| TELLABS INC ITEM 1A RISK FACTORS Our operating results will fluctuate, which may cause volatility in our stock price |
| Our operating results have varied significantly from quarter to quarter, and those results may continue to fluctuate due to a variety of factors, many of which are beyond our control |
| These factors include, but are not limited to: • changing conditions in the telecommunications market and in the US and global economy; • the volume and timing of orders from and shipments to customers; • the timing of, and our ability to obtain, new customer contracts; • the ability to maintain solid and healthy customer relationships and favorable contract terms; • the timing of, and our ability to recognize revenue for, product and service sales; • the potential deferral of customer acceptance of new products compared to our existing products; • the market acceptance of new and enhanced versions of our products and services; • variations in the mix of products and services we sell, and the demand and market acceptance of those products and services; • our utilization of production capacity and employees and our ability to manufacture and ship products efficiently; • the availability and cost of key components; • the ability to obtain reliable and high quality components for our products; • the ability to maintain good relationships and favorable contract terms with our customers and suppliers; • introductions or announcements of new products by competitors; • changes in accounting rules, such as expensing employee stock option grants; • our ability to integrate and operate acquired businesses and technologies; • seasonality, which has often caused revenues to differ from quarter to quarter; and • the ability to satisfy and comply with applicable laws, rules and regulations in the various locations in which we operate our business and sell our products and services, including international locations |
| Our recent operating results may not be a good predictor of our results in future periods |
| Our expense levels are based in part on expectations of future revenues |
| If revenue levels in a particular period are lower than expected, our operating results will be adversely affected |
| The failure to meet the expectations of the investment community may cause our stock price to decline, possibly substantially |
| A significant stock price decline could result in litigation, which could be costly, lengthy and divert management’s attention and resources from business operations |
| The market for communications equipment products and services is rapidly changing and remains very competitive |
| The market for communications network equipment, software and integration services is rapidly changing |
| Our success will depend in part on our ability to develop and introduce new products successfully and successfully compete with telecommunications equipment providers that have lower cost structures and therefore product and service prices, particularly those in Asia |
| We are not able to predict with certainty technological trends or new products in the market, something that our competitors may be able to do more accurately and rapidly than us |
| In addition, we are not able to predict whether our products and services will meet with market acceptance or profitability |
| This may lead to an inability to successfully compete, which may adversely affect our business, financial condition, operating results or prospects |
| Demand for our products may decrease if we do not anticipate and adapt rapidly to changing technology and customer requirements |
| Communications companies face evolving industry standards, changing market conditions and frequent new product and service introductions and enhancements |
| The introduction of new products using new technologies or the adoption 12 ______________________________________________________________________ of new industry standards can make existing products or products under development obsolete or unmarketable |
| To grow and remain competitive, we must adapt to these rapidly changing technologies, enhance our existing solutions and introduce new solutions to address our customers’ changing demands |
| In addition, new product developments often require long-term forecasting of market trends, development and implementation of new technologies and processes, and a substantial capital commitment |
| We have invested, and will continue to invest, substantial resources for the development of new products |
| We often must make these investments before knowing if the resulting new product will meet with market acceptance or generate revenue |
| We are currently incurring costs and expenses in preparation for the deployment of several new broadband and transport systems, which costs will precede the generation of revenues and profits from those systems |
| We may experience difficulties that could delay or prevent the successful design, development, introduction or marketing of new product solutions |
| These new solutions and enhancements must meet the requirements of current and prospective customers and must achieve significant market acceptance |
| In addition, some of our customer agreements, particularly those with large customers, may contain provisions for payments that are tied to the availability of new product features |
| The success of new products depends on several factors, including proper new product definition, component costs, timely completion and introduction of these products, differentiation of new products from those of our competitors, and market acceptance of these products |
| There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, or achieve market acceptance of our products or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive |
| Specifically, the products and technologies that we pursue may not prove to have the market success we anticipate, and we may not successfully identify and invest in other advanced technologies |
| If we fail to anticipate or respond on a cost-effective and timely basis to technological developments, changes in industry standards or customer requirements, if we have any significant delays in product development or introduction, or if our products are not accepted in the market place to the extent we expect, our business, financial condition, operating results or prospects could be adversely affected |
| Our new products will be early in their life cycles and will face challenges for market acceptance |
| We have made and will continue to make significant investments in new products |
| These new products are early in their life cycles and are subject to uncertain market demand |
| They also may face obstacles in manufacturing and deployment and competitive response |
| Customers may not invest the additional capital required for initial system deployment |
| Additionally, as customers complete infrastructure deployments, they may require greater levels of service, support and financing than we provided in the past |
| There is no assurance that we can provide products, services, support and financing to effectively compete for these market opportunities |
| A limited number of our customers represents a large portion of our revenues |
| Any decrease in revenue from these customers could have an adverse effect on our business, financial condition, operating results and prospects |
| A large portion of our revenue likely will depend on sales to a limited number of customers in specific geographic areas |
| The largest customer groups are independent local exchange carriers (ILECs), which include BellSouth, Qwest Communications, SBC (now AT&T) and Verizon and wireless customers, which include T-Mobile, Cingular and Verizon Wireless |
| Sales to each of Verizon (including Verizon Wireless) and BellSouth currently constitute more than 10prca of our revenue |
| These customers primarily operate in the United States |
| There is no assurance that these customers will continue to purchase products from us |
| If a significant existing customer merges with another company, there is no assurance that it will continue to purchase our products |
| The loss of one or more large existing customers or a decrease in the level of purchases from these customers could have a material adverse effect on our business, financial condition, operating results and prospects |
| Due to our dependence on a large portion of our revenue from a limited number of customers, our bargaining power with respect to prices and contractual terms are often limited |
| Our revenues depend on the capital spending programs and financial capabilities of our customers and ultimately on the demand for new telecommunications services from end users |
| Our customers are telecommunications service providers and, in the United States, include, without limitation, incumbent local exchange carriers, independent operating companies, regional Bell operating companies (RBOCs) and wireless carriers |
| Our ability to generate revenues will depend upon the capital spending patterns and financial capabilities of these customers, which in turn depends upon the stage of completion of expanding network infrastructures; the availability of funding; and the extent to which our customers are affected by regulatory, economic, and business conditions in the geographic areas where they operate |
| Additionally, our customers typically have long implementation cycles; require a broader range of service including design services; demand that vendors take on a larger share of risks; and often require acceptance provisions, which can lead to a delay in revenue recognition |
| The 13 ______________________________________________________________________ telecommunications industry recently was affected by financial problems and reduced capital spending by carriers |
| These conditions adversely affected our operating results in prior fiscal years and, if these conditions return, could have a material adverse effect on our business, operating results, and financial condition |
| Further, there is no assurance that carriers, foreign governments or other customers will pursue infrastructure upgrades that require the products and solutions we offer |
| Infrastructure improvements may be delayed or prevented by a variety of factors including cost, industry competition, regulatory obstacles, mergers, lack of consumer demand for advanced telecommunications services and alternative approaches to service delivery |
| Reductions in capital expenditures by companies in the telecommunications industry could seriously harm our revenues, net income and cash flows |
| We operate in a highly competitive industry |
| Our products and services continue to face competitive pressures |
| Our success in competing with other communications equipment providers will depend primarily on the following: • our engineering, manufacturing and marketing skills; • the price, quality and reliability of our products; • our delivery and service capabilities; • our control of operating expenses and management of assets; and • our ability to integrate acquired businesses effectively with ours |
| We also may face more intense competition in certain markets as a reaction to our larger presence |
| Pricing pressures could increase from current and future competitors and customers |
| Many current competitors have, and future competitors also may have, more engineering, manufacturing, marketing, financial and personnel resources available to them, may have better access to such resources and may be better able to attract and retain highly qualified personnel resources |
| Competition also may be affected by consolidation among communications equipment providers as well as entrants into the communications equipment market |
| As a result, other providers may respond more quickly to new or emerging technologies and changes in customer requirements |
| In addition, technological change, the increasing addition of Internet, data, video, voice and other services to networks, the possibility of regulatory changes and industry consolidation are likely to continue to cause rapid evolution in the competitive environment |
| The full scope and nature of these changes are difficult to predict |
| Increased competition, particularly from Asia based competitors, could lead to price cuts, reduced gross margins and loss of market share, which may adversely affect our business, operating results and financial condition |
| Conditions in international markets could affect our operations |
| Approximately 25prca of our revenues were derived from sales outside of North American in 2005 with 34prca derived from sales outside of North America in 2004 |
| Due to the scope of our international sales and our international operations and research and development organizations, we are subject to the risks of conducting business internationally |
| These risks include: • local economic and market conditions; • political and economic instability; • reliance on third parties, who may be competitors, to sell and service our products in certain applications in certain countries; • unexpected changes in legislative or regulatory requirements; • fluctuations in currency exchange rates; • tariffs and other barriers and restrictions, including established relationships between government-controlled carriers and local equipment vendors; • longer payment cycles; • difficulties in enforcing intellectual property and contract rights; • greater difficulty in accounts receivable collection; • potentially adverse taxes, including any US taxes imposed upon our actual or deemed repatriation of earnings of foreign subsidiaries; • potentially lower margins and less certainty of support for customer relationships where foreign sales are made through local distributors; and • the burdens of complying with a variety of foreign laws and telecommunications standards |
| 14 ______________________________________________________________________ We also are subject to general geopolitical risks, such as political and economic instability and changes in diplomatic and trade relationships |
| We maintain business operations and have sales in many international markets |
| Economic conditions in many of these markets represent significant risks |
| We cannot predict whether sales and business operations in these markets will be adversely affected by these conditions |
| Instability in foreign markets, particularly in Asia, Latin America and the Middle East, could have a negative impact on our business, financial condition and operating results |
| In addition to the effect of international economic instability on foreign sales, domestic sales to US customers with significant foreign operations could be adversely impacted by these economic conditions, which may adversely affect our business, financial condition and operating results in the future |
| We are exposed to fluctuations in currency exchange rates that could negatively impact our financial results and cash flows |
| Because a portion of our business is conducted outside the United States, we face exposure to adverse movements in foreign currency exchange rates |
| These exposures may change over time as business practices evolve, and they could have a material adverse impact on our financial results and cash flows |
| Additionally, we have exposures to emerging market currencies, which can have extreme currency volatility |
| An increase in the value of the dollar could increase the real cost to our customers of our products in those markets outside the United States where we sell in US dollars, and a weakened US dollar could increase the cost of local operating expenses and procurement of raw materials to the extent that we must purchase components in foreign currencies |
| Currently, we enter into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on certain foreign currency receivables, investments, and payables |
| In addition, we periodically hedge anticipated foreign currency cash flows |
| Our attempts to hedge against these risks may not be successful, resulting in an adverse impact on our net income |
| We may encounter difficulties obtaining necessary raw materials and supplies |
| Our ability to make and service our products and meet customer demands depends upon our ability to obtain timely deliveries of important raw materials and supplies within certain quality standards |
| The availability of these raw materials and supplies is subject to market forces beyond our control |
| From time to time there may not be sufficient quantities of raw materials and supplies in the marketplace to meet the customer demand for our products |
| In addition, the costs to obtain these raw materials and supplies are subject to price fluctuations |
| Many companies use the same raw materials and supplies to produce their products that we use to produce our products |
| Companies with more resources may have a competitive advantage in obtaining raw materials and supplies due to greater buying power |
| In addition, we currently purchase certain key components from sole or limited-source vendors, and most of our component purchases are on a purchase-order basis without guaranteed supply arrangements |
| If supply is disrupted, we may be unable to find an alternative source in a timely manner, at favorable prices or of acceptable quality |
| These circumstances may limit our ability to meet scheduled deliveries to customers and may increase our expenses |
| Reduced supply or higher prices for raw materials and supplies may adversely affect our business, operating results and financial condition |
| We depend on contract manufacturers and third-party service providers |
| We have purchase agreements with contract manufacturers that require them to purchase component parts used in manufacturing our products and authorize them to buy components in accordance with agreed-upon lead times |
| As customers increasingly demand shorter delivery timeframes, the difficulty of accurately forecasting component needs creates additional risk |
| Failing to estimate requirements accurately can lead to monetary penalties, excess or obsolete inventory or disruptions in manufacturing |
| Further, since our contract manufacturers purchase many of the components for our products, we are subject to and dependent on the terms of the agreements between the contract manufacturer and the supplier |
| As a result, if a component were to fail or be outside of the quality standards that we set, our ability to take legal action against that supplier is limited |
| In addition, the contract manufacturers may not allocate sufficient resources to the timely completion of our orders in accordance with our quality standards |
| Qualifying a new contract manufacturer is costly and time-consuming and could result in significant interruptions in the supply of products to our customers |
| We rely on a small number of contract manufacturers to perform the majority of our product manufacturing |
| The qualification of these manufacturers is an expensive and time-consuming process, and these manufacturers build products for other companies, including our competitors |
| We are constantly reviewing their manufacturing capability to ensure they meet our production requirements in terms of cost, capacity and quality |
| Periodically, we may decide to transfer the manufacturing of a product from one contract manufacturer to another to better meet our production needs |
| It is possible that we may not effectively manage this transition or the new contract manufacturer may not perform as well as expected and, as a result, we may not be able to fill orders in a timely manner, which could harm our business |
| 15 ______________________________________________________________________ These limitations and the failure to deliver products on time may adversely affect our business, operating results and financial condition |
| We rely on the use of third-party customer service providers to deliver, install and turn-up products |
| We depend on such third-party agents to perform key on-site services for our customers |
| We cannot control the availability of such resources or the quality of the services provided by such third parties |
| Scarcity of resources, price fluctuations, or quality or delivery issues may adversely affect our business, operating results and financial condition |
| We may be unable to sell customer-specific inventory, which could result in lower gross profit margins and net income |
| Some customers’ order specifications require us to design and build systems and purchase parts that are unique to a single customer |
| In many cases, we forecast and purchase components in advance and allocate resources to design and manufacture the systems |
| If customers’ requirements change or if they delay or cancel orders, we may be unable to cost-effectively rework system configurations or return parts to inventory as available-for-sale |
| Writedowns and accruals for unrealizable inventory will negatively impact our gross profit margins and net income |
| Intellectual property rights may not be adequate to protect our business |
| Our future success depends in part upon our proprietary technology |
| Although we have attempted to protect our proprietary technology through various mechanisms including patents, copyrights, trademarks, contractual obligations and trade secrets, third parties may attempt to use our technology without authorization |
| It is difficult to police the unauthorized use of products and technologies, particularly in certain foreign countries, whose laws may not protect intellectual property rights to the same extent as the laws of the United States |
| Litigation may be necessary to enforce our intellectual property rights, which could be costly and disruptive while not guaranteeing a successful result |
| In addition, competitors may develop competitive technology independently without violating our proprietary rights |
| Any inability to protect or enforce proprietary rights and information could result in loss of competitive advantage, loss of customer orders and decreased revenues |
| We may be subject to intellectual property infringement claims that are costly and time consuming to defend |
| These claims could limit our ability to use some technologies in the future |
| As competition in the communications equipment industry increases and the functionality of the products in our industry converges, companies in the communications equipment industry increasingly become the target of infringement claims and other intellectual property disputes |
| We are likely to remain subject to claims based upon third-party patents or other proprietary rights, including claims that may originate from competitors |
| Any such third parties may choose to litigate their claims, or we may pursue litigation to determine the scope and validity of such third parties’ rights |
| We may be unsuccessful in any such litigation |
| We may be unable to secure, on commercially reasonable terms, any licenses that we may seek to secure |
| Third-party claims, whether with or without merit, potentially can result in: • costly litigation; • diverting management’s time, attention and resources; • delaying or halting product shipments; • requiring us to pay damages; • requiring us to enter into royalty-bearing licensing arrangements or to obtain substitute technology of lower quality or higher cost; or • otherwise imposing obligations or restrictions that could adversely affect our business, financial condition and operating results |
| Product quality or performance problems could impact our business |
| The development and production of new products with high technology content often involves problems with software, components and manufacturing methods |
| If significant reliability, quality or network monitoring problems develop, including those due to defects in software or faulty components, a number of negative effects on our business could result, including: • costs to fix software or hardware defects; • high service and warranty expenses; 16 ______________________________________________________________________ • payment of liquidated damages for performance failures; • high inventory obsolescence expense; • high levels of product returns; • delays or interruptions in product turn-up; • delays in collecting accounts receivable; • reduced orders from existing customers; and • declining interest from potential customers |
| We may not realize expected benefits from any restructuring initiatives |
| In response to industry and market conditions, we have restructured businesses and reduced our workforce |
| In light of the rapidly changing market for communications equipment, we may have to restructure in the future to achieve certain cost savings and to strategically realign our resources |
| We cannot predict whether we will realize expected synergies and improved operating performance as a result of any restructuring and streamlining of operations |
| We also cannot predict whether any restructuring and streamlining of operations will adversely affect our ability to retain key employees, which, in turn, would adversely affect our operating results |
| Further, in the event the market fluctuates up or down, we may not have the appropriate level of resources and personnel to appropriately react to the change |
| We may be unable to identify or complete strategic acquisitions, investments and dispositions |
| Our long-term growth strategy includes building value for the company through a variety of methods, including acquisition of, investment by us in, or joint ventures in, complementary businesses, products, services or technologies and potential divestitures of certain portions of our business |
| We cannot assure that we will be able to identify suitable third parties for these transactions |
| Even if we identify suitable third parties to participate in these transactions, we cannot assure that we will be able to make them on commercially acceptable terms, if at all |
| If we acquire a company, it may be difficult to assimilate its businesses, products, services, technologies and personnel into our operations |
| These difficulties could disrupt our ongoing business, distract our management and workforce, increase our expenses and adversely affect our operating results |
| In addition, we may incur debt or be required to issue equity securities to pay for future acquisitions or investments |
| The issuance of any equity securities could be dilutive to our stockholders |
| We also may need to make further investments to support the acquired company and may have difficulty identifying and acquiring the appropriate resources |
| If we divest or otherwise exit certain portions of our business, we may be required to record accrued liabilities for special one-time charges, such as workforce reduction costs, closure of excess facilities and excess inventory write-offs |
| Furthermore, estimates with respect to the useful life and ultimate recoverability of our carrying basis of assets, including goodwill and purchased intangible assets, could change as a result of such disposition |
| We are subject to numerous and changing industry regulations and standards |
| Our products must comply with a significant number of communications industry technological regulations and standards, which vary between US and international markets, and must interoperate with other products |
| Testing to ensure compliance with technological standards and interoperability requires significant investments of time and money |
| If we fail to ensure compliance with evolving standards and regulations in a timely manner or fail to maintain interoperability with equipment from other companies, we could experience customer contract penalties or delayed or lost customer orders, decreased revenues and reduced net income that may adversely affect our business, financial condition and operating results |
| To remain competitive, we also must comply with industry certifications such as ISO and TL 9000 |
| We operate in an environment subject to changing governmental regulations |
| The communications equipment industry is subject to governmental regulation in the United States and other countries |
| Our business depends upon the continued growth of the telecommunications industry in the United States and internationally |
| Federal and state regulatory agencies regulate most of our domestic customers, and foreign customers also are subject to regulation |
| In particular, there may be future changes in US telecommunications regulations that could slow the expansion of service providers’ network infrastructures and adversely affect our business, operating results and financial condition |
| Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could adversely affect the sales of our products for certain classes of customers |
| Moreover, uncertainty regarding future legislation and governmental policies combined with emerging competition also may affect the demand for our products |
| Competition could intensify as a result of future regulatory changes or new 17 ______________________________________________________________________ regulations in the United States or internationally, which could adversely affect our business, operating results and financial condition |
| Our failure to comply with applicable environmental laws and regulations worldwide could adversely impact our business and results of operations |
| The manufacture, assembly and testing of our products may require the use of hazardous materials that are subject to a broad array of environmental, health and safety laws and regulations |
| Our failure to comply with any of these applicable laws or regulations could result in: • regulatory penalties, fines and legal liabilities; • suspension of production; or • curtailment of our operations or sales |
| In addition, our failure to properly manage the use, transportation, emission, discharge, storage, recycling or disposal of hazardous materials could subject us to increased costs or future liabilities |
| Existing and future environmental laws and regulations may restrict our use of certain materials in our manufacturing, assembly and test processes or products |
| Any of these consequences could adversely impact our business and results of operations by increasing our expenses and/or requiring us to alter our manufacturing processes |
| Our business would be adversely affected if we are unable to attract and retain key personnel |
| Our success depends in large part on our ability to attract and retain highly skilled technical, managerial, sales, and marketing personnel |
| Competition for these personnel is intense |
| The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future, or delays in hiring required personnel, particularly engineering and sales personnel, could make it difficult to meet key objectives, such as timely and effective product introductions |