July 23, 2002
Conference Call Notes and Observations
Lucent Technologies, Inc.
9 Months ended June 30, 2002
please see Disclaimer at bottom of report
This report was amended on August 17, 2002.
Lucent Technologies, Inc. designs and delivers networks for the world’s largest communications service
providers. Backed by Bell Labs research and development, Lucent, claims to rely on their
strengths in mobility, optical, data and voice networking technologies, as well
as software and services, to develop next-generation networks. Lucent, claims that their systems,
services and software are designed to help customers quickly deploy and better
manage their networks and create new, revenue-generating services that help
businesses and consumers.
Notes From Conference Call
Pat Russo :
1. Progress in 3rd fiscal quarter, despite the difficult environment.
2. Disappointed in revenue levels. Seeing more Capex reductions and financial casualties. Visibility remains poor. Lucent is responding swiftly.
3. 4 Specific Improvements
a. gross margin improvement
b. operating expenses down sequentially
c. improved operating cash flow (first time in 3 years with positive operating cash flow)
d. reduced commitments for vendor financing. Improved by over 12 %
4. Pat mentioned to extend reach among business partners.
1. Lucent took a deferred tax assets charge as described in SFAS 109. Lucent seemed disappointed in the GAAP applications of this rule (that is my view only ). It was made clear that this is a non cash asset. Does not effect business operations, gross margins and customer operations. Continues to target profitability in F2003.
2. discussed positive metrics of the expense section. This includes restructures, gross margins, vendor financing.
3. targets another headcount reduction of 7000 employees. This is expected by December 31, 2002 and should bring employees down to 46,000.
4. Impairment charge of Springtide acquisition.
5. New EPS breakeven target of 3.5 billion. Even in these conditions, Lucent can bring breakeven below 3.5 billion.
cash flow is claimed to be positive
making progress in several areas. Lucent without the charges lost 0.16 per share. I have to review this, as I have skepticism with this type of match up. Operating cash flow improved.
8. No guidance for the future will be given due to lack of visibility.
1. A number of strategic wins. One mentioned was the Verizon win of DWDM in the Metro areas. IP Centrics by SBC Communications. British Telecom 5 year contract for services and support. Lucent thinks this will lead to future contacts. Many CDMA new contracts. Comcast relationship for VOIP (Voice over IP).
2. Expects service business to lead revenue growth. Lucent is looking now to expand this business. Thinks it is a $ 55 billion dollar market in 2001. Claims market share is currently small and could be a growth market. Engineering, maintenance and professional services are offered. This is a high margin revenue opportunity. Focusing on business partners and will discuss that in the future. Looks to strengthen sales leadership team.
Question and Answers
1. Lehman Brothers (Steve Levy), asked why SFAS 109 decision was made now rather than previously. Lucent’s answer was the lack of visibility, decline of revenues, decrease of earnings, the necessity of restructuring for lower break even and extensive discussion with auditors (Price Waterhouse Coopers), hence appropriate to take charge this quarter.
2. Goldman Sachs asked which businesses are seeing better profitability. Goldman also asked about reduction of shareholder equity and how that could impact business.
a. Frank indicated that no forward impact on the business with the equity reduction.
b. Mobility is having the greatest impact on the business. In terms of services, revenues were 630 million, wireless down 10 %, switching down 20 % and optics down about 25 % ( I need to verify these numbers).
3. JP Morgan asks about regional strengths and weakness.
a. North American went to 2,050 b, international to 890m. China was down this quarter.
b. Book to bill will not be discussed.
4. John Wilson asked for cash charges still to come.
a. Cash required for all restructuring will be approximately 1 billion. This factors in all existing restructuring.
b. $ 218 million was used this quarter in restructuring. Claims that they are using less cash than planned.
5. Dresdner asks about cost reduction initiatives. The answer is purchasing, key supplier relationships, due diligence for competitive pricing from suppliers, looking closely at supply chain management. Pat Russo added to this and clarified that supply chain means “working with suppliers from the suppliers methods as well as rigorous workings to determine that customer gets the proper product. Pat says focus on entire chain in the costing efforts. Pat claimed that Lucent internally has integrated to help with supply chain management ( to me this is typical conference call discussion and has little meaning).
6. Frank mentioned that they do not expect revenues of 2.50 billion.
7. Sanford Bernstein asked about Wireless going forward, in light of some completions of CDMA 1X rollouts (Verizon for example). Lucent mentioned that completions are near, but new business is kicking in. Lucent would not comment on current contracts. Pat mentioned that China , India, Korea has a lot of CDMA activity. Mentioned that activity is large in South East Asia and Latin America.
8. Question as to when credit line is coming due ? Will credit line be rolled over ? Is there restricted cash on Balance Sheet ?
a. current credit expires in February 2003, negotiations will begin in calendar 4th quarter.
b. restricted cash is about 300 million.
9. There were two 10 % customers. Lucent would not disclose who they were.
Some “ back of the envelope” financial observations
1. Days Sales Outstanding (DSA) stayed relatively flat at 78 days from 77 days ( It was 98 days at December 31, 2001).
2. Debt to Equity ratio is now at 476.89 % ((173+1750+3237)/1082 ). This is a substantial and concerning increase to the prior Debt to Equity ratio was 50.38 % ( (82+1750+3238)/10064). According to my notes prior Debt to Equity was 40 % in Q4’01, 25 % in F2000, 42 % in F1999 and 35 % in F1998.
3. Current Ratio (Current Assets / Current Liabilities) has fallen to 1.72 from 2.14 at March 31, 2002 and 1.86 at December 31, 2001 and 1.58 at September 30, 2001. We have obviously seen deterioration in this ratio. Much of the decline in the ratio is attributable to the SFAS 109 write down of deferred assets.
4. Accounts Receivable decreased $ 592 million from Q2’02, while sales decreased $ 567 M. If you project revenues to $11 B for F2003 (not our projection, just a “what-if “ argument) then A/R as a % of revenue would be 20 %. Accounts Receivable, as a % of Revenues was 21.57 % in F2001, 28 % in F2000, 29 % in F1999 and 23 % in F1998.. I previously commented that the 28 % in F2000 was “very acceptable”. This is an area that appears to being managed efficiently. This is an area we need to continue to watch as deterioration could come quickly if the business climate continues to deteriorate.
5. Inventory decreased $ 432 M from Q2’02. Again, if we extrapolate F2003 revenues to an arbitrary $11 billion, the Inventory/ Sales ratio would be 18 %. Inventory / Sales Ratio at F2001 was 17.12 %. This compares to 17.65 % in F2000. Not much of a change, yet Inventory turns is a much better comparison.
6. Acid Test Ratio (CA- Inventory)/CL is 1.41 , whereas it was 1.79 at March 31, 2002, 1.51 at December 31, 2001, 1.22 at September 30, 2001, 1.01 at the end of F2000 and 1.14 at the end of F1999.
7. Flow Ratio is 1.45. This continues to slightly improve. The flow ratio is desired to be less than 1.25. Here is the formula : Current Assets = $ 11,103, Cash = $ 4,556, Current Liabilities = $ 6,401 and Short Term Debt = $ 173.
Flow Ratio = (11,103 – 4556) / (6,401 – 173) = 1.45. The ratio was 1.45 on March 31, 2002, 1.48 on December 31, 2001 and 1.52 in F2001, 2.85 in F2000 and 2.36 in F1999.
You can read about the Flow Ratio at this link
Review of the 10Q
1. Preliminary review shows that book value has changed from earnings release. Net Loss at earnings release was $7,906, whereas the true number is 8,068, a difference of $162M. In terms of book value that is a further reduction of $0.05 per share. Book Value is $0.27 per share (920/3428.5). Tangible Book Value is $0.16 per share ( (920-367)/3428.5). At the moment, I am not familiar with what other assets are. Other assets are worth 2,364 or $0.69 per share.
2. Research and development is 16.3 % of revenues for the quarter ( 9 months ended ratio was nearly the same). Keep in mind that Lucent has discussed target of 12 % for about a year + now. Lucent has spent $1625 on R&D this year, compared to $2,775 last year for 9 months. R&D is considered to be vital to the existence of Lucent. An investor has to understand that even if Lucent dropped to $10 billion of annual revenues, that R&D would still be targeted for funding of $1 billion dollars (that is a lot of money ).
3. S,G&A is 29.50 % of revenues for the quarter ( 9 months ended was nearly the same).
4. Interest Expense appears stable.
5. The 10Q shows Other Current Assets at $1,287m, whereas earnings release was $153m less at $1,134.
6. The 10Q shows Other Current Liabilites at $4,240m, whereas earnings release was $315m less at $3,925.
7. Hence the Current ratio decreased from an earnings release reported of 1.72 to 1.66.
8. From 10 Q…
” net employee separation charges of $358 for approximately 7,000
employees, of which $124 is expected to impact cash. The remainder of
the charge was for pension termination benefits of $101 for certain U.S.
employees expected to be funded through Lucent’s pension assets and $133
for pension, postretirement and postemployment benefit curtailment
charges (see Employee separations below for additional information on
headcount reductions); ”
This is an interesting way for Lucent to be paying severance. It historically has been called FMP (Force Management Program). AT&T is undergoing one now and has called it FMPC (Force Management Pension Credit). Lucent appears to be doing this via the retirement plans , as opposed to operating cash. This is $234m that will not have any affect on cash. It could, and our opinion, most certainly will affect the retirement plans. Ultimately , it is our opinion, that Lucent will have to pay the price, by being required to fund the retirement plan. Right now this appears to be a band aid process, with the ultimate purpose of immediate cash flow management.
9. From 10Q Debt.
“On March 19, 2002, Lucent Technologies Capital Trust I (“the trust”) completed
the sale of 1,750,000 7.75% cumulative convertible trust preferred securities
for an initial price of $1,000 per share for an aggregate amount of $1,750.
Lucent owns all of the common securities of the trust. The trust used the
proceeds to purchase 7.75% convertible subordinated debentures issued by Lucent
due March 15, 2017, which represent all of the trust’s assets.”
redeem the debentures, in whole or in part, for cash at premiums ranging from
103.88% beginning March 20, 2007, to 100.00% on March 20, 2012, and thereafter.”
“In connection with this transaction, Lucent incurred approximately
$46 of expenses that are deferred and are being amortized over the life of the
” Holders of trust preferred securities are entitled to receive quarterly cash
distributions commencing June 15, 2002. The ability of the trust to pay
dividends depends on the receipt of interest payments on the debentures. Lucent
has the right to defer payments of interest on the debentures for up to 20
consecutive quarters. If Lucent defers the payment of interest on the
debentures, the trust will defer the quarterly distributions on the trust
preferred securities for a corresponding period. Deferred interest accrues at an
annual rate of 9.25%. Each trust preferred security is convertible at the option
of the holder into 206.6116 shares of Lucent common stock”
10. Lucent has basically streamlined its business so that the revenue mix is 50/50 between Mobility Solutions (think wireless and 3G) and Integrated Network Solutions (INS) (think transportation of data via fiber optic cables and traditional telecom equipment). Much of INS is composed of revenue generators such as Circuit Switching, Core, Metro, Long Haul and Ultra Long Hall markets, IP services for all level of data management. Multiservice Core/Edge Switching, DSL market (although in question with the recent Stinger cut back in West Lake CA), IP Service Control Layer, which focuses on the Springtide switches (If anyone knows more of this, please let us know). Lucent’s revenues as of June 30, 2002 are split near 50/50 between US Sourced and Non US Sourced revenues.
11. A new stock option grant will become effective around November 25, 2002. This program will reissue option grants to individuals who were granted options between October 22, 2001 and April 22, 2002. Individuals will be given the grant of 123.2 M shares. The exercise price of these options will be at least equal to the FMV of the common stock at grant date. If the stock stays at $1.50 the dilution would be around $351M . The dilution appears to be less than 3 % of issued common shares. This does not appear to be shareholder unfriendly on the face of it.
12. Lucent did indicate in the March 31, 2002 10Q under the heading of Management Discussion that they do believe they will eventually use $5.20 billion of tax credits and net operating losses based on forecasted taxable income in the future. They did not describe the time period, but it did indicate that this was expected prior to expiring situations. Lucent described in the June 30, 2002 10Q that they reflected on SFAS 109 ” Accounting For Income Taxes” and have written down this asset (as mentioned earlier this was $7,900m of the current loss). Lucent’s tone in the Conference Call was that they did this write down to comply fully with accounting rules. They mentioned that they would have a better idea of realization when the industry produces more visibility
13. Five Mobility customers represented 75 % of Mobility Solutions revenue for the 9 months ended June 30, 2002.
14. Restructuring Program discussion :
A. actions committed to during April 1, 2002 through June 30, 2002 are expected to have an annual cash savings of $700 million, of which $400 million is expected from operating expenses.
B. total cash requirements of program are expected to be $2.3 billion. Approximately through June 30, 2002 , $1.3 billion has already been paid. Hence another $1.0 billion will be used within the fiscal year. Lucent indicated that of the $1.0 billion left over that $430 million is for lease obligations and that those payments will be made for a “longer period”.
15. Lucent has arranged for an amendment of its credit facility which expires in February 2003. This amendment allowed for an EBITDA loss of $325 million and $300 million for the next two quarters.
16. Lucent sold off a fiber optic cable company to Corning on July 24, 2001 for $225 million. Lucent is now discussing whether a portion of the proceeds may be paid in Corning common stock. This transaction is expected to close prior to September 30, 2002.
17. Here is what Lucent says about her credit ratings in the 10Q
Our credit ratings as of August 9, 2002, are as follows:
Long-term preferred preferred
Rating Agency debt stock securities Last update
————- ——— ———— ———- ————-
Standard & Poor’s B+ (n) CCC+ CCC+ August 5, 2002
Moody’s B2 (n) Caa2 Caa1 March 22, 2002
Fitch B+ (n) CCC+ CCC+ June 13, 2002
(n) Ratings outlook is negative.
Our credit ratings are below investment grade. As a result of past downgrades,
we no longer have the ability to participate in the commercial paper market and
are unable to sell trade and notes receivables to the Trust (see Customer
finance commitments). In addition, a credit downgrade affects our ability to
enter into and maintain certain contracts on favorable terms, and increases our
cost of borrowing.
18. Special Purpose Entities (SPE’s)
SPE’s are what caused the demise of Enron. SPE’s give companies the ability to legally avoid showing certain debts and obligations on a companies consolidated financial statements. Lucent has SPE’s in existence for the ” sales and securitizations of receivables and in real estate financing arrangements”. Lucent goes on to mention that The Financial Accounting Standards Board (FASB) is currently reviewing these rules, and are considering the requirement to consolidate these SPE’s. Lucent identifies its exposure in the 10Q as the following :
A. adding $350M of long term notes receivable and debt obligations to the balance sheet. Lucent did not indicate whether the debt obligations would be short or long term in duration. One could assume the wording to mean long term , but if this is a concern to the reader, it should be independently verified.
B. there is what is called a synthetic lease that if consolidated would result in adding approximately $100 million of Land and Buildings and debt obligations to their balance sheet.
19. What is Lucent’s banking definition of Net Worth ? Lucent mentions in the 10Q that there are minimum net worth requirements that are defined under the credit facility. We discussed the covenants with Lucent. According to Lucent they are in compliance with the Credit Facility covenants in 3Q02. Here was their reply to our question.
In accordance with the February 22, 2001 8K:
The Credit Facilities contain financial covenants that require Lucent to have a minimum net worth and minimum earnings before interest, taxes, depreciation and amortization (EBITDA). The minimum net worth required is $23 billion. The calculation of the net worth covenant will exclude certain items, such as the financial statement accounting effects of the expected Agere IPO and expected Distribution referred to below, certain business restructuring charges, other nonrecurring expenses and gains, and accounting changes.
However, on June 13, 2002 Lucent filed an 8K which amends the definition of net worth:
Amendment to Section 1.01 of the Credit Agreement. (a) The definition of “Consolidated Net Worth” in Section 1.01 of the Credit Agreement is hereby amended by (i) deleting the word “or” at the end of clause (f) and substituting in lieu thereof a comma, (ii) deleting the period at the end of such definition and substituting in lieu thereof a comma and (iii) adding the following new clauses (h) and (i):
(h) any non-cash charges for establishing valuation allowances on deferred tax assets taken in accordance with Statement of Financial Accounting Standards Number 109 or (i) any non-cash charges for impairment of goodwill and other acquired intangible assets taken in accordance with Statement of Financial Accounting Standards Number 121 or 142.
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 August 17, 2002. 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 July 23, 2002 ; it is possible that by July 24, 2002 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).
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