Introduction and Overview of Business

Tellabs designs, develops and supports telecommunications networking products. We generate revenue principally through the sale of these products as stand-alone network elements and as elements of integrated solutions to communications service providers worldwide. We also generate revenue by providing services to our customers. We operate in three business segments:
Broadband, Transport and Services.

The Broadband segment includes access, managed access and data product portfolios that facilitate the delivery of bundled consumer services, wireline business services and wireless communications.

• Revenue from access products is driven by consumer demand for the triple-play of bundled voice, video and high-speed Internet/data services as traditional telecommunications companies and cable service operators compete to be the sole provider of these services to consumers and businesses.

• Revenue from managed access products is driven by the need to provide business-oriented voice, video and high-speed Internet/data services and wireless communications.

• Revenue from data products is driven by demand for wireless and wireline carriers to deliver next-generation business services and wireless services.

The Transport segment includes digital cross-connect systems, optical networking systems and voice-quality enhancement products. These products enable service providers to generate revenue from business services, manage bandwidth, add network capacity when and where it is needed, and improve voice quality. Revenue from the Transport segment is driven by the needs of service providers to deliver wireless services, business services and consumer services.

The Services segment includes deployment, support, training, systems integration and network design/consulting services. Revenue from deployment, support, training and systems integration services arises primarily from the sales of products and continues to represent the majority of Services revenue, while network design/consulting services is the fastest growing part of the Services portfolio.

Tellabs operates in a dynamic industry. Customer consolidation has reduced overall industry capital spending, which together with a lack of consolidation on the part of network equipment companies, has resulted in increased pricing pressure. In addition, customer spending is pressured and competition is heightened by the global economic situation.

Within this backdrop, we continue to transform the company with new products and services. The company is evolving from a business based primarily on the circuit-switched Time Division Multiplexing (TDM) technology used in our digital cross-connect and managed access products to a business based on the packet-switching and Internet Protocol (IP) technology used in our optical networking, access and multiservice data products. These new products are taking root as service providers transform their networks with next-generation capabilities. Some of these products carry gross profit margins lower and some carry gross profit margins higher than the historical average. While we have significantly improved the profitability of these products over time, the mix of products in any given quarter can affect overall profitability.

Management continues to define and implement initiatives to improve our overall performance. On February 5, 2009, management initiated a restructuring plan as we continue to align our costs with customer spending and current market conditions.

RESULTS OF OPERATIONS

For the first quarter of 2009, revenue was $361.7 million, compared with $464.1 million in the first quarter of 2008, as revenue declined in all three segments.

Consolidated gross margin in the first quarter was 44.2%, up 5.9 percentage points from 38.3% in the first quarter of 2008. The increase in consolidated gross product margin was driven by the higher level of data revenue, which grew 45.2% year-over-year, margin improvements associated with our access and optical networking products, and improved services gross margin.

Operating expenses in the first quarter of 2009, including $6.0 million in intangible amortization and $6.7 million in restructuring and other charges, were $151.0 million, down $13.5 million from $164.5 million in the first quarter of 2008.

Net earnings for the first quarter of 2009, driven by the lower level of revenue, were $6.5 million or $0.02 per share (basic and diluted), compared with $16.6 million or $0.04 per share (basic and diluted) for the same period of 2008.

Revenue (in millions)



                                            First Quarter
                                         2009      2008   Change
                      Products        $ 308.0   $ 408.0    (24.5 )%
                      Services           53.7      56.1     (4.3 )%

                      Total revenue   $ 361.7   $ 464.1    (22.1 )%

Revenue declined in the Products and Services segments. In the Broadband product segment, increased revenue from data products was offset by lower access and managed access revenue. In the Transport product segment, the revenue decline was driven primarily by lower revenue from digital cross-connect and optical networking systems. In the Services segment, the revenue decline was primarily driven by a lower level of deployment revenue.

On a geographic basis, revenue in North America (United States and Canada) was $247.0 million in the first quarter of 2009, down 29.3% from the year-ago quarter. Revenue outside North America was $114.7 million in the first quarter of 2009, compared with $114.6 million in the year-ago quarter.

Gross Margin



                                             First Quarter
                                                         % Point
                                       2009     2008      Change
                        Products       45.9 %   40.5 %       5.4
                        Services       34.1 %   22.6 %      11.5
                        Consolidated   44.2 %   38.3 %       5.9

The increase in product gross margin between the first quarter of 2008 and the first quarter of 2009 was driven primarily by the higher level of data revenue and improved margins on access and optical networking products. The increase in services gross margin during the same period primarily reflects improved gross margins for deployment services.

Operating Expenses (in millions)



                                           First Quarter              Percent of Revenue
                                       2009      2008    Change         2009           2008
  Research and development          $  69.5   $  80.7   $ (11.2 )       19.2 %         17.4 %
  Sales and marketing                  42.4      43.4      (1.0 )       11.7 %          9.4 %
  General and administrative           26.4      26.1       0.3          7.3 %          5.6 %

  Subtotal                            138.3     150.2     (11.9 )       38.2 %         32.4 %

  Intangible asset amortization         6.0       5.6       0.4
  Restructuring and other charges       6.7       8.7      (2.0 )

  Total operating expenses          $ 151.0   $ 164.5   $ (13.5 )

The decline in operating expenses was driven primarily by lower research and development expenses. Restructuring and other charges of $6.7 million in the first quarter 2009 primarily reflect severance, facility- and asset-related charges.

Other Income (in millions)



                                                     First Quarter
                                                2009       2008    Change
                Interest income, net          $  5.2     $  9.9   $  (4.7 )
                Other (expense) income, net     (0.5 )      0.6      (1.1 )

                Total other income            $  4.7     $ 10.5   $  (5.8 )

Interest income, net, was lower in the first quarter of 2009 versus the comparable period in 2008. Market interest rates declined during 2008 and remained low in the first quarter of 2009. In the first quarter of 2009, 90% of our portfolio was allocated to governments and government agencies, as compared with 68% in the first quarter of 2008.

Income Taxes

For the first quarter of 2009, we recorded tax expense of $7.0 million at an effective tax rate of 51.9%, compared with a tax expense of $7.3 million at an effective tax rate of 30.5% for the first quarter of 2008. The increase in our rate reflects the absence of a tax benefit on domestic losses (due to the valuation allowance established against our domestic deferred tax assets) and normal tax rates on our international earnings.

Segments

Segment Revenue (in millions)



                                            First Quarter
                                         2009      2008   Change
                      Broadband       $ 178.3   $ 202.1    (11.8 )%
                      Transport         129.7     205.9    (37.0 )%
                      Services           53.7      56.1     (4.3 )%

                      Total revenue   $ 361.7   $ 464.1    (22.1 )%



Segment Profit* (in millions)



                                                First Quarter
                                            2009      2008   Change
                   Broadband              $ 34.3   $   8.7    294.3 %
                   Transport                39.8      79.2    (49.7 )%
                   Services                 19.0      13.7     38.7 %

                   Total segment profit   $ 93.1   $ 101.6     (8.4 )%

* We define segment profit as gross profit less research and development expenses. Segment profit excludes sales and marketing expenses, general and administrative expenses, the amortization of intangibles, restructuring and other charges, and the impact of equity-based compensation (which contains restricted stock and PSUs granted after June 30, 2006, and stock options).

Broadband

Revenue: Broadband revenue between the first quarter of 2008 and the first quarter of 2009 was driven by increased data revenue that was offset by lower access and managed access revenue. Data product revenue was $63.0 million in the first quarter of 2009, up 45.2% from $43.4 million in the first quarter of 2008. Revenue benefited primarily from the continuing rollout of our next-generation wireless backhaul solution in multiple geographic regions. Access revenue decreased to $64.1 million in the first quarter of 2009 from $99.9 million in the first quarter of 2008. Access revenue will likely continue to decline as several key customers are transitioning to alternative network architectures. Managed access revenue was $51.2 million in the first quarter of 2009 compared with $58.8 million in the same quarter of 2008. Managed access revenue declined due to lower revenue from the Tellabs® 6300 SDH transport revenue, as we completed the initial stages of a large build-out in the EMEA region, and lower overall revenue from the Tellabs® 8100 managed access system.

Segment Profit: Broadband segment profit grew $25.6 million, driven by higher revenue from data products, margin improvements associated with access products, and reduced research and development expenses.

Transport

Revenue: The decline in Transport revenue between the first quarter of 2008 and the first quarter of 2009 was driven primarily by lower revenue from digital cross-connect and optical networking systems. The decline in digital cross-connect system revenue reflects lower spending from North American customers; the decline in optical networking revenue reflects the completion of the initial stages of a large build-out in North America during 2008.

During the first quarter of 2009, Tellabs 5500 digital cross-connect product revenue from new systems, system expansions and system upgrades were approximately 19% of the total, compared with 44% in the first quarter of 2008. The remaining balances consisted of port-card growth on the installed base.

Segment Profit: The decline in Transport segment profit was primarily driven by the lower level of digital cross-connect system revenue.

Services

Revenue: The decline in Services segment revenue from the first quarter of 2008 to the first quarter of 2009 was primarily driven by lower revenue from deployment services, which was associated with the lower level of product revenue.

Segment Profit: The increase in Services segment profit primarily reflects improved gross margins for deployment services.

Financial Condition, Liquidity and Capital Resources

Our principal source of liquidity remained our cash, cash equivalents and marketable securities of $1,184.3 million as of April 3, 2009, which increased by $32.2 million since year-end 2008. The increase in cash, cash equivalents and marketable securities for the quarter reflects $44.1 million in cash generated from operating activities, partially offset by cash used for capital expenditures.

Substantially all of our investments are backed by governments or government agencies and are highly liquid instruments. We may rebalance our portfolio from time to time, which may affect the duration, credit structure and future income of our investments.

During the first quarter of 2009, we repurchased approximately 4,000 shares of our common stock at a cost of $17,000 under previously announced share repurchase programs. We provide no assurance that we will continue our repurchase activity and we may change our repurchase activity in the future. We cannot estimate the timing of any such change or the impact on our cash, cash equivalents and marketable securities.

Based on historical performance and current forecasts, we believe the company's cash, cash equivalents and marketable securities will satisfy working capital needs, capital expenditures and other liquidity requirements related to existing operations for the next 12 months. Future available sources of working capital, including cash, cash equivalents, and marketable securities, cash generated from future operations, short-term or long-term financing, equity offerings or any combination of these sources, should allow us to meet our long-term liquidity needs. Our current policy is to use our liquidity, financial strength and stability to fund business operations, to expand business, potentially through acquisitions, or to repurchase our common stock.

Off-Balance Sheet Arrangements

None.

Critical Accounting Policies

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

Outlook for Second Quarter

We expect second quarter 2009 revenue to be flat to up by a high single-digit percentage compared with the first quarter of 2009. We expect gross margin for the second quarter to be flat, plus or minus a point or two, from the first quarter of 2009, as a result of product mix. We expect our second quarter 2009 operating expenses, excluding restructuring charges, to continue on a downward trajectory from the first quarter of 2009.

Forward-Looking Statements

This Management's Discussion and Analysis and other sections of this Form 10-Q, including the statements under the caption "Outlook for Second Quarter", contain forward-looking statements made pursuant to the safe harbor provisions of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements reflect management's expectations, estimates and assumptions, based on current and available information at the time the document was prepared. These forward-looking statements include, but are not limited to, statements regarding future events, plans, goals, objectives and expectations. The words "anticipate," "believe," "estimate," "target," "expect," "predict," "plan," "possible," "project," "intend," "likely," "will," "should," "could," "may," "foreseeable," "would" and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and other factors that may cause our actual performance or achievements to be materially different from any future results, performance or achievements expressed or implied by those statements. Important factors that could cause our actual results to differ materially from those in forward-looking statements include, but are not limited to: overall negative economic conditions generally and disruptions in credit and capital markets, including specific impacts of these conditions on the telecommunications industry; financial condition of telecommunications service providers, equipment vendors and contract manufacturers, including any impact of bankruptcies; the impact of customer and vendor consolidation; new product acceptance; product demand and industry capacity; competitive products and pricing; competitive pressures from new entrants to the telecommunications industry; initiatives to improve profitability that may have financial consequences, including further restructuring charges and the ability to realize anticipated savings under such cost-reduction initiatives; exiting businesses and product areas; impairment charges and other cost cutting initiatives and related charges

and costs; manufacturing efficiencies; research and new product development; protection of and access to intellectual property, patents and technology; ability to attract and retain highly qualified personnel; availability of components and critical manufacturing equipment and capacity; foreign economic conditions, including currency rate fluctuations; the regulatory and trade environment; the impact of new or revised accounting rules or interpretations, including revenue recognition requirements; availability and terms of future acquisitions; divestitures and investments; uncertainties relating to synergies; charges and expenses associated with business combinations and other transactions; and other risks and future factors that may be detailed from time to time in the Company's filings with the SEC. For a further description of such risks and future factors, see Item 1A of our most recently filed Form 10-K. Our actual future results could differ materially from those predicted in such forward-looking statements. In light of the foregoing risks, uncertainties and other factors, investors are advised not to rely on these forward-looking statements when making investment decisions. These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of our business. We undertake no obligation to publicly update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events or changes to future results over time. The foregoing discussion should be read in conjunction with the risk factors, financial statements and related notes and Management's Discussion and Analysis included in our Annual Report on Form 10-K for the year ended January 2, 2009.