Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  
TRANSCRIPT SPONSOR
Better Than AdSense

Alcatel-Lucent (ALU)

Q4 2006 Earnings Call

February 9, 2007 7:00 am ET

Executives

Pascal Bantegnie - Vice President Investor Relations

Patricia Russo - Chief Executive Officer

Jean-Pascal Beaufret - Chief Financial Officer

Analysts

Paul Sagawa - Sanford C. Bernstein & Co.

Tim Boddy - Goldman Sachs

Inder Singh - Prudential Equity Group, LLC

Alexandre Peterc - Exane BNP Paribas

Sandeep Malhotra - Merrill Lynch

Robin Nazarzadeh - Citigroup

Rèmi Thomas - CA Cheuvreux

Kulbinder Garcha - Credit Suisse

Presentation

Pascal Bantegnie

Hello to everyone. With me today on the call are Patricia Russo, Alcatel-Lucent's Chief Executive Officer; and Jean-Pascal Beaufret, Chief Financial Officer. Pat and Jean-Pascal will provide an overview of our fourth quarter and full year 2006 results and discuss the market and the company’s outlook. Later in the call, we will conduct a question-and-answer session. Please limit yourself to one question and no follow-up questions. Instructions will be given at that time.

If any one has not yet seen a copy of our earnings release or the slide presentation for this webcast and call, it is available at our website at alcatellucent.com.

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 contained in today’s release.

Now, at this point I will turn the call over to Pat.

TRANSCRIPT SPONSOR

Better Than AdSense

What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price?

This is exactly what Seeking Alpha is offering with transcript sponsorships.

Seven types of companies are sponsoring earnings transcripts on Seeking Alpha:

1. Company sponsors its own earnings call transcript (example).

2. Company sponsors partner's transcript (example).

3. Company sponsors competitor's transcript (example).

4. Issuer-sponsored research firm sponsors client's transcript (example).

5. Investment newsletter sponsors transcripts of successful stock picks (example).

6. IR firm sponsors transcript of micro-cap company (example).

7. Consulting company sponsors company's transcript in sector of interest (example).

Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.

Patricia Russo

Thank you, Pascal. Hello, everyone. Thank you for joining us. As you know, earlier today we announced our audited results for Q4 and full-year 2006 as a combined company, for which we provided a preliminary indication on January 23. Jean-Pascal Beaufret will go over the numbers in a few minutes, but before he does, I would like to provide some context around our results, the market environment, where we are focusing and the actions that we are taking.

Obviously 2006 for us was an extraordinary year. We did accomplish a great deal and underwent some significant change as we worked to solidify our long-term positioning. We completed the first and largest ever merger to date in our industry. We acquired Nortel’s UMTS radio business, and we completed the first part of the transfer of some of our operations to Dallas.

Obviously this required a great deal of planning to be in a position to be able to start to execute when those transactions closed. Our operations were clearly impacted in Q4. We can see that in the results. I would categorize the impacts in the following ways.

One major category is what I would call uncertainty. Obviously in bringing two companies together and creating a new operating model and a new organization structure creates some uncertainty for our people as we work through the integration. At the same time, from a customer standpoint, uncertainty about the going-forward portfolio is something that we are dealing with until we are able, after we close the merger, to provide the kinds of details that customers are looking for and therefore we clearly saw some of the wait-and-see impact on the business.

A second major category is what I would characterize as the market and that proved to be challenging from a couple of perspectives. First of all, the consolidation activity in North America clearly had an impact on our customer spending. We also saw a shift in spending of some of our large North American customers, and we saw heightened competition in the global wireless market, particularly in the GSM infrastructure and applications areas. These clearly contributed to what was a disappointing Q4.

That being said, we firmly believe that this past quarter’s results are not indicative of the long-term benefits of the merger and the growth potential of the company. Since we began operating as a combined company on December 1st, we’ve made progress on our integration plan, and while we expect some of the factors that I mentioned to continue to impact our results in Q1, we are confident that we can resume growth as the year progresses.

Let me now say a few words about the broader market trends and our focus. In terms of carriers in our market, we continue to see the migration to all-IP networks. Obviously this is a major transformation occurring in our industry, both in terms of core and access technologies. We continue to see a focus on investing in the deployment of video and voice-over-IP services. High-speed data capabilities in mobility continues to be an area of focus, and at the same time, we are seeing an expectation that more video content and more data content will in fact drive investment and the need for capacity in both optical and data networks.

At the same time, as I mentioned when I talked about Q4, the carrier market obviously has some challenges associated with it. I talked about the consolidation of the operators, particularly in North America. I talked about some of the inconsistency of revenues throughout the year. The regulatory environment for access bundling in Europe obviously is influencing investment and, as you all know, our market has been and continues to be a very competitive market.

In the enterprise arena, we continue to see the migration to all-IP networks, as well as increased requirements for voice and multimedia self-service in the call center area.

In terms of services, and consistent with the transformation of our customers’ networks, we continue to see an increasing need for network integration services to address the complexity of the end-to-end solutions that our customers are deploying. We also see opportunities associated with converged services, multi-vendor maintenance opportunities and the like.

In terms of some of our accomplishments with respect to the market, in the carrier space we increased our leadership over the first nine months in the wireline segment, particularly in ITTV, IP routing and optics. We strengthened our wireless position and portfolio with the acquisition of Nortel’s UMTS radio business, as well as the introduction of CDMA Rev-A. At the same time, as you know, we had taken over the course of the year a selective approach with respect to the GSM business in a highly competitive environment.

In terms of enterprises, we confirmed our leading position in call center applications and increased our leadership in IP telephony in Europe.

In the services arena, we have captured new business in the multi-vendor area and we are engaging in many more opportunities around network integration, professional services, and network outsourcing opportunities.

Let me take a minute now just to, at a macro level, speak to the strategic areas of focus for the company going forward. You can think of them in major categories. One is leading the IP transformation and leveraging our strengths in wireless, wireline, in the converged core area, as well as our focus on services to really play a leading position in the industry in this regard. We also intend to leverage our knowledge of the enterprise market with our capabilities in the carrier market to really provide end-to-end solutions for the business customers of our carrier customers.

Secondly, we are focused on partnering with our customers to help manage the many dimensions of convergence that are going on in the industry, whether it is the convergence between communications and media, fixed and mobile, carrier and enterprise. We are clearly focused there. We intend to leverage our services capability, our breadth and depth in that area to provide value-added service offerings, and we also intend to intensify our focus on the enterprise market. We clearly see an opportunity there against the broad enterprise market, intensifying our focus on the governmental opportunities around the world as well as what we call vertical markets, which is focusing on complex solutions for specific industries.

In order to address these strategic areas of importance for us, obviously we had to, as quickly as we could, address the portfolio strategy and the rationalization of the portfolio as we brought the companies together. And so we needed to move quickly and make some important decisions, both to provide clarity for our people and to provide clarity for our customers.

We have, for the most part, finalized our product portfolio. It is aligned with the strategic areas I described and that is reflected in the investments that we are making in IMS, in 3G mobile networks, in value-added services, in the next generation of optical and data technologies, as well as broadband access for both fixed and mobile solutions.

There is a slide that really just highlights the areas in which we have moved quickly to define our strategy. I will not go into all of them, but for example, in wideband CDMA, we have developed a converged product portfolio plan that really takes advantage of the three converging platforms that came from Lucent, Alcatel and the acquisition of Nortel’s business. We have launched our WiMAX solution. We have reinforced our leadership in broadband access with the decisions that we have taken, and we have enhanced our IMS offer.

This is a strong portfolio and we absolutely intend to leverage the strength of this portfolio and its breadth across fixed mobile converged capability in the carrier and the enterprise market to grow our business and gain share over time.

At the same time we have been transforming our portfolio, we have been working to leverage the integration planning work that we have done to really position us to be able to best support our customers. What do I mean? We have a new operating model and a regional structure that enables us to have a global reach while maintaining local ties to our customers. We have added a new business focus through the emphasis on the carrier market and the enterprise market while at the same time, focusing new businesses on converged core and applications, as well as services. In addition, intensified our focus on the enterprise. We continue to drive the optimization of our supply chain and other processes to improve our efficiency. As I mentioned, we defined our product and services portfolio, which is providing a clear road map from R&D to customer delivery. And finally, we are taking actions obviously to reduce overlaps within the organization, especially in terms of some of the support functions.

That brings me to an update on our restructuring. The combination of our original synergy plan and the additional cost-savings that we talked about on January 23rd will enable us to realize a total of EUR 1.7 billion in pretax cost savings within three years. We expect to achieve a substantial majority of these in the first two years, and at least EUR 600 million in 2007. We believe all of these actions will enhance our competitiveness.

As a result, we now expect to reduce our global workforce by about 12,500, which is an increase from the prior estimate of about 9,000. While these are obviously very difficult actions to take, they are designed to ensure that we are best-positioned to serve our customers’ needs while achieving a competitive cost structure and benefiting from the synergies of the merger. We intend to maintain an appropriate workforce level to do that.

Related to these activities, we now expect that our cash restructuring charges will be about EUR 1.6 billion, with about 900 million being needed in 2007.

Let me just wrap up with really reminding us of why we believe we are very well-positioned to lead in this industry, which in some ways goes back to the strategic rationale for the merger. We have, as I said, we are focused on the carrier market. We are focused on the enterprise market and we are focused on the opportunities that cross those markets. We are working hard to leverage our breadth and depth of capability and expertise across our portfolio. We have a strong embedded base and deep customer relationships. We have a very good blend of a global reach and a local presence. We have industry-leading R&D platforms and a rich culture of innovation. We have worked to create an industry-leading portfolio which is designed to address our customers’ priorities. We have the size and scale we believe we need to deliver a comprehensive end-to-end solution, and we have an extremely talented and dedicated and resilient workforce who has the know-how to solve our customers’ problems.

I am confident that we will be in a position, with all of the assets and capabilities we have, as we work through the earlier days of integrating these two companies, I am confident that we have a long-term value proposition here that is quite positive.

I will turn it over to Jean-Pascal and let him give you the details on the financials.

Jean-Pascal Beaufret

Thank you, Pat. Good afternoon and good morning, everyone. I would like to start with the financial reporting framework we are using the first time as Alcatel-Lucent, briefly explaining why we are representing today three different sets of accounts, under which we will show our results.

In accordance with statutory requirements, we are presenting both reported and pro forma earnings. To give you more meaningful comparative information to evaluate our performance going forward, we are also providing adjusted pro forma results. You see that in this chart from reported to pro forma and adjusted pro forma.

It is important to note that this is the first time that we are presenting businesses transferred to Thales as discontinued activities. Capital gains of EUR 745 million and cash proceeds of EUR 710 million associated with these transactions will be recorded in 2007.

It is also important to note that revenues from the UMTS radio access business acquisition are not included in the results, as that transaction closed on December 31, 2006.

Let me begin with reported results. Reported results for the fourth quarter and full year 2006 include Alcatel standalone operations for October and November, 2006, as well as Alcatel standalone operations from January to November, 2006 respectively. But they include also the combined operations for Alcatel-Lucent for December ’06, and they include the non-cash impact of purchase price allocation entries for the month of December only.

Moving now to pro forma, all pro forma and adjusted pro forma results include the combined operation for Alcatel-Lucent as if the merger had occurred on January 1, 2006. So these results for the quarter and full year include three months respectively and 12 months of combined operation for Alcatel-Lucent. However, pro forma results include the non-cash impact of purchase price allocation entries, but adjusted pro forma results exclude this impact.

Also, consistent with the prior reporting periods, the quarterly and full year 2006 adjusted pro forma we are presenting today are excluding share-based payment in the operating profit. Going forward in 2007, we will include the impact of share-based payment in all quarterly operating income, as well as provide a meaningful year-over-year comparison.

If we look now at the differences between the reported pro forma and adjusted pro forma results, I will give some comment on that.

First, the results under the three sets of accounts are showing variances because we are adding Lucent’s U.S. GAAP results for October and November ’06 to the fourth quarter reported results. Secondly, we are reconciling Lucent’s October-November 2006 from U.S. GAAP to IFRS standards. Third, we are including purchase price accounting as if the merger had occurred on January 1, 2006, and for the sake of the comparison, adjusted pro forma results exclude all purchase price accounting entries, so as to compare the economics.

On a reported basis for the year, we recorded revenues of EUR 12.82 billion and a net loss of EUR 0.12 per diluted share, while on an adjusted pro forma basis for the year, we recorded revenues of EUR 18.254 billion and a net gain of EUR 0.23 per diluted share.

For the remainder of our discussions, we will represent adjusted pro forma results as they are a more meaningful comparable basis for future evaluation, which are presented here in the right-hand side column of these charts.

Let’s go now to a more economic view of what has been Alcatel-Lucent in 2006. As you can see, our combined revenues for the first nine months of 2006 grew approximately 4% compared with the year-ago period, to EUR 13.8 billion. In addition, our operating profit increased by one point to 7.3%, despite the 1.5% decline in gross margin from the year-ago period, which primarily reflects the increasingly competitive environment. The improvement of our operating margin was due in large part to our operational leverage and our focus on managing operating expenses.

Turning to the fourth quarter, however, you will see that there was a point of departure from the good performance of the combined company’s operation during the first nine months of the year. As Pat mentioned, our business was significantly impacted by a number of factors in the fourth quarter. Consequently, we recorded revenues of EUR 4.421 billion in the quarter, a decrease of about 16% at current rate, but 12% at constant exchange rate since Euro/dollar rates went up again 8.5% on average year-on-year in the quarter.

This decrease of sales of 12% was primarily due to the following factors: spending decisions that were impacted by the consolidation in North America and by uncertainty regarding our future product roadmap related to the merger; heightened competition in the global wireless market, especially GSM; as well as, as we said before, [inaudible] commercial approach in those markets. This was combined with an uncertainty around UMTS, given the acquisition of Nortel’s radio access business, which was, by the way, in addition to a shift in spending by some of our large North American customers; and finally, this has to be recognized -- uncertainty among our people as we work to develop our new organizational structure.

Gross margin for the quarter was 31.9% of revenues, as compared with 38.3% in the year-ago quarter. The year-over-year decrease was due in large part to less valuable volume and product mix, and the one-time impact of investments which have been required for 3G and migration to MGM. This was due as well, to a lesser extent, to the increasingly competitive market environment.

Now, let me provide you some commentary on our operating segments. This is the first time we are presenting revenues under the new organizational model that was implemented in December, 2006. Due to the implementation of this model, which took place on the first of December which, by the way, did not help the achievement in the quarter, due to the implementation of this model, two-thirds of the way through this quarter was on a stand-alone basis, so it is not easy to reconcile what had been on a pro forma basis each segment. The complexity involved with combining Alcatel and Lucent financials under one reporting system to produce 12 months of results gives us a reason why we are presenting only adjusted pro forma segment revenues for the full year and for the quarter. But we expect to provide you with more detailed information about the fourth quarter segment results and 2006 quarterly segment information by the end of this March quarter.

First of all, carrier segment revenues for the quarter were EUR 3.22 billion and EUR 13.65 billion for the full year. This segment was most affected by the short-term uncertainty related to the merger, as our customers awaited clarity on our future product roadmaps, and we have experienced as well delayed investments related to carrier consolidation in North America and in the global wireless market.

Let me provide you now some details for the business groups that comprise the carrier group. Wireless business revenues were EUR 1.47 billion for the quarter and EUR 5.72 billion for the year. During this quarter, these revenues were positively impacted by IP routing activity, which was partially offset by the short-term uncertainty related to ex-Lucent wireline portfolio, particularly access synaptics in North America, and by some delayed investment resulting from consolidation in the industry.

Wireless business revenues were EUR 1.24 billion for the quarter and EUR 5.79 billion for the year. As we previously stated, our wireless revenues were negatively impacted in the quarter by short-term uncertainty on the part of our customers, relative to UMTS radio access. We were indeed fully redefining our strategy in this space, in which integrated not only the former Alcatel and Lucent technological approaches, but also the new portfolio from Nortel. This was impacted as well by the shift in spending patterns from some of our North American mobility customers, as well as our continued selective commercial participation in a highly competitive environment, which we have previously communicated about GSM.

Convergence business revenues were EUR 0.51 billion for the quarter and EUR 2.14 billion for the year. The convergence group’s revenues were impacted in the fourth quarter by the decline in sales of legacy [inaudible] core, which continues to outpace the ramp-up in next generation solutions.

Now, I come to the results of the enterprise and services segment, which were not affected by the uncertainty and, given the complementary IT nature of these businesses between Alcatel and Lucent, performed quite well.

Turning to the enterprise segment, these revenues were EUR 0.41 billion in the quarter and EUR 1.46 billion for the year. The enterprise business segment revenues were positively impacted in the quarter by voice and IP networking activities, as well as Genesis call center business.

Finally, the services segment had EUR 0.74 billion revenue for the quarter and EUR 2.79 billion for the year. I would like to point out that all revenues related to deployment services and commissioning are now included in the revenues of the appropriate business segments to which these services are attached. Services revenues in the quarter were impacted by end-to-end network transformation and network integration services.

These are, of course, preliminary indications and they are subject to final representation, but they give us today a good view of what was the company at the end of 2006 and the full year 2006.

A few comments now on the P&L. Below the operating line, we recorded a non-cash charge for share-based payment of EUR 24 million for the quarter and EUR 100 million for the full year. In 2007, we expect this non-cash charge to be fairly stable and recorded fairly evenly by quarter.

Restructuring costs, which are primarily non-cash, were EUR 436 million for the quarter, EUR 485 million for the year. I provide more detail on this restructuring cost on the next chart.

Impairment charges of EUR 141 million in the quarter and the full year were related to [path purchase] technologies and not to the Alcatel-Lucent merger. Let me also point out that the EUR 223 million in litigation and settlement charges for both the fourth quarter and the full year 2005 are for a co-judgment related to the litigation between the former Lucent and the trustee for Windstar Communications. This judgment is currently under appeal with the U.S. District Court.

Finance costs and other financial income reflect the impact of Alcatel-Lucent’s pension credit and post-retirement expenses. Let me point out that the full effect of this credit is not included in operating income under IFRS. The service cost of the pension is now reflected in operating income, while the interest cost and expected return on planned assets is reflected in financial income.

Pension credit and post-retirement expenses contributed EUR 70 million to financial income in the quarter and EUR 537 million for the full year. I provide more detail on the current status of Alcatel-Lucent’s pensions and OPEB in the following slide.

We recorded income tax expense of EUR 81 million during the quarter and EUR 146 million for the year.

Next, I will provide some details on restructuring and the impairment expenses. Total restructuring -- we are on page 17 -- total restructuring and impairment expenses for the quarter were EUR 577 million, which includes EUR 436 million or restructuring, primarily related to R&D capitalized in the past, and EUR 141 million of impairment related to past purchased technologies. For the full year, these expenses were EUR 626 million.

They are primarily composed of: write-offs of intangible assets related to 3G mobile and optical and data technologies, which do not impact cash; product rationalization related to 3G mobile and optical and data technologies, which is cash impacting. We expect the cash expenses for this product rationalization to affect our cash outflows over the coming months; and merger of related costs, which reflect limited social or workforce related costs, and account for about 10% of the total expense.

70% of our full year 2006 expenses will have no cash impact, and the remaining 30% will be cash impacting.

Total restructuring costs for the fourth quarter and the full year are a testament to the speed with which we have made decisions regarding the product roadmap and portfolio strategy of the combined company.

As we previously stated, we expect to realize at least EUR 600 million of pretax cost savings for 2007, with a substantial majority of the benefits recognized in the second-half of the year.

Turning now to the balance sheet, I would like to mention that the combined balance sheet as of December 31, 2006, includes the sale valuation of the former Lucent’s assets and liabilities. Good will as of December 31st was EUR 10.11 billion. Good will related to the merger is EUR 8.1 billion. UMTS radio access generated marginal good will in this balance sheet.

Other non-current assets of EUR 13.5 billion include: intangible of EUR 5.3 billion, primarily related to Lucent’s valuation; prepaid pension costs of EUR 2.8 billion, mostly related to the former Lucent; and deferred tax assets of EUR 1.7 billion, as well as property, plant and equipment.

As of December 31st, Alcatel-Lucent had cash and marketable securities of EUR 6.7 billion and a gross [financial net] of EUR 6.2 billion.

From a maturity perspective, as you may know, our debt [for the year] remains relatively long-dated. As of December 31st, more than half of all debt matures in or after 2012, which is five years or more.

Over the year, in 2006, we continued to repurchase debt in advance. As a result, we have redeemed EUR 115 million in certain debt obligations in addition to normal bond debt redemption of nearly EUR 700 million.

Other non-current liability on the balance sheet of EUR 8.2 billion includes combined pension and post-retirement benefit of EUR 5.3 billion, a deferred tax liability of EUR 2.4 billion, related mostly to the severation of Lucent’s assets and liabilities and other items.

Now I will provide some comments on the final stages of our combined pension and post-retirement benefit plan. As of the end of last year, the aggregate fair market value of pension and other post-retirement benefit assets for Lucent stand-alone was $36.6 billion, as compared with the corresponding obligation of $35.6 billion.

The aggregate funding for the combined plan of Alcatel-Lucent improved by more than $700 million last year in dollars in the fourth quarter and by $3.4 billion from September, 2005, to December, 2006, primarily due to plan asset performance and, to a lesser extent, an increase in the discount rate for pension and post-retirement liabilities. Almost all of these assets are related to the U.S. pension plan.

On December 27, 2006, Alcatel-Lucent made a section [inaudible] transfer of excess pension assets from the occupational pension plan in the amount of EUR 504 million to fund healthcare benefits for formerly represented retirees from October 1, 2006 through December 31, 2007.

Our U.S. pension plans meet the requirements of [ASS] current funding rules and we do not expect to make any contribution to the qualified U.S. pension plans through 2008. we currently believe it is unlikely that any requirement contributions would have a material effect on our liquidities through 2011.

Finally, a few words on operating working capital and cash flow statement. I would like just to give you a snapshot on this operating working capital. If we adjust for the non-cash inventory step-up of EUR 263 million resulting from purchase accounting increase, our working capital was 8.2% of revenues over the trailing 12 months. Last year, inventory turns stood at 5.5, DSOs were at 83 days, and for 2007, we estimate our operating working capital will be in the range of EUR 0.08 to EUR 0.12, with possible fluctuations from quarter to quarter.

In terms of cash flow on a reported basis, because cash flow cannot be presented other than on a reported basis, Alcatel-Lucent generated cash flow from operations of EUR 1.2 billion before restructuring of operating working capital and interests last year. Investments in working cap and other working cap, payment of interest, taxes, restructuring cash outlays, resulted in a negative free cash flow of EUR 332 million. On an adjusted pro forma basis, Alcatel-Lucent had a negative cash flow of EUR 238 million after restructuring cash outlays.

You have to remember as well that the acquisition and disposal resulted in a net cash outflow last year of EUR 91 million, primarily due to the acquisition of the Nortel UMTS radio access business. Net debt from the merger represented EUR 284 million, which allowed us to breach from the last net cash situation to the end year, last year and net debt cash situation, and dividend paid during the period amounted to EUR 219 million.

This leads to my final point, which is dividend. Alcatel-Lucent is proposing to maintain in 2007 for 2006 a dividend payment, and to pay a dividend of EUR 0.16 per share. We will propose this at the next shareholders meeting on June 1, 2007, and this payment would result in an approximately EUR 370 million cash disbursement in 2007. It will be obviously payable to all of Alcatel-Lucent shareholders.

With that, I will turn it back to Pat for some concluding comments.

Patricia Russo

So Jean-Pascal, as you can see, there is a fair amount of complexity with all of the pieces that we put together for the fourth quarter and for the year. What we tried to do was provide you a meaningful view so you could use that as a basis for evaluating the company going forward.

Let me just say a few words about 2007. As we said previously, we expect the carrier infrastructure market to grow in the mid-single digits, which would be consistent with what we believe was the case in 2006. We expect, from our standpoint, as we said, that we expect that we will resume growth after a challenging first quarter, to be at least at that rate.

We believe that the short-term uncertainty and the distractions that were related to the merger will obviously be mitigated as we move through the first quarter and into the second quarter. We think they will continue to have a more limited effect on our business in the early months of the year, which will lead to some revenue decline in the first quarter of ’07. However, as I said, we are confident that we can resume revenue growth as the year progresses.

We are aggressively finalizing our organization structure. We are externally communicating our portfolio decisions to our customers. As I said, we believe our portfolio is a strong one. It is aligned with our strategic areas of focus and it is aligned with where our customers are investing.

With that, let me open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question is from the line of Paul Sagawa from Bernstein. Please go ahead.

Paul Sagawa - Sanford C. Bernstein & Co.

Thank you very much. My question concerns cash flows. You have laid out the expected cash costs of the restructuring and then the in-flow from the Thales divestiture. I wonder, as we look forward, assuming that with the recovery to revenue growth that we turn into a positive operating cash flow, what can we expect from working capital with regard to your cash flow over the remainder of 2007? Roughly, how would you expect to exit 2007 with regard to cash balances and your net cash position?

Jean-Pascal Beaufret

In terms of cash flow, I believe that we will not provide detailed guidance on 2007, as we did not, by the way, in any of the former companies before.

What I am saying here is looking at the way we are using our capital in 2006, on a pro forma basis, what I mention as a metric for operating working capital was quite good. The year-end results and the year-end metrics were 5.5 in turns, 83 days in days. This is an average of what Lucent did and what ex-Alcatel did, so I believe that in the 8% range of sales we were last year, it is not -- it is meaningful to believe that with the growth that we anticipate in 2007, we will spend some money and we will guide in the range of 8% to 12% of the last 12 months’ sales. So there will be cash disbursement, back to your question, but in a limited amount and which will take advantage of the low level of operating capital we would have.

Then, in terms of cash flows in 2007, they will be certainly beat by the restructuring program which we have launched and Pat mentioned that we expect EUR 900 million cash outflows for the full year 2007, but we have also said that we should cash in a significant amount of our disposal of activities to Thales, which amounts to EUR 710 million, so net net, all that could probably be partially offset by this disposal.

Dividends would be in the amount of EUR 370 million and is an amount of money which would come back to the shareholder.

Pascal Bantegnie

Next question, please.

Operator

Your next question is from the line of Tim Boddy from Goldman Sachs. Please go ahead.

Tim Boddy - Goldman Sachs

Yes, thanks very much. I just have a couple of questions, and really, they are around the confidence in visibility you have in the business at this point, particularly, of course, following the very weak fourth quarter. Traditionally, I think both companies were in the habit of giving at least some revenue guidance, certainly Alcatel. Obviously you have given an indication rather than specific guidance, so it would be helpful to see -- obviously if we saw normal seasonality in the first quarter, that would imply an extremely weak sales number. So any more clarity around that would be helpful.

Secondly, the gross margin obviously fell very substantially in the fourth quarter, and my understanding is that you expect that to recover. Can you give us some color around the timing and speed of that recovery back towards the 37%, 38% level you have enjoyed in the past?

Patricia Russo

Tim, let me try to address your question on revenue and I will ask Jean-Pascal to comment on the margins.

First of all, if you are taking the typical seasonal pattern of Q4 and then Q1, particularly looking at the former Alcatel pattern, and looking at last year, you are probably looking at numbers that suggest it is down about 15% to 16%. That is not what we expect, because of the unusual nature of last quarter.

So what we are saying is, and the message we are trying to convey is that yes, we were down Q406 over Q405 for all the reasons we described. We expect some of those factors will obviously continue. They do not change because you have clicked into a new quarter, so we believe they will be mitigated and therefore the effect will be more limited.

But we want you to know that we expect that Q1 will be down over Q1 of the prior year, and we expect to ramp through the year. There is a whole host of things that contribute to that, like information about the portfolio getting out, our people having more clarity around jobs and positions as we move through this first quarter. The settling, if you will, of the consolidating impact that is occurring in North America. What we know about we are seeing the order backlog fill in some place, so we are feeling good about some improvement there. We have signed some contracts we have not been able to announce yet.

So as we look at the year, we feel good about our ability to resume growth as we go through the year. It is a little tough looking at typical patterns because we put two companies together. We had a bit different seasonality and I would not take the 15% or 16% decline from Q405 to Q406 and assume -- or I’m sorry, the typical pattern from Q4 to Q1 and assume that is going to happen off of the Q4 that we just had. I hope that makes sense. I know it is complicated.

Jean-Pascal Beaufret

Coming back on the margin question, of course, I won’t provide you with a guidance on a margin, the gross margins especially. You know perfectly well, and we all know, that in this industry, it is experiencing, it is living in an environment which is a continuous pressure on margin, obviously. All the more that some of the growth areas where we are today, say radio’s third generation or next generation product, are precisely experiencing a very, very heightened competitive environment, so no doubt that we will experience continuous pressure on the margin.

However, what we have to say today is Q4 was a real extraordinary, exceptional quarter. As I said in my presentation, you cannot take the level of margin which has been booked in Q4 as reflective of the future just because we have had a real important volume and product mix effect, and we have had as well a one-time impact of investment required in those growth areas.

So we are expecting, of all combination and the work which has been done, we are expecting from a program of restructuring, to continuously cost reduce our product and to continue to improve our competitiveness in this respect. This is what we can say at this point on the margins.

Pascal Bantegnie

Next question, please.

Operator

Your next question is from the line of Inder Singh from Prudential. Please go ahead.

Inder Singh - Prudential Equity Group

Yes, thanks very much. I just wanted to ask a bit about the progress that you are making on the product side a little bit, Pat, as well as communicating that to your customers. Obviously that was one of the issues that you identified in the fourth quarter. So question number one is really how far along are you on it? Then question number two, and more importantly, perhaps, how far along are you on communicating that to your customers?

Patricia Russo

Yes, that is a fair question, Inder. So let me talk a little bit about this in phases. The first thing that you have to do, and we did a lot of this work in advance of day one, where we could, was get the decisions made about the portfolio and the roadmap. By the way, it is not just the decisions but it is the roadmap. How do you blend and merge the feature functionality that will be important to customers? You need plans that really go out a couple of years, and so that work has been, for the most part, done.

But we were not able, as you know, to really communicate anything to customers until we were a combined company, so the communication to customers takes the following form. It is multi-layer, so the first communications are about kind of the general portfolio and what customers can expect, followed by the more detailed technical briefings that the technical folks want to have to understand specifics around roadmaps, timeframes, feature functionality. All of that kind of communication is going on as we speak and in fact, started as soon as we were able to start it. But as you might imagine, it takes time. We have a lot of customers we have to get to and we have multiple meetings that are required.

That is why I said, Inder, we expect some of the spillover effect as we start 2007 but every day, there is more information out there. Customers understand more fully what our game plan is.

The last thing I would say is generally speaking, we are getting positive reaction. There is no, from my standpoint, big surprises. Obviously there is some change that is going to occur, but generally speaking, we are working with our customers and they are working with us around understanding and, if you will, being on board with our plans.

So it is a process that is well underway. A lot has been done with obviously more to do.

Pascal Bantegnie

Next question, please.

Operator

Thank you. Your next question is from the line of Alexandre Peterc from Exane BNP Paribas. Please go ahead.

Alexandre Peterc - Exane BNP Paribas

Yes, hi. I have just a very quick housekeeping question first, and then a more meaningful question. The housekeeping question is pertaining to synergies. Usually companies communicate about synergies at a run-rate at the end of the year, so I would like to make sure that you are talking about EUR 600 million for the full year in terms of economies, and that you were looking at EUR 1.7 billion as a full-year amount of synergies you will achieve in the year 2009.

Then, the more fundamental question would be, what is your confidence looking into Q1 and a little bit beyond and into 2007? What is your confidence of the revenue growth indications you are giving us? Obviously Q4 was way off the mark, so do you have any elements that would support your claim that the decline will soften substantially, i.e., any indication on backlog, any indication on how the CDMA business, which is very [volatile] in nature, develops? Something like that would make us more confident about what you are saying for Q1. Thanks.

Pascal Bantegnie

Alexandre, as we do not guide on the pace of synergies within the next quarters, Q1, Q2, Q3, Q4 2007, I will not give you the run-rate of synergies we will have reached at the end of the year, but what we are sure of is that wireless we will have EUR 600 million full-year cost savings in 2007. Just to go to 2009, full year EUR 1.7 billion.

We believe, as I said, that the substantial majority of the benefit of our cost savings this year will be recognized in the second-half of the year, so that we will have made a large part, a significant part of the total program at the end of 2007.

Patricia Russo

On the question on revenue, first of all, we try to give you the best view we have of what we think we can achieve, given what know about the market and given what we now about our plans by business.

So when you say confidence, we absolutely believe that the company will resume growth as we move through the year. We have a very low fourth quarter against which to compare, so we expect to build momentum by getting people externally focused, by conveying the information about our portfolio and by closing the business opportunities that we see out there.

We think there is no question that there is opportunity in the market. It is clearly a competitive market. We have a very strong portfolio. We have clarified our plans with respect to 3G, which is where investment is going, and so from a confidence standpoint, what I can tell you is our plan suggests that we are going to grow at least at the carrier growth rate as we move through the year, but it will come off of first quarter that will be down from the first quarter last year.

Pascal Bantegnie

Next question, please.

Operator

Your next question is from the line of Sandeep Malhotra from Merrill Lynch. Please go ahead.

Sandeep Malhotra - Merrill Lynch

Thank you. I have a question regarding 3G. What we hear from the market is that some of your competitors, especially in 3G UMTS, are engaging in very aggressive pricing in order to prevent your integrate Alcatel-Nortel UMTS solution from maintaining or gaining share in Europe, the intent really being to create some kind of duopoly in the market.

Can you give us some color on the competitive dynamics in 3G, and maybe tell us specifically if you can on how Alcatel-Lucent with Nortel’s solution will effectively compete, possibly some examples of responses you are getting from customers, and how long do you think it will take before you begin to see share gains and some significant customer traction? Thank you.

Patricia Russo

Okay, that’s a big question. I think there is no question that there is a tremendous amount of competitive activity around the 3G opportunities in Europe. And as you might imagine, competitors always seek to find openings where they perceive there may be some disruption, and we are dealing with that.

Our strategy has been to be very quick to get to customers with respect to the portfolio, which we have done, with all of the embedded former Nortel customer base. We have laid out the roadmap and the portfolio, which customers have responded quite well to. We are accepting the fact that we need to be able to compete and win because there is a window right now where decisions and choices are going to be made, so the actions we are taking are to be very quick to get the portfolio converged and be aggressive about working with customers at reestablishing the footprint, against which we can grow. Those actions are underway as we speak.

The technical capabilities of the portfolio have been reaffirmed to us by customers, so the functionality, the features, the technical performance are all very competitive. So every day, we come to work and we compete and our focus is on winning, and we intend to do that with respect to 3G, particularly around wideband CDMA, UMTS, with the converged portfolio that we have and the position that we have between the Nortel, Alcatel and Lucent positions.

The second thing I would just add is I would not want you to not reflect on some opportunities. We also have an opportunity to leverage our wireline portfolio and its capability in combination with the mobile portfolio, and in that regard, I think there is no question that we have an advantage in the market and it is up to us to find clever ways to take advantage of that.

Pascal Bantegnie

Next question, please.

Operator

Your next question is from the line of Robin Nazarzadeh from Citigroup. Please go ahead.

Robin Nazarzadeh - Citigroup

Thanks very much. The question is also about the mobile business. First, Pat, I was hoping that you could shed some more light on the fourth quarter, particularly for CDMA, and perhaps give us some insight into how we should expect the year to kind of flow through for CDMA revenues. In other words, should we see the same big swings in 2007 as we saw in 2006?

Also, on the GSM business, you mentioned a renewed GSM offer in your prepared remarks. Is that sort of the product refresh in GSM that Alcatel had spoken of? When do you expect that to be fully launched? Would you expect that to drive margin expansion on a pre-synergy basis, to the extent that you could comment on that? Thanks very much.

Patricia Russo

Okay, first of all, CDMA was down somewhat, obviously, Q405 to Q406. You will recall we had a very large Q3 with CDMA as we deployed Rev-A. So if you average those two quarters, we had a major deployment that had a very positive up-tick in Q3.

I do not expect at this point, based on what I see, to have that kind of swing in 2007. There is not a release that would in fact cause that kind of phenomena, and so my expectation would be that it would be a more stable flow, depending upon obviously the operators’ spending plans in North America.

I think you are really asking me are we going to see a big swing like we saw in ’06. I do not believe that will be the case. The only other thing I would say is CDMA continues to be a large market. It is a stable market. Obviously it is flat to somewhat declining, but it continues to be very large, and I would tell you that from a share position, we are in a very strong share position. We have not lost share in North America. In fact, the last data I looked at said that we actually increased share a bit.

We are looking to compete more in the 450 opportunities outside of the U.S., and we are hopeful that the broader reach of the combined company with the portfolio we have will make some of those opportunities more available to us than they were previously.

With respect to GSM, the answer is yes, what I was referring to was a refreshed, cost-reduced, if you will, offering in GSM which, to the best of my knowledge, is now available and being deployed. As a result, we expect to use that to be able to be more competitive and therefore be more competitive with respect to the GSM opportunities. And in that regard, I would tell you that we are starting to see the order backlog come back.

Pascal Bantegnie

We will take two last questions, please.

Operator

Thank you. Our next question is from Rèmi Thomas from Cheuvreux. Please go ahead.

Rèmi Thomas - CA Cheuvreux

Thank you very much. Turning back to the 3G UMTS access offering, I am understanding that you basically decided to focus on Nortel and discontinue the Alcatel volume 3G range, simply because the radio network controller of Nortel was a bit superior in terms of feature, and also because the installed base of 3G nodes out there was higher at Nortel. Could you tell us if the cost of swapping out the 76,000 base stations that have already been deployed at Alcatel is included in the restructuring charge you announced for the fourth quarter? And can you actually confirm that you have chosen the Nortel base station nodes over the Alcatel one?

Jean-Pascal Beaufret

Rèmi, the answer is clearly yes. In the restructuring charge we took in Q4 2006, but of the cash charge I have commented for previously, it is clearly included in that, for an amount of about EUR 150 million. We have provided for all the costs of swapping out all the UMTS bases which were previously made of Alcatel solutions.

Patricia Russo

Sorry for the delay here. I have somebody who knows a bit more about this than I do reminding me to share that the, notwithstanding what Jean-Pascal just described about the plans, what is really happening across the portfolio is we are really taking kind of a mix of the technologies and creating a sort of best-of-breed solution, if you will. That is not inconsistent with the response that Jean-Pascal just provided, but fundamentally we are taking across all three portfolios and really blending those.

Pascal Bantegnie

Okay, we will take the last question, please.

Operator

Thank you. That comes from the line of Kulbinder Garcha from Credit Suisse. Please go ahead.

Kulbinder Garcha - Credit Suisse

Hi, thanks, I’ve got just a couple of very quick questions. The first one is, with the kind of revenue decline you are talking about in the first quarter, I would expect some degree of negative operating leverage, and Jean-Pascal also did remark the cost-savings are going to be for 2007, more back-end loaded. So should we expect, or is it possible, that Alcatel post close to an operating loss, or even break-even from a profit point of view in the first couple of quarters of this year? That is my first question.

The second question is for Pat, and it is kind of a wider question. I think it is impressive that you have raised your cost-saving targets twice now since the deal has closed. I wonder if you could just speak about some of the factors that have caused you to see the upside in cost-saving. I think the next extrapolation then would be from a revenue per head point of view, it probably still implies when I look at Alcatel-Lucent with some of your peers, that there is even more on the headcount side of the cost-savings that could be done. Any comments you have around that would be helpful.

Jean-Pascal Beaufret

The first question is basically once the operating profile, operating profit, operating income profile for the year, you know that we will not guide on the margin. We are clearly committed to execute on the programs, the savings programs which will yield a EUR 600 million total savings in cost of sales and expenses in 2007 full year. This will be partially substantially in the second part of the year. It doesn’t prevent us to work and to fight and to have the best prospect for improving our profitability even in the first part of the year.

Patricia Russo

With respect to the question on cost savings, here is what I would say: we did a lot of integration planning, obviously, before we actually could bring the organization together. Companies in industries like ours are always looking at what more needs to be done to enhance competitiveness efficiency with respect to their operating model, and so as we have come together, as we have assessed what is going on in the market and what our cost structure needs to be, we have, through what we have learned in the integration planning and then subsequently learned as we put the operating model together, that we have some more opportunity we want to take advantage of, and therefore, we are able to raise the total cost savings and synergies that we expect to achieve.

I would tell you from my perspective, this will be never-ending. I mean, we will constantly be meeting to look at ways to continue to improve our effectiveness and our efficiency, and as we learn more about how this model is working and where there is more opportunities, we will obviously look to try to take advantage of them.

But this is really driven by just knowing better, knowing more, having more time and understanding how the processes work and where there may still be overlap and duplication, and then we move to address it. I don’t think our learning is over, if you will, but certainly we were able to take advantage of that to increase the numbers that we have provided to you today.

Pascal Bantegnie

Thank you, Pat, and thank you, Jean-Pascal. This concludes our earnings call. Thank you for your attention.

TRANSCRIPT SPONSOR

Better Than AdSense

What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price?

This is exactly what Seeking Alpha is offering with transcript sponsorships.

Six types of companies are sponsoring earnings transcripts on Seeking Alpha:

1. Company sponsors its own earnings call transcript (example).

2. Company sponsors partner's transcript (example).

3. Company sponsors competitor's transcript (example).

4. Issuer-sponsored research firm sponsors client's transcript (example).

5. Investment newsletter sponsors transcripts of successful stock picks (example).

6. IR firm sponsors transcript of micro-cap company (example).

7. Consulting company sponsors company's transcript in sector of interest (example).

Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Alcatel-Lucent Q4 2006 Earnings Call Transcript
This Transcript
All Transcripts