** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**

**ý****                      ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the quarterly period ended April 1, 2005**

 

**OR**

 

o                        **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the transition period from                  to                 **

 

**Commission file Number: 0-09692**

** **

**TELLABS,INC.**

(Exact name of registrant as specified in itscharter)

 
| **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 bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.               YES ý        NOo

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).  YES ýNO o

 

Common Shares,$0.01 Par Value - 448,280,559 shares outstanding on May 6, 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  6.**  | **Exhibits**                                                                                    |       |
|          |                                                                                            |       |
| **SIGNATURE** |                                                                                            |       |

 

2

----

 

**PART I.FINANCIAL INFORMATION**

**Item 1.Financial Statements**

 

**TELLABS,INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|
| **(In millions, except per share  data)**                | ** ** | **4/1/05**             | ** ** | **4/2/04** | ** ** |
| **Revenue**                                              | ** ** | ** **             | ** ** | ** ** | ** ** |
| Products                                                 | ** ** | **$**                  | **400.5**  | ** ** | $ | 232.1 |   |
| Services                                                 | ** ** | **35.1**               | ** ** | 31.7 |   |
| ** **                                               |       | **435.6**              | ** ** | 263.8 |   |
| **Cost of Revenue**                                      |       |                   | ** ** |   |   |
| Products                                                 | ** ** | **226.6**              | ** ** | 89.0 |   |
| Services                                                 | ** ** | **27.1**               | ** ** | 24.3 |   |
| ** **                                               |       | **253.7**              | ** ** | 113.3 |   |
| **Gross Profit**                                         | ** ** | **181.9**              | ** ** | 150.5 |   |
|                                                     |       |                   | ** ** |   |   |
| Gross profit as a percentage of revenue                  | ** ** | **41.8**               | **%**      | 57.1 | % |
|                                                     |       |                   | ** ** |   |   |
| Gross profit as a percentage of revenue –  products | ** ** | **43.4**               | **%**      | 61.7 | % |
| Gross profit as a percentage of revenue -  services      | ** ** | **22.8**               | **%**      | 23.3 | % |
|                                                     |       |                   | ** ** |   |   |
| **Operating Expenses**                                   |       |                   | ** ** |   |   |
| Research and development                                 | ** ** | **88.8**               | ** ** | 61.9 |   |
| Sales and marketing                                      | ** ** | **46.2**               | ** ** | 37.3 |   |
| General and administrative                               | ** ** | **22.3**               | ** ** | 20.4 |   |
| Restructuring and other charges                          | ** ** | **13.2**               | ** ** | 16.2 |   |
| Amortization of purchased intangibles                    | ** ** | **11.0**               | ** ** | 3.9 |   |
| ** **                                               |       | **181.5**              | ** ** | 139.7 |   |
|                                                     |       |                   | ** ** |   |   |
| **Operating Earnings**                                   | ** ** | **0.4**                | ** ** | 10.8 |   |
| **Other Income/(Expense)**                               |       |                   | ** ** |   |   |
| Interest income, net                                     | ** ** | **5.7**                | ** ** | 5.9 |   |
| Other expense, net                                       | ** ** | **(2.7**               | **)**      | (1.0 | ) |
| ** **                                               |       | **3.0**                | ** ** | 4.9 |   |
|                                                     |       |                   | ** ** |   |   |
| **Earnings Before Income Tax**                           | ** ** | **3.4**                | ** ** | 15.7 |   |
| Income tax expense                                       | ** ** | **(2.7**               | **)**      | (2.3 | ) |
| **Net Earnings**                                         | ** ** | **$**                  | **0.7**    | ** ** | $ | 13.4 |   |
|                                                     |       |                   | ** ** |   |   |
| **Net Earnings Per Share**                               |       |                   | ** ** |   |   |
| Basic                                                    | ** ** | **$**                  | **0.00**   | ** ** | $ | 0.03 |   |
| Diluted                                                  | ** ** | **$**                  | **0.00**   | ** ** | $ | 0.03 |   |
| **Weighted Average Shares Outstanding**                  |       |                   | ** ** |   |   |
| Basic                                                    | ** ** | **455.8**              | ** ** | 415.2 |   |
| Diluted                                                  | ** ** | **458.8**              | ** ** | 420.9 |   |

 

 
| **Amortization of deferred stock compensation** is included in the following cost and  expense categories by period: | ** ** | ** ** | ** ** |   |   |   |   |
|----------------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------|--------|--------|--------|
| Cost of revenue                                                                                                      | ** ** | **$**      | **0.1**    |   | $      | — |   |
| Research and development                                                                                             | ** ** | **2.6**    |       | 2.0    |   |
| Sales and marketing                                                                                                  | ** ** | **0.1**    |       | 0.1    |   |
| General and administrative                                                                                           | ** ** | **0.1**    |       | — |   |
| ** **                                                                                                           |       | **$**      | **2.9**    |   | $      | 2.1    |   |

 

The accompanying notes are anintegral part of these statements.

 

3

----

 

**TELLABS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 
| **(In millions, except share  amounts)**                                                                                                | ** ** | **4/1/05**      | ** **  | **12/31/04** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|-------------|--------------|------------|
| ** **                                                                                                                              | ** ** | **(Unaudited)** | ** **  | ** **   | ** ** |
| **Assets**                                                                                                                              |       |            | ** **  |         |       |
| **Current Assets**                                                                                                                      |       |            | ** **  |         |       |
| Cash and cash equivalents                                                                                                               | ** ** | **$**           | **184.9**   | ** **   | $          | 292.9 |   |
| Investments in marketable securities                                                                                                    | ** ** | **810.8**       | ** **  | 823.3        |       |
| ** **                                                                                                                              |       | **995.7**       | ** **  | 1,116.2      |       |
|                                                                                                                                    |       |            | ** **  |         |       |
| Other marketable securities – Cisco stock                                                                                          | ** ** | **186.9**       | ** **  | 204.0        |       |
|                                                                                                                                    |       |            | ** **  |         |       |
| Accounts receivable, net                                                                                                                | ** ** | **267.7**       | ** **  | 309.4        |       |
| Inventories                                                                                                                             |       |            | ** **  |         |       |
| Raw materials                                                                                                                           | ** ** | **38.7**        | ** **  | 39.2         |       |
| Work in process                                                                                                                         | ** ** | **15.1**        | ** **  | 13.6         |       |
| Finished goods                                                                                                                          | ** ** | **101.4**       | ** **  | 63.6         |       |
| ** **                                                                                                                              |       | **155.2**       | ** **  | 116.4        |       |
| Income taxes                                                                                                                            | ** ** | **64.3**        | ** **  | 62.5         |       |
| Miscellaneous receivables and other current  assets                                                                                     | ** ** | **50.3**        | ** **  | 50.0         |       |
| **Total Current Assets**                                                                                                                | ** ** | **1,720.1**     | ** **  | 1,858.5      |       |
|                                                                                                                                    |       |            | ** **  |         |       |
| **Property, Plant and Equipment**                                                                                                       | ** ** | **613.1**       | ** **  | 619.1        |       |
| Less: accumulated depreciation                                                                                                          | ** ** | **(296.3**      | **)**       | (290.3       | )          |
| ** **                                                                                                                              |       | **316.8**       | ** **  | 328.8        |       |
| **Goodwill**                                                                                                                            | ** ** | **1,096.1**     | ** **  | 1,092.3      |       |
| **Intangible Assets, Net of Amortization**                                                                                              | ** ** | **144.7**       | ** **  | 156.0        |       |
| **Other Assets**                                                                                                                        | ** ** | **115.7**       | ** **  | 126.0        |       |
| **Total Assets**                                                                                                                        | ** ** | **$**           | **3,393.4** | ** **   | $          | 3,561.6 |   |
|                                                                                                                                    |       |            | ** **  |         |       |
| **Liabilities and Stockholders’ Equity**                                                                                           |       |            | ** **  |         |       |
| **Current Liabilities**                                                                                                                 |       |            | ** **  |         |       |
| Accounts payable                                                                                                                        | ** ** | **$**           | **110.1**   | ** **   | $          | 96.3 |   |
| Accrued liabilities                                                                                                                     | ** ** | **179.4**       | ** **  | 206.4        |       |
| Restructuring and other charges                                                                                                         | ** ** | **18.7**        | ** **  | 13.4         |       |
| Cisco stock loan                                                                                                                        | ** ** | **186.9**       | ** **  | 204.0        |       |
| Income taxes                                                                                                                            | ** ** | **45.7**        | ** **  | 43.2         |       |
| **Total Current Liabilities**                                                                                                           | ** ** | **540.8**       | ** **  | 563.3        |       |
|                                                                                                                                    |       |            | ** **  |         |       |
| **Long-Term Restructuring Liabilities**                                                                                                 | ** ** | **29.7**        | ** **  | 33.0         |       |
| **Income Taxes**                                                                                                                        | ** ** | **115.1**       | ** **  | 117.1        |       |
| **Other Long-Term Liabilities**                                                                                                         | ** ** | **54.0**        | ** **  | 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; 467,608,736 and 466,910,981 shares issued,  including treasury stock | ** ** | **4.7**         | ** **  | 4.7          |       |
| Additional paid-in capital                                                                                                              | ** ** | **1,146.9**     | ** **  | 1,145.9      |       |
| Deferred compensation expense                                                                                                           | ** ** | **(17.6**       | **)**       | (21.8        | )          |
| Treasury stock, at cost: 19,705,000 and 3,250,000  shares                                                                               | ** ** | **(248.3**      | **)**       | (129.6       | )          |
| Accumulated other comprehensive income                                                                                                  |       |            | ** **  |         |       |
| Cumulative translation adjustment                                                                                                       | ** ** | **101.1**       | ** **  | 129.0        |       |
| Unrealized net losses on available-for-sale  securities                                                                                 | ** ** | **(5.6**        | **)**       | (3.1         | )          |
| Total accumulated other comprehensive  income                                                                                           | ** ** | **95.5**        | ** **  | 125.9        |       |
| Retained earnings                                                                                                                       | ** ** | **1,672.6**     | ** **  | 1,672.1      |       |
| **Total Stockholders’ Equity**                                                                                                     | ** ** | **2,653.8**     | ** **  | 2,797.2      |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                     | ** ** | **$**           | **3,393.4** | ** **   | $          | 3,561.6 |   |

 

Theaccompanying notes are an integral part of these statements.

 

4

----

 

**TELLABS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW**

**(Unaudited)**

 
| ** **                                                                           | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------|------------|
| **(in millions)**                                                                    | ** ** | **4/1/05**             | ** ** | **4/2/04** | ** ** |
| **Operating Activities**                                                             |       |                   | ** ** |   |   |
| Net Earnings                                                                         | ** ** | **$**                  | **0.7**    | ** ** | $ | 13.4 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities: |       |                   | ** ** |   |   |
| Depreciation and amortization of purchased  intangibles and deferred compensation    | ** ** | **35.6**               | ** ** | 24.0 |   |
| Restructuring and other charges                                                      | ** ** | **13.2**               | ** ** | 7.0 |   |
| Deferred taxes                                                                       | ** ** | **(5.2**               | **)**      | 0.6 |   |
| Net change in assets and liabilities, net  of effects from acquisitions:             |       |                   | ** ** |   |   |
| Accounts receivable                                                                  | ** ** | **37.1**               | ** ** | 9.0 |   |
| Inventories                                                                          | ** ** | **(40.7**              | **)**      | (1.1 | ) |
| Income tax receivable                                                                | ** ** | **0.3**                | ** ** | 11.0 |   |
| Miscellaneous receivables and other current  assets                                  | ** ** | **(1.9**               | **)**      | 39.5 |   |
| Other assets                                                                         | ** ** | **(3.7**               | **)**      | — |   |
| Accounts payable                                                                     | ** ** | **11.7**               | ** ** | (4.2 | ) |
| Restructuring and other charges                                                      | ** ** | **(7.4**               | **)**      | (28.3 | ) |
| Other accrued liabilities                                                            | ** ** | **(36.4**              | **)**      | (4.1 | ) |
| Income taxes                                                                         | ** ** | **3.5**                | ** ** | (2.1 | ) |
| Long-term liabilities                                                                | ** ** | **0.2**                | ** ** | (5.3 | ) |
| **Net Cash Provided by Operating Activities**                                        | ** ** | **7.0**                | ** ** | 59.4 |   |
|                                                                                 |       |                   | ** ** |   |   |
| **Investing Activities**                                                             |       |                   | ** ** |   |   |
| Capital expenditures                                                                 | ** ** | **(8.9**               | **)**      | (7.9 | ) |
| Disposals of property, plant and equipment                                           |       | —                 | ** ** | 13.5 |   |
| Payments for purchases of investments                                                | ** ** | **(249.4**             | **)**      | (584.5 | ) |
| Proceeds from sales and maturities of  investments                                   | ** ** | **269.6**              | ** ** | 537.6 |   |
| **Net Cash Provided by (Used for) Investing  Activities**                            | ** ** | **11.3**               | ** ** | (41.3 | ) |
|                                                                                 |       |                   | ** ** |   |   |
| **Financing Activities**                                                             |       |                   | ** ** |   |   |
| Proceeds from issuance of common stock  under option plans                           | ** ** | **1.4**                | ** ** | 2.6 |   |
| Repurchase of common stock                                                           | ** ** | **(118.7**             | **)**      | — |   |
| **Net Cash (Used for) Provided by Financing  Activities**                            | ** ** | **(117.3**             | **)**      | 2.6 |   |
| **Effect of Exchange Rate Changes on Cash**                                          | ** ** | **(9.0**               | **)**      | (3.3 | ) |
| **Net (Decrease) Increase in Cash and Cash  Equivalents**                            | ** ** | **(108.0**             | **)**      | 17.4 |   |
| **Cash and Cash Equivalents at Beginning of  Year**                                  | ** ** | **292.9**              | ** ** | 245.9 |   |
| **Cash and Cash Equivalents at End of Period**                                       | ** ** | **$**                  | **184.9**  | ** ** | $ | 263.3 |   |

 

The accompanying notes are anintegral part of these statements.

 

5

----

 

**TELLABS, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**1. Basis of Presentation**

 

Ouraccompanying unaudited condensed consolidated financial statements wereprepared in accordance with generally accepted accounting principles forinterim financial statements and the requirements of Form 10-Q and applicablerules of Regulation S-X and accordingly do not include all disclosures normallyrequired by generally accepted accounting principles for complete financialstatements. Accordingly, the financial statements and notes herein should beread in conjunction with our Annual Report on Form 10-K for the year ended December31, 2004.

 

In our opinion,the accompanying unaudited condensed consolidated financial statements includeall adjustments (consisting of normal recurring accruals) that are necessaryfor a fair presentation. Operating results for interim periods are notnecessarily indicative of operating results for the full year. Certain priorperiod amounts have been reclassified to conform to the current periodpresentation.

** **

**2. NewAccounting Pronouncement**

 

In December 2004, the FinancialAccounting Standards Board (FASB) issued SFAS No. 123R, “Share-Based Payment” (“SFAS123R”).  Under this new standard, companies will no longer be able toaccount for share-based compensation transactions using the intrinsic value methodin accordance with APB 25.  Instead, companies will be required to accountfor such transactions using a fair-value method and recognize the expense overthe service period.  SFAS 123R allows for several alternative transitionmethods, but we have not yet determined the transition method we will use. On April 14, 2005, the Securities and Exchange Commission announced theadoption of a rule that defers the required effective date of SFAS 123R forregistrants to the beginning of the first fiscal year beginning after June 15,2005.  We expect to adopt this statementin the first quarter of our 2006 fiscal year.

 

**3. Acquisition**

 

In November 2004, we acquired100% of the outstanding common stock of Advanced Fibre Communications (AFC), aleader in access products, for 0.504 shares of our common stock and $12.00 incash for each AFC share, for a total value of approximately $1.6 billion($794.5 million, net of cash acquired). We issued approximately 44.8 million shares of our common stock for theacquisition, with the cash portion financed with U.S.-based cash and cashequivalents, including AFC’s.  Theoperating results of AFC have been included in our consolidated results ofoperations since the acquisition. The purchase price allocation for AFC has notbeen finalized pending completion of appraisals and integration plans.

 

**4.Restructuring and Other Charges**

** **

Over the past few years,management has implemented plans to restructure our operations due to difficultmarket conditions in the telecommunications industry.  One of those plans involved the outsourcingof our global manufacturing operations at the end of 2003 and beginning of 2004in order to maintain a competitive cost structure.  Implementation of the plans resulted inworkforce reductions of approximately 500 employees, facility closures, assetdisposals and the sale of the majority of our inventory to theoutsourcers.  Consequently, we recordedcharges in 2003and 2004 for severance and related costs, asset impairments andaccelerated depreciation on our manufacturing facility in North America.  We also recorded charges for excess andobsolete inventories and excess purchase commitments. In the fourth quarter of2004, we initiated a plan to reorganize our operations in Denmark to improveprofitability, and in the first quarter of 2005 we initiated a similar plan forour operations in Finland and certain smaller actions in other locations.  Actions under these plans are substantiallycomplete. Restructuring charges for these plans include primarily severance andrelated costs as well as charges for certain asset disposals and are part ofour plan to reduce costs by approximately $45 million during 2005.   For further discussion of restructuring andother activities, refer to our Annual Report on Form 10-K for the year endedDecember 31, 2004.

 

Below is an analysis of therestructuring and other charges recorded year-to-date through the first quarterof 2005 and 2004 by major income statement classification:

 
| **(in millions)**                   | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Income Statement Classification** | ** ** | **Description**                                             | ** ** | **4/1/05** | ** ** | **4/2/04** | ** ** |
| Cost of revenue                     |       | Inventory  adjustments                                      |       | $          | —     |       | $          | 2.3 |   |
|                                |       | Disposal of property, plant and equipment                   |       | —     |       | 0.3        |       |
|                                |       | Other obligations                                           |       | —     |       | 0.2        |       |
|                                |       | Sub-total in Cost of Revenue                                |       | —     |       | 2.8        |       |
|                                |       | Reversal of excess purchase commitments  accrual            |       | —     |       | (12.0      | )          |
|                                |       | Total in Cost of Revenue and Gross Profit                   |       | —     |       | (9.2       | )          |
| Operating expenses                  |       | Severance  and related expenses                             |       | 11.0       |       | 4.1        |       |
|                                |       | Consolidation of excess leased facilities                   |       | 0.3        |       | 1.4        |       |
|                                |       | Disposal of property, plant and equipment                   |       | 3.4        |       | 12.6       |       |
|                                |       | Other obligations                                           |       | —     |       | 2.4        |       |
|                                |       | Sub-total in Operating Expenses                             |       | 14.7       |       | 20.5       |       |
|                                |       | Proceeds from fixed asset disposals in  excess of estimates |       | —     |       | (4.3       | )          |
|                                |       | Reversal of excess leased facilities  accrual               |       | (1.5       | )          | —     |       |
|                                |       | Total in Operating Expenses                                 |       | 13.2       |       | 16.2       |       |
|                                |       | Total Restructuring and Other Charges                       |       | $          | 13.2       |       | $          | 7.0 |   |

 

6

----

 

*Inventoryadjustments and excess purchase commitments accrual*

 

In the first quarter of 2004,we accrued $2.3 million for the revaluation of inventories related to internationalmanufacturing outsourcing.  There wasalso a $12.0 million reduction to the reserve for excess purchase commitmentsdue to a favorable settlement with a vendor.

 

*Severanceand related expenses*

 

In the first three months of2005, we recorded accruals for severance and related costs of $11.0 million forthe reduction of staff by over 165 people primarily in Denmark, Finland and theU.S.

 

During the first quarter of2004, we recorded a $4.1 million charge for severance and related expenses forapproximately 40 (primarily non-manufacturing) employees.  Approximately $3.0 million related toadditional personnel reductions beyond that contemplated at the end of fiscal2003 in our estimate of restructuring and other charges for fiscal 2004.

 

*Consolidationof excess leased facilities*

 

In the first quarter of 2005,we recorded $0.3 million in charges related to international facilityconsolidation related to the Denmark and Finland headcount reductions.  We also recorded $1.5 million to adjustreserves recorded in prior periods for U.S. excess facilities to reflectfavorable subleasing activity.

 

During the first quarter of2004, we charged $1.4 million for costs associated with excess leasedfacilities.  These included charges forthe Montreal research and development office, which was closed at the end ofthe first quarter of 2004, and additional net rental expenses not anticipatedin the initial charges due to the overall weakness of the office rental marketand delays in subleasing certain facilities.

 

*Disposal ofproperty, plant and equipment*

 

During the first quarter of2005, we recorded a $2.4 million charge for property, plant and equipment inDenmark that is held for sale.  We alsorecorded a loss on the sale of a facility in Finland of $0.8 million that hasbeen held for sale since December 2003.  Wealso recorded $0.2 million to adjust reserves recorded in prior periods.

 

During the first quarter of2004, we recorded impairment charges of $12.9 million for property, plant andequipment to be disposed of or held for sale. This amount was approximately $6.0 million more than we anticipated atthe end of fiscal 2003 for our estimate of restructuring and other charges in2004.  The majority of the chargesrelated to the closure of the Montreal research and development facility at theend of the first quarter of 2004, as most of the assets in the office will notbe redeployed within the company as originally anticipated.  Other charges were recorded for U.S. researchand development and manufacturing assets, as well as a small amount for fixedassets sold to Elcoteq due to the international manufacturing outsourcingactivity.  Offsetting these new chargeswas $4.3 million related to the receipt of proceeds from the sale of property,plant and equipment in excess of our original estimate of restructuring andother charges for 2004.

 

7

----

 

*Otherobligations*

 

During the first quarter of2004, we charged $2.4 million for telecommunications contract buyout fees for notmeeting minimum usage requirements under contracts due to workforcereductions.  In addition, we charged $0.2million for international manufacturing transition costs that were incurred inthe quarter.

 

Of the remaining $48.4 millionof liabilities for restructuring and other charges as of April 1, 2005, $18.7million were classified as current because we expect to pay them within thenext 12 months.  We expect to pay thelong-term balance of $29.7 million over the remaining lease terms of our excessfacilities leases, which expire at various times through 2011.

 

The following table displaysour restructuring and other charges activity during the first three months of2005 and the status of the reserves at April 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 |   |

 

Note (a):  Non-Cash activity includes reversals ofpreviously recorded reserves, effects of currency translation on balances, and otherchanges in the reserve balance that do not flow through the income statement,and the reduction of property plant and equipment to be disposed.

 

**5. StockOptions**

 

We account for our stock-basedcompensation plans under Accounting Principles Board (“APB”) Opinion No. 25.  Had compensation cost for our stock-basedcompensation plans been determined using the fair value at the grant dates forawards under those plans consistent with the method required by SFAS No. 123,our net earnings/(loss) and net earnings/(loss) per share would have been asfollows:

 

| ** **                                                                                                                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| **(In millions, except per-share  amounts)**                                                                                                | ** ** | **4/1/05**             | ** ** | **4/2/04** | ** ** |
| Net earnings, as reported                                                                                                                   |       | $                      | 0.7        |   | $ | 13.4 |   |
|                                                                                                                                        |       |                   |       |   |   |
| Add: stock-based employee compensation  expense included in reported net earnings, net of related tax effects                               |       | 3.5                    |       | 3.5 |   |
|                                                                                                                                        |       |                   |       |   |   |
| Less: total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (30.5                  | )          | (11.9 | ) |
|                                                                                                                                        |       |                   |       |   |   |
| Pro forma net (loss)/earnings                                                                                                               |       | $                      | (26.3      | ) | $ | 5.0 |   |
|                                                                                                                                        |       |                   |       |   |   |
| Net (loss)/earnings per share - Basic:                                                                                                      |       |                   |       |   |   |
| As reported                                                                                                                                 |       | $                      | 0.00       |   | $ | 0.03 |   |
| Pro forma                                                                                                                                   |       | $                      | (0.06      | ) | $ | 0.01 |   |
|                                                                                                                                        |       |                   |       |   |   |
| Net (loss)/earnings per share – Diluted:                                                                                               |       |                   |       |   |   |
| As reported                                                                                                                                 |       | $                      | 0.00       |   | $ | 0.03 |   |
| Pro forma                                                                                                                                   |       | $                      | (0.06      | ) | $ | 0.01 |   |

 

8

----

 

The fair value of options wasestimated on the date of grant using the Black-Scholes option pricing modelwith the following weighted-average assumptions for grants in 2005 and 2004:

 

| ** **              | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-------------------------|------------|-----------|------------|-----------|------------|
| Expected volatility     |       | 67.0      | %          | 72.2      | %          |
| Risk-free interest rate |       | 3.6       | %          | 3.4       | %          |
| Expected life           |       | 4.5 years |       | 5.0 years |       |
| Expected dividend yield |       | 0.0       | %          | 0.0       | %          |

 

The pro forma amounts disclosedabove may not be representative of future disclosures because the estimatedfair value of stock options is amortized to expense over the vesting period,and additional options may be granted in future years.  In addition, the Black-Scholes option pricingmodel was developed for use in estimating the fair value of traded options thathave no vesting restrictions and are fully transferable.  The Black-Scholes model requires the use ofassumptions that are subjective, such as the expected volatility of theexercise 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 not givea meaningful comparison of companies in a given industry.

 

**6. RetireeMedical Plan**

 

The following table sets forththe components of the net periodic benefit costs for our retiree medical plan:

 

| ** **                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------|------------|------------------------|------------|
| **(In millions)**                  | ** ** | **4/1/05**             | ** ** | **4/2/04** | ** ** |
| Service cost                       |       | $                      | 0.3        |   | $ | 0.2 |   |
| Interest cost                      |       | 0.2                    |       | 0.1 |   |
| Expected return on plan assets     |       | (0.1                   | )          | (0.1 | ) |
| Amortization of prior service cost |       | —                 |       | — |   |
| Amortization of net (gain)loss     |       | —                 |       | — |   |
| Net periodic benefit cost          |       | $                      | 0.4        |   | $ | 0.2 |   |

 

At December 31, 2004, weestimated that we would contribute $0.8 million to our retiree medical plan in2005, but have not yet contributed to the plan this year.

 

**7.Comprehensive Income (Loss)**

 

Comprehensive income (loss) isan expression of our net earnings (loss) in the condensed consolidatedstatements of operations, adjusted for foreign currency translation adjustmentsand net unrealized gains or losses on available-for-sale securities.  Our comprehensive (loss) income was asfollows:

 

| ** **                                                   | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|
| **(In millions)**                                            | ** ** | **4/1/05**             | ** ** | **4/2/04** | ** ** |
| Net earnings                                                 |       | $                      | 0.7        |   | $ | 13.4 |   |
| Other comprehensive income (loss):                           |       |                   |       |   |   |
| Cumulative translation adjustment                            |       | (27.9                  | )          | (17.2 | ) |
| Unrealized net (loss) gain on available-for-sale  securities |       | (2.5                   | )          | 5.2 |   |
| Comprehensive (loss) income                                  |       | $                      | (29.7      | ) | $ | 1.4 |   |
|                                                              |            |                        |            |  |  |  |  |  |  |

 

**8. Product Warranties**

 

We offer warranties for all of ourproducts.  The specific terms andconditions of those warranties vary depending upon the product sold.  We provide a basic limited warranty,including parts and labor, for all products other than Access products for a periodranging from 1 to 5 years.  The basiclimited warranty for Access products covers parts and labor for periods rangingfrom 1 to 10 years.

 

9

----

 

Factors that enter into ourestimate of our warranty liability include the number of units shipped,historical and anticipated rates of warranty claims, and cost per claim.  We periodically assess the adequacy of ourrecorded warranty liabilities and adjust the amounts as necessary.  On the Consolidated Balance Sheets, theshort-term portion of the warranty reserve is included in Other CurrentLiabilities, while the long-term portion is included in Other Long-TermLiabilities.  Our product warrantyliabilities are as follows:

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| **(In millions)**                             | ** ** | **4/1/05**             | ** ** | **4/2/04** | ** ** |
| Balance at beginning of the period            |       | $                      | 41.1       |   | $ | 19.5 |   |
| Accruals for product warranties issued        |       | 7.7                    |       | 0.5 |   |
| Settlements made during the period            |       | (6.6                   | )          | (1.1 | ) |
| Balance at end of period                      |       | $                      | 42.2       |   | $ | 18.9 |   |
|                                          |       |                   |       |   |   |
| Balance sheet classification at end of period |       |                   |       |   |   |
| Other current liabilities                     |       | $                      | 21.9       |   | $ | 6.4 |   |
| Other long-term liabilities                   |       | 20.3                   |       | 12.5 |   |
| Total product warranty liabilities            |       | $                      | 42.2       |   | $ | 18.9 |   |

 

**9. Derivative Financial Instruments**

 

To address currency risks, we have a policy thatallows us to enter into foreign exchange forward and option contracts withmaturities of less than 12 months to mitigate the impact of currencyfluctuations on existing foreign currency asset and liability balances.  In January 2005, we expanded our foreign currencyexposure management policy to use exchange forward and option contracts of lessthan 12 months to reduce the risk to earnings and cash flows associated withanticipated foreign currency expenditures. In accordance with Statement of Financial Accounting Standard No. 133, *Accounting for Derivative Instruments and Hedging Activities*,all derivatives are recorded on the balance sheet at fair value.

 

In fiscal year 2005, we began utilizingforeign exchange forward and option contracts as cash flow hedges.  We calculate each hedge’s effectivenessquarterly, excluding time value.  A forwardcontract’s effectiveness is calculated by comparing the cumulative change inthe fair value on a spot-to-spot rate basis to the spot-to-spot rate cumulativechange in the anticipated transaction, with the effective portion recorded inother comprehensive 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 the*Other expense, net*captionin our Condensed Consolidated Statements of Operations.  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 ComprehensiveIncome (“OCI”) to *Other expense, net.* The impact ofthe net change in cash flow hedges on OCI for the quarter was 0.1 million ofwhich none was reclassified.  Weanticipate reclassifying the entire gain/loss in OCI to earnings within 12months.

 

We also manage the foreign currency riskassociated with foreign currency denominated assets and liabilities usingforeign exchange forward contracts. Changes in the fair value of these derivatives are recognized currentlyin the*Other expense, net*caption in ourCondensed Consolidated Statements of Operations and substantially offset theremeasurement gains and losses associated with the foreign currency denominatedassets and liabilities.

 

**10. Income Taxes**

 

For the first quarter of 2005, we recorded atax expense of $2.7 million compared to a tax expense of $2.3 million in thefirst quarter of 2004.  Overall, our taxrate continues to be affected by changes in the mix of income from domestic andforeign sources and the impact of the reversal of a valuation allowance ondomestic 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 April 1, 2005, the valuation allowance was$23.4 million.  We expect to reverseadditional portions of our valuation allowance to the extent we continue toexperience profitable results, although such future profitability cannot beassured. When we have achieved a sufficient history of profitability asdetermined under the rules of SFAS 109, we will be required to reverse all ormost of our remaining valuation allowance, if a valuation allowance exists atthat time.  We currently are unable to predict when we will attain asufficient history of profitability, although such profitability could beachieved in 2005.

 

10

----

 

We continue to evaluate the potential benefitof electing the special one-time, dividend received deduction forqualifying cash distributions from our foreign subsidiaries as provided bythe American Jobs Creation Act of 2004.  We expect to complete our evaluationsubsequent to enactment of anticipated technical corrections legislationor similar regulatory guidance.

 

**11. Repurchases of Common Stock**

 

On February 2, 2005, ourBoard of Directors authorized the purchase of up to $300.0 million in shares ofour outstanding common stock.  Purchasesof common stock may be made from time-to-time on the open market or in privatetransactions and will be recorded as treasury stock.  As of April 1, 2005, we have purchased $118.7million (approximately 16.5 million shares) of our common stock.

 

11

----

 

**Item 2.Management’s Discussion and Analysis of Results of Operations and FinancialCondition**

 

**Introduction and Overview ofBusiness**

 

Tellabs designs, develops, deploys and supports products used inwireless and wireline networks in almost 100 countries. Our product portfolioincludes solutions for next-generation transport, Ethernet networks,multiservice edge, next-generation mobile, fiber-based access, advanced voiceand video, and DSL (Digital Subscriber Line). We are focused on three key strategies:energizing our core business, establishing a presence in data and expandinginto adjacent markets.

 

We generate revenue principally through the sale of hardware and licensingof software, both as stand-alone products and as elements of integratedsystems, to many of the world’s largest telecommunications service providers.In addition, we generate revenue by providing installation and professionalservices related primarily to our own products and systems.

 

Within North America we derive the majority of our revenue fromtransport products, principally digital cross-connect systems that manage androute network traffic and combine, consolidate and segregate signals tomaximize efficiency. Demand for these products is sensitive to end-user demandfor wireless services, bandwidth, industry capacity utilization and competing technologies.We also generate revenue in North America from access products. Demand forthese products is driven by the local telephone companies’ plans to delivertriple-play (voice, data and video) services to residential customers as a wayto compete with cable TV providers. According to industry analysts, Tellabs hasa market-leading position in the U.S. bandwidth management and access markets.

 

Outside North America we earn the majority of our revenue from managedaccess and transport systems that control the flow of voice, data and videoacross communications networks. Demand comes primarily from two sources: businessservices for voice and high-speed data and network transport services forwireless communications. Demand for these products is sensitive to end-userdemand for bandwidth, industry capacity utilization and competing technologies.

 

In addition, we are a leading provider of voice-quality enhancementsolutions globally and one of the top three providers of cable telephonysolutions worldwide.

 

We also earn revenue from network construction and other professionalservices. Network construction revenue, which comprises more than half of ourservices revenue, arises primarily from sales of our transport products inNorth America and tends to lag product sales by approximately one fiscalquarter. As a result, it has tended to increase or decrease in similar proportionto the increase or decrease in revenue from those products. Professionalservices offered by the company include network deployment, traffic management,support services and training. Another major source of services revenue issupport agreements related to our managed access and transport systems outsideNorth America.

 

The markets for our products have undergone dynamic change over thelast few years. Beginning in 2001, carrier overcapacity, a softening economyand other factors caused our customers to significantly reduce their capitalspending. The impact on Tellabs was a dramatic decline in revenue for each ofthe years 2001 through 2003 with year-over-year growth returning in 2004. Asthese changes unfolded we were faced with excess manufacturing capacity, excessinventories and a cost structure that could not be supported by our smallerrevenue base. We responded by closing manufacturing facilities, reducing globalhead-count, consolidating office space, exiting certain product lines and institutingcost controls across the organization.  Wealso reviewed our product portfolio and cut back or stopped development effortson some products. In addition, at the end of 2003, we moved to outsource themajority of our remaining manufacturing operations to third-party electronicsmanufacturing services providers to take advantage of their greater purchasingpower and other efficiencies. These actions caused us to record materialcharges in 2001 through 2005 for excess and obsolete inventory and excess purchasecommitments, severance costs, facilities shutdown costs, including accelerateddepreciation on certain manufacturing and office building and equipment due to shorteneduseful lives, and various contractual obligations. We also recorded charges forother impaired and surplus assets.

 

Market stability began in 2003 and continued in 2004 as carriersinvested in their networks at levels at or above 2003. This stability enabledus to post year-over-year revenue growth for the first time since fiscal 2000.However, change continues to be a significant factor in our markets. Growingdemand for wireless services, including the new 3G services, is drivinginvestment by both wireless and wireline carriers. This shift helps drive salesof our transport, VQE and managed access products.

 

Fiscal 2005 began with continued broad-basedrevenue growth.  We have benefited from increasing wireless and datatraffic by selectively enhancing our transport, managed access andvoice-quality enhancement products with new features. In addition, we areaddressing new, evolving growth opportunities with our broadband datanetworking and access products.  Our first quarter results include, forthe first time, a full-quarter’s contribution from AFC, which we acquired inNovember 2004.  We continue to review our spending, asset utilization andproduct development roadmap opportunities to optimize revenue, improve assetutilization and contain spending.

 

12

----

 

**RESULTS OF OPERATIONS**

 

For the first quarter of 2005, our revenuegrew by 65% to $435.6 million.  Theincrease in revenue includes $127.8 million in product revenue from AFC, whichwe acquired in November 2004. Non-AFC revenue, driven by increasing demand forour transport, managed access and broadband data products, was up 17% comparedto the first quarter of 2004. We earned $0.7 million, or less than one cent pershare in the first quarter of 2005, compared with $13.4 million, or $0.03 pershare in the first quarter of 2004. The decline in earnings is primarilyattributable to a 15 percentage point decline in our overall gross margins as aresult of the inclusion of products from the acquisition of AFC. These productstypically carry lower gross margins than our other products.

 

***Revenue***

*** ***
| ** **                    | ** **   | **First Quarter** | ** **   |
|-------------------------------|--------------|-------------------|--------------|
| ** **                    | ** **   | **2005**          | ** **   | **2004** | *** *** | **Change** | *** *** |
| **Transport**                 | ** **   | **$**             | **158.0**    | ** ** | **$** | **136.1** | *** *** | ***16*** | ***%*** |
| **Access**                    | ** **   | **127.8**         | ** **   | **—** | *** *** | ***N/M*** | *** *** |
| **Managed Access**            | ** **   | **93.1**          | ** **   | **69.4** | *** *** | ***34*** | ***%*** |
| **Voice Quality Enhancement** | ** **   | **15.0**          | ** **   | **22.7** | *** *** | ***(34*** | ***)%*** |
| **Broadband Data**            | ** **   | **6.6**           | ** **   | **3.9** | *** *** | ***69*** | ***%*** |
| **Services**                  | ** **   | **35.1**          | ** **   | **31.7** | *** *** | ***11*** | ***%*** |
| **Total**                     | ** **   | **$**             | **435.6**    | ** ** | **$** | **263.8** | *** *** | ***65*** | ***%*** |
| *** ***                  | *** *** | *** ***      | *** *** | *** *** | *** *** | *** *** | *** *** |
| **North America**             | ** **   | **$**             | **324.0**    | ** ** | **$** | **172.9** | *** *** | ***87*** | ***%*** |
| **International**             | ** **   | **$**             | **111.6**    | ** ** | **$** | **90.9** | *** *** | ***23*** | ***%*** |
|                               |              |                   |              |  |  |  |  |  |  |  |

 

Revenue from Transport products improved onthe continuing strength in shipments of our Tellabs 5500 digital cross-connectsystems to wireless and wire-line customers. In particular, wireless customersin North American continue to remain a significant source of growth, accountingfor 58% of all Transport product revenue, compared to 48% in the first quarterof 2004. As a measure of the 5500 business, more than 1.8 million T1equivalents were shipped during the quarter. By way of comparison, we shipped 1.4 million in the first quarter of2004.  Revenue from our Tellabs 7100optical transport systems also grew year-over-year as deployment of thisequipment by a major customer continued into 2005.

 

Revenue from our first full quarter of Accessproduct revenue amounted to $127.8 million. This total is up over last year’s first quarter for AFC and morequarterly revenue than AFC ever reported. We believe the acquisition of AFC gives us a strategic position in fiber-basedaccess product applications that will benefit from residential access growthgoing forward.  We estimate that slightlymore than 40% of this quarter’s Access revenue is related to fiber-based accessproduct deployments, with the balance coming from copper-based accesssolutions.

 

Revenue from Managed Access products grew 34%year over year. The increase was due to strength in both our Tellabs 8100managed access systems and Tellabs 6300 managed transport systems.  The increase comes from broad based demand,driven in part by the continuing release of new software and hardwareenhancements.

 

Overall revenue from Voice QualityEnhancement products declined year-over-year. The decline reflects a strong first quarter 2004 in which one large internationalorder dominated our revenue in this category. Within North America, however, we saw increased year-to-year demand fromwireless customers for our voice-quality products.

 

Broadband Data revenue was up year-over-year,as our products continue to gain acceptance with customers.  We have now shipped our 8800 platform to 12revenue generating customers of which eight are currently using the product todeliver live traffic.  That’s up from twolive networks at this time last year.

 

Our revenue from services increased from theyear-ago period primarily due to the inclusion of the Access products.

 

***Gross Margin***

*** ***
| ** **              | ** ** | **First Quarter** | ** ** |
|-------------------------|------------|-------------------|------------|
| ** **              | ** ** | **2005**          | ** ** | **2004** | *** *** | **Change** | *** *** |
| **Consolidated Margin** | ** ** | **41.8**          | **%**      | **57.1** | **%** | ***(15.3*** | ***)%*** |
| **Product Margin**      | ** ** | **43.4**          | **%**      | **61.7** | **%** | ***(18.3*** | ***)%*** |
| **Services Margin**     | ** ** | **22.8**          | **%**      | **23.3** | **%** | ***(0.5*** | ***)%*** |

 

13

----

 

As a result of our merger with AFC, we have amulti-year agreement with a large customer to provide equipment for their FTTPbuild out.  Although the overall contractis expected to be profitable, gross margins are below our historical grossmargins on other products, and one component–the optical networking terminal(ONT)–is sold substantially below our current cost.  Therefore, the impact of the agreement on ourconsolidated gross margin is dependent on the timing and mix of componentspurchased by the customer.  In addition,we are working to improve the overall margins on FTTP sales through productdesign changes, component price reduction and other actions.  

 

Our overall margins declined during the firstquarter of 2005 compared to the same period in 2004 primarily due to theaddition of AFC’s lower margin Access product line. The addition of the Accessproducts reduced our first-quarter 2005 gross margin by approximately 14percentage points, compared to the first quarter of 2004. This decrease waspartially offset by 2 percentage points of improvement due to the full-quarter2005 impact of outsourcing on our manufacturing costs.  Margins in the first quarter of 2004 werebenefited by 4 percentage points due to a favorable settlement with avendor.  The decline in product margins wasdue primarily to the same reasons noted above for the overall margin decline.  Services margins were down slightly as aresult of the addition of Access services revenue and related margins.

 

***Operating Expenses***

*** ***
| ** **                                 | ** **   | **First Quarter** | ** **   |
|--------------------------------------------|--------------|-------------------|--------------|
| ** **                                 | ** **   | **2005**          | ** **   | **2004** | *** *** | **Change** | *** *** |
| **Total Operating Expenses**               | ** **   | **$**             | **181.5**    | ** ** | **$** | **139.7** | *** *** | ***$*** | ***41.8*** | *** *** |
| **Items included in the total:**           | *** *** | *** ***      | *** *** | *** *** | *** *** | *** *** | *** *** |
| **Restructuring and other charges**        | ** **   | **13.2**          | ** **   | **16.2** | *** *** | ***(3.0*** | ***)*** |
| **Amortization of purchased  intangibles** | ** **   | **11.0**          | ** **   | **3.9** | *** *** | ***7.1*** | *** *** |
| **All other**                              | ** **   | **$**             | **157.3**    | ** ** | **$** | **119.6** | *** *** | ***$*** | ***37.7*** | *** *** |

 

Our operating expenses increased primarilydue to the addition of AFC’s expenses, slightly offset by lower headcount andfacility-related costs due to prior restructuring activities.  Restructuring and other charges for the firstquarter of 2005 were primarily due to the previously disclosed reorganizationof our Denmark and Finland based businesses.

 

The increase in the amortization of purchasedintangibles and deferred stock compensation is due to the acquisitions of AFCand Vinci Systems, both in the fourth quarter of 2004.  This line item includes acquisition relatedamortization of both intangible assets, including developed technology, anddeferred compensation.

 

In order to achieve our targeted synergiesfollowing our acquisitions in 2004, and to support achievement of our strategicand financial goals, we are currently reviewing our spending, asset utilizationand product development roadmap opportunities to optimize revenue, improveasset utilization and contain spending. We expect that potential actions could include closing facilities,reducing our workforce and realigning research and development spending withinour product portfolio.  Although we havenot completed these plans, it is likely that future implementation of the planscould result in restructuring and similar charges.

 

**Other Income/(Expense)**

** **
| ** **               | ** ** | **First Quarter** | ** ** |
|--------------------------|------------|-------------------|------------|
| ** **               | ** ** | **2005**          | ** ** | **2004** | *** *** | **Change** | *** *** |
| **Interest income, net** | ** ** | **$**             | **5.7**    | ** ** | **$** | **5.9** | *** *** | ***$*** | ***(0.2*** | ***)*** |
| **Other expense, net**   | ** ** | **(2.7**          | **)**      | **(1.0** | **)** | ***(1.7*** | ***)*** |
| **Total**                | ** ** | **$**             | **3.0**    | ** ** | **$** | **4.9** | *** *** | ***$*** | ***(1.9*** | ***)*** |

 

Total other income declined as flat interestincome was offset by losses on the sale of certain marketable securities.

 

**Income Taxes**

 

For the firstquarter of 2005, we recorded a tax expense of $2.7 million compared to a taxexpense of $2.3 million in the first quarter of 2004.  Overall, our tax rate continues to be affectedby changes in the mix of income from domestic and foreign sources and theimpact of the reversal of a valuation allowance on domestic tax expense.

 

**Financial Condition, Liquidity& Capital Resources**

 

Our principal source of liquidity remainedour cash, cash equivalents and marketable securities, which decreased byapproximately $120.5 million during the quarter to $995.7 million.  This decrease primarily reflects ourpreviously announced stock repurchase program. Through April 1, 2005, we repurchased $118.7 million (approximately 16.5million shares) of our common stock, under a plan authorized by the board ofdirectors that enables us to repurchase up to $300 million in shares of ourcommon stock.

 

Inventories increased by $38.8 million fromyear-end levels primarily due to a build of fiber-based access product componentsand for buffer stock created to manage the consolidation of our manufacturingsupply chain.  Accounts receivable declinedby $41.7 million 

 

14

----

 

since year end, primarily due to thecombination of more linear shipments in the first quarter of 2005 compared tothat of the fourth quarter of last year and accelerated collections.  We believe that the current level of workingcapital, particularly cash and marketable securities, is sufficient to meet ournormal operating requirements for the foreseeable future. Further, we believethat sufficient resources exist to support our future growth and strategicneeds. Future sources of working capital may be from cash-on-hand, cashgenerated from future operations, short-term or long-term financing, equityofferings or any combination of these sources.

 

Our current policy is to retain our earningsto provide funds to enhance shareholder value by expanding our business,repurchasing our common stock when we believe it to be undervalued and foroperating activities.  We do notanticipate paying a cash dividend in the foreseeable future.

 

***Off-Balance Sheet Arrangements***

 

None.

 

***Critical Accounting Policies***

 

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

 

***Outlook***

 

We expect that wireless carriers will remainan important part of our business for the foreseeable future, and we look forcontinuing strength in 2005 as more wireless carriers begin to build out theirnetworks to support increased minutes of use and deliver new, data-orientedservices.  However, we continue to havelimited long-term visibility as to the amount and timing of wireless andwireline carrier spending as it relates to our products and services and theimpact of future industry consolidation. In the near term, we expect revenue to be up sequentially, between $450million and $460 million for the second quarter of 2005 and margins to bearound 42% for the quarter.

 

**Forward-Looking Statements**

 

This Management’s Discussion and Analysis andother sections of this Form 10-Q contain forward-looking statements madepursuant to the safe harbor provisions of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934, asamended. These statements reflect management’s expectations, estimates andassumptions, based on the information available at the time the document wasprepared. These forward-looking statements include, but are not limited to,statements regarding future events, plans, goals, objectives and expectations.The words “anticipate,” “believe,” “estimate,” “target,” “expect,” “predict,” “plan,”“possible,” “intend,” “likely,” “will,” “would,” “should,” “could,” “may” andsimilar expressions are intended to identify forward-looking statements.Forward-looking statements are not guarantees of future performance and involverisks, uncertainties and other factors that may cause our actual performance orachievements to be materially different from any future results, performance orachievements expressed or implied by those statements. Important factors thatcould cause our actual results to differ materially from those inforward-looking statements include, but are not limited to: economic changes impactingthe telecommunications industry; financial condition of telecommunicationservice providers and equipment vendors, including any impact of bankruptcies;the impact of customer and vendor consolidation; new product acceptance;product and end user demand, and industry capacity; competitive products andpricing; competitive pressures from new entrants to the telecommunicationsindustry; research and new product development; protection and access tointellectual property, patents and technology; ability to attract and retainhighly qualified personnel; availability of components and criticalmanufacturing equipment and capacity; foreign economic conditions, includingcurrency rate fluctuations; the regulatory and trade environment; availabilityand terms of future acquisitions; uncertainties relating to synergies, charges,and expenses associated with business combinations and other transactions andrestructurings; the ability to successfully integrate new businesses andtechnologies; various risks associated with our recent acquisitions andthe impact on our business; and other risks and future factors that may bedetailed from time to time in our filings with the SEC. For a furtherdescription of such risks and future factors, see Exhibit 99.1 to Form 10-K forthe fiscal year ended December 31, 2004, filed with the SEC on March15, 2005.  Our actual future results could differ materially from thosepredicted in such forward-looking statements. In light of the foregoing risks,uncertainties and other factors, investors should not place undue reliance onthe forward-looking statements in determining whether to buy, sell or hold anyof our securities. We undertake no obligation to publicly update or revise anyforward-looking statements to reflect changed assumptions, the occurrence ofanticipated or unanticipated events or changes to future results over time.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

To address currency risks, we have a policythat allows us to enter into foreign exchange forward and option contracts withmaturities of less than 12 months to mitigate the impact of currencyfluctuations on existing foreign currency asset and liability balances.  In January 2005, we expanded our foreigncurrency exposure management policy, and began entering into transactions touse exchange forward and option contracts of less than 12 months to reduce therisk to earnings and cash flows associated with anticipated foreign currencyexpenditures.

 

15

----

 

**Item 4.Controls and 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 April 1, 2005. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer have concluded that our disclosure controls and proceduresare effective.  There were no changesduring the period covered by this Form 10-Q in our internal control overfinancial reporting that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

On June 18, 2002, a classaction complaint was filed in the United States District Court of the NorthernDistrict of Illinois against Tellabs, Michael Birck, and Richard Notebaert(former CEO, President and Director of Tellabs).  Thereafter, eightsimilar complaints were also filed in the United States District Court of theNorthern District of Illinois.  All nine of these actions weresubsequently consolidated, and on December 3, 2002, a consolidated amendedclass action complaint was filed against Tellabs, Mr. Birck, Mr. Notebaert, andcertain other of our current or former officers and/or directors.  Theconsolidated amended complaint alleged that during the class period (December11, 2000-June 19, 2001) the defendants violated the federal securities laws bymaking materially false and misleading statements, including, among otherthings, allegedly providing revenue forecasts that were false and misleading,misrepresenting demand for our products, and reporting overstated revenues forthe fourth quarter 2000 in our financial statements.  Further, certain ofthe individual defendants were alleged to have violated the federal securitieslaws by trading our securities while allegedly in possession of material,non-public information about us pertaining to these matters.

 

On January 17, 2003, Tellabsand the other named defendants filed a motion to dismiss the consolidatedamended class action complaint in its entirety.  On May 19, 2003, theCourt granted our motion and dismissed all counts of the consolidated amendedcomplaint, while affording plaintiffs an opportunity to replead.  On July11, 2003, plaintiffs filed a second consolidated amended class action complaintagainst Tellabs, Messrs. Birck and Notebaert, and many (although not all) ofthe other previously named individual defendants, realleging claims similar tothose contained in the previously dismissed consolidated amended class actioncomplaint.  We filed a second motion to dismiss on August 22, 2003,seeking the dismissal with prejudice of all claims alleged in the secondconsolidated amended class action complaint.  On February 19, 2004, theCourt issued an order granting that motion and dismissed the action withprejudice.  On March 18, 2004, the plaintiffs filed a Notice of Appeal tothe United States Federal Court of Appeal for the Seventh Circuit appealing thedismissal.  The appeal was fully briefed, oral argument was heard onJanuary 21, 2005 and the parties are awaiting a decision.

 

On June 1, 2004, a complaintwas filed on behalf of a putative class of AFC stockholders against AFC, certainof its current officers and directors (“Individual Defendants”), and Tellabs,in the Court of Chancery in the State of Delaware in and for New Castle County.The complaint alleges that the Individual Defendants breached their fiduciaryduties to AFC’s public stockholders by acting to cause or facilitate the mergerof Tellabs and AFC for inadequate consideration, and that Tellabs acted to aidand abet the alleged breaches of fiduciary duty. In particular, plaintiffalleges that the merger consideration originally offered by Tellabs to AFC’spublic stockholders prior to the amendment and restatement of the mergeragreement is unfair and inadequate because, according to the plaintiff, “(a)the intrinsic value of the stock of AFC is materially in excess of the $21.24per share being proposed, giving due consideration to the possibilities ofgrowth and profitability of AFC in light of its business, earnings and earningspower, 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 seeks 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. Tellabsbelieves that the claims against it are without merit and intends to vigorouslydefend itself in this action.

 

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

 

***Repurchases of Common Stock:***

 
| **Period of Purchases** | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Purchase Price  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      |   |
| Total                   |       | 16,455,000                              |       | $                                      | 7.21       |                                                                                     | 16,455,000 |                                                                              |       |   |

 

16

----

 

On February 2,2005, the Company announced that its Board of Directors authorized the purchaseof up to $300.0 million in shares of our outstanding common stock, with noexpiration date to the authorization. Purchases of common shares may be made from time-to-time on the openmarket or in private transactions and will be recorded as treasury stock.  As of April 1, 2005, we have purchased $118.7million (approximately 16.5 million shares) of our common stock.

 

**Item 6.Exhibits**

 
| 10a  |   | 2005  Tellabs, Inc. Employee Stock Purchase Plan                             |
|------|--------|------------------------------------------------------------------------------|
| 10b  |   | Tellabs,  Inc. Executive Continuity and Protection Program                   |
| 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 |

 

17

----

 

**SIGNATURE**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|       | **TELLABS, INC.** |   |
|------------|-------------------|--------|
| ** ** | (Registrant)      |

 
|   | /s/ JAMES A. DITE                                            |   |
|--------|--------------------------------------------------------------|--------|
|   | James  A. Dite                                               |
|   | Vice  President and Controller                               |
|   | (Principal  Accounting Officer  and duly authorized officer) |
|   |                                                         |
|   | May  10, 2005                                                |
|   | (Date)                                                       |

 

18

----

 

**EXHIBIT INDEX**

** **
| **Exhibit** | ** ** | **Description**                                                              |
|-------------|------------|------------------------------------------------------------------------------|
| 10a         |       | 2005 Tellabs, Inc. Employee Stock Purchase Plan                              |
| 10b         |       | Tellabs, Inc. Executive Continuity and Protection Program                    |
| 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 |

 

19

----