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Alcatel (ALA)

Q2 2006 Earnings Conference Call

July 27, 2006 7:00 am ET

Executives

Pascal Bantegnie - Vice President, Investor Relations

Serge Tchuruk - Chairman and Chief Executive Officer

Jean-Pascal Beaufret - Chief Financial Officer

Mike Quigley - President and Chief Operating Officer

Analysts

Mark Sue – RBC Capital Markets

Jeffrey Schlesinger – UBS

Adnaan Ahmad – Morgan Stanley

Alexander Peter - BNP Paribas

Robin Nazarzadeh – Citigroup

Eiji Aono - Credit Suisse

Tim Long – Banc of America

Ed Bell - Cazenove Group

Richard Windsor - Nomura Securities International, Inc.

Remi Thomas - Credit Agricole Indosuez Cheuvreux (CAI-Cheuvreux)

Richard Kramer - Arete Research

Pralin Berg – Dresdner Bank

Tim Body – Goldman Sachs

Tim Daubenspeck – Pacific Crest Securities

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the 2006 second quarter earnings release. At this time, all participants are in a listen-only mode. Later, we will open up the lines for questions and answers.

(Operator instructions)

As a reminder, today’s conference is being recorded. At this time, I would like to turn the conference over to you host, Pascal Bantegnie. Please go ahead, sir.

Pascal Bantegnie

Thank you. Hello to everyone. With me today on the call are: Serge Tchuruk, Alcatel's Chairman and CEO; Mike Quigley, President and COO, joining the call from Dallas; and Jean-Pascal Beaufret, CFO.

We will being the call with Mike and Jean-Pascal providing an overview of Alcatel’s second quarter 2006 results, and then Serge will give you an update on the industry trends and Alcatel’s outlook. We will then open the call up for your questions.

If anyone has not yet see a copy of the slide presentation and earnings release, it is available on our website.

Before we begin, I would like to remind you that certain statements we will be making today may be considered forward-looking. Please refer to the safe harbor statement containing today’s releases.

At this point, I will turn the call over to Mike.

Mike Quigley

Thanks, Pascal, and good afternoon, good morning, good evening to all of you. As Pascal said, I am going to cover the Q2 results. I will start on page 2. As you can see, our second quarter was once again a good revenue growth, above the market rate for us. We are seeing network transformations to all IP infrastructure obviously happening in fixed to provide video, voice and data services, and that we believe is also beginning to happen in the wireless area before too long.

In Q2, our revenues were at EUR 3.4 billion, which grew 7.6% which is, when you add that to our first quarter, 12% year-to-date. We had growth in every one of our segments, but that was led by fixed comms, where we were up 11% in this quarter.

Operating profit was at EUR 263 million, and that was exactly the same as our Q205 number.

Net profit at EUR 180 million, or EUR 0.13 per share. That did include EUR 0.01 from capital gains in fixed assets, which Jean Pascal will no doubt talk more about. When comparing the EPS to last year’s with a net capital gains of EUR 0.05 at that time, so we see an improvement overall of EUR 0.03 in this quarter.

Our net cash position is at about EUR 1 billion. It is stable sequentially and improved by about EUR 540 million compared to Q205.

.

Moving on to slide 3, looking at the segment analysis, as you would expect, we are reasonably pleased with the top-line growth over the period, but the profitability is being impacted by the current industry consolidation we are seeing, and also with the technological transition that is now taking place.

In the fixed area, we had double-digit growth, as we mentioned, and the business did benefit from favorable geographic and product mix. We had strong sales of traditional DSL and both in IP and in MS-WAN, we have some very good growth.

We had continued growth in mobile communications, although somewhat slower. We were about 5% up year on year, where we were 15% in Q1. That was driven largely by growth in radio solutions for emerging markets, and we are also seeing network migration towards NGN, IMS in the mobile switching area.

The profit that came in in mobile is what we expected, about 8% return on sales, which was up a bit from Q1, which was 6.3%, but as I mentioned, it was negatively impacted by what we are seeing as an intensifying competitive environment. That again, coupled with what we are seeing in increasing investment needed in NGN technologies obviously had an impact in profitability in mobile.

In the private area, we are up 5%. We saw revenue growing in all of the segments except for space, which we expect to resume growth in the second half. In the private area, the profits were driven by enterprise and signaling.

Looking at fixed communications now on page 4, I think the strong growth that we are seeing in wireline does confirm the leading position that we have in network transformations to all IP which is happening now. We did record some new wins in the quarter at Deutsche Telekom in Slovakia and in Hungary, and in Spain with Telefonica.

DSL, we had a record volume of 6.7 million lines shipped. You may recall Q2 2005 we were just under 6 million at 5.9 million, so this is about a 13% growth year on year. What we were pleased to see was the high activity we had in the APAC region, where we are seeing [ISAM, inaudible, DSLAM], volume deployments in China as well as other parts of APAC.

We expect in the DSL area to gain a few points in market share in Q206 versus what we had in Q106.

In the service routing area, we had the strongest quarter ever again, we have been on this trend for a while now, with double-digit revenue growth quarter over quarter and year over year, we were at a four-fold increase. We recorded another 15 new wins in IP service routing in this quarter.

What I would also like to stress, just talking about the IPs, is the business is in fact reasonably well-split between consumer services, that is triple play, and enterprise services. So the impression that some people have that our business in IP routing is driven just by triple play is in fact wrong. We are doing a lot of business in enterprise and across a large number of applications with the triple play, with folks such as AT&T, but also in NGN voice, with operators like Telecom Egypt in mobile MP IPMPLs networks, and in BPNs, such as with BelgiaCom. So overall, we continue to be very happy with the progress we are making on IP routing.

In optics, we slowed slightly year on year in Q2 due to some industrial issues in one of our facilities, but that is now past us. We are beginning to see WDM business ramping up. As we see bandwidth needs going up, it is interesting to see WDM coming back again.

The final area, NGN/IMS, was an area that we were not previously too happy with our progress, but we are now starting to see that turn around and really starting to gain momentum. We had two times year on year growth in the first-half of this year compared to the first-half of last year. We now have more than 90 customers at the end of this quarter, and I think just as evidence of that, BT has for the third time in less than two years decided to pick Alcatel for its IMS project for enterprise, so that together with the very positive reviews we are seeing from quite a number of analysts now give us some confidence that we are on the right track on NGN/IMS and fixed.

Moving on now to mobile on page 5, it is clear that we are seeing industry consolidation gaining momentum in this sector. This market has and is becoming even more competitive as players are positioning themselves for the future. We have, as we said in the last quarter, remained quite selective in addressing contract opportunities for the mature technologies, but at the same time, we continue to invest in what we believe are the key future wireless technologies and, to try to make sure we take a leading position in next-gen networks.

That frankly reinforces the importance of the forthcoming Lucent merger, which will bring us added scale, which is essential to make sure we can continue to address the R&D needs in this sector.

While in 2G we had the slowdown that we expected, the momentum was still strong in emerging countries, where we now have 17%, 18% market share in GSM. I would like to mentioned particularly in 2G China, which we saw very good growth in the first-half, we do expect that to slow down somewhat in the second-half.

In 3G, we now have 19 customers and a recent win in Asia with [Socom]. As you would expect, we have ongoing trials in HSDPA, with a number of customers and they are going quite well.

In the NGN space, our core switching business continues to shift, as we mentioned before, from traditional TDM to NGN/IMS. That means we do have a decreased in the TDM activity but obviously an increase in NGN, and we now have, in those NGN platforms, subscriber capacity of more than 50 million calls installed. We have more than 60 live sites, and we have passed now more than 17 billion calls on this next-generation call-server technology for mobile.

As I mentioned, this area is one in which we need to continue strong investment in some of the key technologies to make sure we secure a future footprint to ensure our growth long-term. Those technologies are NGN/IMS, 3G, mobile TV, and of course WiMAX. In that last one, WiMAX, you may have seen the agreement we published in June with BellSouth in the WiMAX 2.3 gig area.

Turning now to the private comms area, we had sustained growth again at 5.4% in this quarter, mostly driven, as I mentioned, by enterprise. What was good to see is the strength in new markets in enterprise in both APAC and Latin America. Those two areas now represent about 1/5 of our total revenue in enterprise, which is important.

We did have somewhat of an impact on sales and profits in Europe from a reorganization we did over the distribution channels, which we expect to then recover. Once again, very strong performance from our Genesis subsidiary.

Transport signaling, which is the other area I mentioned that was doing very well, it remained quite solid. It is principally driven by renovation of mainline rails, and we registered new wins in Spain this quarter for high-speed trains in communications-based train control systems, which is a good win for us.

The space business, as we mentioned, has been on a decline. It declined slightly again in this quarter. It was negatively impacted by a delay in an order intake for one particular institutional program. However, we did see two new commercial wins reported with [Outset and CL2] two this quarter so we do expect to see space turn around as we hit the middle of the year and we expect to post positive growth overall for the full year.

And the last area in integration services in private, we continue to get good traction both in [Teria] as we’re working on these transformation projects and in vertical markets.

Finally, if I can give you a quick view on Page 7 of geographic positioning, you can see there has been a very strong growth in North America this quarter. We in fact registered a 40% growth. As you can also see, North American revenues represented now about 18% of the group’s overall sales. That’s up from 14% from Q205 and with the same percentage for the full year 05.

We’re also happy to see that our operations in APAC is growing quite well, and particularly in China we had more than a 20% increase with quite some significant strength in wireless as I mentioned, while in the rest of APAC apart from China, we performed very satisfactorily and particularly in wireline. That was quite strong. The growth that we saw 3% in Western Europe was mainly in the Private segment.

Finally, in rest of world, the small decline that we saw there, -4%, was largely caused by Latin American in mobile. While we grew in that part of the world in wireline, it wasn’t quite enough to offset the decline we saw there in mobile.

Other parts of the world, Middle East, Africa, India, we grew at a double-digit growth rate in almost every business segment and finally, in Eastern Europe, the market we saw was about flattish.

So perhaps now with that I can pass across to Jean-Pascal for the financials.

Jean-Pascal Beaufret

Thank you and good morning and good afternoon to all of you. Before going through the P&L and the financial I’d like to just mention two points about the scope of the business in the quarter.

First of all, we have acquired a privately-held company which is called Voice GMK in the quarter for Euro 30 million in cash. This company had been founded in 2000. This is a leader in voice self-service solutions, with a software platform based on voice XIMA which, as you know, an open standard used for the developing self-services applications, both for enterprises and carriers and this is complementing very well the Genesis portfolio.

As for the assets, [whose contribution is envisioned today to tell us], we’ve not accounted these assets as assets held for sale under the standard which is ISI 5 just because both parties have not signed in the quarter any contract at the balance sheet date but we envision, of course, to complete this transactions by year end and therefore to discontinue these businesses when we complete the transactions.

Moving now to Page 9, , a quick summary, a few words, I believe that this quarter is characterized by the performance from a financial point of view which is quite good. It would be fair to state in particular that our sales percentage remained very satisfactory, while margins are under pressure. This is the industry consolidation and the technology transition and we succeeded at the same time in maintaining a fairly high net-net cash position and to manage our assets.

So during the quarter, revenues have expanded by 8%, with growth reported particularly at every business segment, except for [inaudible] end space. The growth ranges seen before from 11% in SCG, an impressive 11% to 5% in MTG and PCG.

Gross margin at 33.6% declined by 2 points on the year and by 1.3 points sequentially from the level that was reached in the Q305, Q405 and Q106. This sequential decline is primarily due to margin erosions in the wireless product line, which is impacted by the transition to NGN and IMS solutions. In addition to that, we see some players making a very aggressive play to enter the NGN space and we’ve continued to choose a selective approach with our existing portfolio, continued our investment at the same time primarily R&D or commercial investments in those key strategic technologies to give leading position in the next generation networks.

The operating margin was 7.8%, shows a 1.3 point improvement sequentially, but stands 60 basis points compared to the same quarter last year below. So this is due to the operational leverage which has been coupled with our continuous cost containment program and which has offset the last portion of the compression expense at the gross margin level.

The opex as reported was Euro 874 million, which is flat sequentially and up 2% versus last year, which means 26% versus revenues which is posting a 1.4 point reduction compared to last year in terms of ratio to sales.

Commenting below operating profit line items, we see that restructuring costs were particularly low this quarter. Such limited expense results basically from the management of our vacant assets. We have reviewed our restructuring reserves and needs linked to vacant premises that we were able to lease.

At the end of Q2 our restructuring reserves stood at Euro 300 million, with 140 million utilized so far year-to-date.

We as well as every Q2, every year have reviewed our intangible valuations. We’ve scrutinized all the goodwill, this is usually performed in June and we’ve no other adjustment becoming necessary than the marginal Euro 4 million impairment of goodwill for terminated businesses.

Moving to Page 10, we have seen we have posted Euro 21 million financial costs which are basically resulting from the recurring charges and profits for financial debt and assets. We have had net income from equity affiliates of Euro 50 million primarily related to Telus. We have had a net-net tax charge of Euro 42 million, standing at the high 17% of net income before tax because of the provisioning of fiscal contingencies.

It is to be noticed that in Q2 2005 we have recorded a net tax credit from the evaluation of profit prospects and principally in a couple of geographies. The expenses in Q2 were Euro 42 million, where the net tax credit in Q2 2005 was Euro 27 million.

So all that goes to the net income. We had earnings per share of Euro 0.12 pre-capital gain because we have recorded Euro 12 million capital gains to quarter pre tax whereas last year we were at Euro 0.09 EPS pre capital gains and recorded Euro 67 million capital gains from the disposal of one stake and some real estate.

Going forward into Q3 into the current quarter, the profit and loss lines below the operating profit should come in at about the same amounts that those were recorded in Q106 for share-based payments, restructuring costs and minority interest.

A quick look at the operating working capital for the Q2. Operating working capital to sales stood at 7.8% within the 5% to 10% range we’ve mentioned some quarters ago and it fell in line with seasonal patterns.

The slight increase which has been booked sequentially from the 7% entire quarter is to be attributed to two principal domains: the one is inventories that went up to support forthcoming quarters’ revenue growth, and the second was a reduced level of customer advance payment because of the sales in the quarter.

The inventory level increased but the turns relative to the activities and relative to backward sales went up from the 4.2 which was the situation last year in June to 4.5, which is the situation where we start in June 2006.

Concerning receivables, they remain stable sequentially and the DSOs terms in Q2 are sitting close to 98 days from one of the full days they were each two five on one of the days in March.

Going now to the net cash configuration. In Q2 we see that the main message from this table is basically is that free cash flow as it stands over the first semester of this year a slight improvement primarily coming from two sources. The one is increased cash selection rate from the operating profits. It's improvement in the quality of earnings. The second is a reduced restructuring outlets, which have been partially offset by some investments in the venture working capital. We've preserved the net cash position of $1 billion at the end of the quarter stable sequentially that would present a $5 million improvement versus last year.

What sticks out from this stable is basically that your present cash flow before restructuring working capital interest stood at 149% level after the breaking profit where it was 136% last year in the same quarter. This illustrates the improvement in the quality of earnings. We have several other points of reduction in cash outflow through restructuring and acquisition and disposal from real estate and a significant impact on the dollar cash amounts from the slight decrease in Euro/dollar rates but all that could be commented further.

And lastly the slide Page 13 shows of disclose the usual balance sheet numbers, which are pretty straightforward. The only comment I would like to make is probably that non-current assets have decreased by $530 million sequentially, which is basically a question of classification from non-current to current of certain items like carry back receivables for excess and changes in market value of non-financial placements. This same evolution could be seen in the other current liabilities and assets net line.

So I'm handing it over now to Serge for the last part of the presentation.

Serge Tchuruk

Good morning and afternoon to all of you. So I'm going to try to give you some feelings of where we believe the industry is going giving the deep confirmation taking place right now where we are going in this context and perhaps further down outlook for the rest of the year.

So looking at Page 15 obviously we are living through a sort of earthquake into our industry. There are three examples of the major deals, which have been announced in the last year or so. Many others have been announced of smaller size. In my view this is the beginning and we may see some others coming yet. So if you look at what has been done, obviously, you all know our excellent mark in marketing, which are essentially Y wire assets. We are now part of Lucent since last April and Nokia announced we are a joint venture infrastructure for carriers.

So, obviously, one of the first questions is what is that we are doing with Lucent, which is sort of specific or what are the differences? What's happening? So what makes it specific is first of all I believe we are the largest but that isn't really the most important item. What really makes the difference is we are the first trans Atlantic move actually. I always had the opinion that it made much more sense to put together two large players on both side of the Atlantic rather than putting together two players having, you know, both the same base in Western Europe. Why is this so? Because it's very important for any large global company to have a strong position in U.S. That's a market, which generally speaking, ahead, not only in terms of technology, but in terms of the use technology, more importantly I should say. It's also, given circumstances right now, good to have access to the emerging world market; and by tradition Alcatel in particular has a strong position in the emerging world. So that's the first difference.

The second difference is IP is going to be absolutely key to the future. Right now all the players there is a deep IP transformation in the network of the picture. We have a strong IP technology. Mike showed a while ago showed you some examples of what we achieved. I'm not too sure our two or three main competitors are in the same shape.

Number three if we look ahead at what the market is going to be our view today is that in the next three, four years we should see a sort of reverse of the trends, which we have seen in the past, which transfers to see the wire line decline by a large amount in the difficult years and the wireless in the last two to three years go up quite substantially. We are not too sure this trend will stay the same. On the opposite we expect in the next three, four years probably the wireless market to be more stagnant actually, while the wire land segment to grow more substantially with all maybe the mid single-digit type of growth. So when we look at our two main competitors by and large they are focused on wireless, which obviously was a good thing in the past but when you look at Alcatel Lucent we are about half wire and half wireless and, obviously, I believe that the ideal type of portfolio to offer.

I should also underline the fact that we are going to be one third U.S, one third Western Europe and one third the rest of the world, which is, by in large, the most ideal position to be.

So I think we have a lot of things for us and most dramatically if we turn to Page 16 what is it that we expect from this merger? First of all, and I think we should underline this, this is a merger yes to achieve cost synergies. I will talk about it in a short while but even more importantly to enhance the development of the two companies. We are going to have an extremely strong portfolio of converged solutions and converged services. The two companies have had parallel paths in trying to design solutions end-to-end and when you put them together I don't believe anyone in the market today can equal where we both can combine to be. We are still in old technologies, why by far, very far. Remember one in wire line? We are number three in wireless, large size. Obviously, there is practically no area where we have sub scale and today given the large amount of investment which are needed in R and D and even larger, which may be required in the future, obviously this scale is absolutely a key trend.

Cost synergies, we have evaluated initially to $1.4 billion and I've checked and rechecked this total number through a bottom approach, which is now possible and to be frank we are very comfortable with the initial estimate. We believe that we can achieve it. If you take $1.4 billion and you divide it by the combine sales, which are 18.6 you come down to about seven points of extra profitability per unit of sales, which is a big number and, obviously, now the key is going to be to achieve it and fast. So our initial estimate we're 40% year one, which is '07, 30% year two, 08 and the rest '09. We are going to do our best to try to expedite and achieve it as quickly as we can.

So these are the basic rationale with the Lucent merger. I should underline the fact that we are frankly very glad, I single both sides, to see the reaction of our people. From bottom to top all our people believe it is a very good idea. Nobody is contesting what has to be done and they all work whole-heartedly to adhere to this project. So we are in very fast. We have chosen the business model. We have staffed the key jobs. We are even staffing now the level of hand minus two and we are pretty well on schedule to achieve the merger.

Now on the Telex, here is about what we are going to Telex. As you know, we are the project to move something like 2 billion Euro of sales into Telex. Why are we doing so? What is it serve? It is the satellite business, which is about two-thirds of what we are moving. It's sort of a one-third what you would call a security related assets. Why are we doing this? First of all it deploys the last step to entirely focus Alcatel and now Alcatel-Lucent on communications. We have so much on our plate in communications that we don't believe we can detract too much from achieving what needed to be achieved in the big merger with Lucent. So, obviously, that's one of the first rationales.

The second and most important rationale is to leverage security in defense market and technologies through a very tight partnership. The idea there is to say that security activities are going to be better valued and better developed in the Telus context as opposed to the Atheros context.

What I do believe is they can put a lot of the telecom solutions behind them. So obviously we want to play this card. We also want to play the card of having Telus take advantage of the huge worldwide positioning of Alcatel - Lucent in terms of promoting and partnering with security systems.

What is the outlook, then, short-term? We expect the Lucent merger to close in the last quarter of this year. As you probably know, we got go-aheads on the antitrust issue both in the United States and in Europe. We will know need the approval from CFIUS, which is the Committee for Foreign Investment in the U.S., so we hope this is going to come in due time. So today, current thinking is that this should be closed by sometime in the last quarter of 2006.

So we think we have to give some guidance on what’s going to happen in Q3, which is the last quarter in which Alcatel can be seen as a stand-alone company so three things to consider.

First of all, we will spend a lot of energy and a lot of activities in, you know, in preparing the integration. We absolutely want that on day we start moving and achieving the integration so obviously there are some costs associated with it, which we are willing to bear.

We are doing also one other thing which is we now have a good idea of what areas of R&D will have to be promoted in the two companies. We know what it is, and we are starting in advance to increase R&D in some areas which are going to be quite meaningful for the combined company when they merge, which is obviously going to bring some added costs in Q3. Also, we are obviously trying to have all operation of people keeping focus on the current business.

So overall what we see for Q3 is a mid single-digit year over year revenue growth and we see an operating profit to be around the same level as Q2 of 06. At this stage, we don’t believe there is any sense in giving the full year guidance because in all likelihood, the last quarter will be already a merged quarter and we don’t know what Alcatel standalone would mean in the last quarter.

Now Page 18, talking to you about the calendar. We expect, as I said, to close the Lucent deal in the last quarter. Notice of the shareholders meeting is available early August. The shareholders meeting will take place on September 11, ’06. This is where our shareholders in both companies will have to vote for the deal, and we are proposing a $0.16 dividend payment, as we have already mentioned.

Alcatel Telus, the closing should also take place somewhere in the second half of this year when all the transaction is finalized.

That’s our view of where we stand and I believe that Mike, Jean-Pascal and I are ready to answer any question you may wish to raise.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question today comes from RBC Capital Markets from the line of Mark Sue. Please go ahead.

Mark Sue – RBC Capital Markets

Thank you. Can you help us understand the intensifying competition in wireless a little bit? Most of your competitors have suggested competition and pricing are more or less the same, and with the Nokia Siemens the announcement behind us, I would have thought competition would actually ease going forward, so who’s leading the pricing and are there particular regions where it’s more intense and does it get better by year end?

Serge Tchuruk

Let me try to volunteer; beginning with the financial maybe Jean-Pascal and Mike can complement or say something else, I don’t know.

But what we see happening is obviously a lot of the players which are in the process of merging are trying to reposition themselves aggressively to buy market share, actually. We have seen some of the prices in new contracts, say, in Latin America, to take an example, becoming frankly extravagant. So we have decided not to go into it. We have decided that our customers are not naïve enough to let us recover bountiful margins eventually later on and therefore we have decided to not go. So competition is quite strong, particularly from established players.

Operator

Thank you for your question and we’ll take the next question from the line of Jeffrey Schlesinger from UBS.

Jeffrey Schlesinger - UBS

This question is just following up on that on the mobile side, Mike. Can you give us a sense of the new product cycle such as NGN and IMS and now even GPON? We’re hearing the pricing of those new product cycles is even starting out very aggressive. Does this cause you to think about what the ultimate profitability of some of these new product cycles will end up being if we’re starting out with such aggressive pricing?

And Jean-Pascal, can you give us a sense, just clarify the depreciation in the quarter. I’m a little confused. Accumulated depreciation went down sequentially. Can you just explain what happened there, what actually went through the P&L?

Thank you.

Mike Quigley

I’ll start, Jeffrey, with your question on pricing. I frankly don’t think we’re seeing anything that’s radically different in terms of starting off pricing than we’re used to, to some extent, in the industry in the areas you mention, NGN, IMS and GPON. With the exception of the areas just mentioned, it’s quite clear if you look at the approach to this, that some of our established competitors - and here I’m not talking about the Chinese players who frankly are having to concentrate, I think these days, a lot on execution in wireless - but the established players are seeing this as a time in which they can be very aggressive and establish positions.

Apart from that area, you mentioned areas like GPON, I guess you, you know, new access areas in optics, we’re seeing what we’ve seen before. New technologies, you tend to be somewhat aggressive on price but you have a clear path that’s going to get the margins recovered as you go through cost reductions.

So I think overall it’s – I don’t think there’s anything to panic about. I don’t think it’s any radically worse except for a few specific areas than we’ve seen in the past.

Jean-Pascal Beaufret

On depreciation, if I may, I don’t see anything really new and really surprising in the depreciation, which has been, if you look at our cash flow statement, it went up Euro 19 million over the first half year-to-date first half of the year. While it was Euro 306 last year, which probably reflects the amount of capital used and the depreciated capital, there is nothing new, as well, because you know that this depreciation includes the R&D amortization and we have that over the first half year of this year. We have had Euro 132 million depreciation and [19] amortization while it was 127 last year. So I don’t see any major plans showing a significant change in that.

Jeffrey Schlesinger - UBS

Thank you.

Operator

Thank you for your question and we’ll take a question from the line of Adnaan Ahmad from Morgan Stanley. Please go ahead.

Adnaan Ahmad – Morgan Stanley

Hi, thank you. Good morning and good afternoon. Just two questions. First of all, to what extent do you see vendor financing being used as a competitive tool by other vendors across the portfolio in different regions, such as emerging markets?

Secondly as well, what prospects are you guys seeing with respect to your mobile coms group margins in the second half of this year, given the less aggressive stance that you guys have put into play with respect to new contracts?

Thank you.

Jean-Pascal Beaufret

On the first of your questions, one of the trends between the various competitors in terms of funding or financing the various solutions, we see an ongoing demand of funding by various competitors and particularly those who were building their networks so far, but the good thing is that, first of all, as you know, we are quite well-supported in these emerging countries by various expert credit agencies, those were in China, those were in Europe as well. Just for the sake of the reference, we had a vendor financing exposure at June 30 of Euro 470 million, which was down Euro 40 million from the Euro 510 million of the previous quarter.

So we don’t see any major change in the trend and we are managing carefully, of course, all our exposures.

Mike Quigley

Adnaan, I’ll just comment on the prospect, you said, in the second half in mobile. I don’t think we expect to see any radical shifts. We obviously have factored in our best view of how Q3 is going to look, which is what Serge mentioned at the end of the presentation. So I don’t think there is anything that we would call out to be radically different.

Operator

Thank you for your question. We will go to Alexander Peter - BNP Paribas. Please go ahead.

Alexander Peter - BNP Paribas

Hello. I would like to ask a question regarding your take on the CDMA market. Obviously by merging with Lucent or purchasing Lucent, and therefore linking up with the obvious market leader in CDMA you make a strong statement on what you think of this technology and how you see it developing in the future.

So could you maybe elaborate on what is going on with respect to this market, the mix prospects? There have been some negative evaluations there, I wanted to know what your take on this was. Thanks.

Mike Quigley

Serge, would you like me to take that one?

Serge Tchuruk

Why don’t you take it, Mike. Go ahead.

Mike Quigley

Alex, clearly we look very carefully when we are considering the possibility of the merger with Lucent. We look very hard at the CDMA market. Our view is that while we know that the UMTS market is going to grow substantially in the years ahead, our experience has been that these very large markets – and let’s not forget that there are well over 300 million CDMA subscribers globally today. These large markets do not go away fast. In fact, we expect the CDMA market to continue to grow.

We also know that in terms of technologies such as putting VoIP and some advanced services, CDMA technologies has some advantage and we expect the current round of operators to utilize those.

So that together with the fact that as we know, as we move into 4G technologies they are going to be CDMA-based and we can see quite some possibilities and synergies between the two technologies of the two companies. That leads us to believe this was a sound bet to make.

Serge Tchuruk

Perhaps I would just like to add to what Mike said, is that why do we see the overall wireless infrastructure market rather stable in the few years to come, or slightly growing? We would see, as Mike said, the CDMA market rather stable or slightly growing; UMTS growing fast to the detriment of GSM, particularly when the GSM in the developing world starts to go to, to move towards UMTS. So that is our forecast on the few years to come.

Operator

Thank you, and our next question comes from Eiji Aono - Credit Suisse.

Eiji Aono - Credit Suisse

Hi, thank you. Just following up on the CDMA market issues, maybe we can go into a little more detail on this. We saw just a week or so ago Vivo in Brazil announce that they are going to build out a GSM network; Ericcson looks like they won the majority of that contract, at least, while Vivo has said that they will continue with the CDMA as well as the GSM network.

I guess we have some thoughts that maybe at some point they will start to work down the CDMA and concentrate more on GSM. Obviously for the Alcatel-Lucent combination, if the CDMA portion of that does start to weaken and if we can maybe extrapolate that for the rest of the markets, it does not have a good outlook for Lucent’s CDMA business.

Obviously if Alcatel has won some of the GSM business there, maybe it could be offset. But since Alcatel did not win any of this contract, do you see any risks here if in a scenario there is a shift towards GSM from CDMA in these emerging markets?

Maybe I can ask specifically why Alcatel was not involved in this contract. Was it because of your previous comments in terms of extreme pricing by some of your incumbent competitors?

Serge Tchuruk

The answer is yes. We have absolutely not decided to follow the sort of pricing which is emerging in Vivo. So I think one should not extrapolate the Vivo situation to the entire world. And again, we believe that it doesn’t make sense to put a lot of investment money in terms of losses if you are not too sure you will recover them at some point.

So as I said, I am not too sure these are recoverable and that the customers will be nice enough in the out years to take back the profit.

Eiji Aono - Credit Suisse

In general though, if there is a shift from the CDMA to the GSM and you are not involved in the GSM areas, is that not a risk for the combined group longer term?

Serge Tchuruk

You should not extrapolate the Vivo situation to just about everywhere in the world; I mean that is happening right now in Latin America. We will see what’s next.

Eiji Aono - Credit Suisse

We know that it will be happening in areas like India, and most of the other developing markets.

Serge Tchuruk

No, in India we did something that no one else did. In other words, given the price levels where India has reached right now, we found a way which is a bit more specific to anyone else. I mean, compared to anyone else. In other words, we are not directly marketing in India, we are transferring technology to ITI, which is an Indian company. They are filling, they are integrated with the market, which is completely different in terms of economies.

Eiji Aono - Credit Suisse

So do you feel you have better prospects for getting a Reliance contract with ITI in India, versus the failure at Vivo?

Serge Tchuruk

These comments do not apply to Reliance. Talking about the BSNL, mostly. BSNL, big contracts, and this is going to be an ITI contract using Alcatel technology, actually, which we are transferring to ITI. So ITI will be supplying the base stations and will be supplying some of the software and core product needed.

Eiji Aono - Credit Suisse

Yes, I know. We generally know that. It is just that if Reliance in India makes a similar move that Vivo made, Lucent is one of the main suppliers to Reliance. So if that does shift, I am wondering if Alcatel feels that they can actually gain on the GSM portion?

Serge Tchuruk

We will see when the time comes.

Eiji Aono - Credit Suisse

Okay, thank you.

Operator

Our next question comes from Robin Nazarzadeh – Citigroup. Please go ahead.

Robin Nazarzadeh – Citigroup

Hi, thanks very much. Just a few questions for me. First, I was wondering if you could shed some light on the need to increase R&D spend ahead of the merger, perhaps if you could let us know where the increase is going to be and in what amount?

I was also wondering if you could provide an outlook on the access business for the rest of the year, given somewhat muted view provided by some of the component vendors in the supply chain for broadband access.

And finally, Mike, I was wondering if you could give us an update on the [GPON] tender by the RBOCs in the U.S.? When should we be expecting something there? Thanks very much.

Mike Quigley

I will try and answer these three questions. The R&D spend, I can certainly give you indications of where we are focusing on. Clearly on 3G technologies, WiMax as I mentioned before, the shift to NGN. Obviously I have IP routing access platforms. They are all areas that are very important as we see networks transform and converge.

But I also wouldn’t underestimate the effort that we’ve been putting in for quite some time now into the R&D around integration. It is quite a heavy skillset; very, very skilled people to be able to put these end-to-end solutions together. So we are in fact spending more money in those areas.

I don’t think we are prepared to tell you the amounts, but they are the areas.

The access business overall, it has been very robust, particularly in North America in the first half. It is possible we will see some using of that in North America. But as I’ve mentioned before, we’ve established quite a strong position now in China also and we had a record number of lines in the second quarter. We are still expecting a reasonable growth for the full year.

The important point I think on access is we are reasonably confident now that we are going to improve our market share. We are about 35% in DSL in ’05. We expect to climb up there at least a few points in that time.

The access business will keep going. What I can talk about in general in [GPON] is that we really are starting to see some traction across the world now, in places like SwissCom, BT, AT&T obviously. A lot of interest in VDSL. We are also seeing a lot of interest in [GPON]. We saw that, we’ve seen it in all sorts of places; the Middle East, Nordics, North America here.

I obviously can’t comment on the situation on any specific customer in North America at the moment of anything that is under evaluation.

Operator

We will go to Tim Long – Banc of America. Please go ahead.

Tim Long – Banc of America

Thank you. Two questions on the wireline side, if I could. Obviously another great performance for the IP routing business. Could you just talk a little bit there about the potential opportunities for that business once the Lucent deal is done? How does that open it up, and could that be another leg of growth for that business? Also, on the wireless side as well?

Secondly, you also talked about WDM strength that you are seeing. Could you just talk a little bit about how sustainable you think that growth will be? Are we looking at a few quarters of visibility here, or is this something that you think could be a multi-year growth engine? Thank you.

Mike Quigley

In the IP area, I think the most important thing is what I mentioned during the presentation. What we are really now seeing is a widening set of applications, as I mentioned before. It is triple play, it is VPN for enterprises, it is mobile, it is cable companies -- we are seeing in fact our platforms which by the way is not one platform now, it is four -- four linked platforms, all with the same type of cross [inaudible] all the way from -- into, partly into the core, right down into the consumer segment. We are going to continue to grow and expand that base.

You mentioned if and when the Lucent deal takes place, will that give us further opportunity. I think the answer to that is yes, because we will have access, obviously, to a larger sales force, deeper connections into some customers. It should in fact enhance our profitability in our people. What is now well-recognized as a very competitive platform, from both -- both from cost base and its performance.

Your second part of your question on WDM, what we really are seeing is global traffic demand is in fact steadily increasing. One point I would just, if I could point out, we used to see only about 20% of user traffic ending up on the backbone of networks. We have seen it really begin to increase as we are seeing more peer-to-peer, so that percentage is being driven up.

The other thing which we looked, we are seeing it as well, of course, is while high-speed Internet still dominates traffic, we are seeing video growing very fast, and we expect that to happen over the next couple of years -- probably not quite as fast in APAC, but certainly in other parts of the world.

Both intercontinental and intra-continental traffic, our prediction is that between 2005 and 2010, we will see accumulative annual growth rates around 30% to 60%. Now, at the same time, we are seeing obviously shifts from TDM to ethernet-based, but I would say to answer the last part of your question, this is fairly broad-based and we think it is sustainable, and one good indication of that is the number of projects we are starting now to see in the sub-[inaudible] area.

Operator

Thank you for your question. We have a question from Ed Bell from Cazenove. Please go ahead.

Ed Bell - Cazenove Group

Just coming back to an earlier question, I suppose the question on pricing, on GSN is why do you expect that Ericsson and Nokia are going to change their aggressive approach on these large contracts? Why will they adopt a less aggressive approach when we get to [PO 3G] contracts in emerging markets? That is the first question.

Secondly, I wonder if you could just quantify the impact on the profit that you are talking to in Q3 from these high R&D and strategic moves that you mentioned. Can you separate out the higher R&D elements from the other element that is going to affect Q3?

Serge Tchuruk

On Ericsson and Nokia, if my colleagues want to say something different, but just ask them.

Ed Bell - Cazenove Group

[inaudible]…[multiple speakers]…profit to play with, I am just wondering why they would adopt a different approach in a year or so time?

Serge Tchuruk

I do not know. I cannot speak in their place. The only thing we can do is monitor our own business and make our choices. We decided to make the choices which we explained.

Now, on this R&D thing, I know a magnitude is that the R&D spend in Q3 is going to be 10% over last year, and actually also substantially higher than Q2. But you know, part of it is doing things like boosting the WiMAX R&D, getting to [inaudible] and this sort of thing, we are doing in preparation for the merger, actually.

Ed Bell - Cazenove Group

Coming back to the first question -- should we expect therefore that the [inaudible] Alcatel revenues, before you were guiding for the growth to slow down anyway in the second-half, should we expect that growth to maybe turn negative in the second-half in the mobile part of the business?

Serge Tchuruk

The answer is no.

Ed Bell - Cazenove Group

Okay, thank you.

Operator

Thank you. Our next question comes from Richard Windsor from Nomura. Please go ahead.

Richard Windsor - Nomura Securities International, Inc.

Good afternoon. Just a fairly quick one, really. If we leave the Lucent merger aside for a moment, is there anything in the market in terms of when you speak to your customers or what you see in the market that would lead you to believe that seasonality for the rest of this year will be any different from what we have seen in the last year, particularly last year?

Serge Tchuruk

Richard, the answer is clearly no. The seasonality would be more or less comparable to that of last year.

Richard Windsor - Nomura Securities International, Inc.

Okay, that is very helpful. Thank you.

Operator

Thank you. We will go to Remi Thomas from Cheuvreux. Please go ahead.

Remi Thomas - Credit Agricole Indosuez Cheuvreux (CAI-Cheuvreux)

Thanks, good afternoon. I am sorry to have to come back on this R&D issue, but I am a bit puzzled about what you guys are saying. Traditionally, when you talk about R&D expense, it is the salaries that you pay to engineers. I would be, quite frankly, surprised to see Alcatel increasing its headcount just before the merger with Lucent and these [initiatives] you talked about.

Secondly, you said that you have been able to get more R&D out of the same dollar by moving some of it to Asia.

Third, I guess what you are spending in NGN/IMS, in WiMAX and all that is something you are not spending in more legacy technologies, so are you guys really spending more money on trials, on outsourcing contracts to third parties? Do you have issues with deploying networks that could explain this so-called investment that you are talking about?

Serge Tchuruk

The answer is that we know where we should be shrinking some of the R&D programs in Alcatel when the merger is done, but we are not going to start shrinking them before the merger is closed.

Remi Thomas - Credit Agricole Indosuez Cheuvreux (CAI-Cheuvreux)

But you are talking about an increase. Are you physically recruiting people ahead of the merger?

Mike Quigley

Yes, Remi, we are. We are physically recruiting people of certain strategically important areas.

Remi Thomas - Credit Agricole Indosuez Cheuvreux (CAI-Cheuvreux)

That is not offset by a decline in other areas that are more legacy?

Mike Quigley

Obviously, I mean, this is a complex equation. It goes up and down, but what we are [inaudible] is you said you were puzzled by how could we possibly be increasing headcount. We are frankly making investments in specific areas where we need to have skills to build the business, which we think is going to be important for the future. Frankly, we are not backing away from that.

As Serge said, because we are seeing a potential merger coming up, it does not mean we are going to back off now from what we need to do.

Remi Thomas - Credit Agricole Indosuez Cheuvreux (CAI-Cheuvreux)

It is not related to what we saw a couple of years ago, when there was a disappointing quarter, so a lot of free trials going on in China? This is really on the R&D more than on the SG&A?

Mike Quigley

Just to give you two illustrations, we have increased the number of people we have working on WiMAX and we have increased the number of people we have working on doing integration of very complex projects. That is absolutely happening. Those investments are the way [inaudible] has to take place in higher-cost countries.

Remi Thomas - Credit Agricole Indosuez Cheuvreux (CAI-Cheuvreux)

Just a quick follow-up, if I may. The profitability in enterprise you said in the press release was satisfactory. Year on year, the business was up 5.3%, yet the profitability went from 6% to 4.9%. Was there an issue outside of the satellite business, because most of the other business, with the exception of ISD, traditionally quite profitable.

Serge Tchuruk

We have mentioned that in commencing on the enterprise and private communication group, we have had a channel, one of the major channels, which was reorganized and basically this has been one of the key impacts on the profitability of the enterprise, which is doing well. [inaudible] quite fast, especially on the top-line.

Remi Thomas - Credit Agricole Indosuez Cheuvreux (CAI-Cheuvreux)

Thanks a lot for that.

Operator

We have a question from Richard Kramer with Arete. Please go ahead.

Richard Kramer - Arete Research

Thanks very much. Three areas to touch on that have not maybe been mentioned. First of all, for Serge, now that we have seen some resumption of growth in China, can you comment on the sustainability of a recovery in sales in China going forward, whether you think you see a healthy outlook and spend for the rest of year and into next year, or you continue to see a sort of one quarter on, one quarter off pattern there?

A question for Mike, on some of the large tenders, such as AT&T, SPC, is there a risk or are we seeing Alcatel losing out on some services work in these tenders that might be taken over by large, more traditional IP outsourcing companies?

You also have not mentioned the Telefonica deal at all. Can you talk a little bit about the long-term revenue opportunity you see there? And maybe a question for Jean-Pascal on the net reserves or provisions that are discussed in note 15. It seems you have taken, since the start of the year, 135 million of net new reserves, and even in the quarter alone 72 million of net reserves.

I think it has now been six or eight straight quarters where you have been taking additional reserves. Can you comment on some of the thinking behind this and when we might start to see some net reserves equal out to zero? You are not adding any more than you are taking in a given quarter. Thanks very much.

Serge Tchuruk

Richard, on the China question, what is happening in China among other things is the fact that they are still delaying the announcement of the 3G license locations. The current thinking is that this may not happen before some time in ’07. So obviously since the rate of subscription is going up, one has to invest into more traditional technology, in 2G or 2.5G, as was explained, part of the strength of the Chinese market.

So for as long as they defer the 3G, you will see this going on, although perhaps at somewhat lower rates in the second half. When the 3G decisions are taken, you will see another sort of market developing and probably developing faster than 3G.

Hopefully China, after a couple of years of rather difficult circumstances might be a more healthy market.

By the way, I should also add that it looks today that the TDSCMA has also a good chance of being adopted as the standard by the Chinese authorities. We do believe we are well-positioned on that one because we are associated with Datung. We seem to be well ahead of many others in our capability to meet the requirements.

Mike Quigley

Richard, you mentioned about some of the larger projects that we are working on. I would prefer to not speak about any one in particular, but let me give you an overall view.

We are obviously seen as a company that now has expertise across a whole range of technologies, and that is allowing us to tackle these end-to-end solution issues which we are doing in a number of places around the world.

Is it possible that there will be business in similar or related areas from other traditional, I think you said IT SI companies. We are in fact working hand-in-hand with some of the larger SI companies, as we solve end-to-end problems for our customers. The focus tends to be for ourselves in the infrastructure and up into the OSS. Their focus tends to be from the BSS. There is always a question of where exactly is the dividing line, and that differs from project to project.

I think it is true to say, if anything, we are probably moving up the stack. My view would be we are moving up the stack a little faster than perhaps some of the IT companies thought they could move down, doing integration work in the infrastructure. It is simply very, very difficult to do integration work in telecom’s infrastructure unless you really have a good grasp on the technology.

Jean-Pascal Beaufret

Richard, on the third question I am pretty happy that we have been able, both you and me, to become experts in regard to [inaudible] because from quarter to quarter, it is reassuring to see that we can follow the [progress] piece by piece, bit by bit.

The fact is that 135 million allowances in the quarter, and we have left with 72 million in the net income; 64 million of reversals. Your basic question is, when does it stop? When do your reserves come to a stable, steady state? If I am to understand your question.

My answer to that would be first, when we have used up 300 million reserves which are remaining in restructuring, the first one. You have seen that 60 million of the decreasing reserves from March to June come from restructuring utilization.

Second, just because we keep about 10% of our sales in business reserves for the business. We are lowering as soon as we get sales, we are lowering reserves and we are utilizing these reserves. This is a normal way to manage the business. This is all the businesses on a percentage of completion basis, and this is a business where we have to reserve from the start, as soon as we bid and as soon as we take a contract, or as soon as a contract comes into force.

So we do not see a 10% level of reserves as particularly low today. We see it as completely covering all of the risk which we would have within the next six, 12 or 18 months.

But my answer basically is these reserves will continue to be used over time, [with our] business.

Operator

Our next question comes from Pralin Berg – Dresdner Bank.

Pralin Berg – Dresdner Bank

Thank you very much. I have a couple of very brief questions in three different areas, if I may. The first one being wireless. (a) what do you deem to be a minimum market share in wideband CDMA to be sustainably profitable?

The second, for how long will you continue to support the Fujitsu platform?

Then, in the area of finance, when do you expect to generate cash remotely in line with your operating profits? The second question in that regard, what are the expected costs ahead of the Lucent merger, i.e. related to the Lucent merger. The 1.4 billion.

Finally – very finally – do you have a plan B should the Lucent merger not be approved by two-thirds of shareholders on the 7th of September? Thank you.

Mike Quigley

Serge, do you want me to comment on the minimum wireless market share?

Serge Tchuruk

Yes, please. Go ahead.

Mike Quigley

I think there is no hard and fast rule for this in terms of the minimum market share. I will just remind you of several years ago, when Alcatel had maybe what you would call a sub-critical market share in GSM. Frankly, the Company was focused. What we are now seeing clearly is a GSM play, as we said, 17% to 18% market share in emerging countries, and quite a healthy view on a worldwide basis.

So we can’t answer that question as to what is minimum; we clearly would be aiming to be in the overall mobile space, at least into the double-digit market shares. If you have a look at what will happen to the Company as we move into the merge, assuming that takes place, I think we will have the force and the scale to be able to carve out for ourselves a respectable position. Also remembering that as we move forward in tomorrow’s world, it is very important to be well-positioned in both wireless and wireline, because that convergence is starting to happen. So that is a very important aspect which Serge pointed out, as we compared ourselves to our other large competitors.

On the Fujitsu platform, we are just not in a position today to comment on the evolution and road maps of platforms. We will talk about that a little later.

Jean-Pascal Beaufret

On cash, if I take your question as when does the free cash flow generation equate to operating profit? I would say clearly that operating profit is funding as well the CapEx which includes R&D capitalized for two to three years.

So first of all when R&D is no longer net capitalized, and secondly when your restructuring plan comes to an end, which was the case this year, then the operating profit should be in line with the free cash flow generation. This is a very simple answer.

You have asked as well about the cost of the Lucent merger. These costs for us are not significant if you compare it with the synergies which are expected from the deal. On top of that, the costs of the transaction will be accounted for in the cost of the acquisitions and account for goodwill.

Serge Tchuruk

On the plan B, frankly I don’t want to even think about a plan B because I am so confident that the Lucent merger is the right thing to do that I would be extremely surprised if the shareholders of those two companies didn’t bite. So plan B is not something we have even thought about.

Pralin Berg – Dresdner Bank

Thank you very much.

Operator

Our next question comes from Tim Body – Goldman Sachs.

Tim Body – Goldman Sachs

Thanks very much. I just wanted to ask again a few questions. First of all, give that nearly everyone in the industry seems to have materially disappointed in their earnings expectations since some of these mergers have been announced, it is becoming apparent that the mergers that more defences than offences in terms of their rationale. So although it is incredibly early days, how much of the 7 points of upside in margin implied by the cost reductions do you think an Alcatel-Lucent could hold on to?

Secondly, I noticed that the European business looks rather soft, particularly by comparison with North America. When might we see an increasing commitment by operators to IPTV start driving growth in Europe?

Finally, you mentioned in your release that here has been an [Optix] labor strike. Can you tell us a little more about that and what impact it has had on the business and what it will have going forward? Thank you.

Serge Tchuruk

Let me try to give you the beginning of an answer to your first question. Having [inaudible] to many other types of industries and this is by far not the first time I have seen a consolidation taking place. The same scenario always repeats itself, just before the consolidation settles down, you see hyperactivity in the competition. Because people do, rightly or wrongly believe that they have to sort of acquire positions before the market gets more rigid.

This is precisely what we are seeing just right now. My view, there is no reason why when things settle down these sort of situations should continue.

So your question is, how much are we going to lose of our 7 points in the meantime? I don’t know. I mean, 7 points additional to whatever we do without – so you see where we are currently. I don’t believe we are going to degrade the current situation, given the care we take to not take businesses which we don’t believe are worthwhile. So that is the strategy which we are following.

Jean-Pascal Beaufret

Mike, would you like to comment on the European business?

Mike Quigley

Sure, Jean-Pascal. Tim, it is true that obviously in this quarter the European business was a little soft. We still expect long term we will see the European market pick up as we start to see more video penetration. Now clearly, I think that is likely to happen in the fixed obviously than in [inaudible] but we are also seeing quite some interest in applications and there is going to be the transformation of networks which will take place towards the IMS.

But you are absolutely right, it has gone a little slower. Of course, the penetration on some of the technologies that actually drive telecoms such as HDTV is a little slower, obviously, in Europe. But we are reasonably confident that in due course that will happen.

The third part of your question is on the labor strike which impacted us on optics. That in fact is now behind us and in terms of what effect it had on us, all I can say is it was in fact a significant part of the difference between our results and I think what was the Street consensus was in [FCG].

The good news is that it is now behind us and we expect to move on. As I have said, the optics market, we are starting to see some growth even in long haul WDM.

Jean-Pascal Beaufret

Would you allow me to just complement what you are saying that we are picking up a couple of tenths of a basis point return on sales in the quarter.

Tim Body – Goldman Sachs

Thank you. That was very helpful.

Operator

Our last question today comes from Tim Daubenspeck – Pacific Crest Securities.

Tim Daubenspeck – Pacific Crest Securities

Thank you very much. My question is, very strong results on the North American side. First question is, Mike any concern about consolidation, mergers between AT&T and BellSouth impacting the second half results? Obviously you’ve got pretty tough compares, but have you built in any expectation of a pause or a delay on either AT&T and BellSouth’s side?

The second question is, just for Mike, there has been a lot of concern about you staying with the Company. I am just curious, on your mindset right now, are you still committed to the Company? Thank you.

Mike Quigley

Tim, let me answer the first one first. We are not frankly expecting to see any huge impacts from the merger between AT&T and BellSouth. I think both companies, as I read through the transcripts of their last quarter’s results, it is pretty strong.

Both companies are aggressively deploying DSL which the business is now, as they say, very profitable. We are continuing to work with both companies to try and help them meet their end user needs. So no, we haven’t built in any radical changes.

Now having said that, there is of course, we know, seasonally quarter by quarter ups and downs in some of the volumes, but that is nothing extraordinary.

On the second part of your question, Tim, if I was going to go, I would be gone by now, to be honest. So if I can just make sure I clear this up. I am more than happy to be doing what I’ll be doing for the future Company, looking at the future of technology and our strategy. For a number of reasons, that is the right move for me to make now. I can tell you I have absolutely no plans to be going anywhere else.

Tim Daubenspeck – Pacific Crest Securities

Thank you very much.

Serge Tchuruk

Thank you very much.

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Source: Alcatel Q2 2006 Earnings Conference Call Transcript (ALA)
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