**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

**(MarkOne)**
| **x**                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **For the  quarterly period ended June 30, 2006**                                                                                                                                                                                                                                                                                                                                                                             |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                                                                                                                                                          |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **For the  transition period from                                 to                                 ** |

**Commission file Number: 0-09692**

**TELLABS, INC.**(Exact name of registrant as specified in its charter)

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

 

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

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

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

YES  x   NO  o

Indicateby check mark whether the Registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):

| Large Accelerated Filer x |   | Accelerated  Filer o |   | Non-Accelerated  Filer o |
|--------------------------------|--------|---------------------------|--------|-------------------------------|

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

YES  o   NO  x

CommonShares, $0.01 Par Value – 447.7 million shares outstanding on June 30, 2006.

 

----

 

**TELLABS, INC.INDEX**
|               | ** ** | ** **                                                                                      | ** ** | **PAGE**   |
|---------------|------------|-------------------------------------------------------------------------------------------------|------------|------------|
| ** **    | ** ** | ** **                                                                                      | ** ** | ** ** |
| **PART I.**   | ** ** | **FINANCIAL INFORMATION**                                                                       | ** ** | ** ** |
|          |       |                                                                                            |       |       |
| **Item 1.**   | ** ** | **Financial Statements**                                                                        | ** ** |       |
|          |       | Consolidated Statements of Income                                                               |       | 3          |
|          |       |                                                                                            |       |       |
|          |       | Consolidated Balance Sheets                                                                     |       | 4          |
|          |       |                                                                                            |       |       |
|          |       | Consolidated Statements of Cash Flow                                                            |       | 5          |
|          |       |                                                                                            |       |       |
|          |       | Notes to Consolidated Financial Statements                                                      |       | 6          |
|          |       |                                                                                            |       |       |
| **Item 2.**   | ** ** | **Management’s Discussion and Analysis of Results of  Operations and Financial Condition** |       | 14         |
|          |       |                                                                                            |       |       |
| **Item 3.**   | ** ** | **Quantitative and Qualitative Disclosures about Market  Risk**                                 |       | 18         |
|          |       |                                                                                            |       |       |
| **Item 4.**   | ** ** | **Controls and Procedures**                                                                     |       | 18         |
|          |       |                                                                                            |       | ** ** |
| **PART  II.** | ** ** | **OTHER  INFORMATION**                                                                          | ** ** |       |
| ** **    |       |                                                                                            |       |       |
| **Item  1.**  | ** ** | **Legal  Proceedings**                                                                          |       | 18         |
| ** **    |       |                                                                                            |       |       |
| **Item  1A.** | ** ** | **Risk  Factors**                                                                               |       | 19         |
| ** **    |       |                                                                                            |       |       |
| **Item 2.**   | ** ** | **Unregistered Sales of Equity Securities and Use of  Proceeds**                                |       | 19         |
| ** **    |       |                                                                                            |       |       |
| **Item 4.**   | ** ** | **Submission of Matters to a Vote of Security Holders**                                         |       | 19         |
| ** **    |       |                                                                                            |       |       |
| **Item 6.**   | ** ** | **Exhibits**                                                                                    |       | 20         |
|          |       |                                                                                            |       |       |
| **SIGNATURE** |       |                                                                                            |       | 21         |

 

2

----

 

**PARTI.  FINANCIAL INFORMATION**

**Item 1.  Financial Statements**

**TELLABS,INC.**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**
| ** **                                                 | ** ** | **Second Quarter** | ** ** | **Six Months** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| **In millions, except per-share data** | ** ** | **6/30/06**             | ** ** | **7/1/05**          | ** ** | **6/30/06** | ** ** | **7/1/05** | ** ** |
| **Revenue**                                                | ** ** | ** **              | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Products                                                   | ** ** | **$**                   | **500.6**  |                | $          | 417.3 | ** ** | **$** | **974.7** |   | $ | 818.6 |   |
| Services                                                   | ** ** | **48.7**                |       | 45.2                | ** ** | **89.3** |   | 79.5 |   |
|                                                       | ** ** | **549.3**               |       | 462.5               | ** ** | **1,064.0** |   | 898.1 |   |
| **Cost of Revenue**                                        |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Products                                                   | ** ** | **264.5**               |       | 225.5               | ** ** | **506.7** |   | 452.1 |   |
| Services                                                   | ** ** | **30.6**                |       | 29.8                | ** ** | **60.8** |   | 56.9 |   |
|                                                       | ** ** | **295.1**               |       | 255.3               | ** ** | **567.5** |   | 509.0 |   |
| **Gross Profit**                                           | ** ** | **254.2**               |       | 207.2               | ** ** | **496.5** |   | 389.1 |   |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross profit as a  percentage of revenue                   |       | 46.3                    | %          | 44.8                | %          | 46.7 | % | 43.3 | % |
|                                                       |       |                    |       |                |       |   |   |   |   |
| Gross profit as a  percentage of revenue — products   |       | 47.2                    | %          | 46.0                | %          | 48.0 | % | 44.8 | % |
| Gross profit as a  percentage of revenue — services   |       | 37.2                    | %          | 34.1                | %          | 31.9 | % | 28.4 | % |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating Expenses**                                     |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and  development                                  | ** ** | **91.7**                |       | 82.9                | ** ** | **184.6** |   | 171.7 |   |
| Sales and  marketing                                       | ** ** | **45.0**                |       | 45.4                | ** ** | **90.0** |   | 91.6 |   |
| General and  administrative                                | ** ** | **28.5**                |       | 22.4                | ** ** | **56.6** |   | 44.7 |   |
| Intangible asset  amortization                             | ** ** | **7.1**                 |       | 9.2                 | ** ** | **14.1** |   | 20.2 |   |
| Restructuring  and other charges                           | ** ** | **2.0**                 |       | 1.2                 | ** ** | **2.0** |   | 14.4 |   |
|                                                       | ** ** | **174.3**               |       | 161.1               | ** ** | **347.3** |   | 342.6 |   |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating Earnings**                                     | ** ** | **79.9**                |       | 46.1                | ** ** | **149.2** |   | 46.5 |   |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other Income**                                           |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income,  net                                      | ** ** | **11.4**                |       | 6.4                 | ** ** | **21.9** |   | 12.1 |   |
| Other income  (expense), net                               | ** ** | **(7.4**                | **)**      | (1.7                | )          | **(6.0** | **)** | (4.4 | ) |
|                                                       | ** ** | **4.0**                 |       | 4.7                 | ** ** | **15.9** |   | 7.7 |   |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Earnings Before Income Tax**                             | ** ** | **83.9**                |       | 50.8                | ** ** | **165.1** |   | 54.2 |   |
| Income tax expense                                         | ** ** | **(30.4**               | **)**      | (9.7                | )          | **(59.2** | **)** | (12.4 | ) |
| **Net Earnings**                                           | ** ** | **$**                   | **53.5**   |                | $          | 41.1 | ** ** | **$** | **105.9** |   | $ | 41.8 |   |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net Earnings Per Share**                                 |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                      | ** ** | **$**                   | **0.12**   |                | $          | 0.09 | ** ** | **$** | **0.24** |   | $ | 0.09 |   |
| Diluted                                                    | ** ** | **$**                   | **0.12**   |                | $          | 0.09 | ** ** | **$** | **0.23** |   | $ | 0.09 |   |
|                                                       |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Weighted Average Shares  Outstanding**                   |       |                    | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                      | ** ** | **447.7**               |       | 447.7               | ** ** | **448.8** |   | 451.8 |   |
| Diluted                                                    | ** ** | **458.5**               |       | 451.4               | ** ** | **459.6** |   | 455.2 |   |

**Amortization of stock option expensein 2006 and deferred stock compensation in 2006 and 2005 related toacquisitions is included in the following cost and expense categories byperiod:**
| Cost of revenue             | ** ** | **$**   | **1.6**  |   | $          | 0.1      | ** ** | **$** | **3.0**    |   | $ | 0.2 | ** ** |
|-----------------------------|------------|---------|----------|--------|------------|----------|------------|-------|------------|--------|---|-----|------------|
| Research and  development   | ** ** | **5.4** |     | 2.5    | ** ** | **10.1** |       | 5.1   | ** ** |
| Sales and  marketing        | ** ** | **2.3** |     | 0.1    | ** ** | **4.4**  |       | 0.2   | ** ** |
| General and  administrative | ** ** | **4.2** |     | 0.1    | ** ** | **8.8**  |       | 0.2   | ** ** |
| ** **                  | ** ** | **$**   | **13.5** |   | $          | 2.8      | ** ** | **$** | **26.3**   |   | $ | 5.7 | ** ** |

The accompanyingnotes are an integral part of these statements.

3

----

 

**TELLABS,INC.**

**CONSOLIDATED BALANCE SHEETS**
| **In millions, except share data**                                                        | ** ** | **6/30/06**     | ** **  | **12/30/05** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------|-------------|--------------|------------|
| ** **                                                                                                    | ** ** | **(Unaudited)** | ** **  | ** **   | ** ** |
| **Assets**                                                                                                    |       |            |        |         |       |
| **Current  Assets**                                                                                           |       |            |        |         |       |
| Cash and cash equivalents                                                                                     | ** ** | **$**           | **295.2**   |         | $          | 880.8 |   |
| Investments in marketable securities                                                                          | ** ** | **922.3**       |        | 308.9        |       |
|                                                                                                          | ** ** | **1,217.5**     |        | 1,189.7      |       |
|                                                                                                          | ** ** | ** **      |        |         |       |
| Other marketable securities — Cisco stock                                                                | ** ** | **206.2**       |        | 180.8        |       |
| Accounts receivable, net of returns and allowances  of $8.4 and $8.4                                          | ** ** | **374.1**       |        | 319.4        |       |
| Inventories                                                                                                   | ** ** | ** **      |        |         |       |
| Raw materials                                                                                                 | ** ** | **34.4**        |        | 28.3         |       |
| Work in process                                                                                               | ** ** | **12.1**        |        | 11.7         |       |
| Finished goods                                                                                                | ** ** | **93.8**        |        | 69.1         |       |
|                                                                                                          | ** ** | **140.3**       |        | 109.1        |       |
| Income taxes                                                                                                  | ** ** | **8.6**         |        | 15.9         |       |
| Miscellaneous receivables and other current assets                                                            | ** ** | **48.6**        |        | 58.1         |       |
| **Total  Current Assets**                                                                                     | ** ** | **1,995.3**     |        | 1,873.0      |       |
|                                                                                                          | ** ** | ** **      |        |         |       |
| **Property,  Plant and Equipment**                                                                            | ** ** | ** **      |        |         |       |
| Land                                                                                                          | ** ** | **20.5**        |        | 20.3         |       |
| Buildings and improvements                                                                                    | ** ** | **201.9**       |        | 190.5        |       |
| Equipment                                                                                                     | ** ** | **427.2**       |        | 403.2        |       |
|                                                                                                          | ** ** | **649.6**       |        | 614.0        |       |
| Accumulated depreciation                                                                                      | ** ** | **(349.2**      | **)**       | (313.9       | )          |
|                                                                                                          | ** ** | **300.4**       |        | 300.1        |       |
| **Goodwill**                                                                                                  | ** ** | **1,113.5**     |        | 1,111.9      |       |
| **Intangible  Assets, Net of Amortization**                                                                   | ** ** | **103.2**       |        | 117.2        |       |
| **Other  Assets**                                                                                             | ** ** | **133.6**       |        | 112.7        |       |
| **Total  Assets**                                                                                             | ** ** | **$**           | **3,646.0** |         | $          | 3,514.9 |   |
|                                                                                                          | ** ** | ** **      |        |         |       |
| **Liabilities  and Stockholders’ Equity**                                                                | ** ** | ** **      |        |         |       |
| **Current  Liabilities**                                                                                      | ** ** | ** **      |        |         |       |
| Accounts payable                                                                                              | ** ** | **$**           | **103.8**   |         | $          | 97.1 |   |
| Accrued compensation                                                                                          | ** ** | **62.8**        |        | 83.8         |       |
| Restructuring and other charges                                                                               | ** ** | **7.2**         |        | 7.2          |       |
| Income taxes                                                                                                  | ** ** | **38.8**        |        | 28.9         |       |
| Cisco stock loan                                                                                              | ** ** | **206.2**       |        | 180.8        |       |
| Other accrued liabilities                                                                                     | ** ** | **135.4**       |        | 127.4        |       |
| **Total  Current Liabilities**                                                                                | ** ** | **554.2**       |        | 525.2        |       |
|                                                                                                          | ** ** | ** **      |        |         |       |
| **Long-Term  Restructuring Liabilities**                                                                      | ** ** | **21.1**        |        | 24.0         |       |
| **Income  Taxes**                                                                                             | ** ** | **106.0**       |        | 95.9         |       |
| **Other  Long-Term Liabilities**                                                                              | ** ** | **54.8**        |        | 55.1         |       |
|                                                                                                          | ** ** | ** **      |        |         |       |
| **Stockholders’  Equity**                                                                                | ** ** | ** **      |        |         |       |
| Preferred stock: authorized 5,000,000 shares of  $0.01 par value;  no shares issued and outstanding           | ** ** | **—**      |        | **—**   |       |
| Common stock: authorized 1,000,000,000 shares of  $0.01 par value;  486,208,478 and 477,045,901 shares issued | ** ** | **4.9**         |        | 4.8          |       |
| Additional paid-in capital                                                                                    | ** ** | **1,357.9**     |        | 1,238.7      |       |
| Deferred compensation expense                                                                                 | ** ** | **—**      |        | (10.9        | )          |
| Treasury stock, at cost: 38,520,819 and 27,661,859  shares                                                    | ** ** | **(479.6**      | **)**       | (322.8       | )          |
| Retained earnings                                                                                             | ** ** | **1,953.8**     |        | 1,847.9      |       |
| Accumulated other comprehensive income                                                                        | ** ** | **72.9**        |        | 57.0         |       |
| **Total  Stockholders’ Equity**                                                                          | ** ** | **2,909.9**     |        | 2,814.7      |       |
| **Total Liabilities and  Stockholders’ Equity**                                                          | ** ** | **$**           | **3,646.0** |         | $          | 3,514.9 |   |

The accompanyingnotes are an integral part of these statements.

4

----

 

**TELLABS,INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOW**

**(Unaudited)**
| ** **                                                                           | ** ** | **Six Months** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------|------------|
| **In millions**                                                                 | ** ** | **6/30/06**         | ** ** | **7/1/05** | ** ** |
| **Operating Activities**                                                             | ** ** |                |       |   |   |
| Net earnings                                                                         |       | **$**               | **105.9**  |   | $ | 41.8 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities: |       |                |       |   |   |
| Depreciation and  amortization                                                       |       | **51.6**            |       | 67.3 |   |
| Stock-based  compensation                                                            |       | **33.8**            |       | 7.1 |   |
| Deferred income  taxes                                                               |       | **22.5**            |       | (1.6 | ) |
| Excess tax  benefits from stock-based compensation                                   |       | **(15.2**           | **)**      | **—** |   |
| Restructuring  and other charges                                                     |       | **2.0**             |       | 14.4 |   |
| Net changes in  assets and liabilities, net of effects from acquisitions:            |       |                |       |   |   |
| Accounts  receivable                                                                 |       | **(58.8**           | **)**      | 41.9 |   |
| Inventories                                                                          |       | **(33.5**           | **)**      | (28.3 | ) |
| Miscellaneous  receivables and other current assets                                  |       | **13.9**            |       | (14.5 | ) |
| Other assets                                                                         |       | **18.7**            |       | 10.7 |   |
| Accounts payable                                                                     |       | **7.2**             |       | (17.5 | ) |
| Restructuring  and other charges                                                     |       | **(4.8**            | **)**      | (16.6 | ) |
| Other accrued  liabilities                                                           |       | **(18.3**           | **)**      | (14.9 | ) |
| Income taxes                                                                         |       | **(8.7**            | **)**      | 5.9 |   |
| Other long-term  liabilities                                                         |       | **0.6**             | ** ** | 9.8 |   |
| **Net  Cash Provided by Operating Activities**                                       | ** ** | **116.9**           |       | 105.5 |   |
|                                                                                 |       | ** **          |       |   |   |
| **Investing  Activities**                                                            | ** ** |                |       |   |   |
| Capital  expenditures                                                                |       | **(34.4**           | **)**      | (21.5 | ) |
| Disposals of  property, plant and equipment                                          |       | **0.5**             |       | 15.0 |   |
| Payments for  purchases of investments                                               |       | **(961.7**          | **)**      | (408.5 | ) |
| Proceeds from  sales and maturities of investments                                   |       | **345.2**           | ** ** | 438.4 |   |
| **Net  Cash (Used for) Provided by Investing Activities**                            | ** ** | **(650.4**          | **)**      | 23.4 |   |
|                                                                                 |       | ** **          |       |   |   |
| **Financing  Activities**                                                            | ** ** |                |       |   |   |
| Proceeds from  issuance of common stock under option plans                           |       | **81.1**            |       | 7.7 |   |
| Repurchase of  common stock                                                          |       | **(156.8**          | **)**      | (132.6 | ) |
| Excess tax  benefits from stock-based compensation                                   |       | **15.2**            |       | — |   |
| **Net  Cash (Used for) Financing Activities**                                        | ** ** | **(60.5**           | **)**      | (124.9 | ) |
| **Effect  of Exchange Rate Changes on Cash**                                         | ** ** | **8.4**             | ** ** | (20.3 | ) |
| **Net  Decrease in Cash and Cash Equivalents**                                       | ** ** | **(585.6**          | **)**      | (16.3 | ) |
| **Cash  and Cash Equivalents  — Beginning of  Year**                       | ** ** | **880.8**           | ** ** | 292.9 |   |
| **Cash and Cash Equivalents  — End of Period**                             | ** ** | **$**               | **295.2**  | ** ** | $ | 276.6 |   |

The accompanyingnotes are an integral part of these statements.

5

----

 

**TELLABS,INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

IN MILLIONS EXCEPT SHARE ANDPER-SHARE DATA

**1. Basisof Presentation**

Ouraccompanying unaudited consolidated financial statements were prepared inaccordance with generally accepted accounting principles for interim financialstatements, the requirements of Form 10-Q and applicable rules of RegulationS-X, so they do not include all disclosures normally required by generallyaccepted accounting principles for complete financial statements. Accordingly,the financial statements and notes herein are to be read in conjunction withour Annual Report on Form 10-K for the year ended December 30, 2005.

In ouropinion, the accompanying unaudited consolidated financial statements includeall adjustments (consisting of normal recurring accruals) that are necessaryfor a fair presentation.  Operating resultsfor interim periods are not necessarily indicative of operating results for thefull year.

**2. Restructuring and OtherCharges**

During the secondquarter, we initiated restructuring activities to reduce costs and better alignour resources with our internal needs and our customers’ requirements.  The activities include consolidation of ourtwo order configuration and distribution centers in North America into a singlelocation, and a reduction of headcount in both the Transport and Broadbandsegments of our business.  Headcount willbe reduced by 140 employees and by the end of 2006, and we will close orconsolidate two leased facilities as a result of those reductions.  During the second quarter, we recorded $2.4million of severance and related expenses as part of our workforcereductions.  The total cost is expectedto be in a range of $13 to $14 million and includes $3.8 million in severancecosts, $9.5 million in facility related charges and $0.2 million in assetdisposals.  We expect to save $17.0million annually, primarily from reduced salaries and related benefits, andlease savings.  In addition, there was afavorable $0.4 million adjustment for previous restructuring plans during thesecond quarter of 2006 due to a change in estimate of costs to be incurred.

Our previousrestructuring plans, initiated in the fourth quarter of 2004 and the first halfof 2005, were designed to improve profitability by reducing the combined annualexpenditures of Tellabs and Advanced Fibre Communications, Inc. (AFC) (which weacquired on November 30, 2004) by $30 million in 2005 and beyond by reducingannual expenses from other sources (primarily operating expenses) by anadditional $15 million.  To reach thesegoals, we reorganized our operations in Denmark and Finland, outsourced ourNorth American prototype lab and reduced headcount on a smaller scale in otherlocations.  These actions resulted incharges primarily related to our Broadband products segment.  Implementation of these plans, which is nowcomplete, resulted in workforce reductions, facility closures and assetdisposals.  We recorded charges in 2004and 2005 totaling $16.7 million related to these plans.  Excluding restructuring charges, we achievedcost savings from these plans beginning in the first quarter of 2005.  By the end of 2005, we achieved the goals ofthese plans.  If we incur any additionalcharges or credits for our pre-2006 restructuring plans, we do not expect themto be material.

The following tablesummarizes restructuring and other charges:
|                                           | ** ** | **Second Quarter** | ** ** | **Six Months** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                | ** ** | **6/30/06**             | ** ** | **7/1/05**          | ** ** | **6/30/06** | ** ** | **7/1/05** | ** ** |
| Severance and  other termination benefits |       | $                       | 2.0        |                | $          | 0.5 |   | $ | 2.0 |   | $ | 11.5 |   |
| Facility and  other exit costs            |       | —                  |       | 0.7                 |       | — |   | 2.9 |   |
| Total restructuring and  other charges    |       | $                       | 2.0        |                | $          | 1.2 |   | $ | 2.0 |   | $ | 14.4 |   |

The following table summarizes our restructuring andother charges activity during the first two quarters of 2006 and the status ofthe reserves at June 30, 2006:
|                                           | ** ** | **Balance at  12/30/05** | ** ** | **Charges/  (Reversals)** | ** ** | **Cash  Payments** | ** ** | **Balance at  3/31/06** | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|---------------------------|------------|--------------------|------------|------------------------------|------------|
| Facility and  other exit costs            |       | $                             | 29.7       |                      | —     |               | $          | 2.1                          |       | $ | 27.6 |   |
|                                      |       |                          |       |                      |       |               |       |                         |       |
| Severance and  other termination benefits |       | 1.5                           |       | —                    |       | 0.6                |       | 0.9                          |       |
|                                      |       |                          |       |                      |       |               |       |                         |       |
| Total                                     |       | $                             | 31.2       |                      | —     |               | $          | 2.7                          |       | $ | 28.5 |   |

 

6

----

 
|                                          | ** ** | **Balance at  3/31/06** | ** ** | **Charges/  (Reversals)** | ** ** | **Cash  Payments** | ** ** | **Balance at  6/30/06** | ** ** |
|------------------------------------------|------------|-------------------------|------------|---------------------------|------------|--------------------|------------|-------------------------|------------|
| Facility and other exit costs            |       | $                       | 27.6       |                      | —     |               | $          | 2.0                     |       | $ | 25.6 |   |
|                                     |       |                    |       |                      |       |               |       |                    |       |
| Severance and other termination benefits |       | 0.9                     |       | 2.0                       |       | 0.1                |       | 2.8                     |       |
|                                     |       |                    |       |                      |       |               |       |                    |       |
| Total                                    |       | $                       | 28.5       |                      | $          | 2.0                |       | $                       | 2.1        |   | $ | 28.4 |   |
|                                          |            |                         |            |                           |            |                    |            |                         |            |  |  |  |  |

 

As of December 30, 2005,in addition to the aforementioned restructuring plans and related accruals, wehad a $10.0 million accrual remaining for exit costs related to our 2004acquisition of AFC.  During the secondquarter of 2006, this accrual was charged $0.7 million.  Total charges against this accrual were $1.8million for the first six months of 2006, leaving a balance of $8.2 million atJune 30, 2006.  We expect to complete theserestructuring plans by the end of 2006, with the exception of lease liabilitiesthat are expected to be fully utilized by the end of 2009.

**3. Employee Stock Plans**

TheTellabs, Inc. 2004 Incentive Compensation Plan provides for the grant ofshort-term and long-term incentives, including stock-based compensationawards.  A total of 39,139,977 shares wasapproved for grant under the plan, of which 26,880,684 remain available forgrant at June 30, 2006.  Under the 2004plan and predecessor plans, we granted awards at market value on the date of grant.  Under the 2005 Tellabs, Inc. Employee StockPurchase Plan, employees can elect to withhold a portion of their compensationto purchase Tellabs’ common stock at 85% of the stock’s closing price on thedate of purchase. Shares are purchased under this 2005 plan in April andOctober. When shares are issued under these plans they are new shares, nottreasury stock.

At thebeginning of our first quarter of 2006, we adopted the provisions of SFAS123(R) requiring us to recognize expense related to the fair value of ourstock-based compensation awards.  Weelected to use the modified prospective transition method, and therefore havenot restated prior periods.  In addition,we eliminated the balance of deferred compensation expense in Stockholders’Equity against Additional Paid-in-Capital on December 31, 2005, as required bythis statement.

***StockOptions and Stock Appreciation Rights***

Optionsgranted in the first half of 2006 and all of 2005 generally vest ratably over36 months from the date of the grant. Options granted in 2004 and 2003 generally become exercisable at a rateof 20% on each of the first two annual anniversaries and 60% on the thirdanniversary of the grant date. AFC options that converted to Tellabs options onthe acquisition date of November 30, 2004, vest over 3 to 4 years.  Options granted but unexercised expire 10years from the date of grant.

Weestimated the fair value of stock options using the Black-Scholesoption-pricing model.  This modelrequires the use of assumptions that will have a significant impact on the fairvalue estimate.  The following tablesummarizes the assumptions used to compute the weighted-average fair value ofcurrent period stock option grants:
|                           | ** ** | **Six Months** | ** ** |
|---------------------------|------------|---------------------|------------|
| ** **                | ** ** | **6/30/06**         | ** ** | **7/1/05** | ** ** |
| Expected  volatility      |       | 43.3                | %          | 60.0 | % |
| Risk-free interest  rate  |       | 4.7                 | %          | 3.8 | % |
| Expected term  (in years) |       | 4.5                 |       | 4.2 |   |
| Expected dividend yield   |       | 0.0                 | %          | 0.0 | % |

Webased our calculation of expected volatility on a combination of historical andimplied volatility for options granted in the first half of 2006 and on historicalvolatility for options granted in the first half of 2005.  If we had determined the expected volatilityfor the first half of 2005 using a combination of historical and impliedvolatility, the expected volatility would have been 43.8%.  We based the risk-free interest rate on theU.S. Treasury yield curve in effect at the time of option grant, and weestimated the expected term of the options using their vesting period,post-vesting employment termination behavior and historical exercise patterns.

The following is asummary of the activity in our stock options during 2006 and status at the endof the quarter ended June 30, 2006:

7

----

 
| ** **                                                        | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding —  beginning of year                             |       | 55,320,265 |       | $                                       | 15.90      |                                                                      |       |                            |       |   |
| Granted                                                           |       | 1,138,850  |       | 14.48                                   |       |                                                                      |       |                            |       |
| Exercised                                                         |       | (8,860,404 | )          | 9.17                                    |       |                                                                      |       |                            |       |
| Forfeited/expired                                                 |       | (3,448,560 | )          | 20.43                                   |       |                                                                      |       |                            |       |
| Outstanding —  end of period                                 |       | 44,150,151 |       | 16.86                                   |       | 6.1                                                                       |       | $                               | 147.8      |   |
|                                                              |       |       |       |                                    |       |                                                                      |       |                            |       |
| Exercisable —  end of period                                 |       | 28,023,496 |       | 21.59                                   |       | 5.1                                                                       |       | 70.8                            |       |
| Shares expected  to vest                                          |       | 43,556,919 |       | 16.95                                   |       | 6.1                                                                       |       | 145.7                           |       |
|                                                              |       |       |       |                                    |       |                                                                      |       |                            |       |
| Weighted-average fair  value of options granted during the period |       |       |       | 6.09                                    |       |                                                                      |       |                            |       |
|                                                                   |            |            |            |                                         |            |                                                                           |            |                                 |            |  |  |

Theaggregate intrinsic value in the preceding table represents the total pretaxintrinsic value, based on Tellabs’ closing stock price as of June 30, 2006,which would have been received by the options holders had all options holdersexercised their options as of that date. The aggregate intrinsic value of exercised stock options during thefirst half of 2006 was $43.0 million.

Tellabs’plans also provide for the granting of stock appreciation rights (SARs) inconjunction with, or independent of, the stock options under the plans. OurSARs allow the holder to receive in cash the difference between the SAR’s grantprice (market value of Tellabs’ stock on the date of grant) and the marketvalue of Tellabs stock on the date the holder exercises the SAR.  The SARs are generally assigned 10-yearterms.   SARs generally vest ratably over36 months from the date of the grant.  At June 30, 2006, there were 60,112 SARs outstanding with exerciseprices that ranged from $4.07 to $70.06. The weighted-average price of the 15,900 SARs granted in the first halfof 2006 was $15.00 and the weighted average price of the 3,000 SARs granted inthe first half of 2005 was $7.07.

As ofJune 30, 2006, we had $39.9 million of unrecognized compensation cost relatedto stock options and SARs that we expect to recognize over a weighted-averageperiod of one year.

***RestrictedStock***

Wegranted 124,606 restricted shares in the first half of 2006 and 223,500restricted shares in the first half of 2005. Of the 124,606 shares granted in the first half of 2006, 62,000 vestover a two-year period and 62,606 vest over a one-year period.   Of the 223,500 shares granted in the firsthalf of 2005, 213,500 vest over a two-year period and 10,000 vests over aone-year period.  We generally recognizecompensation cost on a straight-line basis over the vesting periods, whichrange from one to three years, based on the market price of Tellabs’ stock onthe date of grant.  Compensation expensefor restricted stock was $4.5 million in the first half 2006 and $1.5 millionin the first half of 2005.  The weighted-averageissuance price of restricted stock granted in the first half of 2006 was $13.43per share and the weighted-average issuance price of restricted stock grantedin the first half of 2005 was $7.65 per share. Our non-vested stock award activity for the first half of 2006 follows:
|                                      | ** ** | **Six Months  06/30/06** | ** ** |
|--------------------------------------|------------|-------------------------------|------------|
| ** **                           | ** ** | ** **

**Shares**        | ** ** | **Weighted-  Average  Grant Date  FairValue** | ** ** |
| Non-vested —  beginning of year |       | 1,287,677                     |       | $ | 8.67 |   |
| Granted                              |       | 124,606                       |       | 13.43 |   |
| Vested                               |       | (189,353                      | )          | 8.24 |   |
| Forfeited                            |       | (36,139                       | )          | 8.76 |   |
| Non-vested — end of  period     |       | 1,186,791                     |       | 9.23 |   |
|                                      |            |                               |            |  |  |  |

As ofJune 30, 2006, we had $2.0 million of unrecognized compensation cost related torestricted stock that we expect to recognize over a weighted-average period of0.5 years.

8

----

 

***EmployeeStock Purchase Plan***

Underthe 2005 Tellabs, Inc. Employee Stock Purchase Plan, 218,178 shares of commonstock were purchased during the first half of 2006 at an average price of$13.47, and no shares were purchased under the plan during the first half of2005.  As of June 30, 2006, we had9,559,344 shares available for purchase.

***Stock-BasedCompensation Expense***

Thefollowing table sets forth the total stock-based compensation expense resultingfrom stock options, stock appreciation rights, restricted stock and our employeestock purchase plan:
|                                                            | ** ** | **Second  Quarter** | ** ** | **Six  Months** | ** ** |
|------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|
| ** **                                                 | ** ** | **6/30/06**         | ** ** | **6/30/06**     | ** ** |
| Cost of revenue —  products                           |       | $                   | 0.6        |            | $          | 1.2 |   |
| Cost of revenue —  services                           |       | 1.3                 |       | 2.4             |       |
| Research and development                                   |       | 6.2                 |       | 11.7            |       |
| Sales and marketing                                        |       | 2.7                 |       | 5.3             |       |
| General and administrative                                 |       | 5.2                 |       | 10.7            |       |
| Stock-based compensation expense before income taxes       |       | 16.0                |       | 31.3            |       |
| Income tax benefit                                         |       | 4.7                 |       | 8.9             |       |
| Total stock-based  compensation expense after income taxes |       | $                   | 11.3       |            | $          | 22.4 |   |

Due tothe adoption of SFAS 123(R), our net earnings in the second quarter of 2006were $7.4 million lower or $0.02 per basic and $0.01 per diluted share, and ournet earnings for the first six months of 2006 were $14.5 million lower or $0.03per share (basic and diluted).  Prior tothe adoption of SFAS 123(R), we accounted for stock-based compensation plansunder Accounting Principles Board Opinion No. 25.  If compensation cost for our stock-basedcompensation plans had been determined using the fair value at the grant datesfor awards under those plans consistent with the method required by SFAS No.123(R) for our second quarter of 2005, our net earnings and net earnings pershare would have been as follows:

|                                                                                                                                             | ** ** | **Second  Quarter** | ** ** | **Six  Months** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|
| ** **                                                                                                                                  | ** ** | **07/01/05**        | ** ** | **07/01/05**    | ** ** |
| Net earnings as  reported                                                                                                                   |       | $                   | 41.1       |            | $          | 41.8 |   |
| Add: stock-based  employee compensation expense included in reported net earnings, net of  related tax effects                              |       | 3.6                 |       | 7.1             |       |
|                                                                                                                                        |       |                |       |            |       |
| Less: total  stock-based employee compensation expense determined under fair value based  method for all grants, net of related tax effects |       | (14.0               | )          | (44.5           | )          |
|                                                                                                                                        |       |                |       |            |       |
| Pro forma net  earnings                                                                                                                     |       | $                   | 30.7       |            | $          | 4.4 |   |
|                                                                                                                                        |       |                |       |            |       |
| Net earnings per  share:                                                                                                                    |       |                |       |            |       |
| As reported                                                                                                                                 |       | $                   | 0.09       |            | $          | 0.09 |   |
| Pro forma basic  and diluted                                                                                                                |       | $                   | 0.07       |            | $          | 0.01 |   |

 

9

----

 

**4. Retiree Medical Plan**

The following table setsforth the components of the net periodic benefit costs for our retiree medicalplan:
|                                     | ** ** | **Second Quarter** | ** ** | **Six Months** | ** ** |
|-------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                          | ** ** | **6/30/06**             | ** ** | **7/1/05**          | ** ** | **6/30/06** | ** ** | **7/1/05** | ** ** |
| Service cost                        |       | $                       | 0.2        |                | $          | 0.3 |   | $ | 0.5 |   | $ | 0.6 |   |
| Interest cost                       |       | 0.2                     |       | 0.1                 |       | 0.3 |   | 0.3 |   |
| Expected return  on plan assets     |       | (0.1                    | )          | (0.1                | )          | (0.2 | ) | (0.2 | ) |
| Amortization of  prior service cost |       | 0.1                     |       | —              |       | $ | 0.1 |   | — |   |
| Net periodic benefit  cost          |       | $                       | 0.4        |                | $          | 0.3 |   | $ | 0.7 |   | $ | 0.7 |   |

Based on the current funding of the plan, we do notexpect to contribute to the plan in 2006**.**

**5. Product Warranties**

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

Our estimate of warrantyliability involves many factors, including the number of units shipped,historical and anticipated rates of warranty claims, and cost per claim.  We periodically assess the adequacy of ourrecorded warranty liability and adjust the amounts as necessary.  We classify the portion of our warrantyliability that we expect to incur in the next 12 months as a currentliability.  We classify the portion ofour warranty liability that we expect to incur more than 12 months in thefuture as a long-term liability.  Ourproduct warranty liabilities are as follows:

|                                                    | ** ** | **Second Quarter** | ** ** | **Six Months** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                         | ** ** | **06/30/06**            | ** ** | **7/1/05**          | ** ** | **6/30/06** | ** ** | **7/1/05** | ** ** |
| Balance —  beginning of period                |       | $                       | 52.1       |                | $          | 42.2 |   | $ | 49.2 |   | $ | 41.1 |   |
| Accruals for  product warranties issued            |       | 3.5                     |       | 9.8                 |       | 12.8 |   | 17.5 |   |
| Settlements                                        |       | (6.9                    | )          | (5.1                | )          | (13.3 | ) | (11.7 | ) |
| Balance — end of  period                      |       | $                       | 48.7       |                | $          | 46.9 |   | $ | 48.7 |   | $ | 46.9 |   |
|                                               |       |                    |       |                |       |   |   |   |   |
| Balance sheet  classification — end of period |       |                    |       |                |       |   |   |   |   |
| Other accrued  liabilities                         |       |                    |       |                |       | $ | 28.0 |   | $ | 28.5 |   |
| Other long-term  liabilities                       |       |                    |       |                |       | 20.7 |   | 18.4 |   |
| Total product warranty  liabilities                |       |                    |       |                |       | $ | 48.7 |   | $ | 46.9 |   |

**6.Repurchases of Common Stock**

OnApril 27, 2006, Tellabs’ Board of Directors authorized the removal of the$100.0 million cap from the share repurchase program it authorized in January2006 under Rule 10b5-1 of the Securities Exchange Act of 1934.  We intend to continue to use cash generatedby employee stock option exercises (other than those of company officers andboard members) to purchase stock under this plan.  We will record these repurchased shares astreasury stock. As of  June 30, 2006, wehave purchased 3.3 million shares of our common stock under this plan at atotal cost of $49.7 million including $20.2 million (1.2 million shares) in thesecond quarter of 2006.

InFebruary 2005, our Board of Directors authorized the purchase of up to $300.0million of our outstanding common stock. We may purchase shares of our common stock from time to time on the openmarket or in private transactions and record purchases as treasury stock.  As of June 30, 2006, we have purchased 31.8million shares of our common stock under this plan at a total cost of $298.7million including $17.2 million (1.2 million shares) in the second quarter of2006.

**7. Comprehensive Income (Loss)**

Comprehensive income(loss) is an expression of our net earnings (loss) in the consolidatedstatements of operations, adjusted for

10

----

 

foreign-currencytranslation adjustments, net unrealized gains or losses on available-for-salesecurities and fair value adjustments of cash flow hedges.  Our comprehensive income (loss) for thesecond quarter and year to date of 2006 was as follows:
| ** **                                                   | ** ** | **Second Quarter** | ** ** | **Six Months** | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                   | ** ** | **06/30/06**            | ** ** | **7/1/05**          | ** ** | **6/30/06** | ** ** | **7/1/05** | ** ** |
| Net Earnings                                                 |       | $                       | 53.5       |                | $          | 41.1 |   | $ | 105.9 |   | $ | 41.8 |   |
| Other comprehensive income (loss):                           |       |                    |       |                |       |   |   |   |   |
| Cumulative translation adjustment                            |       | 12.6                    |       | (34.9               | )          | 16.9 |   | (62.8 | ) |
| Unrealized net gain (loss) on  available-for-sale-securities |       | (7.1                    | )          | 2.5                 |       | (0.9 | ) | — |   |
| Fair value adjustments of cash flow hedges                   |       | (0.1                    | )          | (0.4                | )          | (0.1 | ) | (0.4 | ) |
|                                                         |       |                    |       |                |       |   |   |   |   |
| Comprehensive income  (loss)                                 |       | $                       | 58.9       |                | $          | 8.3 |   | $ | 121.8 |   | $ | (21.4 | ) |

**8.Derivative Financial Instruments**

We enter intoforeign-exchange forward and option contracts with maturities of less than 12months to mitigate the impact of currency fluctuations on existing foreigncurrency asset and liability balances. In addition, in 2005 we started 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.  We record all derivatives on the balancesheet at fair value in accordance with SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities*.

In regard to the cashflow hedges, we calculate each hedge’s effectiveness quarterly, excluding timevalue.  We determine a forward contract’seffectiveness by comparing the cumulative change in the fair value on aspot-to-spot rate basis with the spot-to-spot rate cumulative change in theanticipated transaction.  We record theeffective portion of the hedge in *Other Comprehensive Income*(*OCI*). Similarly, we calculate an option contract’s effectiveness by comparingcumulative changes in the contract’s intrinsic value on a spot-rate basis withcumulative losses in value of the anticipated transaction measured on aspot-rate basis.  When we recognize thehedged revenue transaction to income, the total change in the hedges effectivevalue, which we accumulate in other comprehensive income, we reclassify tooperating expense.  We record anyineffectiveness, along with the excluded time value of the forward and optioncontracts, in *Other Income (Expense), Net*.  We reclassify the gains or losses on therelated cash flow hedges from *Other Comprehensive Income*(*OCI*) to *Other Income(Expense), Net* at the time it becomes probable that a hedgedanticipated transaction will not occur*.*  Cash flow hedges had a loss of $0.1 millionon OCI in the second quarter of 2006.

We also manage theforeign currency risk associated with foreign currency denominated assets andliabilities using foreign-exchange forward contracts.  We recognize changes in the fair value ofthese derivatives in the *Other Income (Expense),**Net* caption in our ConsolidatedStatements of Income to mitigate the impact of remeasurement gains and lossesassociated with the foreign currency denominated assets and liabilities.

**9. IncomeTaxes**

We recorded income taxexpense of $30.4 million for the second quarter and $59.2 million for the firstsix months of 2006, resulting in effective tax rates of 36.3% and 35.9%respectively.  Our effective tax ratediffers from the U.S. federal statutory rate of 35% primarily due to earningsfrom foreign operations taxed at different rates and the impact of state incometaxes.  Additionally, our tax expense andeffective tax rate for the second quarter reflects the impact of a $3.7 millionvaluation allowance established against the tax benefit of a capital lossrecognized during the quarter.

On November 10, 2005, the FASB issued FASB StaffPosition No. FAS 123(R)-3 *TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards*.The Company has elected to adopt the alternative transition method provided inthe FASB Staff Position for calculating the tax effects of stock-basedcompensation pursuant to SFAS 123(R). The alternative transition methodincludes simplified methods to establish the beginning balance of theadditional paid-in capital pool (APIC pool) related to the tax effects ofemployee stock-based compensation.  Themethod also determines the subsequent impact on the APIC pool and Statements ofCash Flows of the tax effects of employee stock-based compensation awards thatare outstanding upon adoption of SFAS 123(R).

**10.Operating Segments**

Prior to 2006, wereported our results of operations based on us operating in a single segment.Beginning with the first quarter of 2006, we are reporting operating resultsfor three segments:  Broadband products, Transport products and Services.Under applicable accounting rules, the number of segments in which a companyreports is determined by the way the company’s chief operating decision maker(in Tellabs’ case, our CEO) assesses performance and allocates resources.During the first quarter of this year, we began assessing performance on lessof a consolidated basis than in previous reporting periods. Specifically, weare focused on revenue and profitability measures for product and servicecategories that make up the three segments mentioned above.

11

----

 

The Broadband productssegment includes products that enable the delivery of bundled voice, video andhigh-speed Internet/data services over fiber-based networks that enable serviceproviders to leverage existing infrastructure to integrate Frame Relay, ATM,Ethernet and IP data networks onto a converged MPLS infrastructure.  Product offerings include the Tellabs® 1000 multiservice access series, the Tellabs® 1100 multiservice access series and theTellabs® 1600 optical network terminal series (accessproducts); the Tellabs® 2300 cable telephony distribution system, theTellabs® 6300 managed transport system and the Tellabs® 8100 managed access system (managed accessproducts); and the Tellabs® 8600 managed edge system and the Tellabs® 8800 multiservice router series (broadbanddata products).

The Transport productssegment includes products that enable service providers to manage bandwidth.  Product offerings include the Tellabs® 3000 voice-quality enhancement products, theTellabs® 5000 series of digital cross-connect systems,the Tellabs® 5500NGX transport switch, the Tellabs® 6500 transport switch and the Tellabs® 7100 optical transport system.

The Services segmentdelivers installation, support services and professional consulting tocustomers of the Broadband and Transport product segments.

We define segment profitas gross profit less research and development expense.  Segment profit excludes the impact of stockoption expense, amortization of purchased deferred stock compensation andintangibles, sales and marketing expenses, general and administrative expenses,and restructuring and other charges.

Financial information foreach operating segment is as follows:

**Revenue**
| ** **              | ** ** | **Second Quarter** | ** ** | **Six Months** | ** ** |
|-------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **              | ** ** | **06/30/06**            | ** ** | **7/1/05**          | ** ** | **06/30/06** | ** ** | **7/1/05** | ** ** |
| **Broadband  products** | ** ** | **$**                   | **298.4**  | ** **          | **$**      | **247.6** | ** ** | **$** | **558.1** | ** ** | **$** | **475.9** | ** ** |
| **Transport  products** | ** ** | **202.2**               | ** ** | **169.7**           | ** ** | **416.6** | ** ** | **342.7** | ** ** |
| **Services**            | ** ** | **48.7**                | ** ** | **45.2**            | ** ** | **89.3** | ** ** | **79.5** | ** ** |
| **Total revenue**       | ** ** | **$**                   | **549.3**  | ** **          | **$**      | **462.5** | ** ** | **$** | **1,064.0** | ** ** | **$** | **898.1** | ** ** |

**Segment Profit and Reconciliation to OperatingEarnings**
| ** **                                                                               | ** ** | **Second Quarter** | ** ** | **Six Months** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                                               | ** ** | **06/30/06**            | ** ** | **7/1/05**          | ** ** | **06/30/06** | ** ** | **7/1/05** | ** ** |
| **Broadband  products**                                                                  | ** ** | **$**                   | **38.1**   | ** **          | **$**      | **37.4** | ** ** | **$** | **59.5** | ** ** | **$** | **45.9** | ** ** |
| **Transport  products**                                                                  | ** ** | **112.1**               | ** ** | **74.1**            | ** ** | **234.9** | ** ** | **154.2** | ** ** |
| **Services**                                                                             | ** ** | **19.3**                | ** ** | **15.4**            | ** ** | **30.6** | ** ** | **22.6** | ** ** |
| **Total  segment profit**                                                                | ** ** | **169.5**               | ** ** | **126.9**           | ** ** | **325.0** | ** ** | **222.7** | ** ** |
| **Sales  and marketing expenses**                                                        | ** ** | **(45.0**               | **)**      | **(45.4**           | **)**      | **(90.0** | **)** | **(91.6** | **)** |
| **General  and administrative expenses**                                                 | ** ** | **(28.5**               | **)**      | **(22.4**           | **)**      | **(56.6** | **)** | **(44.7** | **)** |
| **Stock  option expense and deferred stock compensation not included in segment profit** | ** ** | **(7.0**                | **)**      | **(2.6**            | **)**      | **(13.1** | **)** | **(5.3** | **)** |
| **Intangible  asset amortization**                                                       | ** ** | **(7.1**                | **)**      | **(9.2**            | **)**      | **(14.1** | **)** | **(20.2** | **)** |
| **Restructuring  and other charges**                                                     | ** ** | **(2.0**                | **)**      | **(1.2**            | **)**      | **(2.0** | **)** | **(14.4** | **)** |
| **Operating earnings**                                                                   | ** ** | **$**                   | **79.9**   | ** **          | **$**      | **46.1** | ** ** | **$** | **149.2** | ** ** | **$** | **46.5** | ** ** |

Our segments use many of the same assets.  For internal reporting purposes, we do notallocate assets by segment and therefore no asset, depreciation andamortization, or capital expenditure by segment information is provided to ourchief operating decision maker.

**Segment Goodwill**

Prior to 2006, wereported our results of operations based on us operating in a single segment.Beginning with the first quarter of 2006, we reported operating results forthree segments: Broadband products, Transport products and Services.  For purpose of evaluation, we tested eachoperating segment for possible goodwill impairment by comparing each segment’snet book value to fair value in accordance with FAS 142, *Goodwill andOther Intangible Assets*.  Aseach operating segment’s fair value was greater than its net book value and noother impairment indicators existed, further impairment tests were not deemednecessary and no impairment loss was recorded. The process of evaluating the potential impairment of goodwill issubjective and requires significant judgment. In estimating the fair value of the operating segments for the purposeof this analysis, we made estimates and judgments about the future

12

----

 

cash flows of ouroperating segments.   Although we base ourcash flow forecasts on assumptions that are consistent with plans and estimateswe use to manage the underlying operating segments, there is significantjudgment in determining the cash flows attributable to these operatingsegments.

A breakdown of goodwillfor each operating segment follows:
|                         | ** ** | **6/30/06** | ** **  |
|-------------------------|------------|-------------|-------------|
| **Broadband  products** | ** ** | **$**       | **595.5**   | ** ** |
| **Transport  products** | ** ** | **395.1**   | ** **  |
| **Services**            | ** ** | **122.9**   | ** **  |
| **Total**               | ** ** | **$**       | **1,113.5** | ** ** |

**11.Subsequent Event - Stock Repurchase Program**

On July31, 2006, we announced that our Board of Directors authorized a new sharerepurchase program permitting us to repurchase up to $300 million of ouroutstanding common stock.  We will recordthe total cost to repurchase shares as treasury stock.

13

----

 

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

**Introduction and Overview ofBusiness**

Tellabs designs,develops, deploys and supports telecommunications networking products aroundthe world.  We generate revenueprincipally through the sale of telecommunications products, both asstand-alone products and as elements of integrated systems, to many of theworld’s largest telecommunications service providers. In addition, we generaterevenue by providing installation and professional services related primarilyto our own products and systems.

Prior to 2006, wereported our results of operations based on us operating in a singlesegment.  Beginning with the firstquarter of 2006, we are reporting operating results for three segments:  Broadband products, Transport products andServices.

The Broadband products segment includes products thatenable the delivery of bundled voice, video and high-speed Internet/dataservices over fiber-based networks and enable service providers to leverageexisting infrastructure to integrate Frame Relay, ATM, Ethernet and IP datanetworks onto a converged MPLS infrastructure. Product offerings include the Tellabs® 1000 multiservice access series, the Tellabs® 1100 multiservice access series and theTellabs® 1600 optical network terminal series (accessproducts); the Tellabs® 2300 cable telephony distribution system, theTellabs® 6300 managed transport system and the Tellabs® 8100 managed access system (managed accessproducts); and the Tellabs® 8600 managed edge system and the Tellabs® 8800 multiservice router series (broadbanddata products).  Demand for Broadbandproducts, which are sold globally, is driven primarily by consumer demand forvoice, data and video services (referred to as the “triple play”) and forbusiness services for voice and high-speed data.

The Transport productssegment includes products that enable service providers to managebandwidth.  Product offerings include theTellabs® 3000 voice-quality enhancement products, theTellabs® 5000 series of digital cross-connect systems,the Tellabs® 5500NGX transport switch, the Tellabs® 6500 transport switch and the Tellabs® 7100 optical transport system.  Demand for these products is driven primarilyby end-user demand for wireline and wireless services.  Revenue from these products comes primarilyfrom North America.

The Services segmentdelivers installation, support services and professional consulting tocustomers of the Broadband and Transport products segments.

**RESULTS OF OPERATIONS**

For thesecond quarter of 2006, our revenue grew 18.8% to $549.3 million comparedwith the second quarter of 2005 and year-to-date revenue for 2006 increased by18.5% to $1,064.0 million with all three segments contributing to theincrease. On a geographic basis, North American revenue was 77.4% in thequarter, up 3.5 percentage points from a year ago, making international revenue22.6%. The six month geographic basis saw a similar shift with North Americanrevenue at 78.7%, up 4.5 percentage points from a year ago, makinginternational revenue 21.3%. Margins increased to 46.3% in the second quartercompared with 44.8% in the second quarter of 2005. On a six-month basis,margins were up 3.4 percentage points to 46.7%. Overall operating expensesincreased by $13.2 million over the second quarter of 2005 and $4.7 millionover the first six months of 2005. Net earnings for the quarter were $53.5 millionor $0.12 per share (basic and diluted) compared with $41.1 million or$0.09 per share (basic and diluted) in the same period of 2005. Net earningsfor the six-month period were $105.9 million or $0.24 per basic and $0.23per diluted share, compared with $41.8 million or $0.09 per share (basicand diluted) in the first six months of 2005.

Weadopted SFAS 123(R) at the beginning of the first quarter of 2006 using themodified prospective method, therefore we did not restate prior periods. Ournet earnings in the second quarter of 2006 were $7.4 million lower or $0.02 perbasic and $0.01 per diluted share due to the adoption of this statement and$14.5 million lower or $0.03 per share (basic and diluted) in the firstsix months of 2006. As of June 30, 2006, we had $41.9 million ofunrecognized compensation cost related to stock-based compensation awards thatwe expect to recognize over a weighted-average period of one year. See afurther discussion of our stock-based compensation awards in Note 3 to ourconsolidated financial statements.

***Revenue(in millions)***
| ** **              | ** ** | **Second Quarter** | ** ** | **Six Months** | ** **   |
|-------------------------|------------|-------------------------|------------|---------------------|--------------|
| ** **              | ** ** | **2006**                | ** ** | **2005**            | *** *** | ***Change*** | ** ** | **2006** | ** ** | **2005** | *** *** | ***Change*** | *** *** |
| **Broadband  products** | ** ** | **$**                   | **298.4**  | ** **          | **$**        | **247.6** | *** *** | ***20.5*** | ***%*** | **$** | **558.1** | ** ** | **$** | **475.9** | *** *** | ***17.3*** | ***%*** |
| **Transport  products** | ** ** | **202.2**               | ** ** | **169.7**           | *** *** | ***19.2*** | ***%*** | **416.6** | ** ** | **342.7** | *** *** | ***21.6*** | ***%*** |
| **Services**            | ** ** | **48.7**                | ** ** | **45.2**            | *** *** | ***7.7*** | ***%*** | **89.3** | ** ** | **79.5** | *** *** | ***12.3*** | ***%*** |
| **Total revenue**       | ** ** | **$**                   | **549.3**  | ** **          | **$**        | **462.5** | *** *** | ***18.8*** | ***%*** | **$** | **1,064.0** | ** ** | **$** | **898.1** | *** *** | ***18.5*** | ***%*** |

Revenue from Broadband products increased $50.8million to $298.4 million in the second quarter of 2006 from $247.6 million inthe second quarter of 2005.  Within theBroadband segment, revenue from fiber-access platforms increased dueprincipally to higher volumes of Tellabs® 1600 optical networking terminal (Tellabs® 1600 ONT).  Revenue from broadband data products improveddue to a larger customer base, which reflects the continuing successful rolloutof these products.  Partially offsettingthis increase in the Broadband segment was a decrease in revenue from managedaccess systems.

14

----

 

Revenue from Transportproducts increased $32.5 million to $202.2 million in the second quarter of2006, up from $169.7 million in the comparable quarter of 2005.  The increase in Transport products revenuereflects the strong demand for increased bandwidth from wireless carriers asthey continue to build out their network infrastructure to meet changing userneeds.

Revenue from Servicesincreased $3.5 million to $48.7 million in the second quarter of 2006, up from$45.2 million in the second quarter of 2005. This increase reflects growth in support and professional servicesprimarily due to focused efforts on increasing support agreement renewals andselling professional services.

***GrossMargin***
|                  | ** ** | **Second Quarter** | ** ** | **Six Months** | ** **   |
|------------------|------------|-------------------------|------------|---------------------|--------------|
| ** **       | ** ** | **2006**                | ** ** | **2005**            | *** *** | ***% Point  Change*** | ** ** | **2006** | *** *** | **2005** | *** *** | ***% Point  Change*** | *** *** |
| **Consolidated** | ** ** | **46.3**                | **%**      | **44.8**            | **%**        | ***1.5*** | ***%*** | **46.7** | **%** | **43.3** | **%** | ***3.4*** | ***%*** |
| **Products**     | ** ** | **47.2**                | **%**      | **46.0**            | **%**        | ***1.2*** | ***%*** | **48.0** | **%** | **44.8** | **%** | ***3.2*** | ***%*** |
| **Services**     | ** ** | **37.2**                | **%**      | **34.1**            | **%**        | ***3.1*** | ***%*** | **31.9** | **%** | **28.4** | **%** | ***3.5*** | ***%*** |

Product gross profit for the second quarter increasedby $44.3 million or 23.1% and $101.5 million or 27.7% for the first six monthsof 2006 compared with the year-ago periods of 2005 due to higher productrevenue.  In addition, product marginsincreased in both periods due to lower product costs and a revenue mix thatfavored higher margin products.

Gross profit fromservices increased slightly in both the quarter and year-to-date periodscompared with the same periods in 2005 due to revenue growth, and a revenue mixthat favored higher margin services.

***OperatingExpenses (in millions)***

|                                      | ** ** | ** **

**Second Quarter** | ** ** | **Percent of Revenue** | ** **   |
|--------------------------------------|------------|--------------------------------|------------|----------------------------------|--------------|
| ** **                           | ** ** | **2006**                       | ** ** | **2005**                         | *** *** | ***Change*** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Research  and development**        | ** ** | **$**                          | **91.7**   | ** **                       | **$**        | **82.9** | *** *** | ***$*** | ***8.8*** | ** ** | **16.7** | **%** | **17.9** | **%** |
| **Sales  and marketing**             | ** ** | **45.0**                       | ** ** | **45.4**                         | *** *** | ***(0.4*** | ***)*** | **8.2** | **%** | **9.8** | **%** |
| **General  and administrative**      | ** ** | **28.5**                       | ** ** | **22.4**                         | *** *** | ***6.1*** | ** ** | **5.2** | **%** | **4.8** | **%** |
| ** **                           | ** ** | ** **                     | ** ** | ** **                       | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Subtotal**                         | ** ** | **165.2**                      | ** ** | **150.7**                        | *** *** | ***14.5*** | ** ** | **30.1** | **%** | **32.6** | **%** |
| ** **                           | ** ** | ** **                     | ** ** | ** **                       | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Intangible  asset amortization**   | ** ** | **7.1**                        | ** ** | **9.2**                          | *** *** | ***(2.1*** | ***)*** | *** *** | *** *** | *** *** | *** *** |
| **Restructuring  and other charges** | ** ** | **2.0**                        | ** ** | **1.2**                          | *** *** | ***0.8*** | *** *** | *** *** | *** *** | *** *** | *** *** |
| **Total Operating Expenses**         | ** ** | **$**                          | **174.3**  | ** **                       | **$**        | **161.1** | *** *** | ***$*** | ***13.2*** | *** *** | *** *** | *** *** | *** *** | *** *** |

 

|                                      | ** ** | ** **

**Six Months** | ** ** | **Percent of Revenue** | ** **   |
|--------------------------------------|------------|----------------------------|------------|----------------------------------|--------------|
| ** **                           | ** ** | **2006**                   | ** ** | **2005**                         | *** *** | ***Change*** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Research  and development**        | ** ** | **$**                      | **184.6**  | ** **                       | **$**        | **171.7** | *** *** | ***$*** | ***12.9*** | ** ** | **17.3** | **%** | **19.1** | **%** |
| **Sales  and marketing**             | ** ** | **90.0**                   | ** ** | **91.6**                         | *** *** | ***(1.6*** | ***)*** | **8.5** | **%** | **10.2** | **%** |
| **General  and administrative**      | ** ** | **56.6**                   | ** ** | **44.7**                         | *** *** | ***11.9*** | ** ** | **5.3** | **%** | **5.0** | **%** |
| ** **                           | ** ** | ** **                 | ** ** | ** **                       | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Subtotal**                         | ** ** | **331.2**                  | ** ** | **308.0**                        | *** *** | ***23.2*** | ** ** | **31.1** | **%** | **34.3** | **%** |
| ** **                           | ** ** | ** **                 | ** ** | ** **                       | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Intangible  asset amortization**   | ** ** | **14.1**                   | ** ** | **20.2**                         | *** *** | ***(6.1*** | ***)*** | ** ** | ** ** | ** ** | ** ** |
| **Restructuring  and other charges** | ** ** | **2.0**                    | ** ** | **14.4**                         | *** *** | ***(12.4*** | ***)*** | ** ** | ** ** | ** ** | ** ** |
| **Total Operating Expenses**         | ** ** | **$**                      | **347.3**  | ** **                       | **$**        | **342.6** | *** *** | ***$*** | ***4.7*** | ** ** | ** ** | ** ** | ** ** | ** ** |

Total operating expenses include $9.9 million of stockoption expense in the second quarter of 2006 and $19.2 million in the first sixmonths of 2006.  There was no stockoption expense in the comparable periods in 2005.  The restructuring expenses of $2.0 million inthe second quarter of 2006 were due to a reduction in workforce to better alignour resources with our current financial model. See a further discussion of our restructuring activity in Note 2 to ourconsolidated financial statements.

15

----

 

***OtherIncome (in millions)***
| ** **                       | ** ** | **Second Quarter** | ** ** | **Six Months** | ** **   |
|----------------------------------|------------|-------------------------|------------|---------------------|--------------|
| ** **                       | ** ** | **2006**                | ** ** | **2005**            | *** *** | ***Change*** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
| **Interest  income, net**        | ** ** | **$**                   | **11.4**   | ** **          | **$**        | **6.4** | *** *** | ***$*** | ***5.0*** | ** ** | **$** | **21.9** | ** ** | **$** | **12.1** | ** ** | **$** | **9.8** | ** ** |
| **Other  income (expense), net** | ** ** | **(7.4**                | **)**      | **(1.7**            | **)**        | ***(5.7*** | ***)*** | **(6.0** | **)** | **(4.4** | **)** | **(1.6** | **)** |
| **Total**                        | ** ** | **$**                   | **4.0**    | ** **          | **$**        | **4.7** | *** *** | ***$*** | ***(0.7*** | ***)*** | **$** | **15.9** | ** ** | **$** | **7.7** | ** ** | **$** | **8.2** | ** ** |

Interest income, net increased by $5.0 million in thesecond quarter of 2006 compared with the second quarter of 2005 due to largerinvested balances and higher interest rates. Other income (expense), net, in the second quarter of 2006 includes a$3.3 million loss for foreign exchange, compared with a $0.7 million gain inthe second quarter of 2005. Other-than-temporary impairments related to long-term investmentsaccounted for a $4.6 million loss in the second quarter of 2006 and a $3.8million loss in the comparable period in 2005.

***Income Taxes***

We recorded income taxexpense of $30.4 million for the second quarter of 2006 compared with $9.7million in the second quarter of 2005 and $59.2 million for the first sixmonths of 2006 compared with $12.4 million for the first six months of2005.  Our tax expense increased due tohigher income earned from both domestic and foreign operations and the impactof a $3.7 million valuation allowance established against the tax benefit of acapital loss recognized during the quarter. Additionally, during 2005 our tax expense was favorably impacted by therelease of valuation allowances maintained against deferred tax assets resultingfrom the utilization of domestic net operating loss carry forwards.

***Segments***

**Revenue (in millions)**
|                        | ** ** | **Second Quarter** | ** ** | **Six Months** | ** **   |
|------------------------|------------|-------------------------|------------|---------------------|--------------|
| ** **             | ** ** | **2006**                | ** ** | **2005**            | *** *** | ***Change*** | ** ** | **2006** | ** ** | **2005** | ** ** | ***Change*** | ** ** |
| **Broadband products** | ** ** | **$**                   | **298.4**  | ** **          | **$**        | **247.6** | *** *** | ***20.5*** | ***%*** | **$** | **558.1** | ** ** | **$** | **475.9** | *** *** | ***17.3*** | ***%*** |
| **Transport products** | ** ** | **202.2**               | ** ** | **169.7**           | *** *** | ***19.2*** | ***%*** | **416.6** | ** ** | **342.7** | *** *** | ***21.6*** | ***%*** |
| **Services**           | ** ** | **48.7**                | ** ** | **45.2**            | *** *** | ***7.7*** | ***%*** | **89.3** | ** ** | **79.5** | *** *** | ***12.3*** | ***%*** |
| **Total revenue**      | ** ** | **$**                   | **549.3**  | ** **          | **$**        | **462.5** | *** *** | ***18.8*** | ***%*** | **$** | **1,064.0** | ** ** | **$** | **898.1** | *** *** | ***18.5*** | ***%*** |

**Segment Profit* (in millions)**
|                          | ** ** | **Second Quarter** | ** ** | **Six Months** | ** **   |
|--------------------------|------------|-------------------------|------------|---------------------|--------------|
| ** **               | ** ** | **2006**                | ** ** | **2005**            | *** *** | ***Change*** | ** ** | **2006** | ** ** | **2005** | ** ** | ***Change*** | ** ** |
| **Broadband products**   | ** ** | **$**                   | **38.1**   | ** **          | **$**        | **37.4** | *** *** | ***1.9*** | ***%*** | **$** | **59.5** | ** ** | **$** | **45.9** | *** *** | ***29.6*** | ***%*** |
| **Transport products**   | ** ** | **112.1**               | ** ** | **74.1**            | *** *** | ***51.3*** | ***%*** | **234.9** | ** ** | **154.2** | *** *** | ***52.3*** | ***%*** |
| **Services**             | ** ** | **19.3**                | ** ** | **15.4**            | *** *** | ***25.3*** | ***%*** | **30.6** | ** ** | **22.6** | *** *** | ***35.4*** | ***%*** |
| **Total segment profit** | ** ** | **$**                   | **169.5**  | ** **          | **$**        | **126.9** | *** *** | ***33.6*** | ***%*** | **$** | **325.0** | ** ** | **$** | **222.7** | *** *** | ***45.9*** | ***%*** |

----

*We define segment profitas gross profit less research and development expense.  Segment profit excludes the impact of stockoption expense, amortization of purchased deferred stock compensation andintangibles, sales and marketing expenses, general and administrative expenses,and restructuring and other charges.

**Broadband Products**

***Revenue***

 

Revenue from theBroadband segment increased $50.8 million to $298.4 million in the secondquarter of 2006, up from $247.6 million in the second quarter of 2005.  Continuing customer rollout of fiber-accessprograms helped increase revenue from access products to a record $189.8million in the second quarter of 2006 from $143.4 million in the second quarterof 2005.  Excluding $4.1 million of pass-throughrevenue associated with video builds, in the second quarter of 2006 revenuefrom fiber platforms was approximately 58% of access product revenue, with thebalance consisting of copper-access platforms. Revenue from managed access products declined to $86.3 million in thesecond quarter of 2006 from $95.6 million in the second quarter of 2005 due toreduced shipments of the Tellabs® 8100 managed access system.  Revenue from broadband data products grew to$22.3 million in the second quarter of 2006 from $8.6 million in the secondquarter of 2005 on the strength of a larger customer base.

***SegmentProfit***

 

For the second quarter of2006, our Broadband segment profit increased to $38.1 million from $37.4million in the second quarter of 2005 as lower cost to build our Tellabs® 1600 ONT broadband accessproduct was offset by a less favorable product mix and higher research anddevelopment expenses.

16

----

 

**Transport Products**

***Revenue***

 

Revenue from Transportproducts increased $32.5 million to $202.2 million in 2006 from $169.7 millionin 2005.  Revenue from Tellabs® 5500 wideband cross-connect products improved,driven by demand from wireless customers as they continued to build out theirnetworks.  Approximately 30% of secondquarter revenue from Tellabs® 5500 wideband cross-connect products came fromnew systems, system expansions and upgrades, which we believe indicates thatour customers continue to invest in this platform.  The remaining 70% consisted of port-card equipmentgrowth on the installed base compared with approximately 66% in the secondquarter of 2005.  We shippedapproximately 2.7 million T-1 equivalents during the second quarter of 2006compared with 1.9 million T-1 equivalents in the second quarter of 2005.

***SegmentProfit***

 

Forthe second quarter of 2006, our Transport segment profit increased by 51.3% to$112.1 million, up from $74.1 million in the comparable period of 2005.  The increase is primarily due to higherrevenue from Tellabs® 5500 systems.

**Services**

***Revenue***

 

Revenue from Services increased$3.5 million to $48.7 million in the second quarter of 2006, up from $45.2million in the second quarter of 2005. The improvement reflects an increase in revenue from support agreementsand professional services.

***SegmentProfit***

 

Services segment profitincreased by $3.9 million to $19.3 million in the second quarter of 2006, upfrom $15.4 million in the second quarter of 2005.  The increase in segmentprofit was driven largely by the increase in support agreements andprofessional services revenue.

**FinancialCondition, Liquidity & Capital Resources**

Our principal source ofliquidity remained our cash, cash equivalents and marketable securities of$1,217.5 million, which increased by $72.9 million during the quarter and $27.8million since year-end.  The increase inthe second quarter was driven by cash from operating activities of $106.8million, while the year-to-date increase reflects an increase of cash fromoperating activities of $116.9 million. During the second quarter of 2006, we repurchased $37.3 million or 2.5million shares of our common stock and on a year-to-date basis, we repurchased$155.8 million or 10.8 million shares.

We believe that thecurrent level of working capital, particularly cash and marketable securities,is sufficient to meet our normal operating requirements for the foreseeablefuture.  Further, we believe thatsufficient resources exist to support our future growth and strategicneeds.  Future sources of working capitalmay be from cash-on-hand, cash generated from future operations, short-term orlong-term financing, equity offerings or any combination of these sources.

On July31, 2006, we announced that our Board of Directors authorized a new sharerepurchase program permitting us to repurchase up to $300 million of ouroutstanding common stock.

Our current policy is toretain our earnings to provide funds to enhance stockholder value by expandingour business, repurchasing our common stock and for operating activities.  We do not anticipate paying a cash dividendin the foreseeable future.

***Off-BalanceSheet Arrangements***

None.

***CriticalAccounting Policies***

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

***Outlook***

For thethird quarter we expect revenue to be up between 10% to 15% above third quarter2005 revenue, which would place third quarter 2006 revenue in a range between$510 million and $535 million.  Weanticipate the third quarter margin, excluding equity based compensationexpense, to be in the range between 46% and 47% depending on product andservices mix.  For the third quarter of2006, we are targeting operating expenses to be flat to slightly down,excluding equity based compensation expense, amortization of purchasedintangibles and restructuring and other charges.  For the balance of 2006, we expect our annualtax rate to be approximately 35%.

**Forward-Looking Statements**

This Management’sDiscussion and Analysis and other sections of this Form 10-Q containforward-looking statements made pursuant to the safe harbor provisions ofSection 27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities 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

17

----

 

regarding future events,plans, goals, objectives and expectations. The words “anticipate,” “believe,” “estimate,”“target,” “expect,” “predict,” “plan,” “possible,” “intend,” “likely,” “will,” “should,”“could,” “may,” “would,” and similar expressions are intended to identifyforward-looking statements. Forward-looking statements are not guarantees offuture performance and involve risks, uncertainties and other factors that maycause our actual performance or achievements to be materially different fromany future results, performance or achievements expressed or implied by thosestatements. Important factors that could cause our actual results to differmaterially from those in forward-looking statements include, but are notlimited to: economic changes impacting the telecommunications industry;financial condition of telecommunications service providers and equipmentvendors, including any impact of bankruptcies; the impact of customer andvendor consolidation; new product acceptance; product demand and industrycapacity; competitive products and pricing; competitive pressures from newentrants to the telecommunications industry; manufacturing efficiencies;research and new product development; protection of and access to intellectualproperty, patents and technology; ability to attract and retain highlyqualified personnel; availability of components and critical manufacturingequipment and capacity; foreign economic conditions, including currency ratefluctuations; the regulatory and trade environment; the impact of new orrevised accounting rules or interpretations, including revenue recognitionrequirements; availability and terms of future acquisitions; divestitures andinvestments; uncertainties relating to synergies, charges, and expensesassociated with business combinations and other transactions; and other risksand future factors that may be detailed from time to time in the Company’sfilings with the SEC. For a further description of such risks and futurefactors, see Item 1A of our Form 10-K for the fiscal year endedDecember 30, 2005, filed with the SEC on March 14, 2006. Our actual futureresults could differ materially from those predicted in such forward-lookingstatements. In light of the foregoing risks, uncertainties and other factors,investors should not place undue reliance on forward-looking statements indetermining whether to buy, sell or hold any of our securities. These factors arenot intended to be an all-encompassing list of risks and uncertainties that mayaffect the operations, performance, development and results of our business. Weundertake no obligation to publicly update or revise any forward-lookingstatements to reflect changed assumptions, the occurrence of anticipated orunanticipated events or changes to future results over time.

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

As of June 30, 2006,there were no material changes to our market risks disclosure in our AnnualReport on Form 10-K for the year ended December 30, 2005.

**Item 4.Controls and Procedures**

Our management,under the supervision and with the participation of our Chief Executive Officerand Chief Financial Officer, has evaluated the effectiveness of our disclosurecontrols and procedures as of June 30, 2006. 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 tomaterially affect, our internal control over financial reporting.

**PART II.OTHER INFORMATION**

**Item 1.  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 for thefourth quarter 2000 in our financial statements.  Further, certain of theindividual defendants were alleged to have violated the federal securities lawsby trading our securities while allegedly in possession of material, non-publicinformation about us pertaining to these matters.

On January 17, 2003,Tellabs and the other named defendants filed a motion to dismiss theconsolidated amended class action complaint in its entirety.  On May 19,2003, the Court granted our motion and dismissed all counts of the consolidatedamended complaint, while affording plaintiffs an opportunity to replead. On July 11, 2003, plaintiffs filed a second consolidated amended class actioncomplaint against Tellabs, Messrs. Birck and Notebaert, and many (although notall) of the other previously named individual defendants, realleging claimssimilar to those contained in the previously dismissed consolidated amendedclass action complaint.  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, appealingthe dismissal.  The appeal was fully briefed and oral argument was heardon January 21, 2005.  On January 25, 2006, the Seventh Circuit issued anopinion affirming in part and reversing in part the judgment of the districtcourt, and remanding for further proceedings.  On February 8, 2006,defendants filed with the Seventh Circuit a petition for

18

----

 

rehearing with suggestionfor rehearing en banc.  On April 19,2006, the Seventh Circuit ordered plaintiffs to file an answer to the petitionfor rehearing, which was filed by the plaintiffs on May 3, 2006.  On July 10, 2006, the Seventh Circuit deniedthe petition for rehearing with a minor modification to its opinion.

On April 5, 2006, a classaction complaint was filed in the United State District Court of the NorthernDistrict of Illinois against Tellabs, Michael Birck, Richard Notebaert (formerCEO, President and Director of Tellabs) and current or former Tellabs employeeswho, during the alleged class period of December 11, 2000 to July 1, 2003,participated on the Tellabs Plan Committee of the Tellabs, Inc. Profit Sharingand Savings Plan (“Plan”).  Thereafter,two similar complaints were filed in the United States District Court of theNorthern District of Illinois.

The complaints allegethat during the alleged class period, the defendants allegedly breached theirfiduciary duties under the Employee Retirement Income Security Act by, amongother things, continuing to offer Tellabs common stock as a Plan investmentoption when it was imprudent to do so and allegedly misrepresenting and failingto disclose material information necessary for Plan participants to makeinformed decisions concerning the Plan. Further, certain of the defendants allegedly failed to monitor thefiduciary activities of the fiduciaries they appointed and certain of thedefendants allegedly breached their duty of loyalty by trading Tellabs stock,while taking no protective action on behalf of Plan participants.  The complaints seek restitution, damages andother relief. The defendants are preparing a response to the complaints.

In addition to mattersdescribed above, we are subject to various legal proceedings, claims andlitigation arising in the ordinary course of business. While the outcome ofthese matters is currently not determinable, we do not expect that the ultimatecosts to resolve these matters will have a material effect on our results ofoperations, financial position or cash flows.

**Item 1A. Risk Factors**

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 30, 2005. Those risk factors described in that Annual Report could materiallyadversely affect our business, financial condition or future results.  The risks described in that Annual Report arenot the only risks facing our company. Additional risks and uncertainties not currently known to us or that wecurrently consider immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

***Repurchasesof 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 Plans(In Millions)** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| ** **              | ** ** | ** **                                          | ** ** | ** **                                         | ** ** | ** **                                                                               | ** ** | ** **                                                                                      | ** ** |
| 1/1/06 through 2/3/06   |       | 781,974                                             |       | $                                                  | 12.65      |                                                                                     | 781,974    |                                                                                            | $          | 197.5 |   |
| 2/4/06 through 3/3/06   |       | 6,713,710                                           |       | 14.45                                              |       | 6,713,710                                                                                |       | 100.5                                                                                           |       |
| 3/4/06 through 3/31/06  |       | 811,600                                             |       | 14.22                                              |       | 811,600                                                                                  |       | 89.0                                                                                            |       |
| 4/1/06 through 5/5/06   |       | 910,840                                             |       | 15.99                                              |       | 910,840                                                                                  |       | N/A                                                                                             |       |
| 5/6/06 through 6/2/06   |       | 1,404,576                                           |       | 14.45                                              |       | 1,404,576                                                                                |       | N/A                                                                                             |       |
| 6/3/06 through 6/30/06  |       | 170,156                                             |       | 14.65                                              |       | 170,156                                                                                  |       | N/A                                                                                             |       |
| Total                   |       | 10,792,856                                          |       | 14.43                                              |       | 10,792,856                                                                               |       |                                                                                            |       |
|                         |            |                                                     |            |                                                    |            |                                                                                          |            |                                                                                                 |            |  |  |

In January 2006, our Board of Directors authorized thepurchase of up to $100.0 million in shares of our outstanding common stock incompliance with Rule 10b5-1 of the Securities Exchange Act of 1934.  We intend to use cash generated by employeestock option exercises (other than those of company officers and board members)to purchase stock under this plan.  Wewill record these repurchased shares as treasury stock.  On April 27, 2006, Tellabs’ Board ofDirectors authorized the removal of the $100 million cap from this sharerepurchase program.  As of June 30, 2006,we have purchased $49.7 million (3.3 million shares) of our common stock underthis plan, including $20.1 million (1.3 million shares) in the second quarterof 2006.

InFebruary 2005, our Board of Directors authorized the purchase of up to $300.0million in shares of our outstanding common stock.  We may purchase shares of our common stockfrom time to time on the open market or in private transactions and recordpurchases as treasury stock.  As of June30, 2006, we have purchased $298.7 million (31.8 million shares) of our commonstock under this plan, including $17.2 million (1.2 million shares) in thesecond quarter of 2006.

On July31, 2006 we announced that our Board of Directors authorized a new sharerepurchase program permitting us to repurchase up to $300 million of ouroutstanding common stock.  We will recordthe total cost to repurchase shares as treasury stock

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

We heldour annual meeting of stockholders on April 27, 2006.  The results of that meeting and relateddisclosures can be found in Part II, “Item 4. Submission of Matters to a Vote of Security Holders” in our Form 10-Qfor the quarter ended March 31, 2006.

19

----

 

**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 |

 

20

----

 

**SIGNATURE**

Pursuantto the 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) |
| ** ** | ** **                                                   |
|       | August 8, 2006                                               |
|       | (Date)                                                       |

** **

21

----