Exhibit 13

tellabs 2004 Annual Report

What’s next?

Tellabs Profile

We deliver technology that transforms the way the world communicates^™ . Tellabs experts design, develop, deploy and support wireless and wireline network solutions. Our comprehensive broadband portfolio enables carriers in more than 100 countries to succeed in the new competitive environment. Tellabs (NASDAQ: TLAB) is part of the NASDAQ-100 Index. www.tellabs.com.

Contents

2	Letter to Stockholders from President and CEO Krish Prabhu
3	Financial Highlights
	Our financial position is among the industry’s strongest.
6	Questions for Krish Prabhu
	President and Chief Executive Officer Krish Prabhu answers investors’ frequently asked questions.
8	What’s Next at Home, at Work and on the Go
	Our leading-edge solutions help service providers deliver what’s next.
14	Tellabs Solutions and Applications
16	Management’s Discussion and Analysis
26	Reports of Management & Independent Registered Public Accounting Firm
28	Consolidated Financial Statements
32	Notes to Consolidated Financial Statements
50	11-Year Summary of Selected Financial Data
52	Board of Directors
54	Officers
55	Glossary
56	Investor Information

Cover: Andrew Langille and his classmates discover what’s next in online learning through Tellabs data solutions.

Right: Tellabs solutions help Martin Mendez, Ivan Fassione, Mariano Perez y Perez, Gonzalo Yazalde and Ariel Pietrocola of Pronto Esporte Clube stay in touch while their soccer team is on the road.

People are communicating in ways never before imagined. Tellabs grows with demand for what’s next.

Over 12 years household spending on communications has increased faster than any other spending category.

(Source Most recent available from OECD, the Organisation for Economic Co-operation and Development Worldwide data from Japan, United States, United Kingdom, and 22 other contries.

TELLABS 2004 ANNUAL REPORT / 1

2004 marked a turning point for telecom and Tellabs.

Dear Stockholders, Customers and Employees,

     In 2004, for the first time, people spent more money on mobile phone service than on conventional phone service. For the first time, most U.S. homes connected to the Internet at broadband speeds. And for the first time since 2000, our customers, the world’s leading providers of telecom services, spent more than they did the previous year.

     Worldwide demand for telecom services, especially mobile and broadband, continues to grow. One out of every four persons — double the number in 2000 — now uses a mobile phone. Telecom service providers are refocusing their capital spending to build next-generation networks. Their efforts are focused on enhancing mobile service, offering higher bandwidth in the “last mile” access network, and providing multiple services on a single network. Tellabs is well-positioned to grow in these three areas as the industry’s cycle of network upgrades unfolds.

     In January 2005, Tellabs marked its 30th anniversary. We enjoy long-standing relationships with our customers, who have deployed billions of dollars worth of Tellabs equipment. We have helped telecom service providers navigate through industry transitions from analog to digital, copper to fiber, wireline to wireless, and circuits to packets. Today, we stand ready to deliver what’s next.

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Financial Highlights
Tellabs fiscal years ended December 31, 2004, and January 2, 2004.

Tellabs’ 2004 results reflected a healthier telecom industry.

     After three years of declining sales, our revenue grew in 2004 by 20% to $1.2 billion (excluding revenue from acquisitions; discussed later). We grew faster than the market by executing well on our strategy to energize our core transport business. We helped our customers introduce tomorrow’s capabilities into today’s networks. For example, we introduced new features to help locate mobile callers during emergencies. In 2004, Tellabs achieved its best-ever sales to mobile service providers, who represented a third of our total revenue.

     It was not a perfect year, though. We had our share of problems as we outsourced manufacturing of international products. The results were orders we could not fill and late deliveries to customers. We have taken forceful action to remedy this problem, and we expect on-time delivery to improve in the first half of 2005.

Profound industry change is under way. That spells opportunity.

     The market for telecom services is a fierce battleground among telephone and cable TV companies. Over the next 10 years, these companies will merge disparate voice, data and video networks into a single, integrated network. These new multiservice networks will deliver a complete, competitive menu

TELLABS 2004 ANNUAL REPORT / 3

of services that includes movies on demand, interactive gaming, high-speed Internet access, VoIP (Voice over Internet Protocol) and more.

     Delivering such services will require much more bandwidth than is currently available in the access portion of the network, which directly connects to homes and businesses. Telecom service providers are spending more and more on building fiber access systems to reach neighborhoods and homes. Analysts project that by 2009, the number of U.S. homes with access to fiber will grow tenfold to 24 million.

Fiber access is a golden opportunity for Tellabs’ strategy to expand into adjacent markets.

     In November, Tellabs acquired the U.S. leader in fiber access, Advanced Fibre Communications (AFC). This acquisition strengthens Tellabs’ position as a strategic supplier to our largest customers, such as Verizon and BellSouth. AFC brings us a portfolio of Fiber to the Home (FTTH) and Fiber to the Curb (FTTC) equipment that we market as Tellabs FiberDirect^SM solutions. Since fiber-access systems reside next to Tellabs transport equipment in networks, we have a unique opportunity to design and deliver end-to-end access and transport solutions that are easier to operate than current systems.

     At $1.6 billion, AFC is Tellabs’ largest acquisition to date. In 2005, our primary focus will be to successfully integrate the people and operations of AFC into Tellabs. While we will continue to control Tellabs’ overall operating expenses in 2005, we are shifting more of our R&D resources towards the high-growth fiber access segment. In December we also acquired an Optical Networking Terminal (ONT) company, Vinci Systems. This action brings to Tellabs a next-generation device that connects fiber to homes more cost-effectively.

     The AFC and Vinci acquisitions generated certain one-time costs that caused Tellabs to report a loss in 2004 of $30 million or 7 cents per share. While we hate to lose money in a year of rebounding revenue, this short-term pain is the best way to position Tellabs in the high-growth area of fiber access.

     We generated positive operating cash flow in 2004, ending the year with more than $1.1 billion in cash and cash equivalents, despite the cash expended in our two acquisitions. In February 2005, we announced plans to buy back up to $300 million in Tellabs shares, since we feel that the market price for Tellabs stock does not accurately reflect our long-term prospects. With our current cash position, repurchasing shares is a good way for us to enhance stockholder value. Tellabs still retains the financial resources to carry out its growth strategies.

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As multiservice networks are built, the industry shift to packet technology continues.

     Running separate networks for data, voice and video is inefficient, but to combine these services cost-effectively, telecom providers are continuing to transition from circuits to packets.

     Under Tellabs’ strategy to establish a presence in data , we now offer service providers a unique transition path to multiservice networks. The Tellabs MultiservicePLuS^SM solution helps service providers make this complex transition in a graceful, reliable and more cost-effective manner.

     Tellabs 2004 data revenues reflect the start-up nature of this business. We are making significant headway with customers. More than 30 telecom service providers are now testing Tellabs’ data solutions in their labs, and a dozen customers are deploy- ing the Tellabs 8800 system in networks around the world. Among our customers is the world’s largest telecom service provider, NTT Communications of Japan, which is doubling its deployment of the Tellabs 8800 system. In the United States, Broadwing is finalizing the construction of a single converged services network based on the Tellabs 8800 system. Tellabs’ data solutions are well-suited to meet the needs of our customer’s evolving networks.

     During the past year, my first at Tellabs, I met and worked with many of our employees around the world. Based on decades of industry experience, I must say that Tellabs has a hard-working, talented team of employees who are dedicated to our customers’ success. We are grateful to our employees for achieving so much in 2004.

     As industry changes unfold over the next decade, Tellabs will continue as customers’ trusted partner, working side by side to manage the complexities of evolving to next-generation networks. I am confident we have the people, the strategies and the resources to do just that. It is the best way to ensure Tellabs’ long-term growth and success.

     Sincerely

     Krish Prabhu

TELLABS 2004 ANNUAL REPORT / 5

Investors’ Frequently Asked Questions

Tellabs’ President and CEO Krish Prabhu answers investors’ frequently asked questions.

Q. How is your access strategy developing with the completion of the AFC acquisition?

A. We finalized the AFC acquisition on November 30, and are focused on successfully integrating the two companies to provide enhanced solutions to our customers. We also acquired Vinci Systems on December 30, which brings us a third-generation Optical Networking Terminal (ONT) that complements AFC products we now market as Tellabs FiberDirect^SM solutions.

We continue to strengthen our relationships with both Verizon and BellSouth, two major North American communications service providers. We also will work to strengthen our position as the North American leader in fiber-access solutions.

Q. What is the industry doing to provide fiber access to homes?

A. Industry analysts predict that by 2009, about 24 million U.S. households will have the option of fiber access. Verizon, for whom Tellabs is the main provider of Fiber to the Home (FTTH) access solutions, plans in 2005 to extend fiber access to at least 3 million households and businesses. BellSouth, where Tellabs has an installed base of nearly 1 million lines of Fiber to the Curb (FTTC) access solutions, may pass up to 3 million households with fiber access by year-end 2005. We will continue to work with our customers to provide industry-leading fiber-access solutions and implementation services.

Q. What progress have you made on your three key strategies to energize the core business, establish a presence in data and expand into adjacent markets?

A. In 2004, we made solid progress on all three strategies.

In our core business, we enhanced our transport solutions with new features that enable our customers to deliver mobile and data services to businesses and consumers. We will continue to enhance these products with the features that operators need to provide high-quality voice services, deliver new data capabilities and handle increasing demand for network capacity. Our year-over-year revenue growth demonstrates the success of this strategy.

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We gained traction in our data business. Our data solutions generated more than $17 million in 2004 revenue. Even more important for the long term, we set in motion more than 30 customer trials and have a current pipeline of more than 100 opportunities worldwide. While the decision cycle for data purchasing is long, we are confident of continuing progress during 2005.

We acted on our strategy to expand into adjacent markets through the acquisitions of AFC and Vinci Systems. Tellabs is now the U.S. leader in fiber-access solutions, which are key to enabling telecom companies to offer a competitive menu of voice, data and video services.

Q. What is your international strategy?

A. As communications services migrate from place-centric to people-centric, the worldwide market grows in importance. We are building on strong international customer relationships and a large installed base of managed access equipment in more than 100 countries. We will foster these relationships to provide a platform for growth in our new Ethernet, multiservice and next-generation wireless solutions. In the longer term, as competition heats up in international markets, we also see increasing potential for fiber-access solutions.

Q. What will drive Tellabs’ future growth?

A. Increasing demand for new, higher-speed data and video services over wireless and fixed networks will drive our growth. The trends we see at work, at home and on the go are detailed on the next few pages of this report. We are focused on providing the solutions our customers need to handle constantly changing demands on their communications networks.

TELLABS 2004 ANNUAL REPORT / 7

Through Tellabs FiberDirectSM solutions, Ryley Conway, Nolan Conway, Lyndsey Conway and Jessica Wolthman watch what’s next in multimedia entertainment.

Analysts forecast that by 2009, 24 million U.S. households will have access to fiber, up tenfold from 2004.

Cumulative U.S. Homes Passed and Subscribers

In thousands

(Source: KMI Research, August 2004.)

What’s next at home?

     Today, you can save a trip to the music store by downloading music over the Internet. Teens play video games with their peers around the world. Employees skip the commute and work from home. So it’s no surprise that in 2004, for the first time, more than half of U.S. Internet users connected from home with broadband links such as cable modems and Digital Subscriber Line (DSL) service. Japan and Korea already have achieved even higher penetration levels of broadband to the home.

     As a result of the AFC acquisition in late 2004, Tellabs now delivers cost-effective DSL solutions, enabling telecom companies to provide service to millions of North American consumers without building new networks. Tellabs’ cable telephony solution also delivers phone service to hundreds of thousands of cable TV customers worldwide.

Tellabs FiberDirect^SM solution speeds up the Internet. Hang on tight.

     What’s next? The blazing speed of a fiber-optic connection, direct to the neighborhood or to the home, will deliver a host of new entertainment choices unavailable through today’s broadband connections. Analysts estimate that by 2009, fiber access will grow tenfold to reach some 24 million households in the United States alone.

     Through the acquisition of AFC, Tellabs now is the leading provider in the U.S. market for fiber-based access. With more than a million lines connected, we have more experience deploying fiber-access networks in the U.S. than anyone else.

Tellabs MediaDirect^SM solution delivers sharp pictures plus more choices.

     Tellabs MediaDirect^SM solution enables telecom companies to outperform their competitors by delivering new services with high reliability and increased bandwidth. This solution delivers Internet Protocol television (IPTV) and Video on Demand (VoD), which offer razor-sharp video, HDTV (High Definition TeleVision) and a wide array of program choices. The Tellabs AdvancedVoice^SM solution delivers a new, more affordable phone service called VoIP (Voice over Internet Protocol).

     Verizon chose Tellabs as its first source for its Fiber to the Home initiative. And BellSouth uses Tellabs access solutions to connect newly built neighborhoods.

     Stay tuned. This story is just beginning.

TELLABS 2004 ANNUAL REPORT / 9

Growing demand for business data services creates opportunities for Tellabs data solutions.

Worldwide Ethernet and Legacy Data Services

In billions of dollars

(Source: Gartner — Forecast Fixed Public Network Services Worldwide 2002-2008; July 2004, Wm. L. Hahn & Alex Winogradoff.)

Tellabs data solutions enable David Utter to conduct real-time business over the Internet with confidence his critical data will reach its destination.

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What’s next at work?

     Communication is the lifeblood of business. Worldwide revenue from business data services is growing by more than $10 billion every year. Businesses rely on communication networks for a wide variety of voice, data, video and mobile applications, including critical, real-time financial transactions.

     To meet this demand, telecom service providers must offer data services that are economical and highly reliable. Many businesses plan to switch to more affordable, faster Ethernet services. However, for critical business communication, traditional Ethernet networks often are not reliable enough.

Tellabs AssuredEthernet^SM solution delivers data with guaranteed reliability.

     Tellabs’ Ethernet solutions can deliver affordable data services with the level of reliability that is required for today’s business needs. Our wide range of solutions provides telecom service providers with multiple choices for deploying high-speed services, including the ability to deliver Ethernet over SONET (Synchronous Optical NETwork), SDH (Synchronous Digital Hierarchy), fiber and DSL. In 2005, we will extend our successful international Ethernet-over-copper solutions to the United States. This solution is tailored to fit the 80% of U.S. businesses that lack fiber access.

     The Tellabs solution is unique because it delivers new Ethernet services with the traditional Quality of Service (QoS) that telecom service providers demand. Additionally, with the Tellabs solution, telecom companies even can customize individual data services for each business customer.

Tellabs MultiservicePLuS^SM solution uniquely blends existing and new data services.

     As new data services emerge, business customers need to exchange data over mixed networks. Tellabs MultiservicePLuS^SM solution enables businesses to share information regardless of network type. For example, a bank branch on a Frame Relay network needs to communicate with the new bank headquarters, which uses a newer Ethernet network. With Tellabs’ solution, the bank branch and headquarters can share data over their existing networks. If the bank decides to move the branch to an Ethernet network, Tellabs MultiservicePLuS^SM solution enables seamless migration, which prevents service interruptions, saves time and lowers costs. With other solutions, in order for the two locations to share data, the branch would need to build a new Ethernet network, incurring service interruptions and additional costs.

     With Tellabs, telecom service providers can deploy new data services in real time, without disrupting current services. MCI uses this feature to tie Internet Service Providers (ISPs) together so they can smoothly exchange Internet traffic.

     Tellabs enhanced its position in the data market in 2003 by acquiring Vivace Networks and the Tellabs 8800 series. Today, the Tellabs 8800 series is deployed at NTT Communications, the largest telecom company in the world. This platform is gaining acceptance worldwide as the next-generation solution for delivering new Ethernet and IP services, as well as current Frame Relay and Asynchronous Transfer Mode (ATM) services on converged networks.

     TELLABS 2004 ANNUAL REPORT / 11

In 2004, for the first time, people spent more money on mobile than on traditional phone services worldwide.

Services Revenue:

Worldwide Mobile vs. Fixed

(Source: Gartner – Forecast Global Telecommunications Market Take 3Q04; October 2004, Wm. L. Hahn, et al.)

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What’s next on the go?

     One-fourth of the world’s population now communicates via a mobile phone. At 1.5 billion users, the number of worldwide mobile subscribers has doubled since 2000. As mobile phones gain new capabilities, people are:

	•	sending more than 400 billion Short Message Service (SMS) messages per year
	•	taking digital photos and sharing them with friends and family
	•	reading newspapers, novels and other texts
	•	connecting to e-mail and the Internet
	•	viewing video clips of televised sports and news events.

     What’s next? New applications in areas such as gaming and streaming video are on the way. And it will become more common for consumers to buy and pay for goods and services using a mobile phone.

     To support these bandwidth-hungry applications, mobile companies around the world are migrating to next-generation networks that are designed to carry data and voice. This ongoing migration will continue to fuel Tellabs’ growth in the wireless sector. The changing mix of voice, data and video traffic in multiple formats drives demand for new solutions such as the Tellabs 8600 managed edge system and the Tellabs 8800 series, which help mobile service providers meet the changing demands on their networks.

Tellabs IntegratedMobile^SM solution enables mobile services around the world.

     About a third of Tellabs’ 2004 revenue came from the wireless market. In the U.S., all of the leading wireless companies use equipment such as the Tellabs 5500 digital cross-connect system in their transport networks. Many also deploy the Tellabs 3000 voice-quality enhancement series to improve sound quality, thereby increasing call length and revenue.

     In international markets, Tellabs partners with Ericsson and Nokia to transport traffic in wireless networks via the Tellabs 8100 and Tellabs 6300 systems. We also work directly with mobile companies. For example, Beijing Zhengtong Network Telecommunications chose Tellabs IntegratedMobile^SM solutions as part of the wireless network for the 2008 Olympics.

In 2005, our wireless solutions will fit into a smaller space.

     Most wireless operators lease space for their network equipment, so floor space is at an absolute premium. To meet this need, in 2005 we plan to introduce a new feature package for the Tellabs 5500 system that saves space and reduces energy costs by tripling bandwidth capacity in the same space. We also are integrating our voice-quality enhancement solution to fit inside the Tellabs 5500 system, saving wireless operators even more space.

TELLABS 2004 ANNUAL REPORT / 13

Tellabs Solutions and Applications

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TELLABS 2004 ANNUAL REPORT / 15

Management’s Discussion and Analysis

Introduction and Overview of Business

Tellabs designs, develops, deploys and supports products used in wireless and wireline networks in almost 100 countries. More than two-thirds of telephone calls and Internet sessions in the United States and several other countries flow through our equipment. Our product portfolio includes solutions for next-generation transport, Ethernet networks, multiservice edge, next-generation mobile, fiber-based access, advanced voice and video and DSL (Digital Subscriber Line). We are focused on three key strategies: energizing our core business, establishing a presence in data and expanding into adjacent markets.

     We generate revenue principally through the sale of hardware and software, both as stand-alone products and as elements of integrated systems, to many of the world’s largest and strongest telecommunications service providers. In addition, we generate revenue by providing installation and professional services related primarily to our own products and systems.

     Within North America we derive the majority of our revenue from transport products, principally digital cross-connect systems that manage and route network traffic and combine, consolidate and segregate signals to maximize efficiency. Demand for these products is sensitive to end-user demand for wireless services, bandwidth, industry capacity utilization and competing technologies. We also generate revenue in North America from access products. Demand for these products is driven by the local telephone companies’ plans to deliver triple-play (voice, data and video) services to residential customers as a way to compete with cable TV providers. According to industry analysts, Tellabs has a market-leading position in the U.S. bandwidth management and access markets.

     Outside North America we earn the majority of our revenue from managed access and transport systems that control the flow of voice, data and video across communications networks. Demand comes primarily from two sources: business services for voice and high-speed data and network transport services for wireless communications. Demand for these products is sensitive to end-user demand for bandwidth, industry capacity utilization and competing technologies.

     In addition, we are a leading provider of voice-quality enhancement solutions globally and one of the top three providers of cable telephony solutions worldwide.

     We also earn revenue from network construction and other professional services. Network construction revenue, which comprises more than half of our services revenue, arises primarily from sales of our transport products in North America and tends to lag product sales by approximately one fiscal quarter. As a result, it has tended to increase or decrease in similar proportion to the increase or decrease in revenue from those products. Professional services offered by the company include network deployment, traffic management, support services and training. Another major source of services revenue is support agreements related to our managed access and transport systems outside North America.

     The markets for our products have undergone dynamic change over the last few years. Beginning in 2001, carrier overcapacity, a softening economy and other factors caused our customers to significantly reduce their capital spending. The impact on Tellabs was a dramatic decline in revenue for each of the years 2001 through 2003 with year-over-year growth returning in 2004. As these changes unfolded we were faced with excess manufacturing capacity, excess inventories and a cost structure that could not be supported by our smaller revenue base. We responded by closing manufacturing facilities, reducing global head-count, consolidating office space, exiting certain product lines and instituting cost controls across the organization. We also reviewed our product portfolio and cut back or stopped development efforts on some products. In addition, at the end of 2003, we moved to outsource the majority of our remaining manufacturing operations to third-party electronics manufacturing services providers to take advantage of their greater purchasing power and other efficiencies. These actions caused us to record material charges in 2001 through 2004 for excess and obsolete inventory and excess purchase commitments, severance costs, facilities shutdown costs, including accelerated depreciation on certain manufacturing and office building and equipment due to shortened useful lives, and various contractual obligations. We also recorded charges for other impaired and surplus assets.

     Market stability began in 2003 and continued in 2004 as carriers invested in their networks at levels at or above 2003. This stability enabled us to post year-over-year revenue growth for the first time since fiscal 2000. However, change continues to be a significant factor in our markets. Growing demand for wireless services, including the new 3G services, is driving investment by both wireless and wireline carriers. This shift helps drive sales of our transport, VQE and managed access products.

     In order to achieve our targeted synergies following our acquisition of AFC, and to support achievement of our strategic and financial goals, we are currently reviewing our spending, asset utilization and product development roadmap opportunities to optimize revenue, improve asset utilization and contain spending. We expect that potential opportunities could include closing facilities, reducing our

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workforce and realigning research and development spending within our product portfolio. Although we have not completed these plans, it is likely that future implementation of the plans could result in restructuring and similar charges.

Acquisitions

On December 30, 2004, Tellabs acquired Vinci Systems Inc. (Vinci), a privately held developer of Optical Networking Terminals (ONTs) for Fiber to the Premise (FTTP) access systems. Under the terms of the agreement, we will pay up to $52.5 million in cash and Tellabs restricted stock related to the acquisition of Vinci. This acquisition enables us to deliver a more cost-effective fiber access solution.

     On November 30, 2004, Tellabs acquired Advanced Fibre Communications, Inc. (AFC), a leading supplier of access products for approximately $1.6 billion. Under the terms of the merger, AFC stockholders received 0.504 shares of Tellabs common stock and $12.00 in cash for each AFC share of common stock. We issued approximately 44.8 million shares of our common stock for the acquisition. We used our U.S.-based cash and cash equivalents to satisfy the cash portion of the purchase price. As a result of the transaction, historical Tellabs stockholders own approximately 90% of the combined company and historical AFC stockholders own approximately 10%. In conjunction with the acquisition, Frank Ianna, a director of AFC since February 2004 and retired president of AT&T Network Services, joined Tellabs’ board of directors. Our results of operations for the fourth quarter and full year 2004 include AFC’s results for the one-month period following the acquisition. Going forward we will report revenue from AFC’s and Vinci’s products in a new revenue category called Access. (See Note 4, Business Combinations, on page 37.)

     Our consolidated balance sheet at December 31, 2004, includes the estimated fair values of the assets and liabilities of AFC and Vinci as determined under the accounting rules for purchase acquisitions. The amounts reflect our best estimate of the fair values of the assets and liabilities at that date, which are subject to change as we complete the valuation and purchase-accounting processes.

     As a result of our merger with AFC, we became party to a multiyear agreement with Verizon Services Group (“Verizon”) to be the primary FTTP project vendor in providing the central office and premises electronics required for the delivery of telephone, data and video services to customers’ homes or business locations over fiber optic cable. Although the overall contract is expected to be profitable, gross margins are below Tellabs historical gross margins. One component, the ONT, is sold substantially below our current cost. Therefore, the associated revenue and profitability are affected by the timing and mix of components in the deployment of FTTP systems and the mix of customers. We expect to ship significantly larger volumes of ONTs in 2005 than in 2004 and that ONTs will constitute a larger percentage of our overall revenue. If that does occur, the impact would be lower overall gross margins.

     We have an active remediation program in place to address the profitability of the ONT component. Over the next year we expect product design changes, component price reductions and increased production volumes to help improve gross margins. In addition, Vinci is developing a lower-cost ONT which will help improve the overall FTTP gross margins. The other components of the FTTP systems are expected to continue to sell to customers at a profit.

     The Verizon agreement has several provisions requiring penalties for failure to meet key milestones by specified dates. Prior to its acquisition by Tellabs, AFC failed to meet certain milestones related to delivery of products or features, which triggered the penalty provisions. In total, AFC recorded $5.3 million in penalties prior to being acquired by Tellabs.

     In June 2004 Verizon informed AFC that it believed AFC’s failure to meet certain milestones and to deliver certain product features under a corrective action plan constituted a default and a breach of their agreement. Verizon has reserved all of its legal rights and remedies under the agreement, which may include termination of the agreement without the required advance notice, pursuing claims against AFC and Tellabs for costs and other damages caused by the breach, adjusting or eliminating the exclusivity clause and canceling previously placed orders. We could experience additional penalties in the future if we fail to comply with the remaining milestones. However, Verizon has not terminated the contract and continues to purchase products and services from AFC and Tellabs, including FTTP systems.

Results of Operations

For 2004, we recorded a net loss of $29.8 million ($0.07 per share) compared with a net loss of $241.6 million ($0.58 per share) in 2003 and a net loss of $313.1 million ($0.76 per share) in 2002. The year-over-year improvements were driven by higher revenue, lower restructuring and other charges, higher gross margins and lower operating expenses exclusive of restructuring and unusual charges.

TELLABS 2004 ANNUAL REPORT / 17

Revenue

In 2004 we recategorized our product offerings into four areas to better reflect our business dynamics: transport, managed access, broadband data and voice quality enhancement (“VQE”). In December 2004, we added a fifth category, access, to incorporate the access products we obtained through our acquisition of AFC and Vinci.

     Total revenue grew by 26% (20% excluding the December 2004 revenue from AFC) in 2004 compared with a 26% decline in 2003. Total 2004 revenue was $1,231.8 million compared with $980.4 million in 2003 and $1,317.0 million in 2002. Revenue within North America amounted to $813.0 million (66% of total revenue) in 2004 compared with $597.8 million (61% of total revenue) in 2003 and $916.4 million (70% of total revenue) in 2002. International revenue was $418.8 million (34% of total revenue) in 2004 compared with $382.6 million (39% of total revenue) in 2003 and $400.6 million (30% of total revenue) in 2002.

     Transport revenue for 2004 increased by $168.8 million, or 40%, to $588.2 million from $419.4 million in 2003. Transport revenue for 2003 decreased by $159.7 million, or 28%, from $419.4 million in 2002. The improvement in 2004 was attributable to increased spending by wireless carriers to meet growing capacity requirements and to build out their networks to provide new 3G services. We also experienced increased orders from wireline carriers due to increased end-user demand after a period of restrained spending. The decline in 2003 was attributable to the industrywide spending curtailment that began in 2001. This category includes the Tellabs^® 5300 and 5500 digital cross-connect systems, Tellabs^® 5500 NGX transport switch, Tellabs^® 6500 transport switch and Tellabs^® 7100 optical transport system.

     Managed access revenue remained relatively constant at $331.0 million in 2004 compared with $336.1 million in 2003, but declined by $118.9 million, or 26%, from $455.0 million in 2002. This category includes the Tellabs^® 8100 managed access system, the Tellabs^® 6300 managed transport system and the Tellabs^® 2300 telephony distribution system. The decline in revenue in 2003 was primarily attributable to a decline in revenue from our Tellabs 2300 products as a result of a change in business strategy by a major customer.

     VQE revenue increased by $16.1 million, or 24%, in 2004 to $84.3 million from $68.2 million in 2003. VQE revenue declined by $35.5 million, or 34%, in 2003 from $103.7 million in 2002. As with our transport products, the growth in 2004 was attributable to increased spending by wireless carriers. This category includes the Tellabs^® 3000 series of VQE products and other products.

     Access revenue of $53.3 million in 2004 represents one month of revenue from our merger with AFC at the end of November 2004. This category includes the Tellabs^® 1000 Multi-Service Access systems.

     Broadband data revenue more than doubled in 2004 to $17.4 million from $6.4 million in 2003, when Tellabs had the product available for sale during the last six months of the year. This category includes the Tellabs^® 8800 multi-service router series and the Tellabs^® 8600 next-generation wireless aggregation platform.

     Services revenue increased by $7.3 million, or 5%, in 2004 to $157.6 million from $150.3 million in 2003, and it declined by $28.9 million, or 16%, in 2003 from $179.2 million in 2002. The decline in revenue from 2002 to 2003 was attributable to lower sales of products both in the North America and international markets. Revenue from Services did not recover in 2004 at the same rate as product revenue because a larger percentage of our product sales in North America were of products that require less installation or are more readily installed by our customers without assistance from Tellabs.

Gross Profit & Margin

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Gross Profit

Total gross profit was $657.0 million (53.3% of revenue) in 2004 compared with $354.0 million (36.1% of revenue) in 2003, and $486.5 million (36.9% of revenue) in 2002. Unusual charges for excess and obsolete inventories and excess purchase commitments reduced gross profit by $70.7 million (7.2% of revenue) in 2003 and by $99.7 million (7.6% of revenue) in 2002. In addition, in 2003 we incurred $23.7 million (2.4% of revenue) of accelerated depreciation on our U.S. manufacturing facility and equipment due to our decision to outsource our manufacturing operations. The impact of unusual charges on 2004 gross profit was not significant.

     Gross profit declined in 2003 compared with 2002 due primarily to lower revenue. Gross profit improved in 2004 due to higher revenue compared with 2003, the absence of significant unusual charges compared with 2003 and lower product cost as a result of outsourcing our manufacturing operations at the end of 2003.

     Gross margin improved in 2004 compared with 2003 due to the absence of significant unusual charges (9.9%), lower manufacturing-related costs (6.9%), improved margins on professional services (0.7%) and overall product and services mix (1.1%). The inclusion of access revenue and cost of revenue for one month in 2004 reduced full-year margins by 1.4% compared with 2003. Gross margin declined slightly in 2003 compared with 2002 due to the increased impact of restructuring and inventory-related charges (2.4%), offset by favorable product mix driven by reduced sales of the Tellabs 6500 system, which has significantly lower margins than our other products (0.9%) and improved manufacturing and services efficiencies (0.7%).

Product Gross Profit

Total product gross profit was $612.2 million (57.0% of product revenue) in 2004 compared with $317.1 million (38.2% of product revenue) in 2003, and $440.1 million (38.7% of product revenue) in 2002. Unusual charges for excess and obsolete inventories and excess purchase commitments reduced product gross profit by $71.7 million (8.6% of product revenue) in 2003, and by $99.7 million (8.8% of product revenue) in 2002. In addition, in 2003 we incurred $23.7 million (2.9% of product revenue) of accelerated depreciation on our U.S. manufacturing facility and equipment due to our decision to outsource our manufacturing operations.

     Product gross profit improved in 2004 due to higher product revenue compared with 2003, the absence of significant unusual charges compared with 2003 and 2002, and lower product cost as a result of outsourcing our manufacturing operations at the end of 2003. The impact of unusual charges on 2004 product gross profit was not significant. Product gross profit declined in 2003 due primarily to lower product revenue compared with 2002.

     Product gross margin improved in 2004 compared with 2003 due to the absence of significant unusual charges (11.7%), lower manufacturing-related costs (8.1%) and favorable product mix and other (0.7%). The inclusion of access product revenue and cost of product revenue for one month in 2004 reduced full-year product margins by 1.7% compared with 2003. Product gross margin declined slightly in 2003 compared with 2002 due to the increased impact of restructuring and inventory-related charges (2.7%), offset by favorable product mix driven by reduced sales of the Tellabs 6500 system, which has significantly lower margins than our other products (1.3%) and improved manufacturing efficiencies due to outsourcing (0.9%).

Services Gross Profit

Total services gross profit was $44.8 million (28.4% of services revenue) in 2004 compared with $36.9 million (24.6% of services revenue) in 2003, and $46.4 million (25.9% of services revenue) in 2002. Services gross profit improved in 2004 due to higher services revenue compared with 2003. Services gross profit declined in 2003 due primarily to lower services revenue compared with 2002.

     Services gross margin improved in 2004 compared with 2003 due to labor efficiencies achieved as a result of reduced headcount in our services business. The inclusion of access services revenue and cost of services revenue for one month in 2004 reduced 2004 services margins by 0.8%.

Gross Margin Trend

As previously discussed herein, we are obligated to sell access products to Verizon under a supply agreement that contains fixed selling prices. While we anticipate this agreement to be profitable, gross margins are below Tellabs historical gross margins. We are working to reduce the cost of these products through internal development and by the acquisition of Vinci.

TELLABS 2004 ANNUAL REPORT / 19

     In addition, our total gross margin will continue to be subject to variability due to product mix. Our gross margin is different for each product and services category and for each product within a category because they are dependent on specific system configurations sold and customer and geographic pricing differences. Under normal conditions, this variability has tended to impact our gross margin in the range of 2–3% up or down. Going forward, we expect our total gross margin will be in the low 40% range and to trend up through 2005.

Operating Expenses

     Total operating expenses increased to $688.7 million in 2004 after declining to $618.5 million in 2003 from $816.2 million in 2002. Total operating expenses for 2004 include $15.5 million of operating expenses from AFC (excluding $89.0 million of purchased in-process research and development charges) for the one-month period following the merger in the fourth quarter of 2004. Spending on sales and marketing, R&D and general and administrative declined in total by $41.8 million, or 8%, from 2003 to 2004 and by $104.3 million, or 16%, from 2002 to 2003.

     A significant portion of the improvements resulted from lower expenses in headcount-related areas such as benefits, travel and telecommunications due to the reduction of our global workforce. We also significantly reduced spending on prototypes and we incurred lower facilities costs due to having closed or vacated a number of owned and leased facilities over the periods. Sales and marketing expense increased in 2004 due to higher commissions and incentives on higher sales volume compared with 2003.

Restructuring and Other Charges

During 2004 we recorded net restructuring charges in operating expenses of $14.1 million compared with $77.2 million in 2003 and $169.0 million in 2002. (See Note 3, Restructuring and Other Charges.) The charges for 2004 included the following:

	•	$15.4 million primarily for the closure of our research facility in Montreal, Canada, in the first quarter of 2004, of which $9.4 million related to disposal of fixed assets, $3.0 million related to severance costs, $2.2 million related to contractual obligations, and $0.8 million related to facilities costs and other.
	•	$1.6 million for severance-related costs due to a reorganization of our Denmark-based business.
	•	A net reversal of restructuring reserves in the amount of $2.9 million due to changes in estimates of costs related to other restructurings initiated prior to 2004.

     The reorganization of our Denmark operations is part of a plan to improve the profitability of our operations at that location. As part of this plan, in January 2005 we announced a further reduction of approximately 80 employees at the Denmark facility. We expect to record an estimated $8.1 million of severance and related expenses associated with those reductions during 2005, principally in the first quarter. It is likely we will incur other unusual charges related to the restructuring as we complete our plan. However, we are currently unable to estimate the magnitude or nature of those charges.

     In January 2005, we also announced our intention to reorganize our operations in Finland, which will result in a headcount reduction of approximately 70 positions. As a result, we expect to record an estimated $3.6 million of charges for severance and related expenses and other costs during 2005, principally in the first quarter. It is possible we will incur other unusual charges related to the restructuring as we complete our plan. However, we are currently unable to estimate the magnitude or nature of those charges.

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     We will also eliminate approximately 50 jobs at other U.S.-based facilities. We will incur costs for severance-related benefits related to these actions in 2005, primarily in the first quarter.

Purchased In-Process Research and Development

During 2004 we charged $102.1 million to operating expenses for the estimated fair value of in-process research and development (IPR&D) that we acquired in our acquisitions of AFC and Vinci. IPR&D refers to the value of technology under development that does not have an alternative use outside of its value within the acquired business. Generally accepted accounting principles require that IPR&D be expensed in whole at the time it is acquired. The value of the IPR&D at AFC was approximately $89.0 million of the total charges and was primarily attributable to development of enhanced versions of the company’s Fiber to the Premise products. The remainder, approximately $13.1 million, was attributable to development at Vinci of Optical Networking Terminals. The estimated fair values of the IPR&D at both AFC and Vinci were determined by using a discounted cash flow analysis that incorporated estimates of the amounts of costs remaining to complete the development, the amount of revenue that would result from the fully-developed technology and an estimate of risk.

Intangible Asset Amortization

Amortization increased in 2004 to $17.8 million from $12.6 million in 2003 and $8.8 million in 2002. The increase in 2003 was attributable to amortization of developed technology acquired in our acquisition of Vivace in 2003, and the increase in 2004 was due to amortization of developed technology acquired in our acquisitions of Vivace in 2003 and AFC in 2004.

Asset Impairment Charge

During the fourth quarter of 2004 we reviewed our amortizable intangible assets for indicators of impairment. We determined that impairment indicators existed for our Tellabs 5500 NGX asset group because actual and forecasted revenue for that asset group was lower than expected. We further determined that future undiscounted cash flows would not be sufficient to support the total carrying value of the asset group. We therefore recorded an impairment charge of $47.2 million to reduce the carrying value of those assets, principally amortizable intangibles, to their fair value. We determined the fair value of the assets by reference to the present value of the cash flows attributable to those assets over the remaining life of the intangibles, the primary asset in the asset group.

Net Loss on Sale of Real Estate

During the fourth quarter of 2004, we sold an administrative and research and development facility in Denmark and entered into a one-year lease for a portion of the space. The sale resulted in a loss of approximately $21.1 million.

Other Income (Expense)

     Other expense, net includes impairment charges to write down the carrying value of certain cost-basis equity investments in start-up technology companies. These charges, which arose as a result of our normal review of long-lived assets, were $11.2 million in 2004, $3.3 million in 2003 and $29.6 million in 2002. Other expense, net for 2004 includes a $6.6 million foreign currency gain resulting from converting a portion of our non-U.S. offshore cash from Euro-denominated investments to investments denominated in U.S. dollars.

Income Taxes

     Our tax expense increased in 2004 to $19.6 million from a tax benefit of $3.1 million in 2003 due to an increase in foreign taxes on higher foreign source income. Our tax benefit decreased to $3.1 million in 2003 from a benefit of $14.7 million in 2002. The decrease in tax benefit from 2002 to 2003 was due to a smaller benefit on domestic losses, partially offset by lower foreign taxes as a result of lower overall foreign source income.

     Our tax expense for each of the years 2002 through 2004 has been unfavorably impacted by our inability to record a tax benefit for all or a portion of the domestic and foreign tax losses and other unused tax benefits (referred to herein as deferred tax assets) that we are carrying forward to use on tax returns in future periods. Generally, un-benefited tax assets increase tax expense and decrease tax benefits in our results of operations in the year they arise or in the year we are required to record a valuation allowance against them.

TELLABS 2004 ANNUAL REPORT / 21

     At the end of 2003, we had $251.4 million of deferred tax assets for which no benefit was recorded, that is, tax assets that were offset by a valuation allowance. Because AFC and Vinci together had significant deferred tax liabilities, we reversed approximately $187.2 million of the valuation allowance that we had recorded against our pre-acquisition deferred tax assets. We recorded the reversal of valuation allowance as a reduction in goodwill from those acquisitions. At the end of 2004, we had approximately $38.9 million of deferred tax assets for which no benefit was recorded.

     If we generate domestic pre-tax losses in 2005, such losses may not result in a tax benefit if we determine that, based on our recent history of losses and future projections of income, it is more likely than not that such losses will not be utilized (due to absence of tax liabilities). That is, we would be required to record a valuation allowance against the tax benefit arising from those losses. If we generate domestic pre-tax income in 2005, we would record a tax benefit by reversing an amount of our existing valuation allowance on U.S. deferred tax assets equal to the income tax expense on the income. After the valuation allowance is reduced to zero, we would record a tax expense on domestic pre-tax income arising thereafter at a more normalized U.S. statutory rate. We cannot reasonably estimate when such a level of domestic pre-tax income would arise.

Financial Condition, Liquidity and Capital Resources

Our principal source of liquidity remains our cash, cash equivalents and marketable securities, which decreased by $6.8 million during 2004 to $1,116.2 million. During 2004, we generated $214.7 million of cash from operating activities and we used $251.2 million in net cash for the acquisitions of AFC and Vinci. We believe that the current level of working capital, particularly cash and marketable securities, is sufficient to meet our normal operating requirements for the foreseeable future. Further, we believe that sufficient resources exist to support our future growth and strategic needs. Future available sources of working capital include cash-on-hand, cash generated from future operations, short-term or long-term financing, equity offerings or any combination of these sources. Our current policy is to retain our earnings to provide funds for operating and expanding our business. We do not anticipate paying a cash dividend in the foreseeable future.

     On February 2, 2005, Tellabs announced that its Board of Directors had authorized the purchase of up to $300.0 million in shares of the company’s outstanding common stock (approximately 9.5% of the outstanding shares based on the closing price on that date). Purchases will be made from time to time in the open market or private transactions. Tellabs provides no assurances as to the quantity of shares it will purchase or the actual purchase prices. As of February 28, 2005, we have purchased $118.7 million (16.5 million shares) of our common stock.

Cisco marketable securities

As a result of our merger with AFC we acquired the 10.6 million shares of Cisco Systems, Inc. (“Cisco”), common stock that AFC owned as a result of its investment in privately held Cerent Corporation, which was acquired by Cisco in 1999. The shares are presented as Other marketable securities – Cisco stock in the current assets portion of our balance sheet for the year ending December 31, 2004. In 2000, AFC entered into two three-year hedge contracts, pledging all of the Cisco stock to secure the obligations under the contracts. When the hedge contracts matured in 2003, AFC entered into stock loan agreements with a lender, borrowing 10.6 million shares of Cisco stock to settle the hedge contracts. The fair value of those stock loans is reflected as a current liability on our balance sheet for the year ending December 31, 2004. The value of both the asset and liability move in tandem with each other since each is based upon the number of shares we hold at the current stock price.

     In 2004, AFC received a private letter ruling from the Internal Revenue Service holding the use of borrowed shares to settle the hedge contracts in 2003 did not require recognition of a capital gain on the Cisco stock until the stock loans are settled. Following issuance of the ruling, AFC received a refund of $218.6 million in federal and state income taxes that had previously been paid in respect of the transactions.

     Our balance sheet at December 31, 2004, reflects the deferred tax liability that will be due on the hedge contract gains upon termination of the Cisco stock loans. Our agreement with the lender of the stock has no defined date when we must repay the loan, however, the loan is callable at the discretion of the lender. Further, we have no current intention to dispose of the Cisco shares or otherwise take any actions that would result in us having to pay the capital gains tax on the stock. Although we do not have any current intentions of unwinding this transaction, if we did unwind this transaction, we would use the proceeds from the sale of the stock to pay off the stock loan.

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Contractual Obligations

The following table sets forth an overview of our known contractual obligations as of December 31, 2004, that will affect our liquidity and cash flows in future periods:

     We use several contract manufacturers and suppliers to provide manufacturing services for our products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, we enter into agreements with certain contract manufacturers and suppliers to enable them to procure inventory based upon criteria defined by us. Under these agreements, the maximum liability for purchase commitments as of December 31, 2004, was $267.8 million, of which $18.0 million was accrued on the balance sheet.

     The Cisco stock loan borrowing fees are partially based on Cisco’s average share price at the end of each quarter.

Off-balance sheet arrangements

None.

Critical Accounting Policies

The methods, estimates, and judgments that we use in applying our accounting policies can have a significant impact on the results we report in the consolidated financial statements. Some of these estimates require difficult and subjective judgments, often as a result of the need to estimate matters that are inherently uncertain. For the reasons discussed below, we consider our critical accounting estimates to be the allowance for excess and obsolete inventory and excess purchase commitments (collectively E&O), goodwill valuation, the valuation allowance for deferred tax assets, reserve requirements for lease obligations on vacated facilities and the valuation of amortizable intangible assets.

     We have discussed the development and selection of these critical accounting policies and estimates with the Audit and Ethics Committee of Tellabs Board of Directors.

Excess & Obsolete Inventory and Excess Purchase Commitments

We determine our inventory cost using the first-in, first-out method and we value our inventory at the lower of cost or market, with market determined by reference to current replacement cost. We determine the amount of inventory that is excess and obsolete and purchase commitments in excess of requirements using estimates of future demand for individual components of raw materials and finished goods.

     To determine E&O, we compare our existing inventory and inventory purchase commitments with estimates of future product demand and usage requirements. We consider quantities in excess of two years’ expected usage to be excess and we record a full valuation allowance for that amount. For quantities that fall between one- and two-years’ demand we use management judgment to determine the appropriate E&O amount. We do not record an allowance if the quantity is less than one year’s forecasted demand.

     Because our visibility to future sales volume and product mix is limited and actual results can differ materially from our estimates, charges for E&O can have a material impact on our financial statements.

Goodwill

At December 31, 2004, we had approximately $1.1 billion of goodwill on our balance sheet, which arose from acquisitions including the recent acquisitions of AFC and Vinci.

     Accounting rules require that we evaluate goodwill for impairment annually. Because we report our operating results as a single segment or reporting unit, we performed the impairment test in 2004 by comparing the per-share market price of our stock with our net book

TELLABS 2004 ANNUAL REPORT / 23

value per share on our annual measurement date in the fourth quarter. Because the market price exceeded our net book value, we concluded that our goodwill was not impaired. Therefore, we did not perform additional impairment testing or record an impairment charge.

     Segments are generally determined by the way a company manages and measures its business, with particular weight given to the manner in which results of operations are reported internally and the measures provided to, and used by, the company’s chief decision-maker. If facts were to change such that we operated in multiple segments rather than a single segment, then we would be required to apportion our goodwill to each segment, or part of a segment referred to as a reporting unit, and conduct the impairment test on a segment basis or reporting unit basis using a fair value measurement that would not utilize our stock price as a key indicator of value. We cannot reasonably estimate if an impairment would result from that process, or the amount of any such impairment, because it would depend on the number and configuration of segments or reporting units, valuations of the underlying businesses, and the amount of goodwill apportioned to each segment or reporting unit.

Valuation Allowance for Deferred Tax Assets

Deferred tax assets arise when we record charges or expenses in our financial statements that will not be allowed as income tax deductions until future periods. The term deferred tax asset also includes unused tax net operating losses and unused tax credits that we are allowed to carry forward to future years. Accounting rules permit us to carry deferred tax assets on the balance sheet at full value as long as it is “more likely than not” the deductions, losses, or credits will be used in the future. A valuation allowance must be recorded against the deferred tax assets via a charge to income tax expense if the test cannot be met. The accounting rules state that a company with a recent history of losses would have a difficult, perhaps impossible, time supporting a position that utilization of its deferred tax assets was more likely than not to occur.

     Because of a recent history of losses we determined that it was appropriate to maintain a valuation allowance (approximately $38.9 million at the end of 2004) against our domestic deferred tax assets.

     We are currently not able to forecast when an earnings improvement of sufficient size will occur for us to reverse any of the remaining valuation allowances that we have recorded.

Restructuring Reserves – Leases

At the end of 2004, we had $41.8 million of remaining reserves for lease obligations that arose from facility closures that occurred in 2004 and prior years. We determined the amount of the reserve for each facility by calculating our outstanding lease obligation, then reducing it by an estimate of potential sublease income. We examine real estate market conditions in each location where we have a vacated facility and use input from local real estate professionals to formulate an estimate of potential sublease income. We review our estimates quarterly and adjust our reserves as necessary. We believe our estimate of restructuring lease obligations is a critical accounting estimate because it requires us to make assumptions about matters that are highly uncertain: real estate rental market conditions, the length of time required to secure tenants, the amount of tenant incentives and the potential sublease income. Although the changes in our reserves for restructuring lease obligations have not been material in the past, it is possible that future changes in estimates could have a material impact on our financial statements.

Intangible Assets

At the end of 2004 we had $156.0 million of amortizable intangible assets, primarily purchased technology, on our balance sheet, which arose primarily from our acquisitions in 2004 and 2003.

     We evaluate the carrying value of our intangible assets for impairment whenever indicators of impairment exist. If an impairment indicator exists, we compare the sum of the undiscounted future cash flows expected to result from the intangibles, or asset group of which the intangibles are a part, to our carrying value. If the sum of the undiscounted future cash flows is less than the carrying value, then we compare the fair value of the asset group with our carrying value to determine if an impairment charge is required. The amount of impairment is calculated by subtracting the fair value of the asset from the carrying value of the asset.

     We believe that the accounting estimate related to asset impairment is a critical accounting estimate because it requires us to make assumptions about future sales prices, sales volumes and margins for our products, including products that employ new technologies, and uncertainties around customer acceptance, that are highly uncertain. The amount of any such impairment could be material to our financial statements.

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Strategy and Outlook

We expect capital spending by our customers to be stable globally in 2005 with growth in North America. On a global basis, wireless carriers will continue to build next-generation networks to deliver new, data-oriented services. In North America, we expect the regional Bell operating companies to upgrade the access portion of their networks with fiber technology as a means to deliver broadband services to their customers. We also expect that customers will begin to accelerate spending on broadband data infrastructure equipment globally. Tellabs has products either currently available or in development to take advantage of these opportunities.

     In 2005, we will continue to focus on our strategies to energize our core products, establish a position in data and expand into adjacent markets, specifically fiber access. In addition, we are driving toward a business target model that calls for us to achieve over time an overall gross margin of 50% of revenue, operating expenses of 30% of revenue (excluding unusual charges), operating margins at 20% of revenue, and 15% annual revenue growth. While we have achieved and even exceeded these targets in the past, we can not say when or if we will achieve them again, given today’s market conditions and our product portfolio.

     Gross margin will be lower in 2005 than in 2004, reflecting the addition of AFC, whose products have lower overall gross margins than the traditional Tellabs products. We expect overall gross profit margin to improve through the course of 2005, as we begin to ship the single-family ONTs we acquired from Vinci, which have better gross margins than the ONTs acquired from AFC. In addition, for the full year 2005, we expect that synergies associated with the AFC acquisition will reduce overall cost of revenue by $15 million, thus improving overall gross margin performance toward our target.

     Our operating expenses will grow in 2005, reflecting the acquisitions of AFC and Vinci. We expect to reduce 2005 operating expenses by $30 million, compared with the full-year 2004 run rate of Tellabs, AFC (including Marconi NAA) and Vinci. We expect to achieve these savings through a combination of synergies related to the AFC acquisition, reducing fixed cost, especially facilities, adjusting product roadmaps to match market opportunities, and other cost containment activities.

     Operating income is expected to be positive in 2005, including restructuring and other unusual charges discussed previously. In connection with the restructuring actions taken early this year, we expect to take a restructuring charge to earnings in the first quarter, as described earlier. It is possible that we will take further charges in 2005 in connection with cost-reduction activities and the rationalization of our manufacturing supply chain.

TELLABS 2004 ANNUAL REPORT / 25

Management’s Report on Internal Control over Financial Reporting

Management of Tellabs, Inc., and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Securities Exchange Act of 1934 Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, as required by the Securities Exchange Act of 1934 Rules 13a-15(c). In making this assessment, we used the criteria set forth in the framework in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control–Integrated Framework , our management concluded that our internal control over financial reporting was effective as of December 31, 2004.

     Our management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Advanced Fibre Communications, Inc., which is included in the 2004 consolidated financial statements of the Company and constituted approximately $1.1 billion and $800 million of total and net assets, respectively, as of December 31, 2004, and $55 million of revenues for the year then ended. Management did not assess the effectiveness of internal control over financial reporting at this entity because the Company only recently acquired this business on November 30, 2004.

     Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004, has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report that appears on page 27. Ernst & Young LLP’s audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Advanced Fibre Communications, Inc.

March 10, 2005

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors of Tellabs, Inc.:

     We have audited the accompanying consolidated balance sheets of Tellabs, Inc., and subsidiaries (the “Company”) as of December 31, 2004, and January 2, 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

     We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2004, and January 2, 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 10, 2005, expressed an unqualified opinion thereon.

26 

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

To the Stockholders and Board of Directors of Tellabs, Inc.:

     We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting , that Tellabs, Inc., and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

     We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

     A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting , management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Advanced Fibre Communications, Inc., which is included in the 2004 consolidated financial statements of the Company and constituted approximately $1.1 billion and $800 million of total and net assets, respectively, as of December 31, 2004, and $55 million of revenues for the year then ended. Management did not assess the effectiveness of internal control over financial reporting at this entity because the Company only recently acquired this business on November 30, 2004. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Advanced Fibre Communications, Inc.

     In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.

     We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of the Company as of December 31, 2004, and January 2, 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004, and our report dated March 10, 2005, expressed an unqualified opinion thereon.

TELLABS 2004 ANNUAL REPORT / 27

Consolidated Statements of Operations

The accompanying notes are an integral part of these statements.

28 

Consolidated Balance Sheets

The accompanying notes are an integral part of these statements.

TELLABS 2004 ANNUAL REPORT / 29

Consolidated Statements of Stockholders’ Equity

The accompanying notes are an integral part of these statements.

30

Consolidated Statements of Cash Flow

The accompanying notes are an integral part of these statements.

TELLABS 2004 ANNUAL REPORT / 31

Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies

Nature of Business

We operate as one business segment in the design, assembly, marketing and servicing of a diverse line of communications equipment used in public and private networks worldwide.

Principles of Consolidation

Our consolidated financial statements include the accounts of Tellabs and our subsidiaries. All intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Cash Equivalents

We consider all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.

Restricted Cash

Restricted cash equivalents and marketable securities of $20 million are included in other assets. The cash equivalents and marketable securities are held as collateral to back a three-year bond posted for a U.S. customer contract.

Fair Value of Financial Instruments

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, marketable securities and cost-basis investments. The carrying value of the cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of their fair value because of their short-term nature. We determine the fair value of marketable securities and derivatives based on quotes from brokers or current rates offered for instruments with similar characteristics. See discussion in Note 7 regarding derivatives.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method.

Property, Plant and Equipment

Property, plant and equipment is recorded at cost. Depreciation is computed using both the declining-balance and straight-line methods. Buildings are depreciated over 25 to 40 years; building improvements over 7 years; leasehold improvements over the life of the lease, currently 3 to 15 years; and equipment over 3 to 10 years. We evaluate property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.

Stock Options

We are permitted under SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of SFAS No. 123, to apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, in most cases, no compensation cost has been recognized for our fixed stock option plan grants. If we had elected to recognize compensation expense for our stock-based compensation plans consistent with the methods prescribed by SFAS No. 123, net loss and net loss per share would have been changed to the pro forma amounts shown below:

The fair value of options was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for grants in 2004, 2003 and 2002:

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The pro forma amounts disclosed above may not be representative of future disclosures because the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future years. In addition, the Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. It requires the use of assumptions that are subjective, such as the expected volatility of the exercise price and the expected remaining life of the option.

Income Taxes

We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases at enacted tax rates when such amounts are expected to be realized or settled. Valuation allowances are provided if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Goodwill

Goodwill represents the excess of the cost of businesses acquired over the fair market value of identifiable net assets at the dates of acquisition. We compare our market capitalization to book value annually as an indicator of potential impairment.

Intangible Assets

Our intangible assets are made up primarily of purchased technology from acquisitions. These assets are amortized over their estimated useful lives and are reviewed for impairment when indicators of impairment exist such as poor or declining operating performance or cash flows.

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price or fee is fixed or determinable, and collectibility is reasonably assured, in accordance with the guidance in the Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition.

Products

The majority of our revenue comes from product sales for which we recognize revenue either upon shipment or upon delivery to the customer, depending upon the contractual delivery terms.

     Some of our customer agreements contain acceptance clauses that grant the right to return or exchange products that do not conform to our published specifications. When we have sufficient historical evidence that our products meet the published specifications, we recognize revenue upon shipment or upon delivery, and treat any potential returns as warranties. Otherwise, we recognize revenue when the conditions of acceptance have been met.

     A few of our customer agreements grant the right to return or exchange product based upon subjective matters. We have established sufficient historical evidence on rates of return for most of our products to be able to accrue for returns under the guidance of SFAS No. 48, Revenue Recognition When Right of Return Exists. We recognize revenue net of potential returns upon shipment or upon delivery of product to the customer.

     Some of our customer agreements are in the form of distribution agreements, with contractual rights of return, promotional rebates, and other rebates and credits. We recognize revenue net of estimated returns and rebates, which are calculated based on contractual provisions and historical evidence of returns activity.

Services

We also recognize revenue for services performed for customers. Most of our services revenue relates to the installation of our product at customer sites. Customers may purchase installation services from us, install our products themselves, or hire third parties to perform the installation. Revenue for installation services is recognized upon completion.

     Revenue from maintenance and support contracts is recognized ratably over the service period. Other services revenue, including training and other business support services, is recognized upon completion.

Earnings Per Share

Earnings per share is based on the weighted average number of shares (basic) and the weighted average shares adjusted for assumed exercises of stock options and vesting of restricted stock (diluted). Earnings per share in periods of a net loss is based solely on basic weighted average number of shares under generally accepted accounting principles.

Foreign Currency Translation

The financial statements of our foreign subsidiaries are generally measured using the local currency as the functional currency. In such cases, assets and liabilities are translated at exchange rates in effect at the balance sheet date, and income and expenses are translated at weighted average exchange rates during the year. The effect of

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translating a subsidiary’s stockholders’ equity into U.S. dollars is recorded as a cumulative translation adjustment in the equity section of the Consolidated Balance Sheets.

Foreign Currency Transactions

Foreign currency transaction gains and losses resulting from changes in exchange rates are recognized in Other Income (Expense). Net gains (losses) of $3.8 million, $(1.8) million and $(5.9) million were recorded in 2004, 2003 and 2002, respectively.

2. New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued SFAS 123 (revised 2004), Share-Based Payment, which is a revision of SFAS 123. SFAS 123(R) supersedes APB No. 25. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, beginning in our third quarter of 2005, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

     SFAS 123(R) must be adopted no later than July 1, 2005. We expect to adopt SFAS 123(R) in the third quarter of 2005.

     SFAS 123(R) permits us to adopt its requirements using one of two methods:

	1.	A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date.
	2.	A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosure either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

     We have currently not determined which method we will use.

     As permitted by SFAS 123, we currently account for share-based payments to employees using the APB No. 25 intrinsic value method and therefore we usually do not recognize compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)’s fair value method will have an impact on our results of operations, although it will have no incremental impact on our overall financial position.

3. Restructuring and Other Charges

During the fourth quarter of 2004, we recorded restructuring charges for severance and related costs of $1.6 million related to a reorganization of our Denmark-based business. Our fourth-quarter actions in Denmark are part of a plan to improve the profitability of our international transport switching business. As part of this plan, in January 2005 we announced a further reduction of approximately 80 employees at the Denmark facility. In January 2005 we also announced our intention to reorganize our operations in Finland, which will result in a headcount reduction of approximately 70 positions. This plan to drive toward improved profitability also includes headcount reductions on a smaller scale in other locations throughout the world. As a result of these actions, we expect to record charges for severance and related costs and other costs associated with these reductions during 2005, principally in the first quarter.

     Although we have not committed to any plans other than those already announced, we believe that it is possible that further plans, if implemented, could result in further restructuring and other charges for workforce reductions, asset impairments, contractual and other obligations (including facilities costs) and inventory valuation.

     In 2003, management approved plans to further restructure our operations due to difficult market conditions in the telecommunications industry. A major component of the restructuring was the outsourcing of our global manufacturing operations, which resulted in work-force reductions of approximately 500 employees, facility closures, asset disposals and the sale of the majority of our inventory to the outsourcers. Additional restructuring activities during 2003 included non-manufacturing work-force reductions and facility closures. As a result of these actions, we recorded charges for severance and related costs, asset impairments and accelerated depreciation on our manufacturing facility in North America. We also recorded charges for excess and obsolete inventories and excess purchase commitments. Our manufacturing operations in North America ceased at the end of October 2003 and international manufacturing operations ceased at the beginning of January 2004. We recorded restructuring and other charges related to all of these activities in 2003 and 2004.

     In 2002, we approved plans to restructure our operations, including a realignment of worldwide inventory levels to match customer demand, which resulted in the write-off of excess inventories and an accrual for excess inventory purchase commitments; workforce reductions; the closure and consolidation of excess facilities, including manufacturing facilities in Ronkonkoma, New York, and Shannon,

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Ireland, along with the write-off of related fixed assets; and an adjustment of the reserves for excess leased facilities from our 2001 restructuring programs in light of current economic conditions.

     Below is an analysis of the restructuring and other charges recorded during 2004, 2003 and 2002 by major income statement classification:

Disposal of property, plant and equipment

We recorded impairment charges of $18.7 million in 2004 for property, plant and equipment to be disposed of or held for sale. This charge is composed of: $4.7 million for a loss on the sale of our Bolingbrook manufacturing facilities; $7.7 million for the closure of our Montreal research and development facility; $5.5 million for U.S. research and development and manufacturing assets; and $0.8 million for property, plant and equipment sold to our manufacturing contractor as part of our international manufacturing outsourcing. We also received $5.2 million in proceeds from the sale of property, plant and equipment in excess of our original estimate.

     Our review of property, plant and equipment needs during the restructuring activities identified assets that would be sold or disposed. We recorded a loss of $23.6 million in 2003 related to the disposal of this property, plant and equipment. The property, plant and equipment consisted primarily of manufacturing equipment, lab and data equipment, and computer software. This equipment was disposed of primarily by conducting periodic open bid auctions with items sold to the highest bidders. In 2003, we reduced a reserve related to the disposal of property, plant and equipment by $5.0 million to reflect the receipt of sales proceeds in excess of our original estimates.

     We recorded charges of $67.3 million in 2002 related to equipment and leasehold improvements made excess by the closure of our manufacturing facilities in New York and Ireland and the consolidation of a number of smaller facilities.

Severance and related expenses

In the first half of 2004, we recorded additional accruals for severance and related costs of $5.0 million attributable to a change in our estimate of the number of employees to be terminated under our fourth-quarter 2003 restructuring plan and to severance and related costs

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pertaining to the closure of our Montreal, Canada, facility in the fourth quarter of 2003. In December 2004, we recorded an accrual for severance and related costs of $1.6 million pertaining to the Denmark workforce reduction approved toward the end of 2004. These charges were partially offset by a $1.4 million reduction of accruals for severance and related costs pertaining to certain restructuring activities that were initiated in 2003 and prior periods.

     As a result of the outsourcing of our manufacturing operations and our goal to align our employee levels with expected workforce needs, we recorded charges totaling $33.7 million for severance pay and related costs for the reduction of approximately 1,500 employees worldwide in 2003. We also reversed $1.4 million in severance accruals due to changes in the estimated severance and related costs from prior restructuring programs.

     In 2002, we reduced our workforce by approximately 2,000 employees resulting in severance and related charges of $51.3 million. We also reversed $6.2 million of severance reserves due to changes in our estimates of severance costs for restructurings in prior years.

Inventory adjustments and excess purchase commitments

In 2004, we accrued $2.3 million for the revaluation of inventories related to international manufacturing outsourcing, and increased the accrual for North America purchase commitments by $0.1 million. There was also a $12.0 million reduction of the reserve for excess purchase commitments in 2004 due to a favorable settlement with a vendor.

     Due to a slowdown in customer spending levels during 2003 and 2002, and a review of our inventory levels during outsourcing activities, we wrote down the value of our inventories and related non-cancelable inventory purchase commitments for excess amounts. Included in product cost of goods sold for 2003 were net charges of $70.7 million related to the write-down of inventories and accruals for non-cancelable inventory purchase commitments. North American manufacturing outsourcing resulted in a $7.4 million charge, international manufacturing outsourcing resulted in a $10.9 million charge, and $52.4 million was recorded prior to manufacturing outsourcing to write down excess and obsolete inventory and accrue for non-cancelable inventory purchase commitments. Net charges for 2002 were $53.2 million for excess and obsolete inventory and a net $46.5 million for excess purchase commitments. The inventory adjustments were recorded as a reduction to inventory, while the reserve for excess non-cancelable purchase commitments was recorded to accrued restructuring and other charges.

Consolidation of excess leased facilities

In 2004, we accrued $1.9 million for costs associated with the consolidation of excess leased facilities. This amount included accruals for our Montreal research and development office, which we closed in the first quarter of 2004. There was also a reduction of $3.2 million for excess facilities accruals relating to final settlement of obligations associated with previously vacated facilities and favorable subleasing activity in North America.

     Also as a result of the outsourcing of our manufacturing operations, we recorded $1.2 million in charges related to the consolidation of excess facilities in 2003.

     In 2002, we recorded $23.6 million net charges for lease costs for facilities closures, including our manufacturing facility in Ronkonkoma, New York, two research facilities in Virginia and numerous smaller offices. We also recorded additional reserves of $20.4 million for facilities vacated in prior years due to a decline in the real estate sublease market.

Accelerated depreciation on building and equipment

During 2003, due to a change in the estimated lives of certain buildings and equipment because of the outsourcing of our North American manufacturing operations, we recorded $48.5 million in accelerated depreciation on the related buildings and equipment. Of this amount, $23.7 million was charged to cost of revenue during the year with the remaining $24.8 million charged to operating expenses.

Other obligations

We accrued $2.4 million for contract termination costs in 2004 because we failed to meet certain contractual requirements related to volume usage. In addition, we accrued $1.7 million in wage transition charges related to outsourcing our international manufacturing operations. We also reduced a previously established accrual of $0.2 million for software licenses.

     In 2003, we recorded $3.7 million in charges for other obligations that arose as a direct result of our 2003 restructuring activities. These charges represent non-cancelable agreements for software licenses that have been deemed excess due to workforce reductions and product roadmap changes.

     Charges for 2002 included $4.7 million to write down the value of our facility in Ireland, $4.3 million for repayment of local incentive grants and $3.6 million for other fees.

     Of the remaining $46.4 million accruals as of December 31, 2004, $13.4 million is classified as short-term as it is expected to be paid in the next 12 months. The long-term balance of $33.0 million will be paid over the remaining terms of the facility leases, which expire at various times through 2011.

     Of the $109.6 million accruals as of January 2, 2004, $64.8 million was classified as short-term as it was expected to be paid in the next 12 months. The long-term

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balance of $44.8 million was primarily related to excess facilities, and was expected to be paid over the remaining lease terms through 2011.

     The following table displays our restructuring and other charges activity during 2004 and the status of the reserves at December 31, 2004:

     The following table displays our restructuring and other charges activity during 2003 and the status of the reserves at January 2, 2004:

4. Business Combinations

On December 30, 2004, we acquired Vinci Systems, a privately held developer of Optical Networking Terminals for Fiber to the Premise access systems. Under the terms of the agreement, we will pay up to $52.5 million in cash and restricted Tellabs stock related to the acquisition of Vinci. This acquisition enables us to deliver a more cost-effective fiber access solution. In-process research and development costs of $13.1 million related to this acquisition were expensed in 2004 based on a preliminary appraisal.

     On November 30, 2004, we acquired 100% of the outstanding common stock of AFC, a leader in access products, for 0.504 shares of our common stock and $12.00 in cash for each AFC share, for a total value of approximately $1.6 billion ($794.5 million, net of cash acquired) plus liabilities assumed. We issued approximately 44.8 million shares of our common stock for the acquisition, with the cash portion financed with U.S.-based cash and cash equivalents, including AFC’s. AFC’s products enable carriers to provide voice, video and high-speed Internet access over a single network infrastructure. By acquiring AFC, Tellabs became the industry leader in the broadband access market, a market in which Tellabs had not previously been a significant participant. In addition, Tellabs believes that its international distribution channels and deep relationships with regional Bell operating companies will provide growth opportunities for both Tellabs and AFC products not achievable as stand-alone companies. Goodwill and intangible assets from this acquisition were $537.4 million and $185.2 million, respectively. The intangible assets, excluding in-process research and development, will be amortized on a straight-line basis over a weighted average amortization period of seven years. In-process research and development costs of $89.0 million were expensed in 2004.

     Components of the purchase price were as follows:

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     The value of our common stock issued for the acquisition was determined based on an average of our stock price three days before and three days after September 7, 2004, the date of the revised merger agreement. The Black-Scholes option valuation model was used to determine the fair value of the Tellabs stock options exchanged. The deferred compensation represents the intrinsic value of the unvested AFC stock options on the acquisition date, which will be recognized over the remaining vesting period of the options.

     The purchase price allocation for AFC has not been finalized pending completion of appraisals. A preliminary allocation of the purchase price is as follows: