**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

** **
|       | **(Mark One)** |
|------------|----------------|
| ** ** | **ý**     | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For thequarterly period ended July 1, 2005**

 

**OR**

 
| ** ** | **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|------------|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                   to                   **

 

**Commissionfile Number: 0-09692**

 

**TELLABS, INC.**

(Exact name ofregistrant as specified in its charter)

 
| **Delaware**                                                                 | ** ** | **36-3831568**                         |
|------------------------------------------------------------------------------|------------|----------------------------------------|
| (State of  Incorporation)                                                    |       | (I.R.S.  Employer  Identification No.) |
|                                                                         |       |                                   |
| **One  Tellabs Center, 1415 W. Diehl Road,  Naperville, Illinois**           | ** ** | **60563**                              |
| (Address of  Principal Executive Offices)                                    |       | (Zip Code)                             |
|                                                                         |       |                                   |
| Registrant’s  telephone number, including area code: **(630) 798-8800** |

 

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

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  YES  ý     NO  o

 

Common Shares, $0.01 Par Value – 447.5 millionshares outstanding on July 1, 2005.

 

 

----

 

**TELLABS,INC.INDEX**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                       |       |
|-------------------|-------------------------------------------------------------------------------------------------|------------|
|              |                                                                                            |       |
| **Item 1.**       | **Financial  Statements:**                                                                      |       |
|              | Condensed Consolidated Statements of Operations                                                 |       |
|              |                                                                                            |       |
|              | Condensed Consolidated Balance Sheets                                                           |       |
|              |                                                                                            |       |
|              | Condensed Consolidated Statements of Cash Flow                                                  |       |
|              |                                                                                            |       |
|              | Notes to Condensed Consolidated Financial Statements                                            |       |
|              |                                                                                            |       |
| **Item  2.**      | **Management’s  Discussion and Analysis of Results of Operations and Financial Condition** |       |
|              |                                                                                            |       |
| **Item 3.**       | **Quantitative  and Qualitative Disclosures about Market Risk**                                 |       |
|              |                                                                                            |       |
| **Item 4.**       | **Controls and  Procedures**                                                                    |       |
|              |                                                                                            |       |
| **PART II.** | **OTHER  INFORMATION**                                                                          | ** ** |
|              |                                                                                            |       |
| **Item 1.**       | **Legal  Proceedings**                                                                          |       |
|              |                                                                                            |       |
| **Item 2.**       | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                |       |
|              |                                                                                            |       |
| **Item 4.**       | **Submission of  Matters to a Vote of Security Holders**                                        |       |
|              |                                                                                            |       |
| **Item 6.**       | **Exhibits**                                                                                    |       |
|              |                                                                                            |       |
| **SIGNATURE**     |                                                                                            |       |

 

2

----

 

**PART I.FINANCIAL INFORMATION**

**Item 1.Financial Statements**

 

**TELLABS,INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                                                                                    | ** ** | **Three Months Ended** |       | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions, except per-share  data)**                                                                                                     | ** ** | **7/1/05**             | ** ** | **7/02/04**          | ** ** | **7/1/05** | ** ** | **7/02/04** | ** ** |
| **Revenue**                                                                                                                                   |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Products                                                                                                                                      | ** ** | **$**                  | **418.1**  | ** **           | $          | 263.5 |   | **$** | **818.6** | ** ** | $ | 495.6 |   |
| Services                                                                                                                                      | ** ** | **44.4**               | ** ** | 40.8                 |       | **79.5** | ** ** | 72.5 |   |
| ** **                                                                                                                                    |       | **462.5**              | ** ** | 304.3                |       | **898.1** | ** ** | 568.1 |   |
| **Cost of Revenue**                                                                                                                           |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Products                                                                                                                                      | ** ** | **225.5**              | ** ** | 104.5                |       | **452.1** | ** ** | 193.5 |   |
| Services                                                                                                                                      | ** ** | **29.8**               | ** ** | 25.0                 |       | **56.9** | ** ** | 49.3 |   |
| ** **                                                                                                                                    |       | **255.3**              | ** ** | 129.5                |       | **509.0** | ** ** | 242.8 |   |
| **Gross Profit**                                                                                                                              | ** ** | **207.2**              | ** ** | 174.8                |       | **389.1** | ** ** | 325.3 |   |
|                                                                                                                                          |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Gross profit as a percentage of revenue                                                                                                       | ** ** | **44.8**               | **%**      | 57.4                 | %          | **43.3** | **%** | 57.3 | % |
|                                                                                                                                          |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Gross profit as a percentage of revenue –  products                                                                                      | ** ** | **46.1**               | **%**      | 60.3                 | %          | **44.8** | **%** | 61.0 | % |
| Gross profit as a percentage of revenue –  services                                                                                      | ** ** | **32.9**               | **%**      | 38.7                 | %          | **28.4** | **%** | 32.0 | % |
|                                                                                                                                          | ** ** | ** **             | ** ** |                 |       | ** ** | ** ** |   |   |
| **Operating Expenses**                                                                                                                        |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Research and development                                                                                                                      | ** ** | **82.9**               | ** ** | 61.1                 |       | **171.7** | ** ** | 123.0 |   |
| Sales & marketing                                                                                                                    | ** ** | **45.4**               | ** ** | 39.1                 |       | **91.6** | ** ** | 76.4 |   |
| General and administrative                                                                                                                    | ** ** | **22.4**               | ** ** | 18.1                 |       | **44.7** | ** ** | 38.5 |   |
| Restructuring & other charges                                                                                                        | ** ** | **1.2**                | ** ** | (2.0                 | )          | **14.4** | ** ** | 14.2 |   |
| Amortization of purchased intangibles                                                                                                         | ** ** | **9.2**                | ** ** | 3.9                  |       | **20.2** | ** ** | 7.8 |   |
| ** **                                                                                                                                    |       | **161.1**              | ** ** | 120.2                |       | **342.6** | ** ** | 259.9 |   |
|                                                                                                                                          |       |                   | ** ** |                 |       |   | ** ** |   |   |
| **Operating Earnings**                                                                                                                        | ** ** | **46.1**               | ** ** | 54.6                 |       | **46.5** | ** ** | 65.4 |   |
| ** **                                                                                                                                    | ** ** | ** **             | ** ** |                 |       | ** ** | ** ** |   |   |
| **Other Income (Expense)**                                                                                                                    |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Interest income, net                                                                                                                          | ** ** | **6.4**                | ** ** | 6.3                  |       | **12.1** | ** ** | 12.2 |   |
| Other expense, net                                                                                                                            | ** ** | **(1.7**               | **)**      | (1.0                 | )          | **(4.4** | **)** | (2.0 | ) |
| ** **                                                                                                                                    |       | **4.7**                | ** ** | 5.3                  |       | **7.7** | ** ** | 10.2 |   |
|                                                                                                                                          |       |                   | ** ** |                 |       |   | ** ** |   |   |
| **Earnings Before Income Tax**                                                                                                                | ** ** | **50.8**               | ** ** | 59.9                 |       | **54.2** | ** ** | 75.6 |   |
| Income tax expense                                                                                                                            | ** ** | **(9.7**               | **)**      | (10.3                | )          | **(12.4** | **)** | (12.6 | ) |
| **Net Earnings**                                                                                                                              | ** ** | **$**                  | **41.1**   | ** **           | $          | 49.6 |   | **$** | **41.8** | ** ** | $ | 63.0 |   |
|                                                                                                                                          |       |                   | ** ** |                 |       |   | ** ** |   |   |
| **Net Earnings Per Share**                                                                                                                    |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Basic                                                                                                                                         | ** ** | **$**                  | **0.09**   | ** **           | $          | 0.12 |   | **$** | **0.09** | ** ** | $ | 0.15 |   |
| Diluted                                                                                                                                       | ** ** | **$**                  | **0.09**   | ** **           | $          | 0.12 |   | **$** | **0.09** | ** ** | $ | 0.15 |   |
| **Weighted Average Shares Outstanding**                                                                                                       |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Basic                                                                                                                                         | ** ** | **447.7**              | ** ** | 416.1                |       | **451.8** | ** ** | 415.7 |   |
| Diluted                                                                                                                                       | ** ** | **451.4**              | ** ** | 420.3                |       | **455.2** | ** ** | 419.9 |   |
| **Amortization of deferred stock compensation  related to acquisitions is included in the following cost and expense  categories by period:** |       |                   | ** ** |                 |       |   | ** ** |   |   |
| Cost of revenue                                                                                                                               | ** ** | **$**                  | **0.1**    | ** **           | $          | — |   | **$** | **0.2** | ** ** | $ | — |   |
| Research and development                                                                                                                      | ** ** | **2.5**                | ** ** | 0.8                  |       | **5.1** | ** ** | 2.8 |   |
| Sales and marketing                                                                                                                           | ** ** | **0.1**                | ** ** | —               |       | **0.2** | ** ** | 0.1 |   |
| General and administrative                                                                                                                    | ** ** | **0.1**                | ** ** | —               |       | **0.2** | ** ** | — |   |
| ** **                                                                                                                                    |       | **$**                  | **2.8**    | ** **           | $          | 0.8 |   | **$** | **5.7** | ** ** | $ | 2.9 |   |

 

The accompanying notes are anintegral part of these statements.

 

3

----

 

**TELLABS,INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 
| **(In millions, except share  amounts)**                                                                                                | ** ** | **7/1/05**      | ** **  | **12/31/04** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|-------------|--------------|------------|
| ** **                                                                                                                              | ** ** | **(Unaudited)** | ** **  | ** **   | ** ** |
| **Assets**                                                                                                                              |       |            |        |         |       |
| **Current Assets**                                                                                                                      |       |            |        |         |       |
| Cash and cash equivalents                                                                                                               | ** ** | **$**           | **276.6**   |         | $          | 292.9 |   |
| Investments in marketable securities                                                                                                    | ** ** | **770.7**       |        | 823.3        |       |
| ** **                                                                                                                              |       | **1,047.3**     |        | 1,116.2      |       |
|                                                                                                                                    |       |            |        |         |       |
| Other marketable securities – Cisco stock                                                                                          | ** ** | **200.5**       |        | 204.0        |       |
|                                                                                                                                    |       |            |        |         |       |
| Accounts receivable, net of returns and  allowances of $25.0 and $16.6                                                                  | ** ** | **261.9**       |        | 309.4        |       |
| Inventories                                                                                                                             |       |            |        |         |       |
| Raw materials                                                                                                                           | ** ** | **30.8**        |        | 39.2         |       |
| Work in process                                                                                                                         | ** ** | **14.4**        |        | 13.6         |       |
| Finished goods                                                                                                                          | ** ** | **100.7**       |        | 63.6         |       |
| ** **                                                                                                                              |       | **145.9**       |        | 116.4        |       |
| Income taxes                                                                                                                            | ** ** | **34.8**        |        | 38.9         |       |
| Miscellaneous receivables and other current  assets                                                                                     | ** ** | **45.4**        |        | 50.0         |       |
| **Total Current Assets**                                                                                                                | ** ** | **1,735.8**     |        | 1,834.9      |       |
|                                                                                                                                    |       |            |        |         |       |
| **Property, Plant and Equipment**                                                                                                       | ** ** | **608.2**       |        | 619.1        |       |
| Less: accumulated depreciation                                                                                                          | ** ** | **(304.2**      | **)**       | (290.3       | )          |
| ** **                                                                                                                              |       | **304.0**       | ** **  | 328.8        |       |
| **Goodwill**                                                                                                                            | ** ** | **1,117.4**     | ** **  | 1,092.3      |       |
| **Intangible Assets, Net of Amortization**                                                                                              | ** ** | **136.8**       | ** **  | 156.0        |       |
| **Other Assets**                                                                                                                        | ** ** | **121.0**       | ** **  | 133.1        |       |
| **Total Assets**                                                                                                                        | ** ** | **$**           | **3,415.0** | ** **   | $          | 3,545.1 |   |
|                                                                                                                                    |       |            | ** **  |         |       |
| **Liabilities and Stockholders’ Equity**                                                                                           |       |            | ** **  |         |       |
| **Current Liabilities**                                                                                                                 |       |            | ** **  |         |       |
| Accounts payable                                                                                                                        | ** ** | **$**           | **78.9**    | ** **   | $          | 96.3 |   |
| Accrued liabilities                                                                                                                     | ** ** | **220.2**       | ** **  | 206.4        |       |
| Restructuring and other charges                                                                                                         | ** ** | **12.0**        | ** **  | 13.4         |       |
| Cisco stock loan                                                                                                                        | ** ** | **200.5**       | ** **  | 204.0        |       |
| Income taxes                                                                                                                            | ** ** | **17.6**        | ** **  | 15.9         |       |
| **Total Current Liabilities**                                                                                                           | ** ** | **529.2**       | ** **  | 536.0        |       |
|                                                                                                                                    |       |            | ** **  |         |       |
| **Long-Term Restructuring Liabilities**                                                                                                 | ** ** | **28.0**        | ** **  | 33.0         |       |
| **Income Taxes**                                                                                                                        | ** ** | **137.0**       | ** **  | 127.9        |       |
| **Other Long-Term Liabilities**                                                                                                         | ** ** | **60.8**        | ** **  | 51.0         |       |
|                                                                                                                                    |       |            | ** **  |         |       |
| **Stockholders’ Equity**                                                                                                           |       |            | ** **  |         |       |
| Preferred stock: authorized 5,000,000  shares of $0.01 par value; no shares issued and outstanding                                      | ** ** | **—**      | ** **  | —       |       |
| Common stock: authorized 1,000,000,000  shares of $0.01 par value; 468,869,551 and 466,910,981 shares issued,  including treasury stock | ** ** | **4.7**         | ** **  | 4.7          |       |
| Additional paid-in capital                                                                                                              | ** ** | **1,155.5**     | ** **  | 1,145.9      |       |
| Deferred compensation expense                                                                                                           | ** ** | **(14.6**       | **)**       | (21.8        | )          |
| Treasury stock, at cost: 21,407,413 and  3,250,000 shares                                                                               | ** ** | **(262.2**      | **)**       | (129.6       | )          |
| Retained earnings                                                                                                                       | ** ** | **1,713.9**     | ** **  | 1,672.1      |       |
| Accumulated other comprehensive income                                                                                                  | ** ** | **62.7**        | ** **  | 125.9        |       |
| **Total Stockholders’ Equity**                                                                                                     | ** ** | **2,660.0**     | ** **  | 2,797.2      |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                     | ** ** | **$**           | **3,415.0** |         | $          | 3,545.1 |   |

 

The accompanying notes are anintegral part of these statements.

 

4

----

 

**TELLABS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOW**

**(Unaudited)**

 
| ** **                                                                           | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|
| **(in millions)**                                                                    | ** ** | **7/1/05**           | ** ** | **7/2/04** | ** ** |
| **Operating Activities**                                                             |       |                 |       |   |   |
| Net Earnings                                                                         | ** ** | **$**                | **41.8**   |   | $ | 63.0 |   |
| Adjustments to reconcile net earnings to  net cash Provided by operating activities: |       |                 |       |   |   |
| Depreciation and amortization                                                        | ** ** | **67.3**             |       | 40.0 |   |
| Deferred compensation amortization                                                   | ** ** | **7.1**              |       | 5.6 |   |
| Restructuring and other charges                                                      | ** ** | **14.4**             | ** ** | 10.7 |   |
| Deferred taxes                                                                       | ** ** | **(1.6**             | **)**      | (0.6 | ) |
|                                                                                 |       |                 | ** ** |   |   |
| Net change in assets and liabilities, net  of effects from acquisitions:             |       |                 | ** ** |   |   |
| Accounts receivable                                                                  | ** ** | **41.9**             | ** ** | 14.0 |   |
| Inventories                                                                          | ** ** | **(28.3**            | **)**      | (14.8 | ) |
| Income tax receivable                                                                | ** ** | **1.0**              | ** ** | 15.4 |   |
| Miscellaneous receivables and other current  assets                                  | ** ** | **(15.5**            | **)**      | 35.9 |   |
| Other assets                                                                         | ** ** | **10.7**             | ** ** | (8.4 | ) |
| Accounts payable                                                                     | ** ** | **(17.5**            | **)**      | 4.9 |   |
| Accrued liabilities                                                                  | ** ** | **(14.9**            | **)**      | 11.9 |   |
| Restructuring and other charges                                                      | ** ** | **(16.6**            | **)**      | (40.2 | ) |
| Income taxes                                                                         | ** ** | **5.9**              | ** ** | (3.3 | ) |
| Long-term liabilities                                                                | ** ** | **9.8**              | ** ** | (3.9 | ) |
| **Net Cash Provided by Operating Activities**                                        | ** ** | **105.5**            | ** ** | 130.2 |   |
|                                                                                 |       |                 | ** ** |   |   |
| **Investing Activities**                                                             |       |                 | ** ** |   |   |
| Capital expenditures                                                                 | ** ** | **(21.5**            | **)**      | (18.4 | ) |
| Disposals of property, plant and equipment                                           | ** ** | **15.0**             | ** ** | 14.2 |   |
| Payments for purchases of investments                                                | ** ** | **(408.5**           | **)**      | (607.3 | ) |
| Proceeds from sales and maturities of  investments                                   | ** ** | **438.4**            | ** ** | 509.1 |   |
| **Net Cash Provided by (Used for) Investing  Activities**                            | ** ** | **23.4**             | ** ** | (102.4 | ) |
|                                                                                 |       |                 | ** ** |   |   |
| **Financing Activities**                                                             |       |                 | ** ** |   |   |
| Proceeds from issuance of common stock  under option plans                           | ** ** | **7.7**              | ** ** | 3.8 |   |
| Repurchase of common stock                                                           | ** ** | **(132.6**           | **)**      | — |   |
| **Net Cash (Used for) Provided by Financing  Activities**                            | ** ** | **(124.9**           | **)**      | 3.8 |   |
| **Effect of Exchange Rate Changes on Cash**                                          | ** ** | **(20.3**            | **)**      | (3.9 | ) |
| **Net (Decrease) Increase in Cash and Cash  Equivalents**                            | ** ** | **(16.3**            | **)**      | 27.7 |   |
| **Cash and Cash Equivalents at Beginning of  Year**                                  | ** ** | **292.9**            | ** ** | 245.9 |   |
| **Cash and Cash Equivalents at End of Period**                                       | ** ** | **$**                | **276.6**  |   | $ | 273.6 |   |

 

The accompanying notes are anintegral part of these statements.

 

5

----

 

**TELLABS, INC.****NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**1. Basis of Presentation**

 

Our accompanying unaudited condensed consolidatedfinancial statements were prepared in accordance with generally acceptedaccounting principles for interim financial statements and the requirements of Form 10-Qand applicable rules of Regulation S-X and accordingly do not include alldisclosures normally required by generally accepted accounting principles forcomplete financial statements. Accordingly, the financial statements and notesherein should be read in conjunction with our Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

In our opinion, the accompanying unauditedcondensed consolidated financial statements include all adjustments (consistingof normal recurring accruals) that are necessary for a fair presentation.Operating results for interim periods are not necessarily indicative ofoperating results for the full year. Certain prior period amounts have beenreclassified to conform to the current period presentation.

 

# **2. NewAccounting Pronouncements**

 

In December 2004, the Financial AccountingStandards Board (FASB) issued Statement No. 123 (revised 2004), *Share-Based Payment* (SFAS 123(R)), which requires themeasurement and recognition of compensation expense for all stock-basedcompensation payments and supersedes our current accounting under APB 25. SFAS123(R) is effective for all annual periods beginning after June 15, 2005.In March 2005, the Securities and Exchange Commission issued Staff AccountingBulletin No. 107 relating to the adoption of SFAS 123(R).  We are currently evaluating the impact ofSFAS 123(R) on our operating results and financial condition and are assessingvarious valuation methods.  We willfinalize our selection of a valuation method prior to adoption of SFAS 123(R)in the first quarter of fiscal 2006.

 

In June 2005, the FASB issued FSP 143-1, *Accounting for Electronic Equipment Waste Obligations.*  FSP 143-1 was issued to address theaccounting for obligations associated with Directive 2002/96/EC on WasteElectrical and Electronic Equipment (the “Directive”) adopted by the EuropeanUnion.  The Directive obligates a commercialuser to incur costs associated with the retirement of a specified asset thatqualifies as historical waste equipment effective August 13, 2005.  FSP 143-1 requires commercial users to applythe provisions of SFAS 143, *Accounting for ConditionalAsset Retirement Obligations,* and the related FASB Interpretation No. 47,*Accounting for Conditional Asset RetirementObligations*, to the obligation associated with historicalwaste.  It is effective the later of thefirst reporting period ending after June 8, 2005 or the date of the adoptionof the law by the applicable European Union-member.  We are in the process of evaluating theimpact this guidance will have on our financial statements.

 

InJune 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections*, which supercedes APB Opinion No. 20,*Accounting Changes* and SFAS No. 3, *Reporting Accounting Changes in Interim Financial Statements*.  This new standard requires retrospectiveapplication to prior periods’ financial statements of a voluntary change inaccounting principle unless impracticable. This statement also requires that achange in depreciation, amortization, or depletion method for long-lived,non-financial assets be accounted for as a change in accounting estimate effectedby a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections oferrors made in fiscal years beginning after December 15, 2005.  We will adopt this statement on its effectivedate.

 

# **3. Acquisition**

 

In November 2004, we acquired 100% of the outstanding common stockof Advanced Fibre Communications (AFC), a leader in access products, for 0.504shares of our common stock and $12.00 in cash for each AFC share, for a totalvalue of approximately $1.6 billion ($794.5 million, net of cashacquired).  We issued approximately 44.8million shares of our common stock for the acquisition, with the cash portionfinanced with U.S.-based cash and cash equivalents, including AFC’s.  The operating results of AFC have beenincluded in our consolidated results of operations since the acquisition.  During the first two quarters of 2005 we madeadjustments of $28.5 million to the purchase price allocation due to: (1) $14.9million for adjustments to liabilities assumed in the acquisition, and (2)$13.6 million for costs to exit facilities, and costs for employee severanceand relocation.  The reserve for costs toexit facilities, employee severance and relocation was $3.9 million at December31, 2004 and had a balance of $12.7 million at July 1, 2005.  The purchase price allocation for AFC has notbeen finalized pending completion of final adjustments to liabilities assumedin the acquisition, and the completion of integration plans and valuationreports.

 

**4. Restructuring and Other Charges**

 

In the fourth quarter of 2004 and first quarter of 2005, we initiatedplans to reorganize our operations in Denmark and Finland to improveprofitability.  Implementation of theseplans, which have been substantially completed, resulted in workforce reductions,facility closures and asset disposals. We recorded approximately $16.1 million related to these plans,principally in the first two quarters of 2005. We expect additional charges, ifany, for these plans would be immaterial.

 

6

----

 

In the second quarter of 2005, we initiated a plan to outsource ourNorth American prototype lab to our current manufacturing vendor.  Restructuring charges for the plan areprimarily for severance and asset disposals and are expected to be $1.9 millionof which $0.2 million was incurred during the second quarter.  We expect to incur the remaining $1.7 millionof costs during the third and fourth quarter of 2005.

 

Excluding restructuringcharges, cost savings from the above mentioned plans were achieved in both thefirst and second quarters of this year. These plans are part of the Company’sgoal to reduce the combined annual expenditures of Tellabs and AFC by $30million in 2005 and beyond, and an additional $15 million in annual expensesavings from other sources, primarily operating expenses.

 

**The following tables analyze restructuringand other charges recorded during the second quarter and year-to-date periodsof 2005 and 2004 by major income statement classification related to the abovementioned plans as well as adjustments to reserves recorded for priorrestructurings:**

 
| **(in millions)**                   | ** ** | ** **                                                  | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------|------------|-------------------|------------|
| **Income Statement Classification** | ** ** | **Description**                                             | ** ** | **7/1/05**        | ** ** | **7/2/04** | ** ** |
| Cost of revenue                     |       | Disposal of  property, plant and equipment                  |       | $                 | —     |   | $ | 4.5 |   |
|                                |       | Other  obligations                                          |       | —            |       | 1.2 |   |
|                                |       | Total in  Cost of Revenue and Gross Profit                  |       | —            |       | 5.7 |   |
| Operating expenses                  |       | Severance  and related expenses                             |       | 0.5               |       | 0.9 |   |
|                                |       | Consolidation  of excess leased facilities                  |       | 0.1               |       | 0.3 |   |
|                                |       | Disposal of  property, plant and equipment                  |       | 0.1               |       | 0.6 |   |
|                                |       | Other  obligations                                          |       | 0.5               |       | — |   |
|                                |       | Sub-total in Operating Expenses                             |       | 1.2               |       | 1.8 |   |
|                                |       | Reversal of  excess severance Accrual                       |       | —            |       | (1.2 | ) |
|                                |       | Proceeds from fixed asset disposals in  excess of estimates |       | —            |       | (0.7 | ) |
|                                |       | Reversal of  excess leased facilities accrual               |       | —            |       | (1.9 | ) |
|                                |       | Total in Operating Expenses                                 |       | 1.2               |       | (2.0 | ) |
|                                |       | Total Restructuring and Other Charges                       |       | $                 | 1.2        |   | $ | 3.7 |   |

 
| **(in millions)**                   | ** ** | ** **                                                  | ** ** | **Year-to-Date Period Ended** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------|------------|
| **Income Statement Classification** | ** ** | **Description**                                             | ** ** | **7/1/05**                    | ** ** | **7/2/04** | ** ** |
| Cost of revenue                     |       | Inventory  adjustments                                      |       | $                             | —     |   | $ | 2.3 |   |
|                                |       | Disposal of  property, plant and equipment                  |       | —                        |       | 4.8 |   |
|                                |       | Other  obligations                                          |       | —                        |       | 1.4 |   |
|                                |       | Sub-total in Cost of Revenue                                |       | —                        |       | 8.5 |   |
|                                |       | Reversal of  excess purchase commitments accrual            |       | —                        |       | (12.0 | ) |
|                                |       | Total in  Cost of Revenue and Gross Profit                  |       | —                        |       | (3.5 | ) |
| Operating expenses                  |       | Severance  and related expenses                             |       | 11.5                          |       | 5.0 |   |
|                                |       | Consolidation  of excess leased facilities                  |       | 0.4                           |       | 1.7 |   |
|                                |       | Disposal of  property, plant and equipment                  |       | 3.5                           |       | 13.2 |   |
|                                |       | Other  obligations                                          |       | 0.5                           |       | 2.4 |   |
|                                |       | Sub-total in Operating Expenses                             |       | 15.9                          |       | 22.3 |   |
|                                |       | Reversal of  excess severance accrual                       |       | —                        |       | (1.2 | ) |
|                                |       | Proceeds from fixed asset disposals in  excess of estimates |       | —                        |       | (5.0 | ) |
|                                |       | Reversal of  excess leased facilities accrual               |       | (1.5                          | )          | (1.9 | ) |
|                                |       | Total in Operating Expenses                                 |       | 14.4                          |       | 14.2 |   |
|                                |       | Total Restructuring and Other Charges                       |       | $                             | 14.4       |   | $ | 10.7 |   |

 

7

----

 

**2005 Accruals**

 

*Severance and related expenses*

 

In the second quarter, we accrued $0.2 million for severance andrelated expenses attributable to the outsourcing of North American prototype labactivities to our contract manufacturer. We also recorded a $0.3 million charge for severance actions in Denmarkand Finland.

 

During the first quarter, we recorded additional accruals for severanceand related costs totaling $11.0 million for staff reductions in Denmark,Finland and the United States.

 

*Consolidation of excess leased facilities*

 

In the second quarter, we recorded a $0.1 million charge for exitingthe Denmark facility in favor of a smaller and less expensive space.

 

During the first quarter, we recorded $0.3 million in charges forinternational facility consolidation related to the Denmark and Finlandheadcount reductions.  We also reducedthe United States accrual for excess leased facilities by $1.5 million toreflect favorable subleasing activity.

 

*Disposal of property, plant and equipment*

 

During the second quarter, we recorded a $0.1 million charge forequipment that was disposed in Denmark. The year-to-date period also includes a $2.4 million charge forequipment in Denmark that is held for sale. We also recorded a loss on the sale of a facility in Finland of $0.8million, as well as a $0.2 million charge to adjust reserves recorded inprevious periods due to changes in estimates.

 

*Other obligations*

 

During the second quarter, we accrued $0.4 million for non-cancelablesoftware licenses that are excess due to the headcount reductions in Denmarkand Finland, and $0.1 million to adjust the 2004 reserve for minimum-usagecharges that were driven by workforce reductions in prior years.

 

**2004 Accruals**

 

*Inventory adjustments and excess purchasecommitments accrual*

 

In the first quarter, we accrued $2.3 million for the revaluation ofinventories related to international manufacturing outsourcing which occurredin the fourth quarter of 2003 and first quarter of 2004.  There was also a $12.0 million reduction tothe reserve for excess purchase commitments due to a favorable settlement witha vendor.

 

*Disposal of property, plant and equipment*

 

During the second quarter, we recorded impairment charges of $5.1million for property, plant and equipment to be disposed of or held forsale.  This amount included a $4.5million charge for the loss on the sale of our Bolingbrook manufacturingfacilities which closed in the third quarter. In addition, we recorded $0.6 million in impairment charges primarilyrelating to equipment used in our Montreal research and developmentfacility.  We also received $0.7 millionin proceeds from the sale of property, plant and equipment in excess of ouroriginal estimate.

 

During the first quarter, we recorded impairment charges of $12.9million for property, plant and equipment to be disposed of or held forsale.  Of the charge, $7.1 millionrelated to the closure of the Montreal research and development facility at theend of the first quarter of 2004; $5.5 million was recorded for U.S. researchand development and manufacturing assets; and $0.3 million was

 

8

----

 

recorded for equipment sold toour international manufacturing outsourcer. We also received $4.3 million in proceeds from the sale of property,plant and equipment in excess of our original estimate of restructuring andother charges.

 

*Severance and related expenses*

 

Severance adjustments for both the second quarter and first half relateto additional accruals and adjustments to previous estimates for pre-2004restructuring plans.

 

*Consolidation of excess leased facilities*

 

During the second quarter, we accrued $0.3 million for costs associatedwith excess leased facilities.  There wasalso a reduction of $1.9 million for excess facilities accruals relating tofinal reconciliation and settlement of obligations associated with previouslyvacated facilities.

 

In the first quarter, we accrued $1.4 million for costs associated withexcess leased facilities.  This amountincluded accruals for the Montreal research and development office, which wasclosed at the end of the first quarter of 2004.

 

*Other obligations*

 

During the second quarter, we accrued $1.2 million in wage transitioncharges for our international manufacturing outsourcing activities.

 

During the first quarter, we accrued $2.4 million related to contracttermination costs for not meeting minimum-usage fees required under contractsdue to workforce reductions and $0.2 million in wage transition charges for ourinternational manufacturing outsourcing activities.

 

**The following table displays ourrestructuring and other charges activity during the first six months of 2005and the status of the reserves at July 1, 2005:**

 
| **(in millions)**     | ** ** | **Excess Purchase  Commitments** | ** ** | **Severance and  Related Expenses** | ** ** | **Consol. of  Excess Leased  Facilities** | ** ** | **Disposal of  Property, Plant  and Equipment** | ** ** | **Other  Obligations** | ** ** | **Total** | ** ** |
|-----------------------|------------|----------------------------------|------------|-------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------|------------|------------------------|------------|-----------|------------|
| Balance at 12/31/04   |       | $                                | 0.2        |                                | $          | 2.0                                       |       | $                                               | 41.8       |                   | $          | —    |       | $ | 2.4 |   | $ | 46.4 |   |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Additional reserves   |       | —                           |       | 11.0                                |       | 0.3                                       |       | 3.4                                             |       | —                 |       | 14.7      |       |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Cash paid             |       | —                           |       | (4.4                                | )          | (2.5                                      | )          | —                                          |       | ((0.5                  | )          | (7.4      | )          |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Non-Cash activity (a) |       | —                           |       | (0.4                                | )          | (1.5                                      | )          | (3.4                                            | )          | —                 |       | (5.3      | )          |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Balance at 4/1/05     |       | $                                | 0.2        |                                | $          | 8.2                                       |       | $                                               | 38.1       |                   | $          | —    |       | $ | 1.9 |   | $ | 48.4 |   |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Additional reserves   |       | —                           |       | 0.5                                 |       | 0.1                                       |       | 0.1                                             |       | 0.5                    |       | 1.2       |       |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Cash paid             |       | —                           |       | (5.2                                | )          | (2.2                                      | )          | —                                          |       | (1.8                   | )          | (9.2      | )          |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Non-Cash activity (a) |       | —                           |       | (0.3                                | )          | —                                    |       | (0.1                                            | )          | —                 |       | (0.4      | )          |
|                  |       |                             |       |                                |       |                                      |       |                                            |       |                   |       |      |       |
| Balance at 7/1/05     |       | $                                | 0.2        |                                | $          | 3.2                                       |       | $                                               | 36.0       |                   | $          | —    |       | $ | 0.6 |   | $ | 40.0 |   |

 

----

Note (a):  Non-Cash activityincludes reversals of previously recorded reserves, effects of currencytranslation on balances, other changes in the reserve balance that do not flowthrough the income statement, and write-downs of property plant and equipmentto be disposed.

 

Of the remaining $40.0 million of liabilities for restructuring andother charges as of July 1, 2005, $12.0 million was classified as currentbecause we expect to pay them within the next 12 months.  We expect to pay the long-term balance of$28.0 million over the remaining lease terms of our excess facilities leases, whichexpire at various times through 2011.

 

9

----

 

**5. Stock Options**

 

We account for our stock-based compensation plans under AccountingPrinciples Board (“APB”) Opinion No. 25. Had compensation cost for our stock-based compensation plans beendetermined using the fair value at the grant dates for awards under those plansconsistent with the method required by SFAS No. 123, our net earnings and netearnings per share would have been as follows:

 
| ** **                                                                                                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions, except per-share  amounts)**                                                                                                | ** ** | **7/1/05**             | ** ** | **7/2/04**           | ** ** | **7/1/05** | ** ** | **7/2/04** | ** ** |
| Net earnings as reported                                                                                                                    |       | $                      | 41.1       |                 | $          | 49.6 |   | $ | 41.8 |   | $ | 63.0 |   |
|                                                                                                                                        |       |                   |       |                 |       |   |   |   |   |
| Add: stock-based employee compensation  expense included in reported net earnings, net of related tax effects                               |       | 3.6                    |       | 2.1                  |       | 7.1 |   | 5.6 |   |
|                                                                                                                                        |       |                   |       |                 |       |   |   |   |   |
| Less: total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |       | (14.0                  | )          | (9.8                 | )          | (44.5 | ) | (21.7 | ) |
|                                                                                                                                        |       |                   |       |                 |       |   |   |   |   |
| Pro forma net earnings                                                                                                                      |       | $                      | 30.7       |                 | $          | 41.9 |   | $ | 4.4 |   | $ | 46.9 |   |
|                                                                                                                                        |       |                   |       |                 |       |   |   |   |   |
| Net earnings per share - Basic:                                                                                                             |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                                                 |       | $                      | 0.09       |                 | $          | 0.12 |   | $ | 0.09 |   | $ | 0.15 |   |
| Pro forma                                                                                                                                   |       | $                      | 0.07       |                 | $          | 0.10 |   | $ | 0.01 |   | $ | 0.11 |   |
|                                                                                                                                        |       |                   |       |                 |       |   |   |   |   |
| Net earnings per share – Diluted:                                                                                                      |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                                                 |       | $                      | 0.09       |                 | $          | 0.12 |   | $ | 0.09 |   | $ | 0.15 |   |
| Pro forma                                                                                                                                   |       | $                      | 0.07       |                 | $          | 0.10 |   | $ | 0.01 |   | $ | 0.11 |   |

 

The fair value of options was estimated on the date of grant using theBlack-Scholes option pricing model with the following weighted-averageassumptions for grants in 2005 and 2004:

 
| ** **              | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-------------------------|------------|-----------|------------|-----------|------------|
| Expected volatility     |       | 60.0      | %          | 71.9      | %          |
| Risk-free interest rate |       | 3.8       | %          | 3.2       | %          |
| Expected life           |       | 4.2 years |       | 4.9 years |       |
| Expected dividend yield |       | 0.0       | %          | 0.0       | %          |

 

The pro forma amounts disclosed above may not be representative offuture disclosures because the estimated fair value of stock options isamortized to expense over the vesting period, and additional options may begranted in future years.  In addition,the Black-Scholes option pricing model was developed for use in estimating thefair value of traded options that have no vesting restrictions and are fullytransferable.  The Black-Scholes modelrequires the use of assumptions that are subjective, such as the expectedvolatility of the exercise price and the expected life of the option.  Since our options have significantlydifferent characteristics from traded options, and the changes in thesubjective input assumptions can result in materially different fair valueestimates, we believe the existing option pricing models do not necessarilyprovide a reliable single measure of the fair value of the options and do notgive a meaningful comparison of companies in a given industry.

 

**6. Retiree Medical Plan**

 

The following table sets forth the components of the net periodicbenefit costs for our retiree medical plan:

 
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions)**                  | ** ** | **7/1/05**             | ** ** | **7/2/04**           | ** ** | **7/1/05** | ** ** | **7/2/04** | ** ** |
| Service cost                       |       | $                      | 0.3        |                 | $          | 0.2 |   | $ | 0.6 |   | $ | 0.4 |   |
| Interest cost                      |       | 0.1                    |       | 0.1                  |       | 0.3 |   | 0.2 |   |
| Expected return on plan assets     |       | (0.1                   | )          | (0.1                 | )          | (0.2 | ) | (0.2 | ) |
| Amortization of prior service Cost |       | —                 |       | —               |       | — |   | — |   |
| Amortization of net (gain) Loss    |       | —                 |       | —               |       | — |   | — |   |
| Net periodic benefit cost          |       | $                      | 0.3        |                 | $          | 0.2 |   | $ | 0.7 |   | $ | 0.4 |   |

 

10

----

 

We estimate that we will contribute $0.8 million to our retiree medicalplan in 2005.  No contribution has beenmade to date.

 

**7. Comprehensive Income (Loss)**

 

Comprehensive income (loss) is an expression of our net earnings (loss)in the condensed consolidated statements of operations, adjusted for foreigncurrency translation adjustments, net unrealized gains or losses on available-for-salesecurities and fair value adjustments of cash flow hedges.  Our comprehensive income (loss) was as follows:

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions)**                                             | ** ** | **7/1/05**             | ** ** | **7/2/04**           | ** ** | **7/1/05** | ** ** | **7/2/04** | ** ** |
| Net Earnings                                                  |       | $                      | 41.1       |                 | $          | 49.6 |   | $ | 41.8 |   | $ | 63.0 |   |
| Other Comprehensive Income (Loss)                             |       |                   |       |                 |       |   |   |   |   |
| Cumulative translation adjustment                             |       | (34.9                  | )          | (1.4                 | )          | (62.8 | ) | (18.6 | ) |
| Unrealized net gain (loss) on available-  for-sale-securities |       | 2.5                    |       | (9.2                 | )          | — |   | (4.0 | ) |
| Fair value adjustments of cash flow hedges                    |       | (0.4                   | )          | —               |       | (0.4 | ) | — |   |
| Comprehensive Income (Loss)                                   |       | $                      | 8.3        |                 | $          | 39.0 |   | $ | (21.4 | ) | $ | 40.4 |   |

 

**8. Product Warranties**

 

We offer warranties for all of our new products.  The specific terms and conditions of thosewarranties vary depending upon the product sold.  We provide a basic limited warranty,including parts and labor, for all products other than Access products for a periodranging from 1 to 5 years.  The basiclimited warranty for Access products covers parts and labor for periods generallyranging from 2 to 6 years.

 

Factors that enter into our estimate of our warranty liability includethe number of units shipped, historical and anticipated rates of warrantyclaims, and cost per claim.  Weperiodically assess the adequacy of our recorded warranty liabilities andadjust the amounts as necessary.  On theConsolidated Balance Sheets, the short-term portion of the warranty reserve isincluded in *Other Current Liabilities*, while thelong-term portion is included in *Other Long-TermLiabilities*.  Our productwarranty liabilities are as follows:

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions)**                              | ** ** | **7/1/05**             | ** ** | **7/2/04**           | ** ** | **7/1/05** | ** ** | **7/2/04** | ** ** |
| Balance at beginning of the period             |       | $                      | 42.2       |                 | $          | 18.9 |   | $ | 41.1 |   | $ | 19.5 |   |
| Accruals for product warranties issued         |       | 9.8                    |       | 2.2                  |       | 17.5 |   | 2.7 |   |
| Settlements made during the period             |       | (5.1                   | )          | (2.3                 | )          | (11.7 | ) | (3.4 | ) |
| Balance at end of the period                   |       | $                      | 46.9       |                 | $          | 18.8 |   | $ | 46.9 |   | $ | 18.8 |   |
|                                           |       |                   |       |                 |       |   |   |   |   |
| Balance sheet classification at end of  period |       |                   |       |                 |       |   |   |   |   |
| Other current liabilities                      |       |                   |       |                 |       | $ | 28.5 |   | $ | 7.3 |   |
| Other long-term liabilities                    |       |                   |       |                 |       | 18.4 |   | $ | 11.5 |   |
| Total product warranty liabilities             |       |                   |       |                 |       | $ | 46.9 |   | $ | 18.8 |   |

 

**9. Derivative Financial Instruments**

 

Weenter into foreign exchange forward and option contracts with maturities ofless than 12 months to mitigate the impact of currency fluctuations on existingforeign currency asset and liability balances. In addition, beginning in 2005, we are using foreign exchange forward andoption contracts of less than 12 months to reduce the risk to earnings and cashflows associated with anticipated foreign currency net expenditures.  In

 

11

----

 

accordancewith SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities,* all derivatives are recorded onthe balance sheet at fair value.

 

Inregards to cash flow hedges, we calculate each hedge’s effectiveness quarterly,excluding time value.  A forward contract’seffectiveness is calculated by comparing the cumulative change in the fairvalue on a spot-to-spot rate basis to the spot-to-spot rate cumulative changein the anticipated transaction, with the effective portion recorded in othercomprehensive income.  Similarly anoption contract’s effectiveness is calculated by comparing cumulative changesin the contract’s intrinsic value on a spot rate basis to cumulative losses invalue of the anticipated transaction measured on a spot-rate basis.  Effective changes in value are accumulated inother comprehensive income and reclassified to operating margin when the hedgedrevenue transaction is recognized in income. We record any ineffectiveness, along with the excluded time value of theforward and option contracts, in *Other expense, net*.  In the event it becomes probable that ahedged anticipated transaction will not occur, the gains or losses on therelated cash flow hedges will immediately be reclassified from *Other Comprehensive Income* (*OCI*)to *Other expense, net. *We anticipate reclassifying any gain or loss in *OCI* to earnings within the following 12 months.

 

Thefollowing table summarizes the impact of cash flow hedges on *OCI* (net of tax) during the period:

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions)**                     | ** ** | **7/1/05**             | ** ** | **7/2/04**           | ** ** | **7/1/05** | ** ** | **7/2/04** | ** ** |
| Balance at beginning of the period    |       | $                      | 0.1        |                 | $          | — |   | $ | — |   | $ | — |   |
| Net loss on cash flow hedges          |       | 0.7                    |       | —               |       | 0.8 |   | — |   |
| Reclassification to operating expense |       | (0.4                   | )          | —               |       | (0.4 | ) | — |   |
| Balance at end of the period          |       | $                      | 0.4        |                 | $          | — |   | $ | 0.4 |   | $ | — |   |

 

We also manage the foreign currency risk associated with foreign currencydenominated assets and liabilities using foreign exchange forwardcontracts.  Changes in the fair value ofthese derivatives are recognized currently in the*Otherexpense, net*caption in our Condensed Consolidated Statements ofOperations and substantially offset the remeasurement gains and lossesassociated with the foreign currency denominated assets and liabilities.

 

**10. Income Taxes**

 

For the second quarter of 2005, we recorded atax expense of ****$9.7 million**** compared with a taxexpense of ****$10.3**** million in thesecond quarter of 2004.  Overall, our tax rate continues to be affected bychanges in the mix of income from domestic and foreign sources and the impactof the reversal of a valuation allowance on domestic tax expense.

 

We continue to maintain a valuation allowanceagainst our U.S. and certain non-U.S. deferred tax assets arising from thecarry-forward of tax deductions, operating losses, and tax credits.  At July 1, 2005, the valuation allowance was ****$26.5**** million. We expect to reverse additional portions of our valuation allowance to theextent we continue to experience profitable results, although such futureprofitability cannot be assured. When we have achieved a sufficient history ofprofitability as determined under the rules of SFAS 109, we will berequired to reverse all or most of our remaining valuation allowance, if avaluation allowance exists at that time.  We currently are unable topredict when we will attain a sufficient history of profitability, althoughsuch profitability could be achieved in 2005.

 

We continue to evaluate the potential benefitof electing the special one-time, dividend received deduction for qualifyingcash distributions from our foreign subsidiaries as provided by theAmerican Jobs Creation Act of 2004.  We expect to complete our evaluationsubsequent to the release of final guidance by the Internal Revenue Service.

 

**11. Repurchases of Common Stock**

 

On February 2, 2005, our Board of Directorsauthorized the purchase of up to $300.0 million in shares of our outstandingcommon stock.  Purchases of common stockmay be made from time-to-time on the open market or in private transactions andwill be recorded as treasury stock.  Asof July 1, 2005, we have purchased $132.6 million (approximately 18.2million shares) of our common stock, of which $13.9 million (approximately 1.7million shares) was purchased during the second quarter of 2005.

 

12

----

 

**Item 2. Management’sDiscussion and Analysis of Results of Operations and Financial Condition**

 

**Introduction and Overview of Business**

 

Tellabs designs, develops,deploys and supports products used in wireless and wireline networks in almost100 countries. Our product portfolio includes solutions for next-generationtransport, Ethernet networks, multiservice edge, next-generation mobile,fiber-based access, advanced voice and video, and DSL (Digital Subscriber Line).We are focused on three key growth strategies: energizing our core business,establishing a presence in data and expanding into adjacent markets.

 

We generate revenueprincipally through the sale of telecommunication products, both as stand-aloneproducts and as elements of integrated systems, to many of the world’s largesttelecommunications service providers. In addition, we generate revenue byproviding installation and professional services related primarily to our ownproducts and systems.

 

Within North America wederive the majority of our product revenue from two product categories:transport products, principally digital cross-connect systems that manage androute network traffic and combine, consolidate and segregate signals tomaximize efficiency; and access products that support the delivery of voice,data and video services to residential and commercial consumers over copper andfiber optic networks. Demand for transport products is sensitive to end-userdemand for wireline and wireless services, bandwidth, industry capacityutilization and competing technologies. Demand for access products is driven byconsumer demand for voice, data and video services and the competition amongtraditional telecommunications companies and cable service operators to be thesole source provider of voice, data and video services (referred to as the“triple play”). According to industry analysts, Tellabs has a market-leadingposition in the U.S. bandwidth management and access markets.

 

Outside North America we earnthe majority of our product revenue from managed access and transport systemsthat control the flow of voice, data and video across communications networks.Demand comes primarily from two sources: business services for voice andhigh-speed data, and network transport services for wireless communications.Demand for these products is sensitive to end-user demand for bandwidth,industry capacity utilization and competing technologies.

 

We also earn servicesrevenue from network construction, support agreements and other professionalservices. Network construction revenue, which comprises more than half ofservices revenue, arises primarily from sales of our transport products inNorth America and tends to lag product sales by approximately one fiscal quarter.Revenue from support agreements arises from sales of our managed access andtransport systems outside North America. Other professional services offered bythe company include network deployment, traffic management and training.

 

The markets for our productshave undergone dynamic change over the last few years. Beginning in 2001,carrier overcapacity, a softening economy and other factors caused ourcustomers to significantly reduce their capital spending. The impact on Tellabswas a dramatic decline in revenue for each of the years 2001 through 2003 withyear-over-year growth returning in 2004. As these changes unfolded we werefaced with excess manufacturing capacity, excess inventories and a coststructure that could not be supported by our smaller revenue base. We respondedby closing manufacturing facilities, reducing global headcount, consolidatingoffice space, exiting certain product lines and instituting cost controlsacross the organization. We also reviewed our product portfolio and cut back orstopped development efforts on some products. In addition, at the end of 2003,we moved to outsource the majority of our remaining manufacturing operations tothird-party electronics manufacturing services providers to take advantage oftheir greater purchasing power and other efficiencies. These actions caused usto record material charges in 2001 through 2005 for excess and obsoleteinventory and excess purchase commitments, severance costs, facilities shutdowncosts, including accelerated depreciation on certain manufacturing and officebuilding and equipment due to shortened useful lives, and various contractualobligations. We also recorded charges for other impaired and surplus assets.

 

Market stability began in2003 and continued in 2004 and 2005 as carriers invested in their networks atlevels at or above 2003. This stability enabled us to post year-over-yearrevenue growth in 2004 for the first time since fiscal 2000. Change continuesto be a significant factor in our markets. Growing demand for wirelessservices, including the new 3G services, is driving investment by both wirelessand wireline carriers. This shift helps drive sales of our transport, VQE andmanaged access products.

 

Fiscal2005 began with and continues to have broad-based revenue growth.  We havebenefited from increasing wireless and data traffic by selectively enhancingour transport and managed access products with new features. In addition, weare addressing new, evolving growth opportunities with our broadband data networkingand access products.  For the remainder of 2005, we will focus onmaximizing the synergies from our integration of AFC and will continue toreview our spending, asset utilization and product development roadmapopportunities to optimize revenue, improve asset utilization and containspending.

 

13

----

 

**RESULTS OF OPERATIONS**

 

Forthe second quarter of 2005, our revenue grew by 52.0% to $462.5 millioncompared with the second quarter of 2004. The increase in revenue includes $143.5 million in access revenue, theproduct line we acquired in November 2004. Year-to-date revenue increased58.1% to $898.1 million with access products contributing $271.3 million toproduct revenue for the period.  Drivenby continued strong demand for our transport products and our managed accessand broadband data products, revenue excluding the access product family was up4.8% compared with the second quarter of 2004 and up 10.3% on a six-month basiscompared with the first six months of 2004. We earned $41.1 million or $0.09per share in the second quarter of 2005, compared with $49.6 million or $.12per share in the second quarter of 2004. Net earnings for the six-month periodwere $41.8 million or $0.09 per share, compared with $63.0 million or $.15 pershare in the first six months of 2004.  Although our operating expenses declined as a percentage of revenue inboth the quarter and year-to-date periods, the improvement was more than offsetby lower gross margins due to the inclusion of access products which carry alower gross margin than our other products. In particular, one component withinthe access category is sold at a price that is substantially below our cost.

 

***Revenue***

 
| ** **                    | ** **   | **Second Quarter** | ** **   | **Year-to-Date** | ** **   |
|-------------------------------|--------------|--------------------|--------------|------------------|--------------|
| ** **                    | ** **   | **2005**           | ** **   | **2004**         | *** *** | **Change** | ** ** | **2005** | ** ** | **2004** | *** *** | **Change** | *** *** |
| **Transport**                 | ** **   | **$**              | **158.8**    | ** **       | **$**        | **164.7** | *** *** | ***(3.6*** | **)*%*** | **$** | **316.8** | ** ** | **$** | **300.8** | *** *** | ***5.3*** | ***%*** |
| **Access**                    | ** **   | **143.5**          | ** **   | **—**       | *** *** | ***N/M*** | ** ** | **271.3** | ** ** | **—** | *** *** | ***N/M*** | *** *** |
| **Managed Access**            | ** **   | **96.4**           | ** **   | **76.4**         | *** *** | ***26.2*** | ***%*** | **189.5** | ** ** | **145.8** | *** *** | ***30.0*** | ***%*** |
| **Voice Quality Enhancement** | ** **   | **10.8**           | ** **   | **20.6**         | *** *** | ***(47.6*** | **)*%*** | **25.8** | ** ** | **43.3** | *** *** | ***(40.4*** | ***)%*** |
| **Broadband Data**            | ** **   | **8.6**            | ** **   | **1.8**          | *** *** | ***N/M*** | ** ** | **15.2** | ** ** | **5.7** | *** *** | ***N/M*** | *** *** |
| **Services**                  | ** **   | **44.4**           | ** **   | **40.8**         | *** *** | ***8.8*** | ***%*** | **79.5** | ** ** | **72.5** | *** *** | ***9.7*** | ***%*** |
| **Total**                     | ** **   | **$**              | **462.5**    | ** **       | **$**        | **304.3** | *** *** | ***52.0*** | ***%*** | **$** | **898.1** | ** ** | **$** | **568.1** | *** *** | ***58.1*** | ***%*** |
| *** ***                  | *** *** | *** ***       | *** *** | *** ***     | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| **North America**             | ** **   | **$**              | **342.0**    | ** **       | **$**        | **211.9** | *** *** | ***61.4*** | ***%*** | **$** | **666.0** | ** ** | **$** | **384.8** | *** *** | ***73.1*** | ***%*** |
| **International**             | ** **   | **$**              | **120.5**    | ** **       | **$**        | **92.4** | *** *** | ***30.4*** | ***%*** | **$** | **232.1** | ** ** | **$** | **183.3** | *** *** | ***26.6*** | ***%*** |

 

Transportproduct revenue remained strong during the second quarter of 2005 althoughslightly down from the second quarter of 2004, which included a largedeployment at a wireless carrier. Revenues for the year-to-date period of 2005increased 5.3% over those in the same period of 2004.  Wireless customers continued to be theprominent driver for transport product revenue for both the second quarter andyear-to-date periods in 2005.  For thesecond quarter of 2005, North American wireless customers accounted forapproximately 56% of all transport product revenue compared with 60% in thesecond quarter of last year.  Within thetransport products category approximately 34% of 2005 second quarter revenuefor our wideband cross connect platform came from new systems, systemexpansions and software upgrades, with the balance consisting of port cardgrowth on our installed base.  Thisresult compares with approximately 26% in the second quarter of 2004.  Another measure of our wideband cross-connectdemand is T-1 equivalents.  We shippedapproximately 1.9 million T-1 equivalents during the second quarter of 2005compared with 1.8 million T-1 equivalents in the second quarter of 2004.

 

Revenuefrom our access products reached $143.5 million and $271.3 million for thequarter and year-to-date periods, respectively, in 2005.  Both amounts are above last year’s secondquarter and year-to-date periods for the access product line, and are morequarterly and first-half revenue than ever generated by the access productline.  We estimate that 49% of the secondquarter of 2005 access product revenue is related to fiber-to-the-premise andfiber-to-the-curb deployments, with the balance coming from copper-based accesssolutions.

 

Revenuefrom managed access products increased 26.2% and 30.0% for the second quarterand first half of 2005, respectively, compared with that of the comparableperiods in 2004.  The increase was due tostrength in both our Tellabs 6300 managed transport systems and 8100 managedaccess systems from third-generation wireless network build-outs andEthernet-over-SDH applications.

 

Overallrevenue from voice quality enhancement products declined 47.6% for the secondquarter and 40.4% for the year-to-date period compared with the comparableperiods of 2004.  The decline reflects astrong first half of 2004 in which one large international order dominated ourrevenue in this category.  We believethere is a trend in the deployment of this technology from stand-alone productsto integration into transport, switching and access platforms.  During the third quarter of 2005, we expectto release integrated voice quality capability on our wideband cross-connectplatform.

 

Broadbanddata revenue increased to $8.6 million during the second quarter compared with$1.8 million in the second quarter of 2004 and increased to $15.2 million on ayear-to-date basis from $5.7 million in the comparable period in 2004.  We have now shipped our Tellabs 8800multi-service router product to 15 revenue-generating customers, 11 of whichare currently using the product to deliver live traffic as compared with twolive networks at this time in 2004.

 

14

----

 

Ourrevenue from services increased $3.6 million and $7.0 million for the secondquarter and year-to-date periods, respectively, from the comparative year-agoperiods, primarily due to higher product revenue.

 

***Gross Margin***

 
| ** **              | ** ** | **Second Quarter** | ** ** | **Year-to-Date** | ** **   |
|-------------------------|------------|--------------------|------------|------------------|--------------|
| ** **              | ** ** | **2005**           | ** ** | **2004**         | *** *** | **Change** | ** ** | **2005** | ** ** | **2004** | *** *** | **Change** | *** *** |
| **Consolidated Margin** | ** ** | **44.8**           | **%**      | **57.4**         | **%**        | ***(12.6*** | ***)%*** | **43.3** | **%** | **57.3** | **%** | ***(14.0*** | ***)%*** |
| **Product Margin**      | ** ** | **46.1**           | **%**      | **60.3**         | **%**        | ***(14.2*** | ***)%*** | **44.8** | **%** | **61.0** | **%** | ***(16.2*** | ***)%*** |
| **Services Margin**     | ** ** | **32.9**           | **%**      | **38.7**         | **%**        | ***(5.8*** | ***)%*** | **28.4** | **%** | **32.0** | **%** | ***(3.6*** | ***)%*** |

 

Ouroverall margins declined during the second quarter and first half of 2005compared with the same periods in 2004 primarily due to lower product marginsdue to the addition of the lower-margin access product line, and a change inproduct and customer mix in other product categories and lower services margindue to the inclusion of lower margin services related to access products.  Margins on access products are generallylower than our other products.  Inparticular, one component, the optical networking terminal, is sold substantiallybelow our current costs.

 

***Operating Expenses***

 
| ** **                                      | ** **   | **Second Quarter** | ** **   | **Year-to-Date** | ** **   |
|-------------------------------------------------|--------------|--------------------|--------------|------------------|--------------|
| ** **                                      | ** **   | **2005**           | ** **   | **2004**         | *** *** | **Change** | ** ** | **2005** | ** ** | **2004** | *** *** | **Change** | *** *** |
| **Total Operating Expenses**                    | ** **   | **$**              | **161.1**    | ** **       | **$**        | **120.2** | *** *** | ***$*** | ***40.9*** | ** ** | **$** | **342.6** | ** ** | **$** | **259.9** | *** *** | ***$*** | ***82.7*** | *** *** |
| **Items included in the total:**                | *** *** | *** ***       | *** *** | *** ***     | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| **Restructuring and other charges**             | ** **   | **1.2**            | ** **   | **(2.0**         | ***)***      | ***3.2*** | ** ** | **14.4** | ** ** | **14.2** | *** *** | ***0.2*** | *** *** |
| **Amortization of purchased intangibles**       | ** **   | **9.2**            | ** **   | **3.9**          | *** *** | ***5.3*** | ** ** | **20.2** | ** ** | **7.8** | *** *** | ***12.4*** | *** *** |
| **Amortization of deferred stock compensation** | ** **   | **2.7**            | ** **   | **0.8**          | *** *** | ***1.9*** | ** ** | **5.5** | ** ** | **2.9** | *** *** | ***2.6*** | *** *** |
| **All other**                                   | ** **   | **$**              | **148.0**    | ** **       | **$**        | **117.5** | *** *** | ***$*** | ***30.5*** | ** ** | **$** | **302.5** | ** ** | **$** | **235.0** | *** *** | ***$*** | ***67.5*** | *** *** |

 

Ouroperating expenses increased compared with the same periods in 2004 due to theaddition of expenses from the access product line, slightly offset by lowerheadcount and facility-related costs due to prior restructuring activities andcost-management efforts.

 

Restructuringand other charges for the second quarter and first half of 2005 were primarilydue to a reorganization of our Denmark- and Finland-based businesses and theoutsourcing of our North American prototype lab.

 

Theincrease in the amortization of purchased intangibles and deferred stockcompensation is primarily due to the acquisitions of AFC and Vinci Systems,both in the fourth quarter of 2004.

 

**Other Income (Expense)**

 
| ** **               | ** ** | **Second Quarter** | ** ** | **Year-to-Date** | ** **   |
|--------------------------|------------|--------------------|------------|------------------|--------------|
| ** **               | ** ** | **2005**           | ** ** | **2004**         | *** *** | **Change** | ** ** | **2005** | ** ** | **2004** | *** *** | **Change** | *** *** |
| **Interest income, net** | ** ** | **$**              | **6.4**    | ** **       | **$**        | **6.3** | *** *** | ***$*** | ***0.1*** | ** ** | **$** | **12.1** | ** ** | **$** | **12.2** | *** *** | ***$*** | ***(0.1*** | ***)*** |
| **Other expense, net**   | ** ** | **(1.7**           | **)**      | **(1.0**         | **)**        | ***(0.7*** | **)** | **(4.4** | **)** | **(2.0** | **)** | ***(2.4*** | ***)*** |
| **Total**                | ** ** | **$**              | **4.7**    | ** **       | **$**        | **5.3** | *** *** | ***$*** | ***(0.6*** | **)** | **$** | **7.7** | ** ** | **$** | **10.2** | *** *** | ***$*** | ***(2.5*** | ***)*** |

 

*Other expense, net* increased during the second quarter and first six months of 2005compared with that of the same periods in 2004 primarily due to charges ofapproximately $3.8 million in the second quarter of 2005 forother-than-temporary impairments related to long-term investments.  These charges were partially offset by morefavorable foreign currency transaction gains in 2005 compared with that in thecomparable periods of 2004.

 

**Income Taxes**

 

Forthe second quarter and first six months of 2005, we recorded a tax expense of$9.7 million and $12.4 million, respectively, compared with a tax expenseof $10.3 million and $12.6 million in the second quarter and firstsix months, respectively, of 2004.   Our effective tax rate for thesecond quarter and first six months of 2005 were 19.1% and 22.9%, respectively,compared with an effective tax rate of 17.2% and 16.7% for the second quarterand first six months, respectively, of 2004. Overall, our tax rate continues to be affected by changes in the mix of incomefrom domestic and foreign sources and the impact of the reversal of a valuationallowance on domestic tax expense.

 

**Financial Condition, Liquidity & Capital Resources**

 

Ourprincipal source of liquidity remained our cash, cash equivalents and marketablesecurities (Cash) of $1,047.3 million, which increased by approximately $51.6million during the quarter and decreased $68.9 million since year-end.  The increase in Cash in the

 

15

----

 

secondquarter was driven by our cash from operating activities, while theyear-to-date decrease reflects $132.6 million used to repurchase 18.2 millionshares under our previously discussed stock repurchase program.  This program allows us to repurchase up to$300.0 million shares of our common stock. During the second quarter of 2005, $13.9 million or 1.7 million sharesof our common stock were repurchased.

 

Webelieve that the current level of working capital, particularly cash andmarketable securities, is sufficient to meet our normal operating requirementsfor the foreseeable future. Further, we believe that sufficient resources existto support our future growth and strategic needs. Future sources of workingcapital may be from cash-on-hand, cash generated from future operations,short-term or long-term financing, equity offerings or any combination of thesesources.

 

Ourcurrent policy is to retain our earnings to provide funds to enhancestockholder value by expanding our business, repurchasing our common stock whenwe believe it to be undervalued, and for operating activities.  We do not anticipate paying a cash dividendin the foreseeable future.

 

***Off-Balance Sheet Arrangements***

 

None.

 

***Critical Accounting Policies***

 

Therewere no material changes in our critical accounting policies during thequarter.

 

***Outlook***

 

Weexpect that wireless carriers will remain an important part of our business forthe foreseeable future, and we look for continuing strength in 2005 as morewireless carriers begin to build out their networks to support increasedminutes of use and deliver new, data-oriented services.  However, we continue to have limitedlong-term visibility as to the amount and timing of wireless and wirelinecarrier spending as it relates to our products and services and the impact offuture industry consolidation.  For thethird quarter of 2005, we expect revenue to be approximately at the same levelas that of the second quarter of 2005, with margins at approximately 45% toslightly higher.

 

**Forward-Looking Statements**

 

ThisManagement’s Discussion and Analysis and other sections of this Form 10-Qcontain forward-looking statements made pursuant to the safe harbor provisionsof Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. These statements reflectmanagement’s expectations, estimates and assumptions, based on the informationavailable at the time the document was prepared. These forward-lookingstatements include, but are not limited to, statements regarding future events,plans, goals, objectives and expectations. The words «anticipate,» «believe,» «estimate,»“target,” «expect,» “predict,” «plan,» “possible,” «intend,» «likely,» «will,»“would,” «should,» “could,” “may” and similar expressions are intended toidentify forward-looking statements. Forward-looking statements are notguarantees of future performance and involve risks, uncertainties and otherfactors that may cause our actual performance or achievements to be materiallydifferent from any future results, performance or achievements expressed orimplied by those statements. Important factors that could cause our actualresults to differ materially from those in forward-looking statements include,but are not limited to: economic changes impacting the telecommunicationsindustry; financial condition of telecommunication service providers andequipment vendors, including any impact of bankruptcies; the impact of customerand vendor consolidation; new product acceptance; product and end user demand,and industry capacity; competitive products and pricing; competitive pressuresfrom new entrants to the telecommunications industry; margin impact of lowercost competitors entering our markets; research and new product development;protection and access to intellectual property, patents and technology; abilityto attract and retain highly qualified personnel; availability of componentsand critical manufacturing equipment and capacity; foreign economic conditions,including currency rate fluctuations; the regulatory and trade environment;availability and terms of future acquisitions; uncertainties relating tosynergies, charges, and expenses associated with business combinations andother transactions and restructurings; the ability to successfully integratenew businesses and technologies; various risks associated with our recentacquisitions and the impact on our business; and other risks and future factorsthat may be detailed from time to time in our filings with the SEC. For afurther description of such risks and future factors, see Exhibit 99.1 to Form 10-Kfor the fiscal year ended December 31, 2004, filed with the SECon March 15, 2005.  Our actual future results could differ materiallyfrom those predicted in such forward-looking statements. In light of theforegoing risks, uncertainties and other factors, investors should not placeundue reliance on the forward-looking statements in determining whether to buy,sell or hold any of our securities. We undertake no obligation to publiclyupdate or revise any forward-looking statements to reflect changed assumptions,the occurrence of anticipated or unanticipated events or changes to futureresults over time.

 

**Item 3. Quantitativeand Qualitative Disclosures About Market Risk**

 

Toaddress currency risks, we enter into foreign exchange forward and optioncontracts with maturities of less than 12 months to mitigate the impact ofcurrency fluctuations on existing foreign currency asset and liabilitybalances.  In January 2005, weexpanded

 

16

----

 

ourforeign currency exposure management policy, and began entering intotransactions to use exchange forward and option contracts of less than 12months to reduce the risk to earnings and cash flows associated with anticipatedforeign currency expenditures.

 

**Item 4. Controlsand Procedures**

 

Our management, under thesupervision and with the participation of our Chief Executive Officer and ChiefFinancial Officer, has evaluated the effectiveness of our disclosure controlsand procedures as of July 1, 2005.  Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that our disclosure controls and procedures are effective.  There were no changes during the periodcovered by this Form 10-Q in our internal control over financial reporting thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

On June 18, 2002, a class action complaint was filed in the UnitedStates District Court of the Northern District of Illinois against Tellabs,Michael Birck, and Richard Notebaert (former CEO, President and Director ofTellabs).  Thereafter, eight similar complaints were also filed in theUnited States District Court of the Northern District of Illinois.  Allnine of these actions were subsequently consolidated, and on December 3,2002, a consolidated amended class action complaint was filed against Tellabs, Mr. Birck,Mr. Notebaert, and certain other of our current or former officers and/ordirectors.  The consolidated amended complaint alleged that during theclass period (December 11, 2000-June 19, 2001) the defendantsviolated the federal securities laws by making materially false and misleadingstatements, including, among other things, allegedly providing revenueforecasts that were false and misleading, misrepresenting demand for ourproducts, and reporting overstated revenues for the fourth quarter 2000 in ourfinancial statements.  Further, certain of the individual defendants werealleged to have violated the federal securities laws by trading our securitieswhile allegedly in possession of material, non-public information about uspertaining to these matters.

 

On January 17, 2003, Tellabs and the other named defendants fileda motion to dismiss the consolidated amended class action complaint in itsentirety.  On May 19, 2003, the Court granted our motion anddismissed all counts of the consolidated amended complaint, while affordingplaintiffs an opportunity to replead.  On July 11, 2003, plaintiffsfiled a second consolidated amended class action complaint against Tellabs, Messrs. Birckand Notebaert, and many (although not all) of the other previously namedindividual defendants, realleging claims similar to those contained in thepreviously dismissed consolidated amended class action complaint.  Wefiled a second motion to dismiss on August 22, 2003, seeking the dismissalwith prejudice of all claims alleged in the second consolidated amended classaction complaint.  On February 19, 2004, the Court issued an ordergranting that motion and dismissed the action with prejudice.  On March 18,2004, the plaintiffs filed a Notice of Appeal to the United States FederalCourt of Appeal for the Seventh Circuit appealing the dismissal.  Theappeal was fully briefed, oral argument was heard on January 21, 2005, andthe parties are awaiting a decision.

 

On June 1, 2004, a complaint was filed on behalf of a putativeclass of AFC stockholders against AFC, certain of its current officers anddirectors (“Individual Defendants”), and Tellabs, in the Court of Chancery inthe State of Delaware in and for New Castle County. The complaint alleged thatthe Individual Defendants breached their fiduciary duties to AFC’s publicstockholders by acting to cause or facilitate the merger of Tellabs and AFC forinadequate consideration, and that Tellabs acted to aid and abet the allegedbreaches of fiduciary duty. In particular, plaintiff alleged that the mergerconsideration originally offered by Tellabs to AFC’s public stockholders priorto the amendment and restatement of the merger agreement is unfair andinadequate because, according to the plaintiff, “(a) the intrinsic valueof the stock of AFC is materially in excess of the $21.24 per share beingproposed, giving due consideration to the possibilities of growth andprofitability of AFC in light of its business, earnings and earnings power,present and future; (b) the $21.24 per share price is inadequate andoffers an inadequate premium to the public shareholders of AFC; and (c) the$21.24 per share price is not the result of any structure[d] auction process bywhich AFC sought to obtain the best deal possible for its shareholders.” Theplaintiff sought to enjoin the merger, and in the alternative, to rescind thetransaction, and also asserts claims for unspecified compensatory and/orrescissory damages, and an award of costs, including attorneys’ fees.  On June 3, 2005, plaintiff dismissed thecomplaint without prejudice and without notice. No compensation in any form was paid directly or indirectly from any ofthe defendants to the plaintiff or plaintiff’s attorneys, and no promise togive any such compensation was made.

 

**Item 2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

 

***Repurchases of Common Stock:***

 
| **Period of Purchases** | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Purchase Price  of Shares** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Remaining Dollar  Value of Shares  Available to be  Purchased Under  the Plan  (In Millions)** | ** ** |
|-------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
|                    |       |                                    |       |                                   |       |                                                                                          |       |                                                                                             |       |
| 1/1/05 through 2/4/05   |       | —                                  |       | $                                      | —     |                                                                                          | —     |                                                                                             | $          | 300.0 |   |
| 2/5/05 through 3/4/05   |       | 16,455,000                              |       | $                                      | 7.21       |                                                                                          | 16,455,000 |                                                                                             | $          | 181.3 |   |
| 3/5/05 through 4/1/05   |       | —                                  |       | —                                 |       | —                                                                                        |       | $                                                                                                | 181.3      |   |
| 4/2/05 through 5/6/05   |       |                                    | —     |                                   | $          | —                                                                                        |       | —                                                                                           |       | $ | 181.3 |   |
| 5/7/05 through 6/3/05   |       | 1,702,413                               |       | $                                      | 8.16       |                                                                                          | 1,702,413  |                                                                                             | $          | 167.4 |   |
| 6/4/05 through 7/1/05   |       | —                                  |       | —                                 |       |                                                                                          | —     |                                                                                             | 167.4      |   |
| Total                   |       | 18,157,413                              |       | $                                      | 7.30       |                                                                                          | 18,157,413 |                                                                                             |       |   |
|                         |            |                                         |            |                                        |            |                                                                                               |            |                                                                                                  |            |  |  |  |  |

 

17

----

 

On February 2, 2005, the companyannounced that its Board of Directors authorized the purchase of up to $300.0million in shares of our outstanding common stock, with no expiration date tothe authorization.  Purchases of commonshares may be made from time-to-time on the open market or in privatetransactions and will be recorded as treasury stock.  As of July 1, 2005, we have purchased$132.6 million (approximately 18.2 million shares) of our common stock.

 

**Item 4.Submission of Matters to a Vote of Security Holders**

 

An annual meeting of stockholders was held on April 21,2005.  The following directors werere-elected to serve until the annual meeting of stockholders in 2008:

 

| **Director**                      | ** ** | **For**     | ** ** | **Withheld** | ** ** |
|-----------------------------------|------------|-------------|------------|--------------|------------|
| Frank Ianna                       |       | 405,533,709 |       | 7,926,345    |       |
| Dr. Stephanie  Pace Marshall |       | 405,530,251 |       | 7,929,803    |       |
| William F.  Souders               |       | 401,621,273 |       | 11,838,781   |       |

 

In addition, the following directors continued tohold office after the annual meeting: Michael J. Birck, Bo Hedfors, Frederick A. Krehbiel, Michael E. Lavin, KrishA. Prabhu and Jan H. Suwinski.  MellodyL. Hobson did not stand for re-election at the annual meeting.

 

Our stockholders also voted to approve the proposalto adopt the 2005 Tellabs, Inc. Employee Stock Purchase Plan in accordancewith the following vote:

 
| **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Votes** | ** ** |
|-------------|------------|-------------|------------|-------------|------------|----------------------|------------|
| 312,608,339 |       | 8,588,406   |       | 2,960,057   |       | 89,303,253           |       |

 

In addition, our stockholders voted to approve theproposal to ratify the appointment of Ernst & Young LLP, independentauditors, as our independent auditors for 2005 in accordance with the followingvote:

 

| **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-------------|------------|-------------|------------|-------------|------------|
| 404,669,149 |       | 6,000,011   |       | 2,790,895   |       |

 

**Item 6. Exhibits**

 

**(A) Exhibits**

 
| 11   |   | Computation of Per Share Earnings                                                 |
|------|--------|-----------------------------------------------------------------------------------|
| 31.1 |   | CEO Certification pursuant to  Section 302 of the Sarbanes Oxley Act of 2002 |
| 31.2 |   | CFO Certification pursuant to  Section 302 of the Sarbanes Oxley Act of 2002 |
| 32.1 |   | CEO  Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002 |
| 32.2 |   | CFO Certification pursuant to  Section 906 of the Sarbanes Oxley Act of 2002 |

 

18

----

 

**SIGNATURE**

 

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

 
|   | **TELLABS,  INC.**                                          |
|--------|-------------------------------------------------------------|
|   | (Registrant)                                                |
|   |
|   | /s/ JAMES A. DITE                                           |   |
|   | James A. Dite                                               |
|   | Vice President and Controller                               |
|   | (Principal Accounting Officer  and duly authorized officer) |
|   |                                                        |
|   | August 9, 2005                                         |
|   | (Date)                                                      |
|        |                                                             |  |  |

 

19

----