UPDATE 3-Tellabs profit up; sees weak economy continuing

(Updates with share move, analyst comment)

By Ritsuko Ando

NEW YORK, July 22 (Reuters) - Network equipment maker Tellabs Inc (TLAB.O) reported a stronger-than-expected quarterly profit on Tuesday, boosting its shares more than 6 percent, although the CEO said the economy was making customers cautious and a recovery could be as late as 2010.

Tellabs, a supplier to major phone companies like AT&T Inc (T.N), Verizon Communications Inc (VZ.N) and Sprint Nextel Corp (S.N), said earnings for the second quarter rose to $39 million, or 10 cents a share, from $29.6 million, or 7 cents a share, a year earlier.

Excluding a one-time tax benefit, earnings would have been 1 cent per share, better than the average analyst estimate for a loss of a penny a share, according to Reuters Estimates.

Quarterly revenue fell 19 percent to $432.5 million, a bit below Wall Street's average forecast of $433.6 million but within the company's own April estimate of $425 million to $445 million.

Analysts also noted a stronger-than-expected profit margin, helped by cost cuts related to sales of its 7100 ROADM system and 1600 optical network terminals (ONTs).

"Gross margins were a bright spot as Q2 gross margin of 35 percent was well above our estimate and guidance of 31.0 percent, driven by better gross margins from 7100 ROADMs, 1600 ONTs and general cost containment," said J.P. Morgan analyst Ehud Gelblum.

Despite the margin improvement and gains in the shares, most analysts were cautious about the outlook as Tellabs forecast third-quarter revenue to be "flat to slightly down" and said it expected economic risks to keep weighing on customers' spending.

"Tellabs is making progress trimming costs, but we see a slim chance of the top line reaccelerating in the near term," said Bank of America analyst Tim Long.

Tellabs Chief Executive Rob Pullen said customers appeared concerned about weaker consumer spending and the housing market. A decline in housing starts is seen as limiting the expansion of high-speed Internet connections.

"When it comes to the real estate market, the housing market here in the United States is showing continued softness and both I and our customers see that continuing into next year, unfortunately," Pullen said in an interview.

"We do expect it to continue for the next few quarters. We don't have great visibility, but we would hope for a recovery in the end of '09, 2010 time frame," he said.

The company said it expects to lower operating expenses in the third quarter as part of a $100 million cost-reduction plan announced in January, although it forecast gross margins to be flat.

But Gelblum said he had expected higher third-quarter revenue. "We believe slowing growth and contracting valuations could catalyze communications equipment industry consolidation as evidenced by last night's Brocade-Foundry deal," he said.

Data storage switch maker Brocade Communications Systems Inc (BRCD.O) announced on Monday that it plans to buy Foundry Networks Inc FDRY.O, which makes data networking switches, for around $3 billion to bulk up its product line.

The move is seen helping it compete with bigger rival Cisco Systems Inc (CSCO.O), which sells a broader range of network equipment.

Pullen said Tellabs had no imminent acquisition plans, although he would not rule out such a move in the future.

Tellabs shares rose 32 cents, or 6.8 percent, to $5.01 in late afternoon trade on Nasdaq. (Editing by Gunna Dickson, Gary Hill)