Alcatel-Lucent (ALU) Q1 2011 Earnings Call May 6, 2011 7:00 AM ET
Ben Verwaayen - Chief Executive Officer and Director
Paul Tufano - Chief Financial Officer and Executive Vice President
Unknown Executive -
Philippe Keryer - Member of Technology Committee and President of Networks Segments
Patrick Standaert - Morgan Stanley
Sebastien Sztabowicz - Kepler Capital Markets
Didier Scemama - RBS Research
Kai Korschelt - Deutsche Bank AG
Odon de Laporte - CA Cheuvreux
Sandeep Deshpande - JP Morgan Chase & Co
Stuart Jeffrey - Nomura Securities Co. Ltd.
Andrew Griffin - BofA Merrill Lynch
Zahid Hussein - Citigroup Inc
Tim Boddy - Goldman Sachs Group Inc.
Unknown Analyst -
Eric Beaudet - Natixis S.A.
Alexander Peterc - Exane BNP Paribas
So good afternoon, good morning, good evening depending on where you are. Welcome to the Q1 call, and thanks for coming and joining us on the web. You know that we always -- if you had the pleasure of reading this -- the Safe Harbor statement, I'm not going to do it here now, but I'm pretty sure that you will take it and give it your appropriate attention that it deserves.
This has been a very, very good quarter for us. It has been a good quarter because the momentum that we had in the later part of 2010 continued in 2011, and you can see that it is not just the company with momentum, but it's also a market with momentum, and that's an important element to consider. Of course, we have made choices, and the choices are paying off. We've made choices that make end-to-end sense because they addressed the issues that the market is really, at this moment in time, looking into and say, yes, this is what's going to make the difference.
But it is embedded in a market trend, and there are 3 elements that I'd like to stress here. First one, we talked about it many, many times: The explosion in data and video. It's there. It's there to stay, and it drives markets to develop network transformation end-to-end. First in the U.S. China's coming. Europe is coming. You can see that this is a trend that's here to stay, driven by the transformation of the nature of the traffic and the related volume with that.
The second trend is relatively new, and that's a trend that regulators and policymakers not just look anymore to what's the benefit of a consumer, but they also need to look and are increasingly looking into the competitive nature of their infrastructure in the digital knowledge economy, So from countries like Indonesia and Brazil and Mexico and Australia, just to name a few. Many, many initiatives that are taking place right now to say, oh, what do we need to do in order to prepare our markets, our capabilities to compete? Now that has a massive impact on, for example, fiber rollout and other things.
And the third element in the momentum that we have is our ability to translate what is good for the market, what our new product portfolio is all about and make that into a top line and bottom line performance that's increased because of our operation momentum.
So what I'll try to demonstrate to you today is where the relevance of our portfolio is increasing because of the choices that we have made that we're able to translate that increasingly in a positive number for our shareholders, for our customers and for our employees.
So first, networks. We grew 25% in quarter. That is relatively a good number, 25%. And we grew it with a portfolio that is increasingly new stuff where IP is the name of the game end-to-end. Where what we do in one part of the organization is immediately taking an effect into the other part of the organization. The portfolio that we are building is no longer a stove pipe [indiscernible] portfolio. It's horizontal. And the relevance from one end gives benefits on the other end. And that's important to understand because it does 2 things: First of all, it gives us the capability to bring improvements end-to-end to our customers. And second, it speed up innovation throughout our portfolio.
So what you see is a very strong demand in IP. Very strong demand in optical. Wireless is booming. And you see that we also, as I talked, in the Wireline business have surpassed the fact that the legacy business is now less than 50%, substantially less than 50%, of our Wireline business. And I think the Wireline story will be the story for the years to come when it comes to the fiber rollout.
Now if you then look sector-per-sector. IP in Optics, WDM and our router business grew 40%. That is a great number. That is a great number. Interesting enough, if you look to our opticals, you can see that, of course, a translation of the explosion in volume and it also is interesting to note that our Submarine business, much earlier than the cycle would suggest, is picking up the pace again, 6 contracts in the quarter because of this explosion of volume it has to go transported from one end of the world to the other end of the world. So our Submarine business also is enjoying a very good season, so to say.
If you look to the new stuff that's making the difference, it's disruptive in nature. A 100G portfolio, second to none in the market, is really taking off because the disruptive nature of what you present allows our customers to deal with the challenges they have. So great quarter for IP. 28% in total. 40% of that is in the Routing business.
A great quarter also for Optics where the portfolio is moving very quickly towards the new innovative stuff and away from the old classical models of optical.
Now if you then look to our Wireless business, yes, this is an exciting story. Everybody knows that in the U.S. the journey is from 3G to 4G, and we are right smack in the middle of it. So that's great because it's building capabilities. This is not a one-year event. This is going to last a couple of years for it to build out because not only did we manage with our traditional customers to be a major part of that transformation, we also win a lot of new customers on the same concept. So this is good for our classical business. This is great for our new business. And you will see in the 4G build-out that this is going to last way into the future.
Now the interesting thing here is twofold. First of all, we've captured the imagination with our lightRadio project. And the imagination has now been translated, not just in great stories, but in really tangible change in the way we relate to our customer base.
China Mobile and Alcatel-Lucent have signed an agreement where we do co-creation. So China Mobile being the largest mobile operator in the world will get a in-the-tent role to play in designing the whole family of products that we call lightRadio. And it will include more than just the concept of lightRadio. It will include cloud, cloud around the mobile networks and services. And today, I can say that also Telefonica is in that same camp of collaboration. We already had Orange and Verizon. So what you see here is a very different way that you communicate with the community as such of customers in this particular area. It's not the wait and see and we'll lift the curtain and tell you what a product is. If you create together, you gain speed and capabilities by doing that.
Well, if I look to other parts of our portfolio here, growing 37% is a great number. I like much more to be honest on the 37% per se is the way that we built this portfolio. LTE, a very strong performance. 13 contracts, and we are on our way to go to more than 60 trials. And we go into footprint that we have never been before. So that's a very strong performance in real money in this quarter. And the rollout not only brings this type of business into our domain, it also adds to the capabilities of our Services people because system integration with LTE is a massive opportunity for us going forward.
And if I looked at the Small Cell business, which started as an extension of the end of a classical mobile network, it now has capabilities in-house, in enterprise, in public spaces, which all specialized small cell solutions. And the Small Cell business is going to be one of those things that will transform the Wireless business as such. So from those big boxes, not just to the cubicles in lightRadio, but also in the topology of your network that will be much more flexible than we've seen before, and we are very well positioned there.
On the Wireline business, we already talked about the fact that, let's say, the legacy business is going down rapidly. And if you look to the totality of what we have to offer here, there are 2 stories. Story #1, fiber. GPON, EPON, those type of capabilities. And markets like China will invest heavily in that type of capabilities this year, next year and the year after.
The second one is that also there is a future for copper, and the bonding capabilities that we have brought to the market get a lot of attention. So this is a business that I think is in transformation, transformed a little bit later than some of our Wireless and IP business, but I would say this is a business that will provide a kind of building block for nations to build out capabilities that they will need if they want to compete in the digital economy.
Now if you translate all of that what we've done, and we have said all along we have to look to innovation and technology as the cornerstone of what we are as a company. How does it translate into sales for what we call our HLN strategy? Well, we've done terrific in the quarter 90% growth. And somebody will say, yes, but I see an arrow going down from 39% to 37%. How is that possible? Well, that's possible because Frank has decided that 3G when it is 3G of CDMA doesn't fit the definition of HLN. So I thank Frank for his contribution here.
But I'll tell you it doesn't matter. 90% growth is very good and again it's not difficult to predict that before the year end it will go to 50% there. So this is a trend in the right direction. This also is a very good chart to give you a feel how broad our wins are. This is wins in Q1 '11 and not only does it focus on countries like Togo and give you the capabilities that you find in Asia, in Latin America. This is across the business, and what you see are 3 main messages here.
First of all, we win on a global basis. Second, most of our wins are in new territory, in truly new territory. And third, if you look to the wins that you find on this chart, you will see that a lot of things that they buy from us are now end-to-end.
So let's talk about Services. Interesting in Services, if you look to the nature of our Services, Services grew. Actually, all our segments grew this quarter. But Services grew mainly where it was about Network and Systems Integration business, 28%. That's a good growth, and a lot of that business came from strategic industries that it is using your capabilities and make it relevant for other customers than your traditional customers. And you can find that in transportation systems. For example, in New Delhi Airport, they're going to build a metro system and that metro will use our capabilities. It sometimes is in transport systems like in Switzerland, with SBB. Sometimes it is in systems around grids and we'll have an example for you later on in the program here.
And what you will see is that by using our capabilities and expanding it to other markets, we find a lot of solutions that can also come back to the telecom industry as such and where we can take advantage of the knowledge that we have gained from the strategic industries back into how you deal, for example, with customer situations.
Now on Services, it's important to say that we have a great, great order book. So you can see that the traction that we have is, in many aspects of our lines, the one that has performed, I would say, the less in this particular quarter is multi-vendor Maintenance because some of our customers have rescoped that. But if you look to our own Maintenance, if you look to Managed Services and if you look to networks system integration, I'm very pleased with what I've done. And of course, they know that they have to drive the operational performance because that's the name of the game.
On Applications, it's a great story. If you see the change -- I would say the C [ph] change of what type applications people buy from us. This is now old stuff that I would say 2 years ago we would have said, not sure that it belongs to us. Not sure that we would have that capability in digital media, in remote customer service capabilities and all those areas where you bring capabilities and software capacity to your customer base in order for them to use this new reality, which they need to operate and make a difference and make a choice. This is more than Euro 100 million business if you look to the next generation network services that we bring here. And I can see a lot of traction in a lot of different areas that have one thing in common. And the commonality is that you need to have an IP capability in order to maximize those service capabilities that you put on top of it. So the one has everything to do with the other. There is a logic into the combination of services that we bring here, and that is very attractive.
Now our colleagues in Enterprise have done a phenomenal good job. It was a very good quarter. It's a good business. We invest in the business. There's all kind of new stuff going on. Enterprise business grew 5% plus Genesys grew more than 10%, so it's a good business. And we have -- we are seeing good traction in the market with a lot of new innovative formulas there as well.
Now this is an interesting chart because sometimes I hear people say, you know what, you rely too much on this, that or the other. And in geographies people also have sometimes that feeling. And it's interesting because this would show how well positioned we are in the different areas because there is not just the vision of geographies as we have them as Alcatel-Lucent, there's also dynamics in the market. So let's walk through this particular chart and let me start with China.
China in 2010 was a difficult year because they had all those things going on like the World Expo and they had already built out 3G and it was in the first 3 quarters, you remember that, it was a kind of holding back. Q4, they came back and boy, do they come back in 2011 and 2012 and 2013. You can read the 12th 5-year plan, and you will see 3 things that are important.
First of all, in the next 5-year plan, the first word that they use is innovation. The second word is green, and the third word that they use is we need to have a digital infrastructure. And that translate into a drive for fourth generation in China, and we were awarded an LTE TD order with China Mobile in Shanghai. And it drives an expansion into IMS services, fiber services in order to cope with that opportunity that the 5-year plan brings to our Chinese customers. We grew in quarter substantially and the whole of the region grew 6%, but basically the engine for that was China.
If you look to the rest of the world, and I go against the clock here, if you look to the rest of the world there are 2 main factors to get to that 13%. The first factor is Middle East & Africa. Of course, this has been a difficult quarter, given the turmoil in that particular part of the world. I have to give a great deal of respect for our local team not only how they have handled the human aspect of it and the customer aspect of it, but if you look to the numbers, it's minus 8%, which is given the circumstance, a pretty good performance.
This week, our board was in Brazil. We traveled with our board around the world to have first-hand experience also on the board level what's going on in the different markets. And we saw a phenomenal performance from our CALA team, Latin America team. They grew 59% in quarter. And bear in mind they do not have -- they do not enjoy a large wireless footprint. They are very selective in what they do and how they approach it. And they are very, very successful in the market that, in and by itself, is also taking off.
The same if you look to the U.S. The growth in the U.S. has been a very healthy 40% plus. But this is a market that is right now in the forefront of that development. So of course you would see a larger growth than in some of the other markets where they're still contemplating what to do and how to do it against what context. Once the markets are taking off, that's the message I have for you, we're ready to take advantage of the market, and we are very well positioned with our portfolio to do exactly that.
Now in Europe, everybody knows that we are waiting a process with the European Commission when it comes to the national rollout of broadband networks on the regulatory, let's say, certainty that needs to be created around it, and we expect to have a report from industry to the commission in July this year. So I expect that by the time we talk 2012, 2013 this will be one of the major drivers. And you can, therefore, see that there is a logic in how the markets are developing. We're doing very well in IP, very well in optical in European market. But overall, it was flat.
So if you add this up, I think we are very, very well positioned to the situation of where the markets are going together with our portfolio.
Now operationally. Let me start by saying something about Japan because I'm pretty sure that everybody is interested in that. First of all, I think our team has done a remarkable job in Japan from a human point of view, in their relationship. And of course we can only pay the highest respect for the way that the people in Japan, in general, have coped with a situation of an enormity that is very hard to understand. So they have done a great job.
Our Japanese suppliers to us have been exemplary in working with us, extraordinary proactive for workarounds in a very timely basis to find alternatives. And that gives me the opportunity to say to you that we think that this is a very manageable position for us. But I would like to give my respect and gratitude to the people in Japan and especially the partners that we have in that particular market.
Now we had a great gross margin performance in Q1, and Paul will talk about it. But that great performance is based on 3 things: It's the volume. It's the mix. And it is, of course, the geography. And I think if you look to that, it has a great opportunity for us as a company to continue to have strong performance. Because in all 3 elements, if you think through where we are and what type of direction the market has taken, we have opportunities to do that or even better.
Part of that is, of course, that we need to commit and we are committed, and we will execute our cost savings and maybe not important at all is the fact that we have improved our free cash flow situation by Euro 200 million. So if you then bring it all together and you'll say, what's the story of Q1? Well, basically if I say it as easy as I can, as simple as I can. First of all, the company didn't dig a hole for itself in Q1. That's a nice change. Second, we think that we will grow faster than the market and the evidence, I think, is in this presentation. And the third element, we think we will do 5% or better in 2011. Paul?
Thank you, Ben. Okay, good afternoon. What I'll do is give you a little color on the numbers to reinforce the points that Ben made. First, let's start with the breakdown in the quarter. Obviously, it was a strong quarter and continued the positive trend that we've experienced over the course of the last several quarters.
If we look at the bottom line, we posted a Euro 13 million in profit. That was the first profit in the first quarter in many years. As compared to last year, that's over a Euro 200 million swing and sets us off, I think, in the right track. Revenue was strong at 15%, actual rate basis. When you normalize for constant currency, it was about 14%. And gross margins was a 360 basis point improvement year-on-year, primarily driven by volume, which is about 25% of that improvement and mix and geographic mix was the remaining 75%.
On a quarter-on-a-quarter basis, we've held our margins flat at 36.2% even though the volumes have dropped dramatically. Again this is the function of product mix offsetting volume. And I think that we have a good opportunity to hold this at least into the next quarter and slightly beyond.
If you look at our operating expense on the quarter-to-quarter basis, we're down 1.8%. Clearly, we are committed to get the Euro 300 million to Euro 400 million reduction before variable comp we've talked about. That will be more back-end loaded, and you'll see that coming out in the next couple of quarters.
Breakdown by operating segments. We went through a good number of this. You can see the numbers on the chart. Obviously, very strong growth in every one of the segments, but Wireless eclipsed the rest. And again it's the trend of the new products helping us solve customer problems. This is the same trend we've seen over the course of the last several years. So IP 40% growth. As we said, our terrestrial optics, up 22%, driven by WDM. Obviously, Submarine has grown. It was a 6% growth year-on-year as we see the revenue beginning to grow. Strong growth in Wireless and Wireline and of course, our Applications and our Services business.
If you look at profitability by segment. I think the thing to note is every segment improved on a year-over-year basis. Obviously, the Wireless segment -- the Networks segment led the way with both IP and Wireless at the front of that pack. We saw good growth year-on-year in Applications, both in Network Applications as well as our Enterprise Applications. And our Services segment also improved year-over-year driven by Maintenance and improvements in some of our Service divisions.
From a revenue standpoint. Obviously, the revenue distribution shifted slightly this quarter. We normally are about 1/3 North America, 1/3 Europe and 1/3 the rest of the world. Given some of the strength in the U.S. this quarter, we've seen that increase slightly. So the North America is now 42%. I think this will moderate over time. But it's illustrative of our position there.
As Ben stated very strong growth in APAC, driven by China. We saw very good, strong growth in the rest of the world driven by Latin America, Mexico and Brazil. And Europe was essentially flat with Eastern Europe growing slightly and Western Europe offsetting that balance soon enough.
If we turn to the balance sheet. No material changes in the balance sheet this quarter. Obviously, with the dollar-euro conversion rate changing toward the back end of the quarter, there's a lot of FX that primarily affected all of the changes in goodwill and other intangibles. You will see in a later chart that we've had a positive swing in our pension from the funding status from an accounting standpoint. So that improved the net pension liability and had some degree of same offset in the shareholder equity.
If I turn to our operating working capital. We were able to reduce our operating working capital by Euro 185 million on an actual rate basis. If you adjust for currency, it's about Euro 170 million. That was primarily driven by our collections effort on our receivables from the fourth quarter, offset by payables.
Inventory on an actual basis was flat. As we look through the course of this year, as we talked about before, inventory and inventory management will be key focus and our ability to generate cash.
If we look at cash and cash flow, we posted a negative Euro 213 million free cash flow. That is an improvement of over Euro 200 million from the year-ago quarter, so 50% improvement. That improvement was driven primarily by a positive operating cash flow. We generated Euro 169 million of operating cash flow. Euro 82 million of that was from the change in working capital.
I think the thing to note is our restructuring costs were about Euro 82 million, and that is down almost Euro 55 million from the period before. As we said in our fourth quarter call, we attempted to hold our restructuring charges to about Euro 400 million for the year. I think we're on track to do that, but more importantly to ensure that we are able to redeploy resources in the company to more effectively get the utilization of our workforce and save cash charges.
The other thing I'd point out is interest. Interest was very high in the first quarter, than it is normally. A lot of our debt instruments have interest payments in the first quarter. You will see that decline dramatically in the second, increase slightly in the third and again [indiscernible] in the fourth. If I look at the ending cash and marketable securities worth Euro 4.6 billion. In the course of the quarter, we did repay our 4.75% OCEANE in January 3 for about Euro 818 million in principal value. The credit line is undrawn at Euro 1.4 billion and all covenants have been met.
Turning to the Pensions. We saw a dramatic swing in the Pensions this quarter. For the first time in probably since I've been here, from an accounting basis, the Pensions are positive funded status, albeit Euro 10 million. But it's significant Euro 525 million swing quarter-on-quarter. That's primarily due to 2 things: The asset value increased dramatically, and we did have the benefit from a change in the pension plan of about Euro 70 million.
As we said in the fourth quarter call, the most important number is the funded status for the pension plans in the U.S. on an arrested basis. At that time, we said we were highly confident that there'd be no funding through 2012. We remain as confident, if not more so. We've seen the final valuations of our private equity portfolio and our real estate portfolio. And they gave us more confidence that there would be no funding requirement. The only data we're missing is the updated census there.
So given our performance in the first quarter and the market trends that we are seeing, just to reiterate our guidance: We believe that we will grow equal to or faster than the market. And we posted adjusted operating profit of 5% or better.
With that, I will turn it over to you to ask some questions.
Great. Thank you. Could the operator please give instructions on how to ask questions on the line, please?
Unknown Analyst -
Two questions. The first one is regarding the enterprise assets. You are price booked on how good that piece of the business. So what is your price according to you of such a good business? We talked about $2 billion. And the second question is regarding the market trend in Europe. We had KPN-Belgacom with more pressure than expected on the Wireless revenue, so could it prompt your band operators to be more with the wait-and-see stance regarding CapEx in 2011 or no change according to you?
So about the first, you will not be surprised that my answer is that we never comment on speculation or rumor, so even if you put it in into a very creative mode to the same question, I'm not going to give any answer to that other than saying, and I repeat that, it's a great business. There's traction in the market. We invest in it. And it's doing very well, Genesys and our Enterprise business alike. So the second question, it's an interesting question because it posed the question, is a defense mode enough to deal with the pressures you're under. Now clearly, other markets take different suggestions. They say, it's not about just reducing costs, it's also increasing your capabilities to deliver all kind of new services in order to monetize that. And you cannot say a specific region will take a collective approach. Everybody will do the same as their neighbors will do because this is an individual choice of free enterprises. It will make very different decisions. I can tell you that I see a lot of interest to go and to see what you can do with this explosion in data and video to develop new business models very, very actively. So I would say that the reaction will be much more sophisticated than simply cutting and being more defensive. It will differ and I'm not going to speculate about individual players, but what we see happening is that it will differ company by company.
We'll take the next one from the bridge, please.
The next first question comes from Tim Boddy from Goldman Sachs.
Tim Boddy - Goldman Sachs Group Inc.
I had a question about the IP Routing business, which obviously had a fantastic fourth quarter and then a sharp sequential decrease. Is this business just -- did it just have a lot of seasonality or are there any particular dynamics you could characterize that would help give us continued confidence in the momentum there? And then on the OpEx side, your SG&A grew sequentially and you referred to some seasonal accruals. I mean, obviously your portfolio's down year-on-year, but if you could just talk about the trend in SG&A, that would be helpful.
Paul will take the second. I'm dying to take the first question because if you are criticized by only growing 40%, we are right on the right track. We must be on the right track. There are 2 things. There is seasonality in our business. Big seasonality. How does it work? It is called revenue recognition. You have many projects that you build up over a period of time, and you can only recognize the full of the revenues if the sign-offs are coming through. But if you look to where companies are spending and how they are spending and you see what we do on the IP front, I am 100% sure we're taking market share every single quarter now and we're doing tremendously well in the Edge Routing business, in the mobile backhaul. For sure we are the #1 in the market, and I think a 40% growth is a great number for our Q1. Paul?
With regard to the SG&A, you will see that decline over the course of the next several quarters. In the first quarter, we had some aberration in seasonal accruals. And let me just give you an example of one, vacation or holiday accrual. Last year, we made a change to our plans where in essence we asked our employees to take all their vacation. If they didn't take it, we zeroed it out. So we went to a "use it or lose it" policy in certain parts of the world. That gave us a more flatter expense on vacation accrual in the first quarter. This year, we're at steady state, but you have to accrue based on how people earn vacations. So you earn a lot of vacation accrual in dollars in the first quarter, it increases in the second and it comes down in the third and fourth as people take vacations. And in our case, for that part of our population, that is -- cannot carry over vacation. It's zeroed out. That's an example of the seasonal accruals I'm talking about.
Unknown Analyst -
This is [indiscernible]. Could you please provide an update on CDMA market and EV-DO upgrade in the U.S. Do you believe it has peaked in Q1 or should we expect seasonal growth in the next couple of quarters?
So I think we have talked about peaking CDMA for as long as I am here. I've heard this question every single time. I think we will see CDMA growth for a substantial amount of time going forward because there are 2 things to bear in mind. CDMA is still the underlining network in network capabilities, so there was a lot of the traffic elements. And second, it's not just one customer in the U.S. It is now also elsewhere in the world, a technology that will help us to have a, let's say, a long-life expectation on the CDMA business.
Sebastien Sztabowicz - Kepler Capital Markets
One last question if I may. Could you please provide some colors on the seasonality you see for Q2, had in mind that usually a sales increase about 5% to 10% sequentially. Usually, it is a case for [indiscernible]?
So I'm not going to give you a quarter-by-quarter forecast now. But what I think that is happening is that momentum, as I said last time and I repeat it, momentum doesn't look on the calendar. Momentum is momentum. And there are certain momentums in the market that we discussed and that will continue to go forward. So we'll see where we'll end up at the end of Q2. But clearly, the company has momentum.
Our next question comes from Zahid Hussein from Citi.
Zahid Hussein - Citigroup Inc
Just in terms of mix. As we're thinking about 2011, clearly, CDMA is very, very strong. Surely the OT mix will actually have to come in by the second half of the year. Just some little bit of comment in terms of how we should think about that. I'm guessing [indiscernible] revenue right now is still very, very small but it's probably going to ramp up towards the back half of the year and into 2012. Is there any comment you can give us around gross margin? It'll be very, very helpful.
I think that you will see mix shift as we move through the course of the year. I think that given the breadth of our portfolio, the strength of IP, the strength in some of our Wireless categories, the strength of our Optics category, that we saw 36 points, roughly 36.2% of margins fourth quarter and this quarter. I think that you'll see that trend not diminished too much in the second quarter. And I think that the opportunity to hold that through the rest of the year still exists.
Zahid Hussein - Citigroup Inc
That's very useful. And just one in terms of just Japan. Will we see any impact from that on the gross margin line? I mean, clearly, there's going to be a little bit of an impact on top line, I can imagine, but will there be much in terms of gross margin?
Well, I think that as you look at the gross margin, you may have some margin shifts because of mix. But we've got a fair amount of opportunity to sell different parts of the portfolio and take our costs down to offset that.
Alexander Peterc - Exane BNP Paribas
Alexander Peterc, Exane BNP. Just a quick question on the seasonality in Wireless. You say your business is very seasonal. That's been always the case. We've seen Wireless down only 3% in this first quarter versus the usual minus 20%, minus 30%. It can be fairly volatile in this time. But how should we think of seasonality then going forward? Are we going to see really odd quarters in the rest of the year as well or is this a particularly high base of Q1 that we're dealing with here? And then the second slight color I'd like to get is on Asia. China was obviously very strong with GSM being particularly driving sales there. Does that mean that some other regions and some other activities were actually down year-on-year in Asia? If you could tell me which ones and why.
So let me start with Asia. There is, of course, sometimes regions where you have a big project and that ends and then another project starts. It's not always 100% a clear line. India is a great example. We do a lot of services there. So sometimes a services contract come through, sometimes it doesn't. China is a very important situation because it's -- first of all, it's not only GSM, Wideband-CDMA and other technologies that we sell into the market, IP and optical and stronger and stronger also in the Wireline business with IMS and with fiber. We think that 2012 will be a good year -- 2011, sorry, will be a good year for China. We also think that we have opportunities to do better on the margin, and Paul doesn't stop talking about the margin improvements also in the markets that normally where always those markets where people would say, yes, but this is the price to go into. And I think by being much more selective in how we go into markets and with the value proposition, you will see that we will do better there. I think 2010, we started. 2011 and 2012, maybe even half 2013 will be a very important build-out, a couple of years, for 4G around markets like the U.S. and what will happen in China. I think that you will see 2012, '13, '14, '15 in Europe because look around you, smartphones happen, tablets happen, video traffic happens. It will come and therefore, there is a kind of I would say semi-long-term trajectory that you can take to see where trends are going to bring you. Now will there be a seasonality in some numbers? I'm pretty sure there's always some events that will take place in one quarter or the other quarter. But overall, I would say that the macro trend is massive change in the nature of the traffic and that needs to be translated into a building out of IP. A massive drive for national growth of infrastructures and going into the rural areas, which means energy consumption needs to go down and that will also spur new innovations and investments to be made. I don't see it. I don't know what you're asking for if you say the Wireless seasonality. This was a good quarter because it's in the trends, and I don't think that you can expect huge movements during 2011. I don't think so. But maybe Philippe, if you have anything to add to that? Okay, that is now confirmed.
Our next question comes from Stuart Jeffrey from Nomura.
Stuart Jeffrey - Nomura Securities Co. Ltd.
Our next question is coming from Andrew Griffin from Bank of America.
Andrew Griffin - BofA Merrill Lynch
Ben, you alluded to the European Commission to drive broadband. I know you've been asked to cohead a group to report back to the commission. Could you just remind us what the background of this project is, why the commission have felt it necessary to get your customer CEOs together and why the situation in Europe might be different from others. Because if it's like the never ending question on CDMA, I guess we've been waiting for fiber rollout in Europe sometime, too.
So there are if you look to Europe, the estimation is that we need, in the coming 10 years, a Euro 300 billion investment basically. And the discussion is how do we get there. Simply leaving it to the industry probably won't happen. There's no alternative to ask the governments because they don't have the money nor have ways to remodel around it. So you need to come up with something that gives the incentive to go and spend that money because that's the infrastructure boost that we need in Europe in order to stay on the competitive landscape. And the industry has been asked -- worldwide industry, I mean, players from over the top from the U.S. local telcos, companies like us in the technology, to come together, to have the debate and see what type of proposals we can give to the commission. And just before the summer, we'll start. We will have the opportunity to go and have the dialogue. It's important because it gives a kind of certainty around the investments environment that we're seeking. You know that in many countries, policymakers have given targets. President Obama says 97% of all Americans will be connected to high-speed broadband access. In Europe, they have said in 2020, I believe, 100% of people will have access to high-speed broadband networks. That's quite a target to go for 100%. And therefore, we need to find ways how to engage society at large into ensuring that we're going to make those investments. And we'll see what the outcome will be.
Our next question comes from Odon de Laporte from Cheuvreux.
Odon de Laporte - CA Cheuvreux
I have a question about LTE. You said you're winning contracts outside of your footprint. Would you mind to share with us some examples if possible?
So if you look to areas in Eastern Europe, in Russia, you will find some of those examples. New customers in the U.S. that we haven't served before so that's why you have to look.
Our next question comes from Achtal Sultania Credit Suisse.
It's related to your CDMA business. Of the Euro 288 million euro profit number that you made last year in 2010, it seems CDMA was a major contributor right? And how should we see the profit contribution of CDMA evolving in your mix in 2011 and '12? I'm trying to get a sense of whether that number will be higher or lower in 2011 compared to 2010.
First off, in 2010 I thought we had good profit contribution from all Wireless categories, GSM WCDMA, CDMA and even LTE. So I think that in the first quarter we're seeing a seasonal uptick in CDMA. I think that as we move through the course of this year, you'll see the other Wireless categories also contributing. And so I think that it's hard to predict a full year in terms of what the mix is going to be, but I think that we had good contribution last year from all categories, and I expect good contribution this year in the same way.
Okay. And a follow-up is on the network model [ph] addition contract in Europe, how should we see your gross margins -- do you expect that we we're going to actually see some impact on your gross margins because of these contracts in Europe?
So I think it would be wise first to see what model will be used before we go into comment about the gross margin on the contracts. But if I see what we do now on upgrading networks, in systems and networks to make them full IP, I can tell you this is, from a margin perspective, very healthy business because it brings back the core of our new capabilities. And that has very healthy business.
Our next question comes from Kai Korschelt from Deutsche Bank.
Kai Korschelt - Deutsche Bank AG
I have 2, please. Could I perhaps maybe push you a little bit more in SG&A. I mean how back-end loaded should we think about the undoubtedly reductions that we're expecting. You mentioned the seasonality, but as I understand there should also be then structural savings from relocating and property efficiency. So could you maybe just share with us when you expect those particular savings to start to contribute. And my second question, Ben, is just on the core Optical business. If I exclude the Submarine business, clearly that is the high-capacity technology, particularly in backhaul and metro. But it looks like we haven't really seen that much of a actual spend increase. If you look at some of your peers at least if you compare to Wireless. So I'm just wondering can you elaborate on the expected timing of the sort of market around here?
Let me take the first question on SG&A. What we'll see this year is that SG&A will begin to trail off predominantly in the second half of the year. If you go back and look at 2010, remember we had some very large restructuring programs in 2009. They brought a tailwind in early part of 2010. This year, as we said, we are trying -- we have no restructuring programs. We're trying to place people internally through our internal job marts and utilize our resources. So you're going to see most of that -- we're seeing that tracking taking place now. It'll pick up in the second quarter. And you will see the full impact of that in the second half. The same is true with real estate. And so I would tell you that probably you'll see a greater reduction in the second half of the year than you will in the first half of the year. But we're committed to the full year number.
And since Philippe is here, Philippe Keryer, maybe you can answer the question on the Optical?
Yes, related to optical, I believe -- is it okay, yes, related to optical, I believe the trends are definitely aligned with the profit requirements and you have as well in Optical a shift of technologies. We used to have the older technologies in optical and this is moving to a mix of WDM, which is growing 40% as we said, together with the shift to IP. So when you look at the infrastructure and the way it goes, you have an underlying [indiscernible], which is at the WDM, which is growing very fast. And we see the line growth that we see in IP as well. So you see segments which are in certain ways saturating but you have a shift to IP, which is also driving very significant growth in the new technologies of Optical, which is WDM. By the way, our last remark is about the same technologies which are using in terrestrial. I was aware for once but we are using at the end of the Submarine links. This is what you put in with terrestrial stations, and this is where we have definite technology advances with our 40 gig and 100 gig quadrant, which is making the difference.
Eric Beaudet - Natixis S.A.
Eric Beaudet from Natixis. Two questions if I may. The first one is on Services. You mentioned the rescaling of a certain contract. I was just wondering if it's the first quarter we've see an impact or you already had an impact on Services over the last half of 2010. And my second question is again on Enterprise. I know you won't comment on speculation. But I want to know for you, are there any synergies between your Enterprise business and the rest of the group maybe in R&D or the way you go to market with your vertical markets? And did you have the scale -- do you think you have the scale enough in that business considering you're almost absent from the U.S.?
So on the rescoping of a certain contract, that was already in previous quarters as well. So you'll see that's going through. And basically it was one of the examples that I just wanted to give, to give the change that is taking place in our Services. That is going exactly the same way as you can see our product portfolio going. It's going from relatively classical approach to the new approach. So there is logic in the way that you look to the applications, you look to your Services and you look to your products. It is all coming together into a kind of system and network approach. You asked me questions about the Enterprise business. Is there a logic in the Enterprise? Yes, there is. Is there a sell-through capability? Absolutely, there's a sell-through capabilities. We have customers, for example, in France and in Mexico and in some other markets where we have sell-through. Is it -- do we use R&D capabilities in one of the company to the other? Yes. One of the big things that I'll try to make sure that this company is not doing is siloing and one of the changes that we have seen in the performance of the company is the fact that we're teeming, we're teeming early in the process so there is SIP technology on the product, which is very specific to the desktop. But there is also behind it other technologies that you use not just on the desktop but you also use in the rest of the network. So you have a mixture of both. And the size -- I mean, just look to the traction that we have. We grew in this particular quarter, not just the Data business, we also grow our voice business. And we have launched a kind of multimedia type of desktop that was very successful. So I think the size in and by itself given the fact that not all of those businesses are global business, Genesys is. Some of our voice businesses is basically a European business doing very well, given the market size and the capabilities.
Your next question comes from Patrick Standaert from Morgan Stanley.
Patrick Standaert - Morgan Stanley
I've got 2 questions, if I may. The first one is regarding Europe. It's obviously lagging a bit in performance of other geographies and I was wondering if you could tell us what you're expecting and what we should be monitoring to looking at the recovery in that important region. And the second one for Ben and Paul, actually. You were talking about high single-digit margins for next year as a target. The performance of today, is that making you more comfortable about reaching that? And what will bring that high single-margin target for next year and what should we be monitoring?
So comfort questions are always Paul's questions, so why don't you take it?
Well, first off, I don't think we've given guidance for next year yet. What we said is this year it's going to be 5% or better. And obviously, we are reaffirming that today, but we are going to work as we can to drive our top line, the mix and our cost structure to always improve margins.
So I think there are 2 things to say about Europe. First of all, if I look to our portfolio and where the drivers for growth is in Europe, we're well positioned. Make no mistake about it. My expectation of Europe is a growing region. And I expect our team to take advantage of the growth opportunity that's there. Now there are specific things in one quarter that dealt with the number as we see here. Overall, I don't think that Europe will be brilliant, but I don't think that we should take for granted that we should accept that it is a kind of flat region. It shouldn't be. It shouldn't be. And it won't be. And I think that what you've seen is a very strong performance from our teams, very strong performance from our product portfolio, very strong performance from our end-to-end portfolio. So we should be able to demonstrate that going forward.
The next question comes from Didier Scemama from RBS.
Didier Scemama - RBS Research
What I'm wondering is when it comes to LTE and in particular in Western Europe opportunities beyond LTE, of network modernizations, I was wondering if you could discuss your strategy with regards to this opportunity. Whether you intend to participate in all contracts and leverage your new technology goal portfolio or if you would be selective in your bidding?
So as a matter of principle, I think we've learned the lesson as a company that without being selective, you are not going to bring yourself anywhere. So the lesson in the beginning of the merger years was perhaps also sometimes a lack of being selective. We will be selective and regardless what geography you bring up, we will be selective. The second thing in what we're doing is we look to our portfolio of disruptive new technologies. If you look to what lightRadio is doing in the market, it has a massive impact already because it really substantially redefines the capabilities of networks going forward. So a lot of the discussions will go not just on the technology sides, whether if you call it LTE, 4G or whatever it will be on what is the business model that we're going to use, what are therefore the essence that I need to have and where do I going to differentiate from my competitors. That is the discussion we have with our customers. Not so much as a kind of new wave of connect generation. And I think that if you take LTE as a fourth generation, that will be customer-by-customer a different strategy. And if you take LTE Europe, it will be a very different strategy from one player over the other player. With some players, we will have an engaging discussion because they will have a model that fits the way that we look to the market. With others, we won't. And that's perfectly okay. So we will not chase every rabbit number in the field, but we will be very selective in where we're going to play and how we're going to play it. But this is a growth market. We have a great presence in the LTE market. We are a leading player there, and that our assets at [indiscernible].
Unknown Analyst -
Just to point, do you see any risk or opportunities from the concentration of your customer concentration, merger or JV. I think about the JV between France Telecom and Deutsche Telekom, by example. And my second point is, is there a special positive effect of an amendment in United States about the pension fund. If I understood well, it's limited amount of people, which is concerned. Is there any hope to have a larger impact to infrastructure of a new amendment or...
So I'll take that question first and then Ben can talk about the other one. What we did is allowed approximately 3,000 people who are currently in our management plan to elect that retirement a lump sum option. When that happens, it changes the actuarial assumptions, and that led to the Euro 69 million positive. As you've seen over the course of the last several years, we are pretty adept at making changes to the plan around the periphery that have positively affected the ability to maintain the funded status. There is some more in the hopper. We'll talk about those as they become more real. We're always looking at how we can make peripheral changes that give us more flexibility.
Unknown Analyst -
If I understood well, it limits the risk definitively as the people who chose as a capital choice?
What it does is if you look at the discount rate used, if you don't choose a lump sum, it's higher than if you choose a lump sum. So the delta is the actuarial gain over the period, and that's the Euro 69 million.
So on the new models that are trials working together on various levels of the network, working together in the way that you look to purchasing, working together in the way that you on services. There are many examples. I think it's a great, great opportunity for us because what they all have in common is that it is all about preparing the companies for a world to come and not stay where they are today in the world that was. If you want us to win, then I think the more there is change in the way our customers look to the opportunity of the future, the better it is for us. If it is where they stay, if they would stay where they were, then we are where we are. But as massive movement to new models, new technologies, new capabilities and that's why the momentum of this kind company is so important and so promising. So I welcome it.
The last question comes from Sandeep Deshpande from JPMorgan.
Sandeep Deshpande - JP Morgan Chase & Co
Two questions for me. I mean, the guidance of 5% margin that you've given for the year indicates that approximately you need to grow about Euro 800 million of EBIT for the entire year. So I mean, how would we look at the seasonal ramp of this? I mean, would it be like last year with a very large part of it in the fourth quarter? Or do you think it's going to be smoother this year based on what your current indications are? And secondly, the question I have is on the Optical business. I mean, if you look at the profitability of the Optical business x Submarine, is Submarine required to be there in the mix to be profitable in the Optical business?
Sorry. I didn't get your last question.
Sandeep Deshpande - JP Morgan Chase & Co
In the Optical business, if you look at the level of profitability in the Optical business x Submarine, is Submarine required in the mix to be profitable in optical all together?
Okay. So you're going to the detailed guidance per quarter?
Yes. Obviously, our guidance is full year guidance. And we don't talk about what the quarters are between it. So unfortunately, we won't answer your question about will it be more linear or less linear. Just to say that we're off to a good start in the first quarter, and that full year guidance of 5% or better still remains and I think that given our ability to execute in our market presence, we are more confident than ever about doing that.
So I think on the Optical, terrestrial optical is a profitable business. And I think that we are expanding into new products the 1830 and the 1850, and we have greater opportunities there to make it even more profitable. So while Submarine is a great business to be in, without Submarine, if I understand your question correctly, we also will be a profitable business.
Well, thank you.
Good. Thank you, all. See you next time.
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