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Optical/IP

No Surprises From Tellabs

Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA) announced its first-quarter earnings this morning (see Tellabs Reports Earnings, Plans Layoffs), which were in line with analyst expectations but left Wall Street with a hollow feeling in the pit of the collective gut.

The reason? While Tellabs is still profitable, its revenues are down, particularly in the optical arena, and it's continuing to lay off workers while closing and consolidating plants. What's more, CEO Richard C. Notebaert isn't confident that the ongoing lapse in carrier spending will end anytime soon.

"Ongoing structural changes limit the pace of capex," Notebaert told analysts on this morning's call. "We can't control the duration of the structural changes taking place, which are deeper than we thought. It's going to be awhile."

The news seemed to bring no surprises to investors. Late today, Tellabs shares were trading at $9.65, down only $0.09, or less than 1 percent.

Notebaert and other execs on this morning's call painted a gloomy picture of a complicated market that's changing profoundly, in ways that weren't anticipated even last quarter. The company's largest customers, which include Sprint Corp. (NYSE: FON) and Verizon Communications Inc. (NYSE: VZ), aren't showing any signs of better days ahead.

Tellabs reported $371 million in revenues for the quarter, of which $180 million came from sales of optical networking gear. About 4 percent of overall sales came from the vendor's 6500 MultiService Transport Switch and its 7100 Optical Transport DWDM system.

Sadly, revenues in the optical space, the largest slice of Tellabs' revenue pie and the one considered most strategic by the company in days past (see Tellabs Pins Hopes on Optical), declined 32 percent, more than did any other of the company's revenue segments. Broadband access revenues were $115 million, flat sequentially; voice enhancement product sales were $19 million, down 20 percent sequentially; and revenues from various services were $56 million, down about 12.5 percent sequentially.

Tellabs reported net income of $5 million for the quarter and earnings per share of $1. Last quarter, pro forma EPS was $3 and net income was $14 million.

Tellabs plan is to cut expenses even further. The company intends to lay off 1,200 more workers, 18 percent of the roughly 6,600 it now employs. It plans to close a relatively new manufacturing facility in Ronkonkoma, N.Y., which included a sizeable optical testbed.

Analysts picked at Tellabs revenues for awhile on today's call. At one point, someone questioned how Tellabs continues to maintain decent margins and profitability while revenues continue to cascade. Execs cited "faster realization" of gains on restructuring, plus revenues from certain high-margin services.

One bright spot was Tellabs' acquisition of Ocular Networks, which appears to be going as planned (see Tellabs Nabs Ocular). Execs say they still expect to see $50 million to $100 million in sales this year from products acquired, including "good traction in the second quarter."

So what's the upshot? It's tough to tell. Tellabs issued no guidance, and analysts say that's no surprise. "It's extremely difficult to forecast the business Tellabs is in," says George Notter of Deutsche Banc Alex Brown LLC.

The tough nut to crack, Notter says, is that Tellabs plays primarily in the digital crossconnect market, which features a small number of competitors and reliance on RBOCs. "To get a decent forecast, you'd have to look at things like the utilization rate of the Titan 5500 crossconnect within carrier networks, or the inventory of line cards that remain uninstalled."

Can Tellabs hold out for the duration of a downturn whose end is open to question? "I think they can," Notter asserts. The high margins typical of the crossconnect business (Tellabs' latest gross margin is 47 percent), coupled with ongoing expense cuts, should do the trick.

"The real issue is whether they can drive up revenues," Notter says.



— Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com
DoTheMath 12/4/2012 | 10:35:13 PM
re: No Surprises From Tellabs "Ongoing structural changes limit the pace of capex," Notebaert told analysts on this morning's call. "We can't control the duration of the structural changes taking place, which are deeper than we thought. It's going to be awhile."

...

Meanwhile, pricing pressures in both wireline and wireless markets are making it hard to earn a good living.

--------------------------------------------------

Pricing pressures, structural change ... The industry needs drastic overhaul in order to "earn a good living". The current industry structure is incompatible with making money, unless competition is curtailed, and the pricing pressures are made to go away.

Here are my structural remedies:
a) Carrier debt write-down, change in depreciation schedules, along with changes in financing structures for capital expenditure: carriers have to write off their old equipment (old in this context means as young as 4 years), change the deprecitation schedules to reflect the pace of change in technology, and commensurately finance new equipment very differently than long term bonds.

b) Replacement of OPEX with CAPEX: drastic improvement in carrier efficiencies, so that opex can be reduced in favor of increased capex. This is the fundamental process of productivity gains at work - you replace labor (OPEX) with capital (CAPEX). This is consistent with the new 3-4 year equipment/software replacement cycles. I can even envision a 100% expensing regime for much of CAPEX, rather than complex depreciation schedules. Microsoft instantly writes off all R&D expenses, though everyone knows they expect to extract revenue from code written for a while.

This CAPEX for OPEX trade-off also means drastic reduction in carrier employee count. I envision future nationwide carriers to have only tens of thousands of highly productive and highly compensated employees, as opposed to hundreds of thousands.

There is just no way this industry can offer what customer demand at the prices customers people are willing to pay, without dramatic productivity gains in the industry.

c) Separation of content from distribution: again, and again, content and distribution going together has hurt customers and ultimately slowed down innovation. AOL is finding out now that their content (Time, CNN etc) are not easily leverageable with the AOL service.

d) Coupled with these carrier changes, equipment vendors need to become more "horizontally integrated" rather than "vertically integrated". This means that layers such as semiconductors, components, software, systems design, manufacturing and integration are separate tiers with specialist champion companies, rather than vertically integrated "systems houses" with all expertise under one roof. The vertically integrated model is incompatible with rapid evolution of technology, yet the allure of "full control" is still driving a lot of business plans. Progress has been incremental in this area (most systems houses have gotten out of manufacturing, for example). Much more needs to happen.

This is my "pie-in-the-sky" vision, but I am very convinced that absent fundamental change, we are doomed to stagnation, return of monopolies, and end customer frustration.

Those of you that think RBOCs are the answer, keep in mind that in a world of 4 RBOCs controlling communications, there will only be 3-4 equipment houses to supply them. This is the inevitable consquence of the "balance of power" principle of business - it is dumb for smart people to be in a highly dependent and easily abused position as suppliers. Smart guys will consolidate to achieve balance of power, so as to sit across the table as equals of RBOCs to negotiate. Think how the formerly highly fragmented PC industry is consolidating to put power in the hands of Dell, so that he can now extract serious concessions from Gates.
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