Q. What's happening in the telecom equipment industry?
A. Michael J. Birck, chairman of the board: The industry is feeling the aftershock of consolidation, which has reduced the number of service-provider customers and increased the purchasing power of the largest among them. For example, four of our largest customers in 2005 are now one customer with considerable leverage over vendors.
After customers consolidated, some delayed network expansion and upgrades, which was especially evident among North American mobile providers. Moreover, we have seen increasingly aggressive procurement contracting by both wireless and wireline service providers in North America, resulting in paper-thin profit margins for many vendors. Since three-quarters of Tellabs' revenue comes from North America, we were particularly hard hit during 2007.
Responding to service-provider consolidation, some of Tellabs' competitors have joined forces. Our markets have thus become hypercompetitive, with a few very large and dozens of smaller vendors fighting over less business. The inevitable result is increasing pricing pressure that drains profits out of our sector. Tellabs was one of a handful of companies whose network equipment business stayed in the black last year. That meager profit notwithstanding, we are far from satisfied with our 2007 results.
Q. What happened to Tellabs' results in 2007?
A. Timothy J. Wiggins, executive vice president and chief financial officer: Revenue of $1.9 billion dropped by 6%, primarily due to lower spending by North American wireless carriers on Tellabs products. But buried in those results were encouraging trends for our future, including strong uptake of our data, access and services offerings.
- We achieved our highest sales of fiber-access equipment ever, and we rank #1 in fiber-access market share in North America.
- Data revenue grew 50% on the strength of our successful Tellabs 8600 and Tellabs 8800 systems.
- Tellabs® Global Services grew 22%, propelled by existing and new services.
- Nearly half of our 2007 revenue came from products and services we added to our portfolio since 2003, proof that our new offerings are winning customers over.
However, as our product mix shifted toward new products faster than expected, Tellabs' gross profit margins declined 10.5 percentage points. Products that are early in their life cycles often carry lower margins than more established products. We sold fewer Tellabs® 5500 digital cross-connects, an established product; we sold more Tellabs 7100 OTSs, a new product; and we sold more Tellabs 1600 ONTs at negative margins. As a result, earnings fell 65% to 15 cents per share. As we begin 2008, we are aggressively focused on improving Tellabs' performance.
Q. What does Tellabs need to do to get its performance back on track?
A. Timothy J. Wiggins, executive vice president and chief financial officer: We are implementing a plan to increase gross profit margins and reduce our annual operating expenses and overhead costs. Under this plan, together with the restructuring announced in September 2007, Tellabs expects our 2009 costs to be $100 million lower than our 2007 costs. We are working to:
- Reduce our operating expenses by $75 million a year.
- Cut overhead costs of products and services by $25 million a year.
- Increase gross profit margins on new products by reducing costs and winning more customers.
- Increase revenue from customers in Europe, Africa, Asia, Australia and Latin America, and from IOCs and NLECs in North America.
- Return excess capital to stockholders through our stock repurchase programs, including $600 million authorized in November by our Board of Directors.
Q. How are Tellabs' new products doing?
A. Daniel P. Kelly, executive vice president, global products: Our products are performing well in the marketplace and in customers' networks. Today, nearly half of our revenue comes from products we added since 2003, proof positive that we've chosen the right products and targeted the right markets. We are focused on network applications that are growing faster than service providers' overall capital spending, such as consumer broadband services, business services and mobile transport. In 2007, Tellabs invested 18% of sales in research and development.
Our engineers have proven time and again that we can move faster than large competitors to solve customers' problems quickly. For example, we developed the current version of the Tellabs 7100 system on a compressed schedule that enabled us to earn Verizon's business. As a result, revenue from the Tellabs 7100 system quadrupled last year, beating our plans.
To further expand the addressable markets for the Tellabs 7100 system, in 2008 we are:
- Adding international interfaces to meet customer needs outside of North America.
- Launching a smaller version, the Tellabs 7100 Nano system, to address customer needs in smaller networks around the world.
- Integrating Ethernet switching capabilities into the Tellabs 7100 system to converge optical and data functionality into a single platform.
We continue to improve our flagship transport product for North American providers, the Tellabs 5500 system. During 2008, our new high-density shelf will increase optical density sixfold, which reduces our customers' operating expenses.
And we're making strong headway with new data products around the world. Data revenue grew 50% in 2007. Dozens of customers have chosen the Tellabs 8600 system to migrate wireless backhaul networks to Ethernet, reducing operating expenses as much as 90% compared with existing leased lines. Thanks to its highly integrated and cost-effective architecture, the Tellabs 8600 system is delivering solid gross profit margins, early in its life.
The Tellabs 8800 multiservice router (MSR) series addresses our customers' need to continue delivering more profitable existing services, such as ATM and Frame Relay, along with new Ethernet and IP/MPLS services. More than 100 customers have chosen Tellabs' data products for networks around the world.
Q. How is Tellabs doing with customers?
A. Carl A. DeWilde, executive vice president, global sales, strategy and services: I'm encouraged. Tellabs products are competitive and our customer relationships are expanding.
We are focusing on specific network applications such as mobile transport. When mobile carriers needed a new way to haul traffic in wireless networks, our Tellabs 8600 system fit that need. During 2007, the Tellabs 8600 system won 35 of the 36 competitions that we participated in, which contributed to our 50% growth in data revenue.
Such strong new products enable Tellabs to make headway with new customers. For example, our Tellabs 8800 series has brought us new customers such as Telstra in Australia and Telecom Italia.
In fact, during 2007 Tellabs earned business from 30 of the top 35 service providers in the world. Our successful partnership with Verizon to build the FiOS fiber-access network has propelled Tellabs to a #1 market share in North American fiber access.
In 2008, we are sharpening our focus on making profitable sales. Our job is clear:
- Increase business with existing customers.
- Add channel partners to reach additional customers.
- Win more business from telecom service providers outside North America and customers such as IOCs and NLECs in the United States.
- Pass up potential deals that deny us the opportunity to realize a fair profit.
Q. How is Tellabs' supply chain contributing to profitability and customer satisfaction?
A. John M. Brots, executive vice president, global operations: Tellabs' supply chain initiatives have reduced costs by more than $100 million over the past three years, as we completed our conversion to outsourced manufacturing.
Our current supply chain initiatives focus on reducing costs by continuing to:
- Realize new efficiencies in sourcing components in low-cost geographic regions.
- Engineer products for better manufacturability.
- Reduce the costs of converting parts into finished products.
- Assure the quality of products before they ship.
- Optimize our highly efficient distribution network.
We are always working to improve customer satisfaction by meeting customer requirements more consistently. Since 2005, our key customer satisfaction measure has increased at double-digit rates. That said, with today's price pressure, our primary focus remains the job of making Tellabs' supply chain more efficient and more effective for customers.
Q. What is Tellabs doing to make business processes more efficient?
A. Jean K. Holley, executive vice president and chief information officer: To improve our visibility of revenue and gross profit margins, last year we deployed a tool that enables us to forecast revenue and gross profit margins in a more granular way. Now we can manage the business more effectively.
We are consolidating the primary engineering tools in our R&D and supply chain organizations. These tools lower our supply chain costs, simplify collaboration by employees around the world, and enable us to leverage consistent, global engineering practices as we move to low-cost geographies.
Q. What is Tellabs doing to address its corporate social responsibility?
A. James M. Sheehan, executive vice president and chief administrative officer: In keeping with our tradition, Tellabs continues to invest in the communities where we do business through programs to match employee gifts of time and money. Over the past decade, the Tellabs Foundation has given more than $10 million to nonprofit organizations focused primarily on education, health and the environment.
Last year, Tellabs established a cross-functional team to open a dialogue with investors and customers about Tellabs' broader commitment to corporate social responsibility.
In 2008, we are taking steps to adopt a Supplier Code of Conduct and report regularly on Tellabs' corporate social responsibility performance. In keeping with the company's values, we want to ensure that, throughout our supply chain, workers are treated with respect, working conditions remain safe, and our vendors use environmentally responsible manufacturing processes.
Q. Where is Tellabs going long-term? Can you survive as an independent entity?
A. Michael J. Birck, chairman of the board: We run Tellabs for the long term, so Tellabs' Board of Directors and senior executives studied these issues and their ramifications throughout the year.
Our careful review of the industry and our business prospects convinces us that Tellabs has what it takes to survive independently. We have the right customers, products, people and financial resources to go it alone.
To do that, however, we will need to augment our current products and services to better position us for growth and profitability, and we are continually examining such opportunities.
The share repurchase program now in progress is evidence that we believe in our future as an independent organization. It enables Tellabs to return capital to stockholders and signals our confidence in our future as a stand-alone company, one with considerably better share price performance than was recently exhibited.
Yet, we are mindful that challenges abound and circumstances can change, just as they did during 2007. It would be unwise to rule out possible future business combinations. If we see clear opportunity to create value for customers and stockholders through either an acquisition or a merger, we will act accordingly.
This industry is much more difficult and complex than it was a few years ago, yet we still believe it holds ample future promise, enough to justify the hard work that will surely be needed.