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Alcatel-Lucent (NYSE:ALU)

Q4 2012 Earnings Conference Call

February 6, 2013 7:00 a.m. ET

Executives

Ben Verwaayen - CEO

Paul Tufano – COO & CFO

Analysts

Francois Meunier - Morgan Stanley

Gareth Jenkins – UBS

Johannes Schaller – Deutsche Bank

Achal Sultania – Credit Suisse

Sandeep Deshpande – JP Morgan

Alexandre Peterc – Exane BNP Paribas

Didier Scemama – Bank of America Merrill Lynch

Sebastien Sztabowicz – Landsbanki Keppler

Ben Verwaayen

So good morning, good afternoon, good evening, depending on where you are. Thank you for joining us for the Q4 call. As you may know we have issued this morning two public statements. One about the results and one about me. I propose that I go through the presentation on the Q4 and what I have to say, and then make a logical step to, maybe give you some background about why we have a statement about my future position as well. If you don’t mind that will be, I think a great way to do it.

So let me just start by drawing attention to one of the favorite charts that we have every quarter, the safe harbor. I would encourage you to read it your leisure but it’s an important piece of information. Q4, if I would bring it together, Q4, I would say, our performance plan is starting to pay. That is the message that Q4 has. And I would like to remind you on the points of our performance plan. First of all it is focus on cost and cost reduction. Second, on being selective and making sure that you make your selection not just on distribution but also on the portfolio and a certain element is to focus on cash.

And if you look to our performance in Q4 and Paul will go into detail, but if you look to those points, you can see that all of those three elements of our performance plan are starting to work. And my suggestion is that they will contribute in the way forward. So the first one is cost. We did better than we forecasted. Our cost saving is really going now into all the mains of the business, especially also in SG&A. And that’s important because it has a kind of staying power in that part of your cost structure because if you change that cost structure, your SG&A, it is there to stay with you throughout a longer period of time.

And second, if you remember, on the cost also we had issues that we were talking about a long-time, about our IT, about our infrastructure, our buildings and the rest of the things and all of those elements in the cost are now attacked. We also talked about the managed services contract. And the managed services contract I have to say that the team did a fantastic job. We did more than 50% of those contracts that we needed to address already. And you can see the benefit of that in the results in Q4.

Now if you then see what the trends of our products and services are in Q4, there are three that I would like to emphasize, first of all, IP. It’s the core of what we do. And IP had another remarkable quarter, the biggest ever. So, 25% growth and not only in the known part of the business, but also in our core routing. In our core routing, we gained six commercial contracts, 20 trials and it will be a significant contributor in the years to come. So very good performance from IP.

If you look to optical, the optical domain is of course crucial. We are going to talk about 2015 and the plan for 2015 in a minute. It is identified, as some of you did identify that as a key element to it. And if you look to optical, the way to look at that is that we need to embrace our business on the 1830 and on the traction on the 100G. We are number one in the market according to independent research. 29% market share in ports shipped in the 100G. And on the 1830, you can see that the traction is growing.

Now it is true that it is still a market that has to go from one transition to the other transition. WDM is now 50% approximately of what we do but it is in the terrestrial business. A business of transition that we have to go through. You have to go through the cycle. In this quarter the most significant, I would say contributor, has been the new services. The services on top of 4G, the services on top of the generation that uses data and video. That’s what you see, enormous traction for subscriber management, for customer experience management and software for the capabilities that you have on voice-over-LTE. All those elements are now significant contributors. And with the spread of 4G, going around the world you will see more of that. And you can see that we do have the products for it and the capability to make a difference there.

It’s also true that our maintenance business held very nicely in the quarter but the difference that you see in the numbers and a significant contribution has been from this new service capabilities. And then of course our strong free cash flow in the quarter, €355 million, is without a doubt a good number. And it is a number that is extremely pleasing because of the quality, how it is achieved, and Paul will come back to that. So a solid, a strong result at the end of a difficult year. Because it has been a difficult year, the first six months no doubt were not good.

And when we reacted after Q2 and we performed a kind of review of where we were and what we needed to do and we baptized that performance plan. Since then we have executed on all elements of it. But the year in total of course was a loss of $260 million and a negative cash flow is not a good year. And after 2011, and I repeat that because it’s true, it’s a disappointment to have here because 2011 was getting the feeling that traction was going up. And as always it’s hard to then go through a situation as we have seen in 2012. But we ended strong, and what is also very important that at the end we did all the things to stabilize the company.

If you look to the balance sheet and you look to the operations, you look to the cost management. I think we have stabilized the company and we have a great basis to make a change. Now if you look to the performance plan as I said, so you have seen all of that, so we quickly look to where we were at the end of 2012 and [Frank] made this very nicely by seeing progress by the end. As I said, the year itself is not good year but at the end we have created a momentum on cost, it’s absolutely true. We have sharpened our focus and our pen, and it is true that the refinancing plan has been a major success.

I would like to thank Paul and his team for the efforts they have done. It was not always obvious for everybody around us that this would be a good outcome but I think that mostly the persistence in which it had been executed and the way it has been executed. And some luck of the market of course, that’s also not bad to have. But it is well perceived and it’s helping us tremendously in the stabilization of the company as we just described.

So I think the end of 2012 was a strong end of a year that is probably not one of the most happy ones. Now as part of this journey that accompanies the financial transition that we had to make for the structure loan, you had to give a kind of viewpoint where you will be in 2015. And you have seen it because we have published it, what our 2015 profile is. Now some of you have commented about it and said, well you know paper has a lot of patience. I am here today to tell you that it has not just patience we have a real plan and we have meat on the bones to make that happen.

So what I tried to today is to walk you through on the translation of where we are today towards the plan in 2015. So what are the steps you need to take to go from where we are today and what proof points do we have, that we have a prudent and cautious plan for 2015. Now prudent and cautious if you have a target of 6% to 9% OP, that will be a good combination.

So the first one is, we have not assumed crazy numbers in our revenue for 2015. We have been very prudent on our revenue, and I will come back on all those three points. We did assume a better gross margin profile. Because the gross margin profile that we today is a reflection of, let me say, not the best mix in product and in markets where we have those products, and I will explain that. The third element is we did assume a continuation of a cost improvement to a very, very strong cost management continuation.

So let me go the revenue first, the target. We assume if you -- that part of your portfolio will grew and other part will not grow, the part that will grow a very strong emphasis of course in where you put your resources at work. If you make your selection on where you put your R&D, you put it there where you can make the biggest difference. That’s basically the story that is here. And we can make a very big difference on IP. We are still gaining traction. As I said, it’s not just in our traditional good IP business. It’s also true that we now have a portfolio of products in IP coming very close to the optical layer.

So the combination between IP and optical, I don’t know any other company in the world that has that opportunity to create that market segment growing fast. And as a former operator, let me tell you this. There are many things that you will fight for investments if you are an operator. The thing most important to you is the service differentiation that you can give to your customers in their hands. That is where the battle is. The service differentiation ahead. That’s why you see a services growth and that’s why you see, I am pretty sure, flat IP will be the name of the game in our next generation networks.

That is not just transport, it’s not just IP, it’s the combination that will make the difference. We have assumed here -- and I think that it’s safe to say that this is a safe assumption that that is going to happen in the course of the coming three years. It is the sector coming in the supplementary business, you know all about that. I talked already about the expansions and applications. And we will be and stay selective about our services. Some people thought that that meant getting out of managed services. We just signed a contract with Reliance in India. Very proud of that. Very good contract because it’s a good mix. It’s not just classical services, it’s also expertise, professional services and equipment. So that combination makes it into a contributor for us. And those type of contracts we are happy to have of course.

So let’s now go to the parts of the business that are not growing in the assumption for 2015. We have been cautious on terrestrial optical, for a good reason. Because of course these are parts of the network where operators have a choice to invest or not. These are things that capacity, or simply the capacity. It’s not what you notice in your hands. It’s the capacity part of it. And you also see that there the focus for us has to be and will be when the 1830 expansion will continue and most of all, while it’s not just the box so to say, with a low margin, but you get a card in there as the usage of the 1830 increases. And you will have to look to build the 100G.

If you look to the numbers today. It has doubled. Mostly 1830 and the 100G as a percentage of our revenue has doubled. So from that perspective you could be optimistic. We have been rather subdued on that given the assumptions that we wanted to make for 2015. The wireless business is very simple, the decline in the classic part of the business will be compensated by LTE. That means it total, it will not grow. That’s the assumption there. And of course in wireline, wireline is the wild card. To be honest, I think if you want to look for surprises in the company, look to wireline.

I think we have been ultra-conservative here which is always good to be. After a couple of years that wireline was a business where people would just ask, why would I be in that business. Well, the answer is two-fold. The answer is, broadband rollout, and the other answer is factoring. But in the assumption that we have here, we have not made any speculation about anywhere around growth. Now that’s about the top line. So then you need to look to the margin improvement. And here what we have given to you is some guidance, what to watch for.

How do you know that we going to make it better? And it means that we make you the promise that what to watch for is something we report on. Otherwise, we can give you what to watch for but you don’t know what to watch for. So we will make sure that we give you that information. As I said, strong contribution from IP, not just on the top line, it also in absolute terms contributes substantially to the growth between now and 2015, just as a function of the growth and high margin that we have in that particular business in the gross margin. So that’s one.

The same is on the next generation optics. There margin will come back. We don’t expect anything else but to come back to historical terms that we had not super great but today it is, let’s say, not good. And it has gone back to something that is somewhat more realistic and by looking to the 1830 and the 100G, we believe that’s a potential that’s there. Then of course we have the increase in licensing. A new team in place and I think that what we have seen already after a couple of months is very encouraging. We have taken very modest assumption in the plan but it means a yearly increase. So we have taken our time in the assumption for 2015 that will come.

Strongly improve the managed services, 50% already done. You have seen their results, the rest will be done, I would say, before the half 2013. And of course the improvements that we see in network applications. Now if you want to follow that, while it’s true what I just said, in IP you have to look to new products except as a revenue growth. So how many people are really going to acquire a router. Six so far, 20 trials. Do we converse that in real or it will be a meaningful difference going forward. In optics, you just have to look to the 1830 and the 100G.

On the licensing you have to look to why is your annual rate is going up, because it needs to go up. And on the managed services it is, where do you exit as much as where do you win. So then there are certain parts where we have limited change in our gross margin because we have sometimes even a limited decline. In wireless, CDMA today is at a level of gross margin average of the company. So that is as a bleeder past us. Now, of course volume is important. LTE is picking up very very nicely and we have to look to what the opportunity forward is going to be on LTE in China and LTE in some of the other markets. In the U.S., we have a very strong order book this Q4. The rest of the world is also not bad. But it is important if you want to watch how this assumption is going to work out. You have to watch for LTE especially those in China.

And on the wireline, well, my favorite subject, will Europe get its act together and build a little infrastructure for the economy or not. If that’s going to happen, that’s a plus. Because we have assumed that nothing is going to happen. So that’s on the gross margin. Now then you have to ask the question, okay, what is your differentiation in the market? What is the card you are going to play? Because, yes, the cost will down, yes, it’s understandable that you will go into a market that where the choices have to be very linked to your ability to generate both positive cash and positive margin contributions. What is going to inspire the market to go and do that?

So the first one is, we are going to accelerate innovation. Innovation for us is the make or break of the company. It is what makes the difference. And innovation will be focused on those areas where we can make the best differentiation. So it’s next generation. It’s next generation services. It’s next generation software. It’s next generation wireline, it’s next generation wireless. It’s next generation optical. Those are the points where you will find a shift from the R&D going into those domains. Then we need efficiency and legacy technologies. You could say better end of lifecycle management.

We have sometimes years out some of the products, for legitimate reasons, with customers. But we need to better and that will directly improve our bottom line in the end of life cycle management. And then the portfolio management is, make the hard choices and stick to it. I think we have done a pretty good job there. But there is more to come if you want to focus on innovation.

On cost, you get a feeling for it, it’s SG&A and it is the infrastructure around it. We need absolutely quarterly decreases. And, Paul, probably you will say a little bit more about that part of the equation. You will also say a little bit more about the secured loan. We have our asset disposal program. I would like to echo what Paul said this morning. It’s not a fire sale. This is a very, very well organized program that we have. Time horizon, 18 to 24 months. We look to strategic assets, we look to strategic assets to increase and we look to other assets to dispose off, but in a way that is helpful for the company and for the longer term.

We have that capability now and stability in the platform that we have created. And that’s what we are going to do. So what about 2013? What can you expect? Well, first of all, we have given as a byproduct of the secured loan. Probably it’s the only player in the industry, a very detailed scheduled road map to 2015. And it won't be any surprise that that means that 2013 should be set on the road to 2015. So, as a kind of guidance, what I can tell you is, execution on the plans is absolutely number one, in order to get as quickly as possible to the details that we have given for 2015 and a completion of our performance plan is also absolutely mandatory.

Now if you listen to the story that I tell you, and you would ask what is the major requirements now going forward from a management perspective? It’s execution, execution, execution. In May 2013, so this May, my mandate is up for renewal. And for those of you not familiar with it, it the French system you go up for renewal as a director and the board then has to appoint you as the CEO. So there is a distinction there. And when the dust settled down around the structured loan, I have taken a little bit time to look in the mirror and say, okay, what is now required from a management position to go. I mean we made a big commitment to the market, we made a big commitment to our customers. What's now required.

Our customers are, I can tell you, very happy with what we have done so far and the best way they can demonstrate that is to see that in the order book, and the order book is really going in the right direction, pretty strong. So the question to ask the mirror is, what is absolutely required. And the operational focus of the company is now absolutely required. And you also have to be very honest. That is not my natural inclination, not my natural strengths. When I came here, the task at hand was, create a company not a multiple of companies, making sure that there is a recognizable profile of the company. Make your product portfolio choices. Ensure that you have a customer-centric culture in the organization and ensure that you have a road map that’s understood by the people.

I think most of that has been done. But the next phase in the company has a slightly different focus. So not easy for me but I went back to the board and started a discussion. If you raise the question, you answer the question. So that means that I have said to the board, it’s time for change. So the board did what a good board always does, go to process. Went through the process, and the process is that we have now a search committee. We hired Russell Reynolds -- they hired Russell Reynolds, I want to be very, very clear. I will have nothing to do with the succession. I don’t think that’s best in class practice that somebody is going to be interfering on his own succession. So that won't happen. An independent board committee, a search committee hired Russell Reynolds yesterday.

So all the stories about last year or whatever, yesterday they were hired. They will do a search according to best in class rules, which internal and external. They will listen to what customers have to say, other people have to say, so to get the input on profile and also on the requirements given the program that we have. In the meantime, we will continue to execute. There is no time for lame duck, period as I made it very, very clear, internally and externally. There is not time for that. We are going to execute. We are going to execute whether I am here or not. We are going to execute this plan because this is the plan, this is the commitment that we made to the market.

And I hope that you realize that it’s important that also our own organization is absolutely crystal clear on the road map that we have in front of us. And I can guarantee you that after all the discussions that went today, we are aligned. And I am very grateful for that.

So with that in mind, Paul, why don’t you walk us through the numbers?

Paul Tufano

Thank you, Ben. Okay, good afternoon. Ben kind of started, but let's just talk about the year. And you have to be very honest, this was a disappointing year. It was not as we expected it when we were sitting here 12 months ago. We had come into this year with the expectations of continuing our profit and margin expansion. And in the first half of the year we were confronted by a number of situations which undermine that expectation. Those were primarily three things. One was the technology shift, primarily in the U.S. from CDMA LTE that was much faster than we ever expected.

It is probably the fastest technology transition in this industry that we have seen in quite some time. But be there as it may, we had a significant margin impact. We saw slowdown in China that GSM sales. And we saw the conditions in Europe deteriorate and become very fluid. Those three things affected us. And they affected the industry. And in July we had to alter our course. And we talked about how would be different. There were three things that were embedded in our discussion in July. They were embedded in the performance plan.

The first was that we would remix our revenue base to much higher margin contributing products. And that we would de-emphasize less than corporate average margins on products. Namely, emphasizing IP, advanced optics, parts of our applications platform. And de-emphasizing things like managed services. Same thing we said we would do, the second pillar of that strategy was reducing our cost and expense structure. We announced an additional €715 million reduction to take it to €1.25 billion. And the third was that we would take steps to stabilize the balance sheet.

I think that as we sit here today at the end of 2012, we have been able to execute that in this second half. And as we go through the numbers, I want to keep those themes and reinforce them as we talk about various elements. Now clearly, we reported earnings today. On a reported basis we lost €1.4 billion for the quarter and for the year. Now, obviously it’s a massive loss. That loss is entirely due to an impairment charge we took in the fourth quarter. And I am going to speak more about that in the next few minutes.

If you were to normalize for that impairment, you would see a profit for the full year of approximately €36 million. Now as you know, an impairment charge is a non-cash charge and we do an impairment analysis quite often. At least once a year, sometimes two and three and times a year. The other drivers on the year were increasing restructuring charges. Because the restructuring in the fourth quarter was about €250 million, it’s about €500 million for the full year in terms of P&L impact. And if would look year-on-year that’s an increase of almost €290 million. The entire of that is social charges, the majority of that growth is social charges. Those social charges are directly linked to the actions we are taking to reduce headcount around the world but specifically in Western Europe. And that will continue into 2013.

We have also noted that there is a positive gain of €170 million for post-retirement plan benefit changes. We did make an amendment change to our U.S. plan to allow for certain retirees to take a lump sum distribution. That affected us positively by about € 170 million. But at the end of the day, the issue that probably most of you will look in is that impairment charge. Let's talk about the impairment charge.

So as you know, every year you are obligated to do a test on whether or not your assets are impaired. It’s a very technical test. We do them multiple times. Now, we have maintained consistent methodology in this impairment test. Same as we did last year and as we did in the interim test during the course of this year. And most importantly, as you do an impairment charge, you look out over the future as to what the earnings potentials are of your businesses, from 2012 through 2017.

All the business plans that were used in these impairment tests are consistent with the business plans that were embedded in the secured financing documentation. So there is consistency. And as you would expect, you know the majority of the change came from primarily wireless and optics. Wireless because of the reset in the margins in the U.S., and optics because as we have said before, we thought we were going to get into a lower period and our recover would be less than we had anticipated.

And so if you look at the impairment, approximately €900 million is for goodwill and intangibles. The majority of that is in optics and wireless, over 90%. And then you have a €500 million deferred tax asset impairment that goes with that, with that impairment of those assets. Now the point I would like to make again is it’s non-cash. That was done consistently with methodology and more important the business plans. And if you discount that, it is a slightly profit for the full year. But more importantly we talk about adjusted operating margin. And so from an adjusted operating performance standpoint, I think you would say that the fourth quarter was a solid performance. We executed as we indicated.

And I think that’s important. Because the consistency is the most important thing as we move forward. We reported €117 million adjusted operating margin, operating profit for the full year -- for the fourth quarter, for the year unfortunately it was minus €260. And if you look at our revenue growth, especially in the quarter, we did return to revenue growth. It’s 13.8% quarter-on-quarter and actual rate when you adjust for currency is 16%. But for the full year we are probably down 10%. The good news is that in everyone of our geographic regions we saw growth in the fourth quarter.

The other good point on this chart is our gross margins. Our gross margins again returned to 30%. We were at 30.5% which is an increase of 250 basis points quarter-on-quarter. 250 basis points quarter-on-quarter is really driven by the volume increase we saw, but more importantly the product mix. Then the product mix, the two drivers that really highlight all that growth was contributions from applications, especially from our IMS in subscriber data management products, as well as the fact that the activity on managed services had a positive quarter-on-quarter impact.

If we look full year and year-on-year but for the full year and the quarter, you see it’s almost a four point decline. Four points in the fourth quarter, almost five points in the full year. The entirety of that is product mix. And that product mix is probably related to wireless and the transitions of legacy technology. On operating expenses, we adjust for currency. On the full year we are down about 8.6% on total OpEx. Of that SG&A is over 12%. So I think we are continuing to track to our commitments on reduction of expenses especially in SG&A. And has been indicated earlier, for 2012 we were able to reduce year-over-year approximately €650 million of total cost in expense. We told you we would do €500 million, so over achieved by almost €150 million. And to the €1.25 billion, our commitments were about 51% attainment.

Now if you peel back those reductions in the fixed cost and expense lines, you can see €390 million of savings year-on-year. 70% came from SG&A, with over €265 million reduction. That’s over 12%. Infrastructure, both IS and IT and real estate were another €60 million, that’s 6%. And our work in fixed operations cost, especially supply chain yielded another €37 million. And if you look at the SG&A headcount for the entire global population, we took it down by 11% year-over-year. On the variable cost that saving is of €255 million but little over half of it came from negotiations with third parties on contracts and services. The rest came from project savings and productivity that we have been able to enjoy over the course of this year.

If we look at revenue by segment. I think the thing to note is, those products that drive higher margins are the ones that grew. So obviously you see the significant growth in IPD. Then Ben talked about it, 23% almost 24% at constant currency in the quarter. About 18% for the year. Good traction on our new products especially the core router but more importantly, extensive deployment of EDGE routing as well as voice products and backhaul products. And this will be the driver of the performance over the next three years.

As we look at optics, you can see that optics is down 23%. Clearly submarine is a big driver of that. It’s down over 37% in the quarter and almost 35% for the full year.

The submarine division is now at its low point. The backlog is building as we’re winning new contracts. So you will see over the course of ’13 into ’14 a sustained recovery in that area. Terrestrial optics, down about 19% both for the quarter and the year, driven primarily by legacy products.

WDM has moderated in terms of decline. We actually grew 37% in WDM in the quarter, especially in 1830 and 100 gigabit products. And that is attenuating the reduction and should help show that recovery in ’13. And in Wireless, across the board we saw reductions primarily in the legacy technologies we saw an 84% growth in LTE.

If I turn to profitability, clearly from a profitability standpoint, our networks division posted a loss of €103 million and at adjusted operating profit line. That is €185 million quarter on quarter and almost €750 million year-on-year and when you peel that back, the entirety of that is primarily coming from Wireless and it’s that mix shift I talked about earlier. IPD continues to grow and contribute and in fact our Wireline products also contributing year-on-year. So it’s primarily a Wireless issue and as we asymptote on our legacy products and get stability in the year, you’ll see that come back up as we move through the course of ’13.

Service as you see had a fantastic year on a profitability standpoint. It delivered €230 million of profit, €65 million year-on-year and about €79 million as well per quarter. That is primarily due to strong growth in maintenance, the improvements in MOD I talked about and the improvements in professional services. In the quarter, if you will quarter-on-quarter, you would see almost €180 million swing in the services group. A lot of that came from network apps. As you know we deploy, we work on projects over the course of the year. A number of projects were recognized and they claimed revenue in the fourth quarter primarily, except for IMS and SDM, but it shows the application’s impact on our overall bottom line.

If I turn to revenue, the U.S returned to growth in the fourth quarter, growing 10%, driven in North America. That is at constant currency. For the full year we’re down 9%. We had an exceptionally strong year in 202. We’re seeing that growth return. APAC has been challenged during the course of the year at about 12% year-on-year growth for the quarter and the year. That’s driven by China. But we’re starting to see some recovery in China. We saw 11% growth quarter-on-quarter and we think that as you move into ’13 you’ll start seeing a rebound in China which will fuel the rest of Asia-Pacific. I think the thing to note though is we did see good progress or good momentum in both Australia and in Japan where we had year-on-year growth of about 41%, primarily driven by our IPD penetrations and our optical penetrations in Japan and as you know, those markets are tough to crack once you get in. the business is extremely good and the margin is extremely healthy.

Europe in total was about down 13% to 17% respectively quarter-on-quarter and year-on-year. The story there is primarily Western Europe and Western Europe will probably be a watch item throughout the course of 2013.

In the rest of the world we saw good growth for the full year. We saw the Middle East growing 17%. We saw CALA growing 17% as well and in the quarter South America and Latin America grew 21% driven by Mexico and Brazil and again this is I think 7, 8, 9 consecutive quarters of growth in CALA which is a positive for us.

If I turn to the balance sheet, there are two things that drive every item on this balance sheet. One is the impairment. If you look at the impact of the impairment results it affects the goodwill by the 522. It affects the intangibles. The rest is currency. And so those two things will explain (inaudible) of the balance sheet change.

Working capital, we were able to reduce our working capital during the course of the year, through the course of the fourth quarter by €330 million. When you adjust for currency, it is €310 million. Inventory was the biggest reduction during the quarter. We reduced inventory €221 million. That primarily came from reductions in both operations and in our regions, especially in Asia-Pacific and in Europe, Middle East and Africa and we actually grew inventory slightly in the Americas as we continue to deploy new networks for selected customers.

Our receivables were about €25 million reduction quarter-on-quarter, heading to positive free cash flow. During the course of the quarter, we discounted approximately €1.1 billion of receivables. Now, we’ve been very vocal that we have the ability to flex up and down on that receivable discounting and I think that demonstrates our flexibility during the course of the year and obviously payables were a €64 million decrease which affected the net change. Overall our cash conversion cycle was 60 days, an improvement of almost 9 days year-on-year.

If I turn to cash flow, we had strong cash flow in the fourth quarter. We did €355 million positive free cash flow. That puts us at about breakeven for the half. Unfortunately though, we burned €680 million for the full year. Now, the driver of that €355 million was obviously adjusted operating profit of €117 million, but more importantly we converted almost €259 million of cash off that net change of working capital.

A couple of things to point to you would be that pensions for the full year were €190 million. That is flat year-on-year and below the guidance we gave you of €200 million. Restructuring for the full year was €340 million. That’s flat year-on-year and below the guidance we gave you of below €400 million.

Our CapEx was €582 million. That’s slightly up more in intangibles, but still below the guidance we gave you of €600 million. And we ended the year with cash and marketable securities of €4.9 billion prior to any proceeds from the secured financing and you can see that is up close to €450 million year-on-year, primarily because of currency changes.

Our net cash was €126 million. That is positive net cash. Again we gave you guidance that we would be positive net cash at the end of the year so we achieved that as well. And the revolving credit facility has been terminated with results of the secured loan. But prior to the end of the year all covenants were met.

And finally, if I just turn to pensions. We saw underfunded status of the pensions improve by €653 million quarter-on-quarter. When you adjust for currency impacts, approximately €490 million of that is the result of fair value increases of the pension assets. So we saw our pension assets go up by over €490 million. Our obligations came down by €154 million and in that you saw €170 million from the plan adjustment. You saw €172 million due to discount rates increasing slightly and that was offset by service costs for the year.

If you look at it from a funding standpoint in the U.S, we’ve done our preliminary assessments on funded status. All of our pension funds will be over 100% funded and as we’ve said before, we believe that there is no funding requirement for any U.S pension until at least 2016, if then.

So with that let me close and will turn it to Ben then we can do some Q&A.

Question-and-Answer Session

Operator

(Operator instructions).

Francois Meunier - Morgan Stanley

It's Francois from Morgan Stanley. I've got two questions if I may. The first one is on the restructuring cash cost. If you could give us an update on how much do you have to spend this year and next in terms of restructuring cash costs. Also are you discovering more pockets of potential restructuring to do? If I look at NSN they've been very aggressive in terms of restructuring and it's working quite well. I'm sure you've seen their margins in Q3 and Q4. That's my first question. And Ben, that's my second question, you've been at Alcatel for a very long time. You know the company very well. What should be the key skills in your view of the next CEO? I guess turnaround specialist and good at cash generation are key requirements, but is there anything else you think he should do?

Paul Tufano

So I’ll take the first question. We’ve been very public there. 2013 there will be €500 million of cash restructuring charges and so we’re staying consistent with that.

Ben Verwaayen

So as I said, I think it’s a very bad idea for somebody to interfere with the succession plan and if I would go and give you a profile that was exactly what I’m doing. So I’m not going to go and do that. I can tell you that the board has a very good idea where the company is. I think that if you look to the choices that we’ve made and I try to articulate that, it’s also quite clear that as a company we have many things in front of us that we need to do and execute and I am very, very confident that the board will make a thorough and speedy process because here is the challenge, that you have to do it hence with speed and thoroughly.

Operator

The first question comes from Gareth Jenkins from UBS. Please go ahead.

Gareth Jenkins – UBS

Thank you, and, Ben, if I don't see you prior to you leaving, the best of luck for the future. First question is just on asset sales. I think you've highlighted that you're potentially selling assets at €1 billion to €1.5 billion in the next 12 to 18 months, Paul, and I just wondered why potentially two of the assets that are for sale are above Group average margins, through cycles so particularly Submarine Networks and Application Software given those have been effectively loyal servants through prior cycles. And secondly, just in terms of the Software and Services impact on gross margins, can you help us quantify how much was walking away from loss-making services business and how much was software in LTE spend, CDMA, etc. Thank you.

Paul Tufano

So if we look to answer your first question on the asset sales. We’ve been pretty vocal that we’ll look at asset sales. We haven’t said which ones they are. The most important thing to note is we’re not going to do it in a hasty fashion. Our focus will be on valuation and maximizing valuation and while we’re preparing for potential market transactions, the most important thing is to ensure that the trends of those businesses yield those valuations. So we’re going to be judicious in the timing. As it relates to the gross margin, I think that in the fourth quarter, if you look quarter-on-quarter, the impact of the software recognition probably was in the order of magnitude of 20, 30 basis points. It could b higher. Managed services probably had one or two basis point improvement as well. So the €1.2 billion points of product in geography mix it might have been a little less than half of it.

Gareth Jenkins – UBS

Thanks, Paul. That’s very clear. If I could just as a follow up, on the EUR650m cost saving, it seems like your absolute OpEx fell by just over €200 million year over year last year. I wondered in terms of the additional €600 million, should we expect more to flow through in terms of the net OpEx reduction during the course of 2013?

Paul Tufano

If you look at OpEx and you look at the SG&A line itself, it’s tough to use – to calibrate it off of the reported earnings because it’s an actual rate and you have currency variations. So if you looked at SG&A with constant currency, as I said it was down over 12%. I think if you look at SG&A going forward into ’13 you’ll look for something similar.

Operator

The next question comes from Johannes Schaller from Deutsche Bank. Please go ahead.

Johannes Schaller – Deutsche Bank

Thank you and all the best from my side as well for your future, Ben. I just had a question really on the S3 profitability level. That was really good in the fourth quarter. And just if you could elaborate a bit on how sustainable that is. I mean you said there was an increase in contribution from IMS and some other, I think management software in there. Was that just a one-off in the fourth quarter or is that going to continue over 2013? And is there more to come from Managed Services, more improvements you can do here on the other contracts? And fi I just really annualize the year-on-year improvement in Q4, then it was about 500 basis points, takes me to a margin level of about 10% almost for next year. Is that the right way to think about it? Or maybe you could shed some light into that here. Thank you.

Paul Tufano

So I think if you look at the contribution from network application software, what drove is was voice over LTE in the U.S. That was a big piece. Now, I think voice over LTE will continue to be a trend we see not only in the U.S but around the world. I think we’re very well positioned with engagements with multiple customers. Right now it’s a lumpy business. It’s lumpy in that it takes a while to deploy it and then the recognition happens. So that’s why you’ve got that volatility of the curve. So I believe that we’ll continue to see growth in network applications. It was one of the things we highlighted in our improvement in margin over the period to ’15. It probably won’t be as linear as you would like it to be at least on a quarterly basis, but it should be more linear over the period than it has in the past. And I think on Managed Services, I want to echo Ben’s point. I think the teams have done a great job in addressing some of those contracts. There’s still more to be done and I believe there’s more opportunity in ’13.

Johannes Schaller – Deutsche Bank

That's very helpful. And just as a follow up, so basically voice over LTE that would suggest that some of the operators are moving forward here already, because I think some of the latest news would almost have suggested that they are pushing this out a bit further. But that's not what you are seeing then?

Ben Verwaayen

No. if we look to the choices that operators make, I said already about the differentiation. This is clearly a point of differentiation. So voice over LTE is going to be a very interesting opportunity for them to differentiate. And in addition to that, what we called motive which is customer experience management. We just signed a substantial deal with BT and also there the pipeline is looking very good. As Paul said, this is not going to be a linear business. Because you get a contract, you need to install it, you make it happen and then you get the benefit, but once you get the benefits it’s substantial.

Unidentified Company Representative

Thank you. Next question in the room please.

Unidentified Analyst

(Inaudible). Maybe some color on the support from tier-1 operators notably in Europe. I suppose less support from compared to U.S and the second question, maybe Ben in your mind your biggest achievement and your biggest miss on your journey on Alcatel-Lucent.

Ben Verwaayen

So let me start with the second one. The biggest achievement I leave to you. The biggest miss clearly is being the fact that I misjudged 2012 in the beginning, clearly. Too optimistic on the 2012 side and that’s not good. So on the tie-1 in Europe, I think I’ve repeated this so many times that I get a little bit sick and tired of it, but unfortunately it’s the same story. It is not a lack of market. It’s a lack of capability to tap into that market and that has to do with the regulation and the lack of incentives. We just had in Davos a fantastic discussion with the regulators from Latin America where we booing. I mean we have now nine consecutive quarters of growth in Latin America with all the Chinese and everybody competing. We’re getting market share. Actually if you look at the numbers from everybody else, we’re getting market share in Latin America. But the incentive there is an incentive based on an appetite to make new services available to a population. In the U.S it’s all about innovation and when the regulator put in the word and innovation to its charter, it changed everything because then you can allow companies to make differentiation and choice also in pricing up to the customer which is not possible here in Europe because in Europe the only way the measurement is regulated is low prices for consumers. And therefore it stays in the voice era where we live in the video data era. That’s the story. I think tier-1 operators do want to make a difference, do want to invest. We need to give them the opportunity to do so.

Operator

The next question comes from Achal Sultania from Credit Suisse. Please go ahead.

Achal Sultania – Credit Suisse

Thank you. So my question is on your networks business and the profitability in that part of the business. I guess the margins there have been quite weak in Q4 and now going forward, as we go into 2013 what do you think is going to be a bigger driver in terms of margin improvement? Is it product mix or is it margin improvement within the different businesses that you have within networks?

Paul Tufano

So if you think about Wireless going forward, we said that -- when Ben talked about the 2015 plan and we talked about that with investors, one of the roadshow for the recent financing, we were pretty upfront that we thought Wireless over the period would not have substantial revenue growth. In fact it would have probably slight revenue decline and that margins would be in essence flattish. So for us it’s going to be more selectivity in where we participate in the market and driving that selectivity into better cost profiles on the products we sell.

Achal Sultania – Credit Suisse

Just to follow up on the cash flow side, what do you think the CapEx numbers are going to be for this year? Any indication around that?

Paul Tufano

We haven’t provided any guidance for this year. So I’m not going to start by playing with individual elements.

Unidentified Company Representative

We will take the next question from the room.

Unidentified Analyst

Good afternoon. Francesca (inaudible). I've got a couple of questions for your divestments. I was wondering, you are going through the sale of your Submarine assets. It seems that France Telecom is interested. Maybe can you say something about whether it's going to go piecemeal or in a whole? Or is it going to be only French bidders accepted and maybe something about valuation. I know it's a lot. And another question is, if I understand well, is anything but IP a potential divestment? That's another question. And are you going to issue more bonds? Is it enough what you issued so far? Some bankers and analysts seem not to believe that. So maybe can you comment on that?

Ben Verwaayen

If you take the last one I’ll take the first two because they will be quick. So the first one is, we have given you two things. We have given you the fact that we’re going to go after disposals and we’ve given you a timeframe and an amount. So the timeframe is 18 to 24 months we’ll finish it. The amount is €1 billion to €1.5 billion and the fact that we’re going to go after disposals, that’s it. We’re not going to do any of the speculation. I’ve seen some of the speculations. It’s quite interesting. Some is right. Some is definitely wrong. Second, we are not going to put a company into pieces for sale. So it’s not true that everything but IP. It is a coherent strategy that we have. The world of telecommunication will go to high definition video wherever you are. That is the next big step that’s going to happen. So also on your video you can have more than three minutes on YouTube so to say in high definition. Everything that allows that to happen which is the software layer, transport layer, it’s the excess layer on the next generation is important to have as a component of a service offering to the marketplace. That’s the story. The submarine is part of our business. I just commented about it. Very strong order intake in Q4. I believe altogether we have issued press releases that are in the public domain for more than 25,000 kilometers of activities that are going on and we have nothing else to say about it other than that we are going to have disposals. Disposals will be taking place in an 18 to 24 months period and we think the proceeds will be between €1 billion and €1.5 billion. So Paul?

Paul Tufano

With regard to bonds, we just raised €2 billion with the cash. Our objective now is to utilize that €2 billion in our liquidity management activities.

Operator

The next question comes from Sandeep Deshpande from JP Morgan. Please go ahead.

Sandeep Deshpande – JP Morgan

Thanks for letting me on. My question is on, within the networks business on Wireless. This was the key delta between 2011 and 2012 that the mix shifted in Wireless which caused the overall networks business to go into a loss. The question is, if you see your 2015 guidance on Wireless, it is going to be lower in 2015 in revenue terms than it is today and the gross margin doesn't change very much. Is there a plan to turn around the Wireless business? You've talked about exiting some businesses within Europe, et cetera, but how will this business become profitable, or is it part of the overall network strategy that this business won't be profitable but other businesses will become much more profitable? Thanks.

Ben Verwaayen

So the 2015 plan, we have shared with you assumptions. That does not say that there are no aspirations and capabilities to do better than the assumptions. But the assumption that we have here is in order to be prudent in what we need to do is that the numbers are as the numbers are. That is the assumptions for 2015 plan. Now, it is quite clear that we have many different iterations between now and then. For example the market will go massively into small sales. Whether that will happen in 2014 and 2015 I’m not so sure that we know today, but they will go massively in small sales which happens to be a part of our expertise where we have a very strong end play. It is also true that LTE will come to Europe, but you know when I can count that and write it into the books, that will make a difference. It’s also true that in the legacy business, we still have a substantial amount of R&D in order to make sure that it’s in line with all the rest of the business. So these are all kinds of elements that you can expect the company to work on, improve on, focus on but in the assumptions for 2015 this is what we have taken.

Unidentified Company Representative

We will take the next question from the room.

Alexandre Peterc – Exane BNP Paribas

Alexandre Peterc with Exane BNP Paribas. I’d just like to understand again a little bit about network applications. Is there a strong seasonality between two quarters, Q4 last year and in ’11 as well where you had a very strong sequential growth? So is that a specifically seasonal business and is that how we should model it? And then I’d just like to understand, on the underlying gross margin, apart from what happens in 3S, have you actually seen an improvement in Q4? And then a third question, sorry if it’s a bit long. Are you seeing any tendency of the operators to spend more on capacity in the second half of the year as does Ericsson or is that not true because you’re participating in the same markets, particularly (inaudible)? Thanks.

Ben Verwaayen

Will you take the first question?

Paul Tufano

So if you look at the network application business, it’s a lumpy business. It’s not linear in terms of when you recognize revenue. So it has happened that the last two years we’ve seen a significant revenue recognition last quarter of the year. It’s a function of when the projects start and when they end. So you’re going to have that same revenue recognition earlier in the year. It depends when you start the project. So as I said, we’ll see growth but I think that growth will not be as linear as you’d like it to be. It will be lumpy, but the training line will be linear. With the credit gross margin, we did see gross margins from other parts of the business and saw gross margin improvements in a number of products. And so I think this goes back to the point I made earlier. We will emphasize those products that have higher margin in the corporate average and as we do that it will take the margin off. So obviously you saw the growth in IPD. The IPD margins are considerably higher than the corporate average. We saw growth in WDM. The WDM margins have improved. So I think it’s a combination of both.

Ben Verwaayen

I think that it’s safe to say that 2013 will probably be slightly better than 2012. If you look to the capacity play as such, that will be not a driver of that in my view. The differentiation in the hands of the customer will be the driver. Now, anything that’s left for investments will then go to capacity because there will be a time between now and then that capacity becomes the bottleneck and that will then affect the way that they can compete. But in today’s environment, especially here in Europe, if you’re going to spend your money on capacity, I think you have a difficult thing to explain and at a certain point in time that will change. Whether that’s in 2013 Europe I doubt it. The rest of the world capacity play has been I would say managed differently than here in Europe.

Operator

The question comes from Didier Scemama from Bank of America. Please go ahead.

Didier Scemama – Bank of America Merrill Lynch

Good afternoon, gentlemen. Thanks for taking my question. I was just thinking, Paul and Ben, you've been quite vocal in the recent past about how the profit pool in Wireless for the industry is going to come down and you've been again reiterating that view to some degree today. I'm just wondering, given that you also see a greater profitability for Alcatel going forward in IP and in Optical, do you think the Wireless Division should be part of Alcatel-Lucent’s portfolio on a three year basis? That would be my first question. And the second question, just coming back to the seasonality in Q1, you had a very strong working capital movement in your favor in in Q4, and obviously EBIT has been a bit better than expected. How should we think about free cash flow generation in the first quarter? Thank you.

Ben Verwaayen

So should I take the first question?

Paul Tufano

Please.

Ben Verwaayen

If you look to the way the market will be structured going forward, it will and I think we discussed this before, it will be very hard to make a distinction between Wireline and Wireless, because if you just see the latest software that BT offered that makes your Wireless phone act as if it is an extension of your Wireline and therefore you get the tariff structure of Wireline, that you will see more and more type of activities going forward. So the notion of taking it into divisional approach I think is the wrong way to look to it. It is much better to look to generations of technology and the nature of the product. And so I would say as let’s say a bit looking back to this employer and the previous employer, they all had a kind of tendency of being Wireline focused in the beginning and they both ended up in doing stuff, a lot of stuff that actually is very Wireless and very in the Wireline business and I think that is a notion that you should bear in mind.

Paul Tufano

With regard to Q1, I think you should expect normal seasonality and with regard to free cash flow forecast for the first quarter, as we said we’re not giving forecast. Giving the first quarter forecast would be breaking that rule.

Didier Scemama – Bank of America Merrill Lynch

Right and just a quick follow up if I may. Just on your capital structure, since you've done a pretty powerful refinancing, could you may be shed some light as to which bonds you intend to buyback please?

Paul Tufano

We were pretty vocal that would look at near term maturity. What we’re going to do and how we’re going to do I’d ask you to wait a little bit till we announce it.

Unidentified Company Representative

And on that answer we’ll take the next question please and the final question. Thank you very much.

Sebastien Sztabowicz – Landsbanki Keppler

Sebastien Sztabowicz with Keppler. I’ve got one question regarding lightRadio. You are not talking anymore about this solution when it comes to your midterm outlook. Could you please any kind of date on this solution this year?

Ben Verwaayen

Yes. Big mistake. Biggest mistake that I made because really big mistake. LightRadio is going very nicely. In Australia was two weeks ago, one of the major sport events, the only way that they could cope with the specific beaming of the information and giving the capacity of the stadium was lightRadio. In the U.S we see great traction going into event management. It is absolutely gaining traction. So I thank you for offering me the opportunity to make this omission disappear because it is a powerful part of our portfolio, especially because I quote one of our biggest U.S customers who warned – I think they warned when you were there that in a couple of years’ time a massive part of their investment will be small cells.

Unidentified Company Representative

Thank you very much. Well that concludes our conference for the Q4 and full year 2012 results. Thank you very much. We look forward to seeing you again soon.

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