Conference Call Notes and Observations
Lucent Technologies, Inc.
6 Months ended March 31, 2004
please see Disclaimer at bottom of report
This report was last amended on May 25, 2004.
Lucent Technologies, Inc., designs and delivers networks for the world’s largest communications service providers. The reportable segments are Integrated Network Solutions (“INS”), Mobility Solutions (“Mobility”) and Lucent Worldwide Services (“Services”). The INS segment provides a broad range of software and wireline equipment related to voice networking (primarily consisting of switching products, which Lucent, sometimes refer to as convergence solutions, and voice messaging products), data and network management (primarily consisting of access and related data networking equipment and operating support software) and optical networking. The Mobility segment provides software and wireless equipment to support radio access and core networks. The Services segment is a worldwide services organization that provides deployment, maintenance and professional services in support of Lucent’s own product offerings as well as multi-vendor networks.
Notes and observations
1. According to 2Q04 form 10-Q, Lucent claims that market for telecommunications equipment is stabilizing. Yet, Lucent continues to remain cautious.
2. Believes that Service Providers will continue to face challenges in 2004, primarily related to reducing the cost of their operations, while at the same time expanding their service offerings to increase revenues.
3. Mobility revenues increased because of CDMA sales in the US, as certain customers continued to upgrade their wireless networks and deploy additional capacity to support subscriber growth. Sales to Lucent’s largest two TDMA customers represent 1% and 5% of revenue respectively. We are hoping for growth in this area as Cingular with former AT&T Wireless and other TDMA or GSM operators to convert to UMTS.
4. Lucent recognized charges of $246M related to shareowner lawsuit settlement during the 6 months ended March 31, 2004, primarily as a result of changes in the estimated fair value of that warrants that are expected to be issued.
5. A gain of $64M was recognized during the 6 months ended March 31, 2004 related to the maturity of forward sales contract for Corning common stock. This relates to the common stock obtained in F2002 for the sale of the Optical Fiber business.
6. Incurred net charges of $7M related to the early extinguishment of debt during the 6 months ended March 31, 2004. Less of the securities were repurchased by Lucent because of “economically unattractive pricing levels”.
7. Lucent continues its focus on R&D in the area of CDMA, UMTS, VOIP, metro optical and broadband networking solutions. Believes that current R&D spending levels are “aligned with current and expected market opportunities.”
8. Lucent continues to estimate that the Medicare Prescription Drug, Improvement and Modernization Act of 2003 signed on Dec 8, 2003 will reduce the accumulated healthcare benefit by approx $500 million and reduce the expense of providing the prescription drug benefit by an amount less than $50 million annually. If the accounting standard that effects these estimates is finalized in its current form, Lucent expects to 75% of the impact in its
fiscal fourth quarter results. Lucent has elected to defer recognizing the effects of the Act until the plan assets and obligations are remeasured or until there is authoritative guidance issued.
9. Lucent has received “preliminary negative advice” from the IRS regarding its “significant” NOL carryback claim, relating to its 2001 federal net operating loss. Lucent continues to believe that its claim has merit and is in discussions with the IRS.
10. During the three months ended March 31, 2004, INS revenues declined by $41 million. The $87 million decline in the U.S. was primarily due to a reduction in sales to a large service provider due to the completion of certain capital spending programs in the prior periods. This customer reduced its annual capital spending and is assessing the timing of future investment as well. This decline in the U.S. was partially offset by a $46 million increase in non-U.S. regions, primarily in Europe and Other Americas, due to higher sales of access and optical networking products. Five customers accounted for approximately 43% and 41% of INS’s revenues during the three months ended March 31, 2004 and 2003, respectively.
11. Almost 95% of wireless product revenue is derived from CDMA technology. Lucent continues to have UMTS/ W-CDMA trials in China, Spain and Miami Florida. UMTS revenues were not significant during the quarter, but revenues were recognized.
12. Lucent does not expect to receive any significant cash proceeds from business or asset dispositions in the near future. Lucent did receive proceeds of $31M from the sale of a former manufacturing facility in Columbus, Ohio.
13. Since March 31, Lucent has retired $19M of debt (no specific issue noted) for approximately 5M shares of common – implying a $3.80 share price.
14. Revenue from the five largest INS customers represented 43% of segment revenue in 2Q04 up from 41% in 2Q03. Revenue from the five largest Mobility customers represented 85% segment of revenue in 2Q04. This was up from 79% in 2Q03.
15. Lucent has paid $110M in postretirement health care obligations. Lucent expects the total number for F2004 to be $240M. Hence, Lucent has paid 46% of the current obligation. Lucent expects this number to increase to $300M annually and thereafter in F2006. By F2007, Lucent expects the plan assets set aside in trusts to fund retiree benefits to be depleted. Lucent expects funding to increase substantially. If changes are not made in the US plan “would” severely impact Lucent’s ability to stay competitive. These items will be discussed in the collective bargaining discussions later this year.
16. When using Stock Based Compensation, the net income for the 6 months ended March 31, 2004 is reduced from $0.09 to $0.05 per share.
17. Contributions to Pension Plans are not expected to be material during F2004.
18. Lucent discussed its liability from the special purpose trust (ISPT) that contains Lucent’s previously off-balance sheet defaulted customer loans. As of March 31, 2004 Lucent may be required to fund $79M in fiscal ’04 of which $45M has been prefunded in the first half of the year, leaving $34M for the remainder of F2004 and $150M thereafter through 2008.
19. Lucent expects to pay a shareholder litigation settlement of $315M with cash, common stock or a combination of both. The method of payment is at the option of Lucent.
20. On December 24, 2003, Lucent deposited 33 million shares of our common stock into escrow, representing the initial $100 million payment of the settlement amount. These shares were subsequently sold in the market by the escrow agent for $105 million during the second quarter of fiscal 2004. The net proceeds remain in escrow as of March 31, 2004. Lucent will issue warrants to purchase 200 million shares of their common stock at an exercise price of $2.75 per share with an expiration date three years from the date of issuance. As of March 31, 2004, the value of these warrants was $422 million, based upon the Black-Scholes option-pricing model.
In addition to their contributions, certain of their insurance carriers have agreed to pay their available policy limits of $148 million in cash into the settlement fund. Avaya Inc. ( a former affiliate), is contractually responsible under its agreements with Lucent to contribute an additional $24 million to the settlement. In connection with the settlement Lucent is required to pay up to $5 million in cash for the cost of settlement administration and they will pay for certain other costs involved in the issuance of securities. The settlement covers all claims generally relating to the purchase of Lucent securities during different class periods. The primary class period is October 26, 1999 through December 20, 2000.
Lucent expects that the appeals and claims administration process will continue until sometime in the fourth quarter of fiscal 2004 or in early fiscal 2005 and do not expect to distribute any proceeds until that time.
21. As of March 31, 2004, outstanding letters of credit and amounts unused and available to us under these agreements were $183 million and $297 million, respectively.
22. Environmental reserves of $123 million have been established for environmental liabilities that can be reasonably estimated as of March 31, 2004. These reserves are not discounted to present value. We had receivables of $38 million with respect to environmental matters due from third-party indemnitors as of March 31, 2004
23. According to the 10-Q ratings agencies have categorized Lucent’s credit ratings as follows:
|Rating Agency||Long-term debt||8.00% convertible securities||Trust preferred securities||Last Change|
|Standard & Poor’s (a)||B||CCC+||CCC||March 10, 2004|
|Moody’s (b)||Caa1||Caa3||Caa3||March 26, 2004|
(a) Ratings upgraded; ratings outlook is positive.
(b) Ratings affirmed; ratings outlook is positive.
Question and Answers
This is old data from 1Q04. i have not updated. i left it here as a proforma guide for new report
1. When wireless revenues are excluded, revenues were down from $1,393M in Q4’03 to $1,299M in Q1’04, or a decline of 7% . Wireless revenues included a $150M acceptance of previously delayed income. We have previously mentioned that we believe this to be the Reliance Infocom contract in India. Nevertheless, Wireless revenues were up 28% sequentially from Q4’03 when the $150M revenue discussed above is excluded.
2. Optical Networking revenues were down 9% and Data Networking were down 20%.
4. Lucent reminded investors to watch the VOIP landscape. They hinted for investors to watch Lucent announcements on “circuit to packet (c2p)” announcements and VOIP build-outs.
5. VOIP market is possible growth area. Lucent’s Accelerate product addresses the VOIP market. As discussed by Lucent, Nortel was selected by Verizon recently as it’s VOIP equipment provider. We have not disseminated the reasons for Nortel’s selection over Lucent. The Nortel selection by Verizon should be watched closely by Lucent investors. Future announcements of VOIP equipment providers should be watched as well. Lucent as a large legacy circuit switch installed base and market share will be interesting to watch as legacy networks converge to VOIP platforms. The argument of Lucent’s possible future in this area, was described by someone I know as the following, ” This is a very complex issue which could take a page or two to explore in detail, but here’s an overview.
NT has a working softswitch which has been deployed. Lu has a concept that will be ready in about a year. Verizon selected a working switch versus a concept. Lu has VoIP equipment like the OIU, Optical Interface Unit, that will allow the 5E to receive VoIP data. After VoIP switches are deployed, I would imagine that there would be lots of work in the 5E switches to allow them to receive VoIP traffic.
The big advantage that Lu has is the thousands of 5E switches presently deployed in the US. Lu will develop an evolutionary solution to VoIP that will enable the BOCs to evolve their existing 5Es to VoIP rather than pulling them out and replacing them with softswitches. This latter option would be extraordinarily costly and would be virtually impossible to justify with a business case.
Keep in mind that it took 25 years for the BOCs to replace their analog switches with digital switches, and this was when they had enormous cash at their disposal because of their monopoly status. So don’t expect VoIP to be fully deployed in a few years. The vast majority of subscribers couldn’t care less if their calls were switched with softswitches rather than circuit switches. Unless the BOCs will offer significant discounts, I just don’t see the drivers for universal softswitch deployment. Moreover, there are still hurdles to be overcome with VoIP like “dropped packets” that will affect QOS, and there are security issues.”
6. We have read that AT&T Wireless is trialing Lucent’s 3G/UMTS solution. We do not know how a buy-out of AT&T Wireless would affect the timing or the selection of a WCDMA deployment. We also have read that Lucent has WCDMA trials underway with T-Mobile, Telefonica and China Netcom.
7. DSO’s (Day’s Sales Outstanding) decreased from 67 days to 63 days from the Q4’03.
8. Gross Margin was 41%. This was down from Q4’03 gross margin of 43%. Lucent guided down gross margin during the Q4’03 conference call. The 41% Gross Margin was in excess of our anticipations. Nevertheless, this is merely one quarter’s reporting and we will merely continue to monitor the margins.
9. Lucent issued warrants in relation to its shareholder lawsuit settlement. The warrants are expected to be issued late in calendar year 2004. Until the warrants are issued, Lucent is required to mark the warrants to market. Hence, if Lucent’s stock price goes up, the mark to market of the warrants will cause a non cash charge, which will bring down GAAP earnings per share. CFO, D’Amelio mentioned during the call that if the warrants were marked to market at this time, the charge would be around $300M. Keep in mind that the price of Lucent common at that time was approximately $4.70 per share. This is a confusing topic and we will need to explore the full dilution levels as the 10Q is released. We have always emphasized the importance of using GAAP results as opposed to Pro-Forma results. This is a rare time that the warrant effect on eps should be considered during analysis.
10. Pension income was $201M. Hence if Pension income was not included as a reduction of operating expenses, operating income would have been $70M and not $271M. Lucent’s reporting seems totally GAAP proper. We just need to emphasize that the cash flow is not affected by this item and it is our belief that pension income should not be looked at as normalized earnings. Lucent’s operating margin is 12% as reported, without the pension income, the net operating margin would be 3.1%.
11. Focus on forward revenues. This industry has a history of lumpiness in both margins and revenue flows. The telecom networking industry is hopefully coming out of a depression, and at the same time remains both a disruptive and infant industry.
12. The big surprise for us this quarter was the dilution factor from the warrants. The warrants and dilution has a material effect on market capitalization.
13. Net Income $338M, less Pension Income inclusion of $201M, less tax benefit $101, equals net adjusted normalized income of $36M. Total fully diluted shares outstanding are 5,136M, hence eps would be 36/5136 or .007 per share, which is less than a penny.
Net Income $338M
Pension Income ( 201)
Tax benefit (101)
Normalized Net Income $36M
Fully Diluted Shares Outstanding 5,136M
Normalized Earnings Per Share $0.007
14. Market capitalization with 4,178M shares (last quarters fully diluted) at a price of $5 would be $20,890,000,000, whereas market cap with current fully diluted of 5,136M would be $25,680,000,000. Hence market cap increased by dilution alone by almost 5 billion dollars. That is not minor dilution, especially considering that market capitalization was $10.5 billion at Q4’03 conference call.
15. Lucent’s price dropped about $1.00 off of its pre-earnings release high of $5.00, to a post earnings low of near $4.00. That is a drop of $5 billion dollars. The potential of that fall is that Wall Street adjusted Lucent for the new dilution and addition of 1 Billion shares.
16. We have heard, without confirmation, that Lucent had two 10% customers during the quarter. The two alleged greater than 10% customers are Verizon and Sprint.
17. Lucent has not proven itself in IP based products. Lucent abandoned several soft-switches over the last few years. Lucent has since teamed with Juniper in attempts to become a prominent player in this market. Customers of Lucent and most long term industry watchers, realize that Lucent needs to be a “show me ” company to the industry. Lucent, in our opinion has earned its “show me” status, as is discussed in many Financial Statement Analysis text books, billion dollar shareholder lawsuits, SEC investigations, revenue recognition methods, massive write offs from their mergers and acquisitions, as well as a golf course in the hills of Jersey. It is our belief that the convergence of networks from the traditional switch (PSTN) to IP based networks is in its infant stages. It is vital for Lucent to become prominent and threatening in this area. The team up with Juniper gives Lucent the ability to gain traction now. The margins with Juniper will be smaller than if produced solely by Lucent. We think the Juniper relationship and strategy is proper for Lucent at the moment. There has been discussion on Lightreading.com , that Lucent and Sonus are looking to team up. This of course is mereley speculation and noise, yet, it was interesting to read.
18. We have read and have not verified that Lucent contributed $30M for post retirement benefit plans during the quarter. Lucent has previously discussed a $300M funding level for F2004.
19. Lucent will fund approximately $315M in either cash or stock sometime in calendar 2004 (our guess as to the timing, although Lucent mentioned “early F2005” during the call) for the shareholder litigation settlement.
Some “ back of the envelope” financial observations
1. Current Ratio (Current Assets / Current Liabilities) .
The following table lists prior Current Ratios :
December 31, 2003 1.39
September 30, 2003 1.56
September 30, 2002 1.40
September 30, 2001 1.60
September 30, 2000 2.00
September 30, 1999 2.10
September 30, 1998 1.50
September 30, 1997 1.20
September 30, 1996 1.20
2. Accounts Receivable decreased $390 million from Q4’03, sales increased $232M from Q4’03. Receivables appear to be managed properly, yet revenues are so low, that this ratio is not as valid. If Lucent ever reaches revenue stability, this ratio should prove to be a more useful indicator.
Accounts Receivable Turnover ratio (Sales/Average Accounts Receivable). On the face, this has shown improvement. Just another metric to watch.
The following table lists prior Accounts Receivable Turnover Ratios :
December 31, 2003 5.5
September 30, 2003 5.6
September 30, 2002 3.9
September 30, 2001 3.2
September 30, 2000 3.3
September 30, 1999 3.3
September 30, 1998 3.8
September 30, 1997 5.4
September 30, 1996 3.1
3. Inventory increased $58M. Again, if we extrapolate F2004 revenues to an arbitrary $8.5B, the Inventory/ Sales ratio would be 8%. Inventory / Sales Ratio at F2003 was 7.50%, F2002 was 11.06 %, F2001 was 17.12 % and 17.65 % in F2000.
Inventory Turnover ratio (Cost of Sales/ Average Inventory) . On the face, this has shown improvement. Just another metric to watch. We have calculated this by using trailing 4 quarters of inventory to determine the average inventory.
The following table lists prior Inventory Turnover Ratios :
December 31, 2003 7.2
September 30, 2003 6.6
September 30, 2002 4.3
September 30, 2001 4.1
September 30, 2000 3.7
September 30, 1999 3.7
September 30, 1998 4.2
September 30, 1997 4.9
September 30, 1996 2.8
4. Quick Ratio (CA- Inventory)/CL .
The following table lists prior Quick Ratios :
December 31, 2003 1.26
September 30, 2003 1.44
September 30, 2002 1.20
September 30, 2001 1.20
September 30, 2000 1.50
September 30, 1999 1.60
September 30, 1998 1.10
September 30, 1997 0.90
September 30, 1996 0.90
5. Research and Development was $292M, or 12.93% of revenues. At December 31, 2002 it was 18.75 % of revenues. The last known guidance I can recall regarding R&D is that Lucent claims it will level out at 12 %. This was discussed by Lucent in 2001. I believe that management intends on keeping the ratio in the 15% range.
The following table lists prior Research and Development to Sales Ratio :
December 31, 2003 12.93
September 30, 2003 16.50
September 30, 2002 18.75
September 30, 2001 16.53
September 30, 2000 11.00
September 30, 1999 13.10
September 30, 1998 15.05
September 30, 1997 11.54
September 30, 1996 11.59
6. Flow Ratio is 0.72. The Flow Ratio is desired to be less than 1.25. Here are the givens : Current Assets = $7,406, Cash = $4,277, Current Liabilities = $5,330 and Short Term Debt = $917.
The Flow ratio is similar to the Cash ratio, except it includes a reduction of short term debt from current liabilities. It is similar to the Quick Ratio.
Flow Ratio = (CA – Cash) / (CL – STD) = 0.71. Interesting to notice an improvement in this ratio over the last few years. Since the industry and company are in a depression, I do not believe that definite relevance can be established. On the face, it does look like financial management is being optimized.
The following table lists prior Flow Ratios :
December 31, 2003 0.71
September 30, 2003 0.72
December 31, 2002 1.09
September 30, 2002 0.76
December 31, 2002 1.48
September 30, 2001 1.52
September 30, 2000 2.85
September 30, 1999 2.35
September 30, 1998 1.69
September 30, 1997 1.36
September 30, 1996 1.26
7. Total Asset Turnover Ratio is ( Sales/ Total Net Assets). Generally, the higher the multiple, the more efficient the company. The industry standard, which I have quickly , unofficially and haphazardly appears to be between 0.80 to 1.10. Like other ratios here, this is merely a ratio to watch.
The following table lists prior Total Asset Turnover Ratios :
December 31, 2003 0.59
September 30, 2003 0.54
September 30, 2002 0.69
September 30, 2001 0.63
September 30, 2000 0.61
September 30, 1999 0.76
September 30, 1998 0.83
September 30, 1997 1.16
September 30, 1996 0.70
8. Gross Margin (Cost of Sales/Sales).
The following table lists prior Gross Margin Percentages :
December 31, 2003 40.7 quarter only
September 30, 2003 31.3
September 30, 2002 12.6
September 30, 2001 15.3
September 30, 2000 40.5
September 30, 1999 48.0
September 30, 1998 46.9
September 30, 1997 44.5
September 30, 1996 41.4
9. Operating Margin Percentage ( Operating Income (loss)/Sales). I believe that Lucent’s ultimate goal is a 10% to 15% margin.
The following table lists prior Operating Margin Percentage :
December 31, 2003 12.00 quarter only, includes pension income
September 30, 2003 ( 0.03)
September 30, 2002 (54.40)
September 30, 2001 (90.50)
September 30, 2000 9.40
September 30, 1999 14.00
September 30, 1998 8.00
September 30, 1997 5.80
September 30, 1996 3.10
10. Net Profit Margin Percentage (Net Income (Loss)/Sales). I believe that Lucent’s ultimate goal is a 10% margin.
The following table lists prior Net Profit Margin Percentage :
December 31, 2003 15.45 quarter only, includes pension income/tax benefit
September 30, 2003 (13.70)
September 30, 2002 (96.98)
September 30, 2001 (76.20)
September 30, 2000 4.20
September 30, 1999 17.70
September 30, 1998 4.40
September 30, 1997 1.60
September 30, 1996 1.40
11. Return on Equity (ROE) Net Income/Equity . There are more thorough ROE formulas, such as “The Dupont Formula”, but for this, we will use the simple calculation.
The following table lists prior ROE :
December 31, 2003 N/A
September 30, 2003 N/A
September 30, 2002 N/A
September 30, 2001 N/A
September 30, 2000 6.10
September 30, 1999 44.30
September 30, 1998 19.20
September 30, 1997 14.80
September 30, 1996 10.90
12. Long Term Debt to Equity .
The following table lists prior Long Term Debt to Equity :
December 31, 2003 N/A
September 30, 2003 N/A
September 30, 2002 N/A
September 30, 2001 29.70
September 30, 2000 11.60
September 30, 1999 29.90
September 30, 1998 31.20
September 30, 1997 49.20
September 30, 1996 60.80
12. Times Interest Earned Ratio . This ratio measures the ability to meet interest payments. Formula is Earnings before Interest and Taxes (EBIT)/ Interest Expense. This is also referred to as the “Interest Coverage Ratio”.
The following table lists prior Times Interest Earned Ratio :
December 31, 2003 3.98 Quarter only, includes pension income
September 30, 2003 (18.40)
September 30, 2002 (17.50)
September 30, 2001 (37.40)
September 30, 2000 7.90
September 30, 1999 13.00
September 30, 1998 14.40
September 30, 1997 7.10
September 30, 1996 2.70
13. Total Liabilities to Total Assets Ratio .
The following table lists prior Total Liabilities to Total Assets Ratio :
December 31, 2003 124.86
September 30, 2003 121.41
September 30, 2002 117.20
September 30, 2001 61.80
September 30, 2000 44.90
September 30, 1999 60.60
September 30, 1998 73.70
September 30, 1997 85.80
September 30, 1996 88.10
14. Weighted Average Shares Outstanding .
December 31, 2003 5,136
September 30, 2003 4,178
September 30, 2002 3,427
September 30, 2001 3,401
September 30, 2000 3,232
September 30, 1999 3,102
September 30, 1998 3,025
September 30, 1997 2,895
September 30, 1996 UNK
13. Total Shares outstanding are 5,136M. Current market price is $4.70. Hence, market capitalization is $24,139M. The current Price to Sales multiple is 2.85X , using revenues of 8,470M. If we add Long Term debt of $4,421M to the $24,139M Market Capitalization, we get a total Enterprise Value (EV) of $28,560M. The EV to Sales Ratio in this case would be 3.37X. It is interesting to note that Price to Sales ratio at September 30, 2003 was 1.24X.
14. Company was Free Cash Flow negative in the quarter. Net Cash used in operations was ($257M).
15. Altman Z would be an interesting calculation. I will continue another time.
Items which were not resolved and perhaps need to be reviewed
1. Discuss potential currency fluctuations. Frank previously mentioned at NYC analyst meeting that currency fluctuations do not affect Lucent.
2. Pension funding issue, has been and remains a future concern of ours.
3. Fully review dilution issues with warrants when 10Q comes out.
4. Review Net Operating loss issues and try and determine if Lucent forfeited any future NOL’s with an IRS settlement.
5. Review normalized earnings calculations and look at projected future cash flow. Compare this to EBITDA.
If you are a client of ours, and if you have questions regarding Lucent, please call our office. If you are not a client of Redfield, Blonsky & Co. LLC Investment Management Division and are reading this report, we urge you to do your own research. We will not be responsible for any person making an investment decision based on this report. This report is a “by-product” of our research. We are not responsible for the accuracy of this report. We are not responsible for errors that may occur in this report. Please do not rely on us to monitor or update this or any other report we may issue. In theory, we could come across some type of data or idea, which causes us to eliminate Lucent from our portfolios. This report has undergone revisions starting on January 25, 2004. We will not notify readers of future revisions. We are not responsible to keep readers of this report updated for changes or material errors or for any reason whatsoever. This report is dated January 25, 2004; it is possible that by January 26, 2004 we could have eliminated our entire Lucent position without giving notice to any reader of this report. We manage portfolios for clients, and those clients are our greatest concern as it relates to investing. Certain clients of Redfield, Blonsky & Co LLC may not have Lucent Technologies in their portfolios. There could be various reasons for this. Again, if you would like to discuss Lucent Technologies, please contact Ronald R. Redfield, CPA, PFS (partner in charge of investment management division).
Information herein is believed to be reliable, but its accuracy and completeness cannot be guaranteed. Opinions, estimates, and projections constitute our judgment and are subject to change without notice. This publication is provided to you for information purposes only and is not intended as an offer or solicitation. Redfield, Blonsky & Co. LLC and Ronald R Redfield, CPA, PFS, may hold a position or act as an advisor on any investments mentioned in a report or discussion.