network — A system ofequipment and connections for the transmission of signals that carry voice,video and data.

 

ONT (Optical NetworkTerminal) — A device that connects a fiber-access network to a home or businessto deliver voice, data and video services.

 

Optical Transport —Technology that transmits communications traffic in the form of laser lightover fiber-optic cable.

 

QoS (Quality of Service) —Measurement of the integrity of traffic moving over a network. QoS is especiallyimportant for real-time transmissions such as financial transactions, voice andvideo.

 

RF (Radio Frequency) Overlay— The transmission of video over radio wavelengths, which is used in cable TVand fiber-access networks.

 

ROADM (Reconfigurable OpticalAdd/Drop Multiplexer) — A system that enables the remote configuration of anywavelength on any network element, thereby reducing the need for technicians tobe dispatched.

 

SDH (Synchronous DigitalHierarchy) — Transport format for transmitting high-speed digital informationover fiber-optic facilities outside of North America, comparable to SONET.

 

SLA (Service Level Agreement)— An agreement between an end-user and a service provider that establishesmetrics for Quality of Service and measures the service provided to ensure theagreement is met.

 

SONET (Synchronous OpticalNETwork) — Transport format for sending high-speed digital signals throughfiber optics in North America, comparable to SDH.

 

Switch — A device thatestablishes and routes communications paths.

 

T-1 — A high-speed networkconnection.

 

Transport — The process ofmoving voice, data or video a cross communications networks.

 

Triple-Play Services —Offering of voice, video and data from a single service provider.

 

VQE (Voice-Quality Enhancement)— A technique that improves sound quality by isolating and filtering outunwanted signals and sounds such as echoes and background noise.

 

VoD (Video on Demand) — Aservice that enables consumers to watch a video program when they choose to.

 

VoIP (Voice over InternetProtocol) — The transmission of phone calls over data or Internet links.

 

VPN (Virtual Private Network)— A connection that enables businesses to securely transmit their own voice,data and/or video traffic over a public network (i.e., owned by a phone companyor Internet service provider) at a lower cost than a dedicated private network.

 

WAN (Wide Area Network) — Acomputer network covering a wide geographical area. 

 

Wireless — Mobile networksthat use radio frequency rather than cables.

 

Wireline — Networks that usecables rather than radio frequency.

 

57

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**Information for Our Investors**

 

**OwnershipStructure and Investor Rights**

 

Stockholder class and votingrights:All Tellabs stockholdersare entitled to one vote for eachshare held. Only stockholders ofrecord as of February 27, 2006,the record date for the annualmeeting determined by the boardof directors, are entitled toreceive notice of, to attend andto vote at the annual meeting.

 

Votes cast in person or byproxy atthe annualmeeting of stockholders will betabulated by the inspectors ofelection appointed for the meeting whodetermine whether a quorum, amajority of the shares entitledto be voted, is present.

** **

**StockholdersOwning More than 5% of the Company’s shares:**(as of December 31,2005)

 

AXA Group

Michael J. Birck

Columbia Wanger Group

 

**StockholderLogistics**

 

If you have a question forthe boardof directors,would like to make a stockholderproposal or nominate a directorfor the board, contact James M.Sheehan, Tellabs chief administrativeofficer, general counsel,executive vice president andsecretary at +1.630.798.8800.

 

For inclusion in the Company’sproxystatement for theTellabs 2007 Annual Meeting ofStockholders, proposals ofstockholders must be received byJames M. Sheehan, Secretary ofthe Company, no later thanNovember 20, 2006.

 

To nominate one or moredirectorsforconsideration at the 2007 annual meeting,a stockholder must provide noticeof the intent to make such nomination(s)by personal delivery or by mailto the Secretary of the Company,no later than November 20, 2006.The Company’s bylaws set specificrequirements that such writtennotice must satisfy. Copies ofthose requirements will be sent toany stockholder upon written request.

** **

**Certificateof Incorporation and Bylaws**

 

Tellabs’ certificate ofincorporation and bylaws are available online at www.tellabs.com/investors.

** **

**Code ofEthics**

 

Tellabs’ code of ethics andglobal business policy are available online atwww.tellabs.com/about/ethics.shtml.

** **

**ImportantDates for Stockholders**

 

(Dates subject to change)

** **

**FirstQuarter 2006**

 

Record Date for AnnualMeeting: Monday, February 27

Earnings Call: Wednesday,April 26 (7:30 a.m. Central time)

Annual Meeting: Thursday,April 27

** **

**SecondQuarter 2006**

 

Earnings Call: Thursday, July27 (7:30 a.m. Central time)

** **

**ThirdQuarter 2006**

 

Earnings Call: Thursday,October 26 (7:30 a.m. Central time)

** **

**We’re Hereto Help You**

 

You can contact Tom Scottinoin Tellabs Investor Relations at +1.630.798.3602. You also can get investorinformation online at www.tellabs.com/investors.

** **

**TransferAgent**

 

Computershare InvestorServices serves as the stock transfer agent for Tellabs. If you need totransfer stock, change ownership, report lost or stolen certificates, or changeyour address, please contact Computershare Investor Services at+1.312.360.5389.

 

Tellabs Common Stock MarketData

*In dollars*

** **
| ** **      | ** ** | **2005**  | ** ** | 2004     | ** ** |
|-----------------|------------|-----------|------------|----------|------------|
| ** **      | ** ** | **High**  | ** ** | **Low**  | ** ** | High |   | Low | ** ** |
| First  Quarter  | ** ** | **9.28**  | ** ** | **6.88** |       | 11.37 |   | 8.05 |   |
| Second  Quarter | ** ** | **9.15**  | ** ** | **6.56** |       | 10.02 |   | 7.63 |   |
| Third  Quarter  | ** ** | **10.60** | ** ** | **8.40** |       | 10.32 |   | 7.40 |   |
| Fourth  Quarter | ** ** | **11.49** | ** ** | **8.73** |       | 9.59 |   | 7.87 |   |

 

58

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**Requests forInformation**

 

Additional information isavailable without charge. For additional copies of annual reports, 10-Ks, 10-Qsor other financial information, please contact:

 

Secretary

Tellabs, Inc.

One Tellabs Center

1415 West Diehl Road

Naperville, IL 60563

U.S.A.

Or visit: www.sec.gov

** **

**StockTrading Information**

 

Tellabs stock is traded inthe UnitedStates, listedon the NASDAQ Stock Market underthe symbol TLAB. It appears innewspaper stock tables asTellabs. Tellabs is a component ofthe NASDAQ-100 Index, the Standard& Poor’s 500 Index and theDomini 400 Social IndexSM.

** **

**Trademarks**

 

All trademarked or registeredtrademarkproduct andservice names used herein are theproperty of Tellabs or one of itsaffiliates in the United Statesand/or in other countries. Allother product or company names usedherein may be the property of theirrespective companies.

** **

**AnnualMeeting**

 

The 2006 Annual Meeting ofStockholders will be held at 2 p.m. Central time on Thursday, April 27, 2006,at:

 

Hilton Lisle/Naperville

3003 Corporate West Drive

Lisle, IL 60532

U.S.A.

Doors will open at 1 p.m.

 

Internet users can hear asimultaneous live webcast of the annual meeting at www.tellabs.com.

** **

**ElectronicVoting**

 

As an added convenience,stockholders can vote their proxy by mail, by phone at +1.800.690.6903, or viathe Internet at www.proxyvote.com.

** **

**IndependentAuditors**

 

Ernst & Young LLP,

Chicago, IL U.S.A.

** **

**The TellabsFoundation**

 

The Tellabs Foundationsupportsnonprofitorganizations in the priority areasof education, environment andhealth. For an annual report on corporateand foundation community activities,contact Meredith Hilt at meredith.hilt@tellabs.com.

** **

**WorldwideLocations**

 

Please visit www.tellabs.comand see the “Tellabs Locations” section for the most up-to-date, completeinformation

on Tellabs’ global presence.The “Contact Us” page also provides easy access to the right people.

** **

**ForInformation:**

 

In Asia Pacific

Phone: +65.6215.6411

Fax: +65.6215.6422

 

In Europe, Middle East andAfrica

Phone: +44.870.238.4700

Fax: +44.870.238.4851

 

In Latin America andCaribbean

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 ReachUs**

 

One Tellabs Center

1415 West Diehl Road

Naperville, IL 60563 U.S.A.

Phone: +1.630.798.8800

Fax: +1.630.798.2000

www.tellabs.com

 
|        | Report printed entirely on  recycled paper. This report costs $1.98 per copy, less than the cost of the  average annual report. |
|--------|---------------------------------------------------------------------------------------------------------------------------------|
|   |
|   | ©2006 Tellabs, Inc. All  rights reserved. Printed in U.S.A.                                                                |

 

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