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Executives

Ben Verwaayen - Chief Executive Officer and Director

Paul Tufano - Chief Financial Officer and Executive Vice President

Unknown Executive -

Analysts

Patrick Standaert - Morgan Stanley

Sebastien Sztabowicz - Kepler Capital Markets

Kai Korschelt - Deutsche Bank AG

Odon de Laporte - CA Cheuvreux

Anuj Krishan - UBS Investment Bank

Pierre Ferragu - Sanford C. Bernstein & Co., Inc.

Zahid Hussein - Citigroup Inc

Tim Boddy - Goldman Sachs Group Inc.

Kulbinder Garcha - Crédit Suisse AG

Unknown Analyst -

Eric Beaudet - Natixis S.A.

Alexander Peterc - Exane BNP Paribas

Alcatel-Lucent (ALU) Q2 2011 Earnings Call July 28, 2011 7:00 AM ET

Ben Verwaayen

Hello, good morning, good afternoon, good evening, depending on where you are. Thank you for joining us on the Q2 call. You know that we always start this activity with showing you this chart, this one or the next one, okay, if it works. Yes, there it is. Please, read it at your leisure. It's one of the chart that people work very hard on, and it will be a pity if you would not spend a little bit of time on it.

So where are we as a company? The message is very clear. We are on track, and it's important to put it into perspective of the journey that we have as a company to reach our targets for 2011, but not stop at 2011, but build the capabilities to do much better in 2012 and '13. So it's not just important to look to where are we in order to meet our targets. It's also very important to see whether we can make the transformation, as we have said many times to you, into a company that has innovation at the heart of what we do. And I think Q2 demonstrates that we are right on track of doing that.

First of all, the market is truly positive around us, positive in the sense that things happening quite fast and not just in one market, but around the world. If you look to the transformation, the easiest way to describe this is transformation around voice to video. That's what people do. That's what people have in their hands when they have a smartphone or a tablet. And they do incredible different things than they did 2 or 3 years ago, which means that for our audience, our customers, the transformation is not an option, it's a must do. And you can see it around the world. And during this presentation, I hope to show you that this is happening not just in one market but in all markets.

Second, I think that we have a great track record of understanding where the markets are going and what type of needs those specific markets have. So those 2 elements are important to look to our agenda from a performance agenda but at the same time, also from a product and product direction agenda. I think this quarter was a good continued financial progress. It's good on the top line, and it's good on the bottom line. If you look to the first 6 months, it's the first half of the year, 12.5% approximately growth on the top line. We did EUR 300 million better on the bottom line than last year and EUR 300 million better when you look to cash flow. So I think we are on track, and therefore, we have a -- we reiterate our full year guidance. That is not the direction we want to go. This is the direction we want to go.

So here's a very important chart. Last time, and we do listen very carefully to what you have to say to us. Last time, you said, "We have the feeling that you are too dependent on the U.S." So what I thought we'd do is, we’d look to where we were 12 months ago in 2010 and where we are today in 2011. And you can see that in 2010, 39% of everything we did was in the U.S. In 2011, 40% of everything we do is in the U.S. Then we look to, okay, what's happening in Europe? And Europe, 31%, and after everything’s said and done, it's 30% now, and the rest is actually equal. So the shift is not that shift, but look underneath because that is truly the message.

In 2010, we arrived at a number against a backlog -- against a background, better said, where the U.S. was the only growing market for Alcatel-Lucent. It grew 17%. Today, it grew 18%. So actually, that is stable. But the massive change is taking in the other parts of the world. 12 months ago, we were down in Europe, 9%. Today, we are flat, down 1%. And if you look to Asia-Pacific, it's even more dramatic. 12 months ago, we were down 32%. Today, we were up 14%. And if you look to the rest of the world, you can see a minus 14% to plus 9%. And if you look to the plus 9%, it's interesting because the plus 9% is a composition of that one going very, very strongly in Latin America. It's a true battleground for every of the competitors in the world, and of course, down in North Africa if you would -- as you would expect.

So if you look to the markets, let's go market by market and maybe compare notes on where the market dynamics are and where we are as a company. So first of all, what you see in the U.S. market, this is at the front of the revolution because what's happening is every single participant in this revolution has, one way or the other, a massive impact on what's happening in the U.S. market. So it is the build out of networks. The response is aggressive build out of 3G and 4G. The response is, at the same time, as aggressive as the build out in the Wireless domain, optical and IP. So and if then people look to what's your position in that particular market, it has to do with 2 main factors. First of all, we do enjoy great relationship with the master players in the U.S. I believe that AT&T and Verizon this quarter will be more than 10%, which is a great way to underpin the journey we have made as a company. It's not one product anymore, it's multiple products. It's a deeper relationship. At the same time, in the U.S., we have many more customers than we had 12 months ago, and our portfolio is much broader than 1 or 2 products.

And interesting enough, one of the fastest growing part of the North American market is what we call strategic industry, where you use technology that was, until recently, just used in the telecom industry and is now used in many, many different industries as well. So the whole story in the U.S. is one of deeper, broader relationship from a customer base and a better and broader portfolio.

If you look to Asia-Pacific, there are 2 interesting stories here. First of all, I think that Asia-Pacific is the region in which countries understand very well and take action very rapidly to defend their competitive position in the digital economy. They build a variety of plans, some of them massive plans, to invest in a high-speed broadband access infrastructure. So if you see Australia that's the known story. But then China, China came out with fiber cities, China broadband fiber cities. So China Telecom says, "I'm going to, between now and 2015, I'm going to bring fiber to the home to 100 million homes." And we're right in the middle of it.

So if you look to India, India will very shortly come out with a backbone story where they have the fiber backbone story to build from to bring to the rural areas the services needed to expand not just government services, but also health services and educational services. These are concrete plans, and they are happening right now. And what interesting -- what's very interesting and what has changed over the last 18 months, 24 months is that the newest technology is the hottest technology in this particular market. So where in the past, maybe, you would have a time lag, it's now happening there, 100G in China. Look at it. It's happening there.

And if you then look to our position, we grew substantially in Asia-Pacific, more than 40% in China because in China, the story becomes like in the U.S. It is more customers, deeper relationships. So it's not just one product anymore. It's a multiple of products. And I think you can see that in the key wins, it's not just in one area. It's not just in PON where they build those broadband environments. It's in the Wireless environment, and more important, it's also in IMS. So that market, like any of the other markets, will now look to what's the added value it can bring to my customer base. And they are as aggressive as other markets are in looking to the application enablement capabilities. So you will see that the Asian market will be pretty robust for a long time to come.

Now we talk about Europe, a hesitant market, I call it. A hesitant market because first of all, there are more than one stories. So I think it is pretty clear that if you look to Eastern Europe, there is a very different dynamics than in Western Europe. Eastern Europe, we did extraordinarily well in Russia. We are building a long-lasting infrastructure in Russia with partners to ensure that we have capabilities that are in that particular market, very important. And we have grown in the last quarter something like 45%, 46%. So it's a substantial growth engine for us.

At the same time, we had some weakness on the Services front in some of the other Eastern European countries. In Western Europe, we are flat. And the reason for that is there is uncertainty in the model in Western Europe. There's an overhang of what do I need to do to ensure that all the investments I'm going to make in those wonderful objectives that Europe has by 2012 -- by 2020 to have every single citizen connected to high-speed broadband, what model do I have that justify my investments? So that was a massive and major initiative, quite recently, where the European Commission asked the industry to come together and to work through those elements, where we had the over-the-tops from Europe and from the U.S. We had the players, the attackers and the incumbents, everybody around the table and the suppliers, like ourselves. And we focused on that. And I think it's important to spend one minute on the issue because I think there is a change in sentiment. And that will be an important change.

The digital agenda is highly ambitious. It is probably one of the most ambitious digital agendas anywhere in the world. If you look to what they have to deliver, 100% in 2020, 30 MB, 30 MB with 50% over 100 MB in the U.S. They have a discussion whether high-speed broadband is 4 MB or not. So this is highly ambitious. And this is 100%. This is not 90%, this is 100%. In order to do that, there are 3 questions that needed to be answered. First of all, can we make money out of it? What's the business model? Second, can we reduce the cost in order to go and do that? So you can make money because the cost is reduced.

And the third one is, what are the rules of the game? How are we going to make sure that we're going to make those investments and that it will stick? And I think it's good to report here that the industry came at -- after, let's say, somewhat emotional roller coaster discussions, they came with 11 principles that we submitted to the European Commission. And we are convinced that based on those 11 principles, we can maintain the net neutrality as a principle, which is a best-effort network; differentiate on services on top of that, which means new income for operators; and have a model where we do not have to duplicate every single investment, which is a -- especially in the lower end of the market, which is an impossibility. And we can have corporation to a larger scale than we have seen before.

Scale matters also in Europe. If market parties have to play the role, scales matters. And that means that you have to have the freedom to go and organize yourself also in the level of scale. I think that there will be somewhat more work to be done that will be done in the coming weeks and months. But I think that you will find that this market in Europe will have a different sentiment 12 months from now than where it is today.

So if we then look to the rest of the world, 2 stories here. The first story is the Middle East, and you will understand that, especially when it comes to new build, that was not a particularly inspiring quarter for us. But given the political unrest, that should not be a surprise to anyone. Very inspiring, the situation in Latin America where, like you can see in Asia-Pacific, they are building really national rollouts of infrastructure in order to be competitive as a country. And we have grown substantially there. We grew 46% -- 49% actually, in Mexico, 32% in Brazil on the back of a quarter in Brazil that we were growing more than 45% last time. So very, very strong growth in a very lucrative part of the world, where we compete with everybody and their friends.

On networks, how are we doing? Well, I make a habit of never making any comments on any of our competitors, so I'm not going to start today. But we have a different view than some views that I heard over the last couple of days. We think that IP is a great market. We think it's a growth market. We grew 35% in Q2. We see that we have a fantastic portfolio. It is global in nature, and we see an order portfolio that's very encouraging. I think that on IP, we have really captured the imagination of the market with our latest invention of the 400G. I think if I look to the customer reactions, it has been very, very, very powerful. And we have a great momentum in the markets, and I think that momentum is -- will not go away for a long time to come. So we are very positive about that.

If you look to the brother in that relationship, the brother or the sister, whatever you want to call it, it's optical. The one goes hand-in-hand with the other. And in the optical domain, we have a similar approach as we have in the IP domain. It's all about a new world. So you will see that we will aggressively expand our products portfolio in optical, and the reception in the market was great. As we grew 35% in IP, we're now growing 6% in total in optical, but 16% in WDM. So it gives you a feel that it's really -- and if I look in the order book, extraordinarily strong, it's really going in the right direction.

The whole HLN story is not only understood, as I said to you many times before, it is now incorporated in a lot of things that our customers are doing. And it's all about having the capability end-to-end. It doesn't help just to fix one side of the story. You need to really be end-to-end. And you can see that also in our Wireless domain, 15% growth. In this particular quarter, very strong growth in CDMA and video. Last quarter, it was very strong on the Wideband CDMA front. If you build out its projects, it's how you recognize the project during the build out of the rest, but 15% growth is really good.

And it's not just the U.S., it's also China. And I think that you will see that if we peel – if you peel down the onion, and you look, for example to LTE, it's now 15 contracts, 15 contracts and more than 71 other trials on top of that. So it's a pretty robust 3G, 4G story that we're developing in Wireless. And I'm not going -- I promise, I will not make the same story today about the cube. I think you heard that story many times before.

If I look to the fixed broadband access, truly important. Half of all what we do in Wireline is now PON, optical high-speed broadband access. And the important story here is, if you look to China, what I've just said to you, 100 million homes, this is going to be a vital part of the whole end-to-end story. If you believe that video is here to stay, you believe that this business is a growing business, and I do. We have 4% growth in quarter. So if you look to the total, you say, 35% in IP. You have 6% in optical, of which 16% in the new stuff. You have Wireless, 15% growth and you have 4% growth in Wireline and 50% of that is already in new PON, you have a feel that our HLN portfolio is right in the middle of where we are. So you can see that if we do the favorite Frank Maccary slide, and I -- 2 health warnings, I have to give every single time that I present this. The first health warning is concentrate and the second one is that for whatever reason, our 3G CDMA is not in this number.

But even without -- with that handicap, you can see that this is going to the 50% pretty rapidly. So, good traction there. We had 92 different wins in the quarter around HLN, most of them are not public. It's -- you will understand, in a time where people have to make a lot of different decisions, not everything goes public. But you will see that at your leisure if you look to this. And then we have to talk about service and applications because what is very important is that we feel strong enough now as a company and the signal has been given to you quite recently with the management alignment that we don't need to ring fence anymore our Application Enablement business in a kind of nursery environment. We have to ring fence it and protect it against the weather outside. I mean, it's robust enough now to stand on its own, to be measured and counted and be similar in nature of this -- of the new Services direction we take and the software direction. It makes much more sense to bring it together and to be much more robust in what we do in the market. So I think you will see, going forward, a lot more synergies coming out of these activities.

Now if we, in Q2, were they still, on a standalone basis to 3, you'll see strong growth in network systems and integration. Interesting in that particular market is that 80% is in strategic industries. It grew 12% in the market. Managed services did very well, and across the regions, 20%-plus growth. Not so well was a network build, which is mainly civil works, and it's mainly in the Northeastern region, North African region. So, no surprise there. And maintenance, that was in the minus 2%, both our own maintenance and multi-vendor maintenance. Because in a time that you have to be careful where to spend your money as customer, this is one of the first areas people look at. So it's a strong business. And interesting, it's growing where the added value is the highest.

Network applications is truly a fantastic story about Application Enablements to new stuff that grows very fast. It is Motive, which is remote customer service. It is the Digital, the whole digital media activities, and this was a particularly strong quarter for everything around messaging. All in all, our application business, great progress in profitability. The translation of good revenue growth is now also into a good bottom line.

So wrapping up, we're growing where the market is growing. I cannot underline it enough. That is truly important. We have the capability with our global footprint and with our products to be where the market is growing. We are selective. We don't change -- chase every rabbit that we find running around. We are selective, but we are there where we need to be. And I think that this is a position we went in for a long time in the past.

We have looked to our portfolio, and we are continue to look at our portfolio. If you see the change that we made in R&D allocation over the last 24 months, has been phenomenal. I've mentioned that before. In the past, we've spent 75% on existing technology that needed to be ready-made for one customer or the other. The customization is back to a very small percentage of our R&D. And the massive part of the R&D money is now spent on new stuff, the next generation that you can see it coming through.

At the same time, we also need to look to our portfolio. And that's the reason why we have made some management changes to make sure that we bring the portfolio together to be more focused and more rapid with the introduction of Application Enablement capabilities, new service capabilities on top of the HLN story. At the same situation, we have communicated to the market that we are looking into our options that we have for our enterprise business. Enterprise is a great business. Genesys is a great business, but we're looking to our options with the objective to do what's right for the business because it's good business and what's right for Alcatel-Lucent. And no decision have been taken, but just wanted to communicate that we're looking to the options.

So if you then look to where we are as a company, we did EUR 300 million better in operating profit, in adjusted operating profit. It was great to see this quarter the second quarter in a row that we are profitable in a -- on the reported basis and a massive swing there. Free cash flow EUR 300 million better in the first half. And we reiterate the guidance for the full year. Paul?

Paul Tufano

Okay. Thank you, Ben. Good afternoon. What I'll do is give some colors on the numbers, and go into a little more detail what Ben has indicated. I think if you look this quarter, you could say it was a progressive quarter. We made progress, and we are on track to do what we said we were going to do for the full year.

If we turn to the P&L, as you can see we posted EUR 3.9 billion of revenue. That is up 2.4% at actual rate. When you adjust for currency, it is up 10.4%. Currency was approximately EUR 240 million reduction to revenue in this quarter, given the weakness of the U.S. dollar. We were able to hold our gross margins at about 35.8%. You can see it's slightly down from both the first quarter and year-on-year by 400 and 300 basis points, respectively. The driver of that, obviously, is some FX. But more importantly, it is the native impact of product and geographic mix, offset by volume and fixed cost reduction.

And if you look at our overall OpEx, you can see that they're down 5% year-on-year, both quarter-on-quarter and year-on-year. When you adjust the year-on-year, currency effect has a major play there. We actually are under in SG&A. R&D is up year-on-year given the fact that we increased R&D spending in the latter part of last year to accommodate some of the programs Ben talked about. As we said before, our expense program is back-end loaded. You will see an acceleration of expense reduction in the second half. And overall, we've reported EUR 108 million of operating profit, 2.8 points, a swing of EUR 80 million year-on-year, and as Ben said, about EUR 300 million to the half.

Turning to the breakdown of revenue by our segments, we delivered growth across all of our segments, and I think that's important. And when you look at where the growth emanated from, it's the continuing story of where we help customers transform their voice networks into data networks, we are having success. So networks is obviously up 14%. IP is up 35% at constant currency. When you look at IP/MLS (sic) [IP/MPLS], it is actually up 48% year-on-year. And this is the third quarter where our IP division has had 25%, 30%, 35% growth rates. I think we are gaining a share on IP across the board, and we're very encouraged by the introduction of the 400-gigabit processor and what that means to the next generation of products that will be launched in 2012 and the extension of this progress.

If you look at Optics, it is up, as you see on the chart, by approximately 6%. We did this quarter, see a return to growth of submarine. Our submarine business had been on a down cycle in 2010. It is now on an up cycle. It grew over 24%. Our Terrestrial Optics was flat. When you peel that back, our newer WDM products at 100 gigabit grew in essence, 16%. It was offset by a decline in some of the legacy.

Wireless grew by 15% year-on-year. As Ben indicated, strong growth in CDMA. GSM also grew. And we had meaningful LTE shipments. And obviously, Wireline was our PON products. In the applications arena, our networks applications grew by 13% year-on-year, primarily fueled by our Digital Media Store, our relationship management software and Motive. And in the enterprise business it had approximately a flat growth. Genesys was up, and voice and data were slightly down. And obviously, in Services posted a 3% growth year-on-year with our managed services and our Network and System Integration growing both in excess of 10%, and slightly offset by maintenance.

If you would look at the profitability, once again, all of our segments were profitable at the -- for the quarter. You can see, obviously, networks were leading at EUR 48 million of revenue -- excuse me, of operating profit, a significant year-on-year swing, driven primarily by our Wireless contribution. In the applications, it was EUR 19 million of profit for the quarter, a significant year-on-year swing, primarily driven by our network applications. And in services, you see that EUR 53 million of operating profit, both a positive swing year-on-year, as well as quarter-on-quarter. And again, that was by improvements in both the managed services business, as well as our network and System Integration business.

Ben went through the revenue chart in detail, I'll just provide some update on the numbers to give you a little more color. Obviously, a budget rate, the U.S. or North America grew at 18%. It was up 5% quarter-on-quarter. AT&T and Verizon were over 10% customers, respectively. In APAC, we had a 14% growth at constant currency. China was up 41% year-on-year at the same base. Europe, essentially flat, but when you peel back Western Europe from Eastern Europe, we see that Western Europe was up 1%. Eastern Europe was down approximately 8%, primarily in central part of Eastern Europe. Russia was up 44%. And in the rest of the world, CALA grew by 33% year-over-year. And it had a 16% sequential growth, driven by Brazil and Mexico. The Middle East and Africa was down 7% year-on-year, primarily affected by North Africa.

If we turn to our balance sheet, quite frankly, there are no material changes in the balance sheet. We did conduct our impairment test for the year as part of the second quarter. I'm happy to announce there’ll be no impairment at this time. All of our business segments passed. All the movements in the balance sheet were primarily the result of currency changes. The one area that we will focus on will be our net change in other working capital, you'll see that it did increase by EUR 194 million this year -- this period, excuse me. And I think we need to spend some time talking about what drove that because as you know, this reflects or impacts our ability to generate free cash flow.

So in the period, we reported that our operating working capital increased by EUR 194 million at actual rate. When you adjust for currency, that number is EUR 188 million increase. And the primary drivers of that are as follows. Our inventory went down by about EUR 32 million at budget rate in the quarter. We had good progress in reducing our inventory in our operations, both in intake of products and products on our shop floor.

In our customer-facing inventory, we had a mix. Both in EMEA, as well as in APAC, we had a reduction in customer-facing inventory. That was offset by growth in the U.S. As you know, in the U.S., we are currently involved in a number of large build outs for our customers. When you have a network build out, you cannot claim the revenue and therefore, the reduction in inventory until parts of the network are ready for acceptance. And those are by circles. So we saw that growth in U.S., primarily as a result of the build out of those circles. You will see significant reduction in inventory in the second half of the year as those circles are claimed into revenue and as we have continued progress on inventory reduction in the other parts of the world.

Our net receivables contributed about -- increased EUR 45 million. We were more back-end loaded than we would have liked, primarily because of some of the APAC sales. And in the quarter, we had EUR 175 million consumption of cash for the reduction of payables. Now as we go through the course of the second half, our focus will continue to be on inventory reduction as we drive turnover to improve free cash flow.

In that regard, if you look at the free cash flow, we consumed EUR 350 million of cash this quarter. That's an improvement of EUR 85 million from the previous quarter. Year-to-date, we are EUR 563 million on free cash flow consumption. That's about EUR 300 million better than it was a year-ago period. Obviously, the big driver of free cash flow this quarter was that operating working capital, driven by the modest inventory reduction.

We were able to maintain our restructuring charges to EUR 80 million for this quarter. That's EUR 160 million for the half. Our guidance is to be below EUR 400 million, and we believe we will achieve that, if not be slightly below it. We controlled our CapEx to EUR 132 million. At the half, we're at EUR 278 million of CapEx. Our guidance was EUR 700 million. We believe we'll be below that. And so we will do everything we can to drive cash consumption charges to the minimum as we go through the course of this year.

Our cash and marketable securities ended at EUR 4.028 billion. Our credit facility of EUR 1.4 billion is undrawn and all covenants are met. If you turn to Pensions, the funded status of our Pensions improved. We were approximately breakeven on funded status from an accounting standpoint at the end of the first quarter. That improvement in funded status increased marginally to positive EUR 50 million. That was primarily due to the fact that the return on our assets were significantly better than the increase in liabilities as a result of the reduction of the discount rate. As you know, this is an accounting view. For the U.S. Pensions, it is the ERISA calculation that's the most important because that dictates whether you have to fund the Pensions. As we said in the past and we'll confirm it today, we believe there will be no contribution to the U.S. Pensions through 2012.

And finally, I'll just close on just the reiteration of what Ben said in terms of our guidance. We believe that we will grow faster than the addressable market, and that Alcatel-Lucent can reach an adjusted operating margin of 5% or better.

So with that, we'll now open the phone for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Unknown Executive

Thank you, Julie. We'll the first question from inside the room, please.

Sebastien Sztabowicz - Kepler Capital Markets

Sebastien Sztabowicz with Kepler in Paris. Could you please provide an update on the U.S. market for the coming quarters and more specifically for the CDMA technology? And what do you call also the untapped market i.e., the cable cos. and the data centers. And also, could you come back on the progress you made on the Network Vision project with Sprint, please?

Ben Verwaayen

So I will try to answer your questions without being very specific customer by customer because I'm sure that some of the customers will not be very happy if I'm going to become their spokesperson. Actually, if you look to the U.S. market, it is clear that some of our customers have indicated that they will take a good look at our CapEx, as they should. But that's a headline number. If I look to what we do with our customers, and we have looked to the project that we have in place, and I look to the number of customers that we have and the broad portfolio that we serve, I have no hesitation to say to you that I think that the U.S will remain strong for us. I am not disputing any of other people's comments. I'm just saying, looking to us, looking where our customers are, what their plans are, what they've shared with us, how they look to it, I think we have a pretty clear look in what we need to do. And I think that, by definition of where we are in that particular market, it will be strong. I'm not going to, as I said, go customer by customer. In addition to our strong relationship with our existing customer base, we are expanding our customer base. It's not just in the cable footprint that we make some very good inroads, it's also in new businesses like safety, where new technologies are used, that we see some pretty good opportunities going forward. But, let's say, let's not distract from the core of the question. I understand your question very well. In our addressable markets with our existing customers, what we have to do, I think, we have a very clear picture. And it's a positive picture, let me be clear because, otherwise, you may think it is not positive. It's strong.

Unknown Executive

Thank you very much. We’ll take the next question from the bridge, please.

Operator

Your next question comes from Tim Boddy from Goldman Sachs.

Tim Boddy - Goldman Sachs Group Inc.

This is a question perhaps for Paul. I didn't understand from your remarks as to why the networks business or operating profit reduced both sequentially and year-on-year despite the better level of revenue activity. So more – any more color on that would be very helpful, and in particular, whether CDMA was down sequentially in the quarter or not.

Paul Tufano

So Tim, look, I think the -- if you look at the networks business, we saw good growth out of China across the board, and we saw mix of growth within the products within the networks. It was those 2 factors that affected the overall profitability. So it's really, again, product mix and geography mix.

Tim Boddy - Goldman Sachs Group Inc.

Can you add any further color as to which particular products, I mean, within the business?

Paul Tufano

I think I'd just like to end it there.

Unknown Executive

Thank you very much. We'll take the next question from the bridge, please?

Operator

The next question comes from Zahid Hussein from Citi Global Markets.

Zahid Hussein - Citigroup Inc

Yes, a couple for me, please. EUR 240 million hit the top line for FX. Can you give us any color in terms of what was the hit to EBIT? And secondly, as we're talking about 2012, '13 and the broader picture as opposed to sort of quarterly margins, can you give us the sense of where you think things are going in 2012 and ‘13 and what you're expecting?

Ben Verwaayen

Go ahead.

Paul Tufano

So I don't think it's appropriate to talk about '12 or '13 yet. As it relates to the currency, we did see, as I said, about EUR 250 million, EUR 248 million impact on the revenue line for currency. As you know, we are -- we have a fair amount of our expenses in dollar and in euro. So to the bottom line, the impact was minimal at best. Yes, it would be nominal, I'd say, between -- no more than EUR 5 million.

Ben Verwaayen

But maybe I can make -- without going specific in 2012, 2013, give you 3 ideas to put in your head. First of all, we see build out of infrastructure in countries that will be backbone and fiber to the x. Those will be multi-year programs. Upgrades will be multiyear programs, and they cannot be stopped one day, started the other day and then will stopped again. I mean, these are decisions that have a multi-year impact. That's the only thing I'd like to say on that.

Unknown Executive

Thank you very much. We take the next question in the room, please?

Unknown Analyst -

I notice your minority interest was EUR 15 million, I'm assuming this is mostly from Alcatel Shanghai Bell. If I work it out, it means about 30% of your pre-margin income net income came from that business. Am I on the right lines? What's the tax impact and basically, are you having to give away 1/2 of that very profitable business?

Paul Tufano

So, look, I think if you look at the minority interest, it is for minority shareholders. Our joint venture partners in China aren't our largest minority shareholder. Obviously, we fully consolidate Alcatel Shanghai Bell into our numbers. The profit calculation doesn't have all the expenses against it. So as we do that, we follow the right consolidation accounting rules and the result is a EUR 15 million adjustment.

Unknown Analyst -

Would I be right in saying that business is more profitable than your reported number overall?

Paul Tufano

I would say that if you look at its contribution to us, it is a good contributor, but it is not the highest contributor we have.

Unknown Executive

Thank you very much. We will take the next question from the bridge, please? Then we'll come back to the room after that.

Operator

The next question comes from Kulbinder Garcha from Credit Suisse.

Kulbinder Garcha - Crédit Suisse AG

I have a couple of questions, please. First of all, on the full year guidance, to be very specific, unfortunately, a lot of the CDMA carriers in the U.S. have implied that their CapEx in the second half is going to decline and that the radio spending in particular within that may decline. They've been very clear about that. And given the margin that business has, I'm wondering what kind of a headwind that presents in the second half to hit your second-half margin targets because it does look like your margins may have to evolve to 5% and then maybe 11% in Q4? And that seems like that would be a risk. So I'm trying to reconcile what visibility you have, maybe not just there, what the other offsets may be in the second half of the year? And then my question for Paul is, just be clear, with the cash burn that you’ve seen in the first half, do you still believe that this year, you will generate free cash flow in the overall group for the full year?

Ben Verwaayen

So let me take the first half of the question. I hope that it's no surprise to you that what you just said is what we also heard in certain statements. I wouldn't say it's the official statement on every single customer, but let me be crystal clear. We understand very well, very well where we are in the market. We make the plans together with our customers. So we know location per location what will go in and when will it go in. So we are fully aware of what -- on any specific technology happens in that particular market. So no surprises there.

Kulbinder Garcha - Crédit Suisse AG

I guess my -- I'm sorry. I guess my question is then, what are the positive offsets to that? So like, for example, like what is this going to give that? I know we have a very seasonal -- you're a very seasonal company, second half versus first half. I really do understand that. But what I'm wondering is that, if that's a headwind this year versus normal years, what are the other offset? Is it restructuring, cost cutting coming through or other mix geographies being strong or what could offset that, is my question.

Ben Verwaayen

Well, our product portfolio has sufficient capability for -- because you're now talking about a specific market, to be very attractive in this specific market. I am not going to argue with you on a product per product basis because I don't think that would be appropriate for me to go and do. I don't make your model, but I can tell you where we have looked very carefully before we're going to reiterate our guidance. This is not on automatic pilot. And we have looked to our products. We have looked to our markets, and we know what we need to do, and we have the plans to go and do that. And I don't think that headwind would not be my characterization of that particular market. You know that the death of CDMA has been proclaimed a few times before, and I have to tell you, I am not proclaiming any death nor do you when you talk about headwind. And it depends maybe on your expectation that you had about this particular product. I think we became -- we become less and less a one product-dependent company even from a margin perspective.

Paul Tufano

So to answer your free cash flow question, obviously, we are committed to the goal of achieving free cash flow. Now what's going to allow us to go do that are 2 things. Number one, it is an increase in operating margin or operating profit that the second half will have to have. But the most important variable will be the rate and pace of progress we make on inventory reduction. We have made -- we are making good progress in reducing our operations inventory. Now it's going come to down what we can convert in the field. And that's going to be a function of how ready our build outs are as it relates to customer acceptance and our ability to square off inventory that's sitting in the field to claim revenue in the other parts of the world, especially EMEA and APAC. We're all very focused on this. We know it's the key variable, and the goal is free cash flow positive.

Unknown Executive

Thank you for that question. Next question will be from inside the conference room.

Alexander Peterc - Exane BNP Paribas

Yes, Alexander Peterc, Exane BNP Paribas. Firstly, just on the IP segment, would you be able to comment on any market share progress in this quarter either sequentially or year-on-year? And secondly, a question more specifically for Paul regarding the comments you made on the fixed costs decline. Are we actually going to see more of a decline year-on-year in the second half versus what we saw in the first half on the fixed costs?

Ben Verwaayen

You will start with the cost, the easier question.

Paul Tufano

So our fixed cost reductions are back-end loaded. So you should see more decline in the back half. And the plans are in place to go execute that.

Ben Verwaayen

And I think management is -- if you talk to management in Alcatel-Lucent, you will know that they know exactly what type of actions they need to take from a cost perspective. IP, I can just say this. We have taken market share, let's take the U.S. as an example, 11 points, it is truly a great story. I think we started outside the U.S., very strong in Europe, very strong in Asia-Pacific. And only in the last 18 months we gained an enormous amount of traction in the U.S., and I'll say this to you, that traction will continue. If we look to our order portfolio, if we look into the pipeline, it's a very healthy business. And it's a business that has a lot of legs.

Unknown Executive

Thank you. We'll take the next call from bridge, please.

Operator

The next question comes from Patrick Standaert from Morgan Stanley.

Patrick Standaert - Morgan Stanley

How many people have been restructured year-to-date? Because if I look at the restructuring cost this quarter, it's EUR 50 million. And if I'm correct, I think it's 2,000 people have been restructured. It looks very low. I'm just trying to understand what you have already in the model.

Ben Verwaayen

So let me say something about the philosophy here, because it's really important. What the company did up until not too long ago was to pay people to leave, and we paid hefty. We have paid altogether in cash terms -- what have we paid over the last 10 years?

Paul Tufano

Well, the last 5 years, at least EUR 3 billion.

Ben Verwaayen

Okay. So I will not make any qualification about that amount. But if you then end up with roughly the same amount of people, there must be a smarter way to do it. So we created, internally in the company, a kind of monster.com. And it's working very, very, very nicely, where we have a capability for people to make changes in the organization in a scale and in the depths that we couldn't do before. And second, we are no longer making all kind of offers to people to leave with a hefty sum. So yes, we have reduced our work force in a much more intelligent way than we've done before. And I would say that the instrument is beneficial for the individual. The opportunity they have in the organization is much broader. And I think on the long term, it is also very good for our financials to have a somewhat different approach than just having payoffs.

Patrick Standaert - Morgan Stanley

But how much have you reduced the net amount of headcount in Q2 just for us to understand the impact on the OpEx line?

Paul Tufano

All right. So let me give you a little color. If you look at that EUR 50 million, more than 50% of it is for non-social charges. So those are facilities exits, those are other things. As we've said all along, our intent is not to reduce expense through restructuring and social charges but rather to redeploy people. Over the course of the first 6 months, we've taken out several thousand. A fair amount of them have been either to attrition or to redeployment into customer revenue-basing types of jobs. The actual amount of restructuring for social plans has been relatively minimal and is laser shot at specific functions in countries. So there are no massive restructuring plans. They are very targeted. They're targeted to where we could drive efficiency and where we drive leverage. And you will see that continue through the course of this year and into next year as well.

Unknown Executive

Okay. We'll take one more question from the bridge, please.

Operator

The next question comes from Kai Korschelt from Deutsche Bank.

Kai Korschelt - Deutsche Bank AG

I had 2. Just sorry to ask another question on the U.S., but just want to clarify. When you say it should remain strong, are you looking or expecting a typical sort of seasonal uptick in the second half versus the first half? Or do you expect the U.S. to stay at around the clearly very strong level of the first half? And then my second question was just on Wireline. It looks like growth has slowed and the comparables in the second half against the previous year do get a lot more difficult. So just wondering if on a full year basis, Wireline could possibly decline? And how does that tally with the pretty strong PON deployments?

Ben Verwaayen

So let me try again about the U.S. I'm not going to give you a quarterly forecast. I mean, we do an annual forecast; you’re in the business of the quarterly forecast, and I respect that. And I think we should stay on, let's say, in each other's territory. And that means that I do an annual forecast, you do a quarterly forecast. I think the U.S. will be strong for us. And if you look to the build out that we have in programs, if you look to the build out that there are on certain technologies in the backhaul, if you look to the optical domain, if you look to the application layers that people are building, you can see that it is not difficult to see that there is a demand that is very strong in the U.S. to fulfill the requirements of a changing -- of a very changing market. So I'm going to use a lot of words because I'm not going to give you a comparison on a quarter-by-quarter basis, but it is a solid contributor to our forecast that we have for the full year. Now on the Wireline business, I have to say I'm looking to Philippe, but I don't understand fully what you say. I don't foresee at all that we will have a decline in our Wireline business. There are demands in markets that are just getting started. If you look to China, I mean, 100 million homes in 2015, they have to hurry. So they are on a roll. If you look to what happens in India, if you look at what happens in Australia, if you look to what happens in some of the European markets, they are on a roll. So I'm not sure that I understand fully your reasoning.

Kai Korschelt - Deutsche Bank AG

Sorry, the question was on a year-on-year basis at least stated, it declined, you were down year-on-year. And it was against a very low first half, and then the year-on-year growth accelerated in the second half of last year, which would imply on the similar revenue run rate, you could be -- we could be looking at a full year down revenue year.

Ben Verwaayen

Yes, and you would be right if the portfolio would be 100% stable. But as we have now grown PON already to 50% of the business, just imagine if it's going a little bit further than 50% of the business and see that slope going forward. So I think if you look at from that perspective, you will have an idea where my our view is coming from.

Unknown Executive

Thank you. We'll now take the next question from the room, please?

Pierre Ferragu - Sanford C. Bernstein & Co., Inc.

Yes. My name is Pierre Ferragu. Just to come back on the guidance reiterating of the operating margin about 5%, so indirectly just to assess your assumption roughly, so we talked about strong U.S. Does it mean as well confident on the strong order book in IP to drive gross margin? And what kind of outlook or assumption you have for Europe, do you integrate back-end loaded strike -- strong back-end loaded Europe?

Ben Verwaayen

So we can do – he wants to have your total breakdown of the 5%, Paul.

Paul Tufano

Well, look, I think that as we've said, there'll be a strong U.S. We're seeing good strength in APAC now continue. I think Europe will improve from where it is today. If you look at the overall portfolio, we have a lot of engine -- a lot of cylinders in the engine. We've got IP. We've got backhaul. We've got optical. We've got parts of the Wireless platform. We've got parts of the applications platform. And so, it's the combination of the entirety of the portfolio that we will use to hold the margins that have slight improvement at the gross margin level.

Unknown Executive

Thank you very much. We'll go to the bridge for the next question, then we'll come back to the room in a second. Thank you.

Operator

Your next question comes from Eric Beaudet from Natixis.

Eric Beaudet - Natixis S.A.

Two questions, if I may. The first one is concerning your working capital. I noticed you had a strong decrease in payables. I was wondering what led to that and if we should expect a turnaround of these payables in the second half? And my second question is concerning your cost cutting. You mentioned over the past 2 quarters that you were actually increasing investments in R&D. Is that going to continue going forward in the second half, or will you start declining not just your SG&A, but also your R&D?

Paul Tufano

So if you look at the payables, the sharp decline in payables, part of that was some prepayments for maintenance contracts, the rest was in other contracts and the like. So I don't think you'll see EUR 200 million in the third quarter or the fourth quarter. So it is more of a one-off, if you will. If you look at our overall cost and expense reduction plan, obviously, our R&D will be on an annual basis about flat. And so that will require us to have about the same level of R&D you've seen in the first half replicated into the second half. We will look to reduce our expenses in both the SG&A areas, as well as our fixed operations cost, as well as our infrastructure costs in real estate. And it is the combination of all those that will be the targets for our cost and expense reduction plan.

Unknown Executive

Thank you very much. We will take the next question here in the room.

Odon de Laporte - CA Cheuvreux

This is Odon de Laporte with Cheuvreux. I was wondering what is the part of WDM within Terrestrial Optics? And is it more profitable than the legacy products?

Paul Tufano

So as you know, we don't split that out. But WDM has been growing at a fast pace. It was at over 30% last quarter. It's at 16% this quarter. So you can see WDM, specifically new products in WDM, getting to a position that is significantly higher than legacy. And I think that as you know, WDM is a product that has a shelf, and you have a number of upgrade slots that you increase capacity with. I think that the ability for WDM to contribute enhancing margin over the years will be -- over the next several quarters and years, will be the function of the fact that as those base shelves are expanded, they provide good opportunity for us.

Odon de Laporte - CA Cheuvreux

If you'll allow me an additional comment, as long as you move to higher bandwidth, which is 100 gig, which is exactly what we are supporting on the WDM platform, then you have a need to switch at the lower layer, which is continuous, and this is why we merge the WDM, as well as your cross connect platform into one single platform, which is the 1830, for which we issued a product, which was about 2 weeks ago in Monte Carlo, as you know.

Unknown Executive

Thank you very much. We'll take -- the next question is going to come from our webcast, and Alex is going to read that out.

Unknown Executive

One question from Rishi Saraf from HSBC. How much of the services operating margin was due to cost reductions? And how much to the lower share of network build in the mix, which I assume has relatively lower margins.

Paul Tufano

So if you look at the improvement in the margins in the networks business, it really came from 2 things. First our Network and System Integration business grew quite handsomely, and that has a better margin profile than managed services. Secondly, the execution performance of our managed services business on a number of contracts improved such that the margin contribution from those contracts improved. And I think that what you will see as we go through the course of the remainder part of this year into next year is you'll see enhanced margin contribution from MOD as we are addressing some of the issues in some certain contracts and enhancement from network systems integration as that grows with both new services Ben talked about, as well as growth in our strategic industries.

Unknown Executive

Thank you very much. We'll take our final question from the bridge, please?

Operator

The next question comes from Anuj Krishan from UBS.

Anuj Krishan - UBS Investment Bank

Just a couple, if I may. Firstly, just on the optical business. It appears that growth rates on a constant-currency basis slowed down from about 10% in Q1 to 6%. I know you've talked about the legacy dragging it down, and you've talked about a very strong order book in that area. If perhaps you could just give some more granularity around that order book? And whether we should expect the growth rates to pick back up again in the second half in Optics? And secondly, perhaps for Paul, to me, it appears that to get the full year guidance of about 5% margin, you really need to execute on the cost savings in the second half. And you've talked about EUR 300 million to EUR 400 million target for the full year. Is that something that you're still standing behind, or is there any change to the full year cost savings target?

Ben Verwaayen

So let me start with the optical order book, which you talked about. We have a very strong order book. And the traction on our new products has been really, really encouraging. If you want to appreciate our optical business, this is what I would say. Up until 2008, we were a leader in the field. And for whatever reason between 2008 and 2009, there's been a difficult period of transformation to the new stuff and that we paid a price for that. I mean, brutally honest, that's what the situation is. We have now a new portfolio that is absolutely leading in the industry. It's absolutely of a very different complexity than the situation we are now working out. And I think that you will see in many aspects of our optical business that we have -- we will benefit from not just a better margin perspective, a better customer perspective, a less complex supply chain perspective, but also from the capability to bring it together with the IP platform that will enhance greatly the capacity that we have both in IP and in optical. So we have great -- we have strong reasons, we have great expectations from our optical platform.

Paul Tufano

Okay, so the fixed cost and expense reduction, as we said, the majority of that fixed cost and expense reduction will be back-end loaded. And as we look at the drivers of that reduction, let's be honest, a fair amount of those are people reduction or people costs. We're making good progress in redeploying folks to other parts of the business such that we can minimize restructuring, and therefore, cash outflow. We're continuing that focus. I think our ability to get to within the range we talked about in cost and expense, may be challenged by our ability to go do that. But nonetheless, we are able to reaffirm our guidance using other levers even if we don't make the initial guidance we talked about.

Unknown Executive

Thank you very much. That concludes or present analyst conference for Q2. Thank you very much for your time. And we look forward to seeing you again soon.

Ben Verwaayen

Thank you.

Paul Tufano

Thank you.

Operator

Thank you. This concludes the conference call. Thank you for participating. You may now disconnect.

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