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Executives

Paul J. Tufano - Chief Financial Officer, Executive Vice President and Member of Management Committee

Ben Verwaayen - Chief Executive Officer, Director and Member of Management Committee

Frank Maccary - Vice President of Investor Relations

Analysts

Gareth Jenkins - UBS Investment Bank, Research Division

Francois Meunier - Morgan Stanley, Research Division

Zahid S. Hussein - Citigroup Inc, Research Division

Eric Beaudet - Natixis S.A., Research Division

Tim Boddy - Goldman Sachs Group Inc., Research Division

Sebastien Sztabowicz - Kepler Capital Markets, Research Division

Stuart Jeffrey - Nomura Securities Co. Ltd., Research Division

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Unknown Analyst -

Odon de Laporte - CA Cheuvreux, Research Division

Achal Sultania

Alcatel-Lucent (ALU) Q3 2011 Earnings Call November 4, 2011 8:00 AM ET

Ben Verwaayen

Good evening, depending on where you are. Thank you for joining us at the Q3 results meeting. You know that we always start these presentations with some literature that I strongly recommend you to see and read at your leisure. And let's talk about the quarter, the year and the market.

So first of all, we are making profitable progress in our journey, in our 3-year journey, and beyond. It's important to note that today I can tell you that all our segments are profitable. Our margins are up year-over-year. And if you take the first 9 months of 2011 and you compare it with the first 9 months of 2010, you will see that we have made an improvement of over EUR 400 million in profitability. So our profitability is doing pretty well.

And if you look to what we're doing from a margin management perspective, in making choices, in making choices where to invest, what type of projects to go after, how to deal with it, we're also making good progress. If you look to our costs, well, our costs are, I would say, starting to have a good impact in the organization. You have seen probably if you look to the numbers this quarter that, for example, in SG&A, we have a 3% impact, which is a good start. Then we continue to do that, and it's even a better start for what we need to do. But it's not enough. So you will see that for 2012, we're going to increase our cost-reduction efforts, both in the fixed and in the variable. And we think that EUR 200 million in fixed, additional, EUR 300 million in variable cost reduction is an important element in our way to go forward.

We work in many markets. We work with markets around the world, and some of the markets are doing terrific. Some markets are hesitant. Europe is hesitant, and especially because people need to make choices in a very uncertain reality of the market there is the tendency in Europe to make the decisions in favor of the expansion of the 3G networks, and it happens to be that we are not as strong in Europe as in other regions in the 3G footprint. So therefore, we are particularly vulnerable for those changes in the European scenario versus other markets. And if you look to the reflection that, that will have on what we can expect in Q4, we could actually say that up until quarter 3, we are more or less in line with what we wanted to do.

But in Q4, which normally is the quarter where you can see a bump up, especially in Europe, we expect that our revenues will be not as robust as we initially planned for. And that will have an impact on the way that we have to look through our profitability for the year, and we have to, therefore, not to my pleasure, but we have to reduce our full year guidance to around 4%.

Actually, if you look to the structure of what we're doing as a company, what we're trying to do, what we're trying to sell, how are we trying to help our customer base, how we have increased our relationship with our customers, nothing gets changed from that perspective. If you look to the various markets that we have operated -- which we're operating, most of those have not changed. The change is, as I just explained, in the European scenario, where with all the uncertainties, people make choices, and I understand those choices. And we have on top of the market uncertainty also the regulatory uncertainty still around, are we going to make the investments necessary for a broadband rollout if you combine all of that, this is where we had to come forward and say we think that the year will be around 4%.

Now if you look to our performance in 2011 quarter 3, and you look upon the market perspective, that's exactly the story. We have some amazing things happening around the world. Our growth in Latin America, which is absolutely full in competition with all our competitors from around the world, including the Chinese, we grew 36% year-over-year. We grew a whopping 186% in Mexico. So there is a lot of growth around the world in a very competitive environment across the board. And remember, what we sell to our customers is the journey from voice to video, the ability to deal with the explosion also in the mobile sector as in the fixed, to deal with a very different pattern of usage from our customers.

U.S. grew 10%. If you look to the Rest of the World, you will see that in China, surprisingly, we had a minus 10%, a pulse in the Wireless expansion. Next quarter, you will see that we'll resume business, as usual. But we want, for example, in China, contrast with the Rest of the World, a lot of footprint in PON. So the fiber expansion that is, let's say, hesitant, reluctantly going on in Europe, is going full speed in China, and we play major role on that. I think the market grew -- our role in the market grew something like 60% there.

So you can see that there is a different strategy with a different footprint. Middle East & Africa for us, of course, having historically had a great footprint, both in Egypt and Tunisia and in Libya, was down substantially. You would expect that. And Europe was minus 10%. So that is from a geographical point of view what Q3 was for us.

If you look to products, networks from a profitability point of view, they grow more than 100%, 31 to 70. And if you look to our strengths, we are going from strength to strength in IP. You know that we announced new products in the pipeline, and the traction of that is also very promising. We're growing across the business, across the portfolio in IP. And there, when we combine optical with IP, we even get a greater traction. We have, I believe it is called our Converged, I have to read this, Converged Backbone Transformation network. Basically, what it says is you take your IP, you optically collapse it into one, 55 cases now, 55 reference cases in which we're operating, which almost doubled from the beginning of the year.

So we have a product set, a capability set that is right in the middle of that transformation. It's doing its work. It's going to be better and better. If you look to our Optics situation, 2 things happened there. WDM is going very well, above 20% growth. If you look to the rest of the portfolio in this quarter, it's one of those things that if you have a hesitant market, you can postpone. It's happening there. So in that particular market, you won't see a strong optical performance.

And at Submarine, we have started many big projects, actually a little bit earlier than the trends would normally would indicate. A start-up quarter is never a good quarter from that perspective. So I expect that will be in later quarters coming back to us.

The Wireline business is going down the fastest because this is where you have the choices. Do I invest? Do I not invest? If I invest, do I invest in the old technology just to run out my broadband? Do I go to the optical new model? Will I do it now? And both in the U.S. and in Europe, you see that people confronted with a turbulent market make the choice to go to Wireless. That's why you see our Wireless business in the U.S. growing. CDMA, yes, growing very strong in the quarter. You can see that Wireless business is growing because people make a judgment call and say it's more important for us to invest in Wireless than in Wireline. So there where we're strong in Wireless like in U.S., we're gaining footprint in Latin America, we have a great footprint in China, and so with the other markets around there. There we have a grown -- a strong position. If you are not so strong in Wireless, this particular market is not very favorable to you. That's basically the story for what happened.

Given the choices, people go to Wireless over Wireline, and that's why you see also the Wireline story. If you translate that into how we are doing with the percentage of HLN, it's going up nicely. It's about the things that I talked about, the IP routing. It's WDM. It is the PON. And nicely for LTE, we had a very good quarter in LTE because of a recognition issue in the U.S. that went this quarter in our favor.

So if you look to wins, wins are particularly important because it tells you where the pipeline is going. In this picture, what you will see is that more and more of our wins are in the new business. Less and less is in the old business, which is very important because it gives you an indication of where we are going to make the difference. And there are 3 wins here that I think are particularly important.

The first 1 is Telefónica. Telefónica, one, is important because it talks about LTE, 4G LTE, and its pilot networks in Madrid and in Barcelona. That is a very important issue for us because, as you know, we don't have a Wireless footprint in Telefónica.

The second important one is the VDSL2, which is the Vectoring using copper to perform like fiber. That's the easiest way to put it. Belgacom, I would say on the minute of announcement of the product, you saw this contract there. And a very important contract in strategic industries, we don't talk about it too much about strategic industries, but it's gaining momentum in the market. A contract with the French Ministry of Defense for a long period of time, running a part of their network and upgrading a part of their network. I think if you look to where the wins are and with whom they are, you can see that the shift in what is important for our customers is reflected in our order portfolio.

We made a change, and I think that I have to apologize to some of you because you don't like the changes that we're going to make in the way we operate our company. You have to make all kind of adjustments to your model. I apologize for that. But it's better to run the business this way because there is a direct impact between Services, Software and the Solutions business that we had. And to get a much better traction around the interaction between those things, it's very important to bring it together.

And what you see here are 3 stories. The first story is on Services. The smarter the service, the better it is. From a margin perspective, from a contribution perspective and from the impact it has to our customers. So in this particular quarter, we had a minus 30%-plus on network builds, because network build is stuff you do in the Middle East and Africa and those markets. A lot of civics in there. It's not happening. But we saw growth where it matters. We saw growth where you talk about professional services, network integration services, things where you add your own IP and your own capability and you bring it with your product portfolio to bear for your customers. So that's one.

Second, if you look to the Network Applications, Motive, which is our remote customer service capability, is growing very fast. I mean, you talk about 50% growth or something like that, very fast. And it's now looking into new domains like managing smartphones over mobile networks, very interesting part of the business. In our payments system, we have an issue with one customer in a delay. I don't think that's a strategic or a sustained issue that we have.

Networks Application is a business, a good business for us. We have made our selections where we can make an impact and how we can run it. And it also shows in the profitability, Services went up from EUR 25 million in 2010 to EUR 55 million in 2011.

Now on Enterprise, I can tell you that -- of course, let me start with the Genesys business. Genesys business did very well, grew 20%. You know that, that business is -- that we received a firm offer from Permira, and we are going through the process. It's doing well as a business. Now people have doubted and said, okay, how is the business going with Enterprise? How much is that linked and what is the opportunity there? And for us, it was important to look to what the quarter did because it had to deal with a whole issue of Genesys. And it did very well. It did very well in the data business, and the voice business held its own as well. And the profitability went up. I think that we have a very good structure in where we have, from an intellectual property position, a corporation that is really working from both sides. And I think that the market where we will link it more to our -- naturally will link it more to our service providers business, we'll have opportunities to go forward. So I'm pretty positive about what's happening in that particular area.

This, of course, is the quarter to talk about the operational part of the organization. And therefore, it's important to talk about a few things. First thing we need to talk about is our cost. And I'm sure that, Paul, you will talk a little bit more about it, so I'll take it on a high level. We will exit the year with a EUR 300 million fixed cost saving. The reality is that we've tried to run the cost savings in a way to minimize the cash exposure of the programs that we run.

Actually, that had as an implication, that we were somewhat late in the programs, it took longer. So they started later. That's a choice we have made, and we have to stick to that choice now because that's what the program is going to run for. We see the traction. The traction was not there in the first half year. You could say that should have been faster, and I probably, in hindsight, agree with that. But we have the traction now, and I think that will be a good basis for the necessary cost improvements for 2012.

What is not good is our negative free cash flow. If you look to the why, we have assets around the world. That's a good thing because it's not lost. It's there. It's sitting there because we have large contracts. Markets functions. So we have, for example, LTE in the U.S. was, in Q2, in this inventory, customer-facing inventory, recognized in Q3. So you get those large contracts and recognize it. But if you look to the speed in which it translates from inventory to cash, that's actually not acceptable. We should increase that. The cycle times need to increase. We need to look through our working capital, and you will see that we announced today a plan to increase our capabilities to get to the free cash flow much faster than we were in today. This is not good. We need to do better there.

So if you look to the acceleration of the transformation, there are 3 elements here that I'd like to -- these are choices. So this is not a law. This is a choice. We have chosen to continue to invest in R&D. We have chosen that differentiation for this company is the way we deal with innovation. And therefore, you see a equal when it comes to the R&D, and that means that we need to accelerate our cost transformation, both in the cost of goods sold, as in SG&A. And it means that you have to look -- if you look to the COGS, you have to look to your variable and your fixed. You will see announcements pretty soon about an intense relation with EMS, our partners, for the fixed part. We will look to our delivery and project management to make improvements there.

I think we have great opportunities now, we brought it together on a global basis to make cost improvements there, we need to do that. And the same when it comes to the product mix and the volume growth. Because a lot of things are in a market where price erosion needs to be compensated very, very quickly and you need to be ahead of the game for price erosion and cost improvements. So we're going to put extra effort into the cost improvement and do it earlier so you can deal with the price erosion. SG&A, minus 3%. I think this is an area where you'll see in 2012 much more focus going forward.

So where does it bring us in 2011? It will bring us in a reality that there is uncertainty in the markets, especially in Europe. We have strong position. The fundamentals of the company haven't changed. Actually, the fundamentals of the market haven't changed. So I'm not going to blame the market for where we are. I think that will be not justified. We are where we are because of the combination between what's happening in the market and our own ability to have the speed to make our transformation. So it is as much a reflection on our own capability as it is a reflection of the realities in the market. And therefore, we're looking to an adjusted operating income in 2011 from around 4%.

Paul?

Paul J. Tufano

Okay, Ben. Thank you very much. Good afternoon, and good morning. What I'll do is provide some color around the quarter and give you some detail. Obviously, in the third quarter we posted revenue of EUR 3,797,000,000. That is, as you see in the chart down, about 7% in actual currency. At constant currency, that's about flat, minus 0.7%. The adjusted operating income of EUR 173 million, that's 4.6 points with OP. That's a 310 basis point year-over-year. And as you can see, it's about 280 basis point improvement from the previous quarter.

During the course of the quarter, the gross margins increased year-over-year by about 250 basis points. Volume and mix was about half of that. Mix for products and geographies was the other half. On the quarter-on-quarter improvement of 50 basis points, it was really volume, cost and expense reduction, offset by volume and mix.

If you look at our expenses, you can see that year-on-year, the actual rates, they're down 8.3%. That's approximately EUR 109 million. When you adjust for currency, it is 3.8%. On a quarter-to-quarter basis, we are down 6.4% at actual rate. When you adjust for currency, it's 7.2%.

If we now turn to the cost actions that Ben was talking about. As we always said at the beginning of the year, our focus was to reduce our cost and expense structure, primarily in our fixed operations costs, which are supply chain people, our people who do scheduling and those activities that are related to the control of our manufacturing supply chain. We also said that we would be very focused on the infrastructure in our business, which is real estate and IT, and the general administrative and selling functions of the company. And we said that as we would go through the course of the year, we'd be more back-end loaded. As we now come to the third quarter, we're seeing the results of our actions of these areas.

So if you look at this chart, you can see the improvement in variable margin, primarily through the mix and volume. The things noted are the ones that are on the right-hand part of the chart. Year-to-date through the third quarter, we have reduced our fixed cost of operation by about 13%. During that same period, we increased our R&D by 3%. The reason for the R&D increase, obviously, is to invest in future products and diversified product portfolio. And we have taken out in total from our SG&A about 3%. And if you look at the mix of that, we're really seeing a lot of benefit year-to-date in our infrastructure, which is IT and real estate. As we move towards the fourth quarter, that will further accelerate with more coming out of our general administrative and our SG&A and our selling functions.

For the full year, that would give us an exit run rate of about EUR 300 million. It will continue on until 2012. As Ben said, we're looking for another EUR 200 million on top of that as we move through into 2012 with another EUR 300 million from the variable cost line.

If you look at our revenue by operating segment. Ben gave you a pretty good highlight of it. I'll just take you through some of the details as it's reported here. The thing to note is that this is the new segment reporting for the company. So in this segment reporting, you can see the new organization of Services, Software & Solutions. That encompasses the old Services business with the addition of Network Applications. That leaves Enterprise primarily being Genesys and our enterprise voice and data business.

In the fourth quarter, we will report Genesys as a discontinued operation. But for the segment reporting, we'll include it on this chart, so you'll see what the full year impact is. Obviously, year-on-year, you'll see that constant currency basis, networks were down 3%, and on a quarter-to-quarter, down 9%. We had good growth in IP/MPLS, 12% year-on-year. In terrestrial, we had minus 8% growth with WDM minus 3%, but we saw good growth in WDM in the U.S.

In the Wireless, you can see the overall Wireless number is up about 2.8%, driven primarily by growth in the U.S. in Wireless. And we did have a reduction in fixed line, but PON grew very strongly, especially in China.

In the Services side and Software and Services, we're up 1% and 5%, respectively, on a year-on-year and quarter-to-quarter basis, primarily driven by number of consistent integration, as well as our customer care maintenance services. Network Apps dropped, but Motive grew dramatically at 15% and 11%, respectively.

And in the Enterprise business, Genesys grew 20% year-on-year. The Enterprise voice and data grew 1% and 29%, respectively. So a fairly good performance in the Enterprise space.

If you look at the breakdown by operating segment, all segments are profitable. And they've increased year-on-year and quarter-on-quarter to profitability. So I won't spend much more time on this.

If we move to revenue by geography. Clearly, year-on-year North America grew 10%, which continues that strong trend in North America. That's at constant currency. Asia Pacific was down 13% at constant currency. China was down about 10% for the reasons Ben indicated, the positive Wireless spending. In Europe, which is hesitant, we saw about a 10% decline. Western Europe was about the same 10%. And we saw strong growth in CALA at 30% year-on-year, which drove the Rest of the World at 9%. The Middle East & Africa was down 13%, but when you adjust for North Africa, it would have been relatively flat.

Turning to the balance sheet. There's only really 2 things to talk about the balance sheet: one is the change in the currency that affected the majority of the line items; the second was the fact that as discount rates dropped during the third quarter, we had to reset our actual gain or loss assumptions. There's almost EUR 1 billion of actual gains went into our liability and net pensions, and that was -- had an offset in the shareholder equity. When we get to the pension segment, I'll tell you that from a 2011 and 2012 standpoint, we don't see any contributions to our Pensions. This is an accounting presentation.

The major item in our balance sheet was the change in working capital, which we reflect here. And from an actual rate, you saw working capital increased EUR 350 million in the course of the quarter. When you adjust for currency, that's about the same number, EUR 340 million, with a different mix.

If you look at inventories. At actual rate, they look flat. When you adjust for currency, inventories declined by EUR 73 million. Now, obviously, inventory reduction has been a primary focus in the company for the last several quarters. In that EUR 73 million reduction, we saw that our operations inventories reduced by EUR 34 million. So we're making good progress in reducing operation cycle time and our own manufacturing.

We have just recently signed an agreement with one of our EMS partners to hand over even more manufacturing to them. That will take place in the fourth quarter, and it'll be a significant piece of our business moving to an EMS partner.

As it relates to inventory in front of customers in the field, every region declined except for EMEA. EMEA actually grew quarter-on-quarter by approximately EUR 47 million. And the reason for that, quite frankly, as the demand dropped in EMEA, we weren't able to reschedule out the parts.

Now with that trend, you will see us continuing to reschedule parts and work through that inventory over the next couple of quarters because it's not perishable inventory. As it relates to overall inventory management, especially in EMEA, the organization has gone to drive a sustained analysis by every project in EMEA by type of project, by entitlement of inventory and the gap analysis to figure out how they can reduce inventory actions.

This activity has been ongoing for the last 4 to 5 months. I would expect it to yield more productive inventory to clients over the course of the next 2 quarters. But it is a systematic approach to ensure that every project and every customer has a focus on an entitlement inventory to actual inventory and the gap analysis and an actual plan to reduce it. And for those of you who have worked on inventory problems, you know they're multiquarter problems to address. For the Rest of the World, we're making good progress, and I would expect that to continue as we move through the course of the next several quarters.

If you look at receivables. Our receivables grew at budget rate about EUR 26 million quarter-on-quarter. Obviously, the third quarter is a back-end loaded sales quarter. As a result of that, you saw our receivables grow. And our payables decreased by EUR 387 million, and it was really the reduction in the payables that drove the majority of that change in operating working capital. Now as we reschedule parts to meet our new full parts on demand, you'll see the payables asymptote as the inventory comes down to drive the free cash flow. And that's our objective over the next several quarters.

As we get to free cash flow, we did consume EUR 436 million of cash in this quarter, not what we wanted to do. If you look at what drove that, EUR 288 million of that was consumed with the change in working capital, which I just explained. As it relates to nonworking capital items, I think we have pretty good control on restructuring. We consumed EUR 99 million of cash in restructuring. Year-to-date, that is EUR 261 million spent on restructuring. We had told you that we would be at EUR 400 million. We'll probably come in below EUR 400 million.

On capital expenditures, we spent EUR 141 million. That is both tangible CapEx as capitalized R&D. Now that brings us to EUR 407 million year-to-date. We said that, that would be EUR 700 million. We'll be below EUR 700 million. We did repurchase EUR 50 million of debt during the course of the quarter. At the end of the quarter, we have EUR 3.75 billion cash and marketable securities. Our credit facility is undrawn. All the covenants are met. And as we just discussed earlier, we have just received a binding offer on Genesys. That's for USD $1.5 billion. Depending on the exchange rate, the net proceeds for that should be a little over EUR 1 billion, EUR 1.50 billion. We expect that transaction to close by the end of this year, early next year.

From a pension standpoint -- from an accounting standpoint, we saw a significant deterioration in the funded status of the pension by approximately EUR 1.3 billion. The reason for that, quite frankly, is the discount rate dropped by 75 basis points during the course of the quarter. That increased our liabilities by almost EUR 3.3 billion, and the gain on the fair value of our assets could not offset that, by about but EUR 1 billion.

As you know, this is the accounting view. From a regulatory view, you had various techniques to smooth at year end. In October, we elected our valuation techniques for both the fair value of our assets, as well as the discount rate. We can tell you that based on that election, that there'll be no cash contribution through 2012 into 2013.

In addition, in order to provide a little more headroom to our management plan, we've also announced that we were transferring approximately 10,000 beneficiaries from the occupational plan to the management plan before the end of the year. That will bring with it an additional 340 million of surplus. Again, we're always very focused on ensuring that the funding requirements of the U.S. Pensions are contained.

And so in summary, as Ben indicated, market uncertainties have, especially in Europe, have forced us to adjust our guidance. The new adjusted guidance is around 4%, adjusted OP for 2011.

And with that, I will stop and take your questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Odon de Laporte - CA Cheuvreux, Research Division

This is Odon de Laporte with Cheuvreux. So I appreciate your operational progress, that you deliver on your targets so far this year. But to be honest, the cash flow, as you say, it is shocking. And I was wondering why is there such a discrepancy between as a guidance provided at the beginning of the year and the actual number. I know this is tough industry, but I'd like to understand that, how, why this discrepancies.

Paul J. Tufano

Well, I think it's very simple. We said we wanted to get to breakeven to positive free cash flow. We always were very articulate that one of the key drivers to get that was a reduction in inventory, and we have not made as much progress in inventory reduction. Now there's a lot of reasons for that. But I'm not going to make excuses. It's not acceptable. It's just not acceptable. Fact of the matter is if you look at our inventory around the world, it is in operations buckets and it's in buckets in front of customers. On the operations buckets, which are more self-contained, we have made much more progress faster. In the inventory that's in front of customers, it has been harder to get at because it is so diffused. It's by project with individual customers. As you look at the mix of our business, it's shifting from drop ship box business to more integration business and more projects, which means you have to go through every project to understand, now, what's the issue? Is it that you have buffer? Is it that you have milestones that the customer that won't let you claim the revenue, therefore, get the inventory? Is it a timing gap between the supply chain delivering what you need? And so over the course of this year, we've been peeling that back into the levels. As I said earlier, we're in a position now where in the most project-intensive areas of our business, which is really in EMEA and APAC, the U.S. is more quickly drop-ship business. We are now getting that down to a level of detail that you're going to get to actualize. Now it's unfortunate it's taken us this long, but we're into thousands and thousands of projects. Now the good news is we are there. And as we work through it, I'm sure we're going to break the back of the inventory, and I think that is the primary answer as it relates to that question. But we are not happy with this free cash flow, not 1% happy.

Operator

Our question from the bridge is from Tim Boddy from Goldman Sachs.

Tim Boddy - Goldman Sachs Group Inc., Research Division

A couple of things that stood out. The first is in IP routing. We saw the IP division. We saw the sharp growth slowdown from around 30% in the prior quarter. Can you talk about Q4? You've got a very challenging comp. It feels like we could see that business down 10% or even 20% year-on-year, and does that suggest something is changing in terms of your market share or competitive position? Second question's really building on the speed of liquidity. It would be very helpful to understand what you think the cash cost of the additional restructuring you've announced today is going to be, and whether you think you can be free cash flow breakeven before 2013 or even 2014.

Ben Verwaayen

So you can do the free cash flow point. Let me do the IP position. I think if you look to the numbers, we have gained market share. It's true that this quarter, although the numbers are good numbers, I mean, no doubt about it, if you go 12% in IP/MPLS, then that's a good number. I don't see anywhere that we have a tendency to lose market share. I don't see it anywhere. I mean, Philippe is in the room. Maybe I've missed something. I don't think so. And I think that what you see is a trend. In mobile backhaul, we are #1 in the world. We were nowhere there a couple of years ago. So I think that what you will see is a continuation of our growth, and we will also expand in 2 other areas. That's what the announcement has been from the division, and I think that if you look to the traction that we have with major customers around the world, what they have in their labs, I'm very optimistic about the growth for IP going forward.

Paul J. Tufano

So Tim, with regards to the free cash flow question. 2013 and 2014 are too late. We are building our 2012 plan right now. And as we do that, our primary objective is to be free cash flow breakeven or positive at the end of 2012. And so we have to engineer a plan that gets us there. And that is the overwriting objective that will guide what we do on what we sell, where we sell it, where the margins are and our cost structures. So our objective is to get to that breakeven or positive free cash flow next year. And anything beyond that, just is not acceptable.

Tim Boddy - Goldman Sachs Group Inc., Research Division

So just to confirm, you're looking for a full year of free cash flow breakeven in 2012? Or you're looking to hit that by the end of 2012?

Paul J. Tufano

I would like to see a full year.

Ben Verwaayen

That's how we're building the budget. And I would like to add to that, this is not just Paul's commitment to you. This is what the corporation is building its budget on. So we have brought everybody back and said, okay, if you look to what the message should be, I mean, we are doing fantastic things in the market and as some of you -- or we just said, I mean, it's great to see that we built the profitability. Profitability in and by itself is not good enough. We have to translate it also into cash. So we're going to build the plan 2012 based on that 0 cash base that Paul talked about.

Tim Boddy - Goldman Sachs Group Inc., Research Division

And that doesn't include Genesys, that free cash flow excluding Genesys?

Paul J. Tufano

That's correct.

Eric Beaudet - Natixis S.A., Research Division

Yes, so Eric Beaudet from Natixis. Two questions, if I may. The first one is regarding Europe. You mentioned we're in an upgrade cycle in mobile in Europe where you don't have a strong foothold and, therefore, you don't benefit from that upgrade cycle. My question is this: With your lightRadio becoming available for the first deliveries next year, do you think you can penetrate some accounts to be able to participate in that 3G densification and upgrades in Europe? Will that change your competitive positioning? And my second question regards HLN networks. After 9 months, your carrier division is up 3%, and your HLN is up only 8%, basically in line with the whole division. Considering IP, LT are going very strongly, what is actually the drag on the HLN growth?

Ben Verwaayen

Well, on the HLN drag, you have to look to your neighbor on the right-hand side. And I think that I've said it a few times. It's the definition of what we do. If you look to third-generation CDMA, which is an important part of our expansion footprint, for whatever reason that's not being calculated into this number. If you look at the rest of our portfolio, this has not been -- to be fair with you, this has not been the strongest quarter when you look to some of our core components in the HLN strategy. But if you look to the trend of this, it's clearly making the bulk of our business. I would be surprised if we wouldn't see at the beginning of next year over 50% of our business being in HLN. So that's one. Second, or your first question, if I look to a footprint, expansion of the existing footprint is the norm in the industry. You can see that how we're doing in the U.S., we're doing very strong. We had a footprint. We expand from that. We're doing very well. If you look in China, we're doing extraordinarily well. We're winning on many new fronts of the expansion, and by the way, in an increasing better margin position than we were in the past. So you don't -- are in a position anymore that the markets are that different in certain of their demands. If you want to break it, you need to do something that's a disruption. And I think lightRadio is a disruption. We just made this quarter the first video call from a connected car in Shanghai over the China Mobile 4G LTE-TD network, ours, to the U.S. And it tells you what a new opportunity it develops for the market. I think that you will find in 2012 us breaking into new markets because of the disruptive technology, we have more of that in 2013, because the portfolio will come and start in 2012. If you want to have an end-to-end portfolio, we will talk about beginning of 2013. I think if you look to where we are on Wireless, while we're optimistic that we can monetize our investments so much better going forward is because we have the disruptive technologies here, and we have an early indication on the companies willing to do co-creation with us, which is basically open up our labs and research and say, come with us and develop it together. Also, for -- with companies that are not in our footprint. That has not been done before. So I'm pretty optimistic that you will see that capability.

Operator

The next question comes from Zahid Hussein from Citigroup.

Zahid S. Hussein - Citigroup Inc, Research Division

Just a couple for me, one in terms of the cost savings. You're targeting EUR 200 million. Can you just clarify, let's say, how much is that going to cost? And secondly, does that include OpEx savings from the disposal of Genesys? That's the first one. The second one is in terms of this patent income you've got from TCL. Is that recurring in nature, or should we assume that's a full-off one-off? I believe last year you got about EUR 150 million in IPR income. Is that the same sort of run rate for this year? And thirdly, in terms of your planning assumptions, you're talking about 2012 trying to be free cash flow breakeven or positive, obviously that was the emphasis for this year. That was one of the major targets for why Alcatel performed so well this year at the start and clearly one of the areas that investors will find very hard to believe having heard this again. So I think you're going to -- it would be helpful for us if you kind of help us understand, firstly, the progress you've made actually, and actually what steps you're going to take in the first part of the next year to get there.

Paul J. Tufano

Okay. Yes. So let me start with your first question, which is the expense number. If I may repeat the question to make sure I've got it right. Of the EUR 200 million, how much of that is cost versus expense? The EUR 200 million is primarily fixed cost and expense. It will come out of infrastructure, G&A and some selling and marketing. R&D will be relatively flat, and there will be some additional fixed cost savings like we had this year. It will not include the disposal of Genesys. In other words, we're not going to have the base with Genesys in it, and the new number with Genesys is out, it's apples-to-apples. That was the first -- I mean, that was your first question. Your probably most important question is why should you believe us on free cash flow? Because we are pissed that we didn't get it this year.

Ben Verwaayen

That's a foreign word. What he means is we're not very pleased.

Paul J. Tufano

It is unacceptable that we are going to end up where we are. And so we will, as I said, make free cash flow the primary objective, which means as we look at the deals we take, as we look at the terms and conditions, as we look at how we're going to manage inventory in the field and operations, all of our decisions will be predicated around what does it do to the free cash flow lines. And so I understand your skepticism. I appreciate it. It's up to us to show you as we go through the course of next year what our progress is on that.

Ben Verwaayen

On the patent, let me say 2 things about it. First of all, we're the proud owner of 28,000 patents. Very proud of it, very good for us, gives us a very strong position. It's true that in every year, we make deals around some of the patents. You have seen in this quarter some of it, and I'm pretty sure that you will see regularly in quarters some of it. But the basic idea that we have around patents is to build a strong company. To have a strong company, maybe there are opportunities in the future to look slightly different to some of the patents that we have. It's not our objective. It's not our way to get out of the situation we're in. We're not going to be in a mode that is doing anything else than fixing operational issues by operational activities. But in the meantime, we have this great asset. And if we find opportunities, fine, sure, we'll look to it.

Operator

Our next question comes from Francois Meunier from Morgan Stanley.

Francois Meunier - Morgan Stanley, Research Division

Yes, your cash position next year, I'm a bit confused because if I end up restructuring Pensions and interest cash outflow for next year, it's around EUR 1 billion of cash outflow. Let's say, I don't know, you make 4%, maybe 5% if you're lucky, EBIT percent, EBIT margins next year. Where do you find the difference?

Paul J. Tufano

Well, look, I think your math is right. Your math is correct. As I said before, we are engineering the plan to drive positive free cash flow.

Ben Verwaayen

So we have to make choices. Let me be a little bit less delphic. We have to make choices. That EUR 1 billion probably is right. Your 4% may not be right. It may be -- maybe it needs to be a little bit higher. And you can make choices. We make a lot of choices for the longer term in projects. We make a lot of costs that we may not want to make. We need to get to breakeven, at least breakeven free cash flow in 2012. That's how we're going to build the plan. That's what we're going to do. That's what we're going to discuss with you. That's how we're going to work around building the company and its bets going forward, because every single of the project that you look into are project that have to fulfill certain criteria. And I think that what you have heard from us now is that free cash flow will go to the top of the criteria. That's basically what it is. We are pretty confident that we can make the arrangement work.

Francois Meunier - Morgan Stanley, Research Division

Okay. Very good. Now another question maybe on the U.S. and your big U.S. exposure from the legacy of Lucent, especially on CDMA. I understand from the press release that CDMA and LTE were still growing. But do you mean CDMA was growing as well? And how do you see CDMA going in Q4 and potentially in Q1? Has it already started to roll over, as Ericsson says recently?

Ben Verwaayen

So the answer is that CDMA did grow in the quarter. The answer is that CDMA is a part of the solution that we are building. That thrives in this building in this particular case. The answer in the U.S. is that we have diversified much further in our customer base, our product base, our capability base than sometimes I think people realize. So I think that if you look to announcement being made by individual customers quarter-by-quarter, we're going down x or we're going to change our portfolio from where we are today into more civic works or all those things that you find on an individual case, are all true. If you add them up, maybe 2 years ago we would have been extraordinarily vulnerable. But we have built a resilient capability with many other customers, some of them becoming very quickly very big, that gives us this capability to dampen some of the effects and even do better than dampening it. So what I expect is that at a certain point in time, for sure, CDMA will go down. I mean, that will happen at a certain point in time. It may be that the demise of CDMA has been announced a few times too many and that there may be some more legroom there than people anticipate.

Unknown Analyst -

[indiscernible]. Two quick questions. First one is Europe, a little bit on what happens in Europe in Q4. Is it just more wait and see from telco to protect its EBITDA minus CapEx to reassuring results. Also, just to reaffirm, no really need to invest in the networks even with the traffic increase? And if we look at the first report from the telco in Europe, if I look, for example, at France Telecom, I can finance on EBITDA. So not really explaining a drop in CapEx. And the second question is, are we getting vendor financing in credit crunch? Sprint was explicit a few weeks ago on the demand for vendor financing. So what kind of risk you would be able to accept on your balance sheet to support Sprint?

Ben Verwaayen

So you want to start with the vendor financing?

Paul J. Tufano

So with regard to vendor financing, in general, not with regard to any one customer, we are very judicious about how we use our balance sheet. And in fact, we've shrunk the amount of vendor financing in our balance sheet over the last 2 years. We will, however, arrange a variety of syndicated loans working with export agencies to support our customers. And we've done that in a variety of the cases for customers around the world.

Ben Verwaayen

So if you look to Europe, what's going on? I think first of all, it's very customer-specific. That's one of the things in a hesitant market. Some people are more hesitant than others. Some people make different choices than others. Some countries are more specific in, for example, broadband rollout than others. And the broadband rollout is not important so much for us from a broadband line perspective, from the fiber perspective, than it is for the backhaul and the rest of the network perspective. I would say there are 3 things happening. First of all, the climate is not very encouraging to take bigger risk. And the ability for operators to predict to their shareholders what the returns will be is a pretty important part of their business models. That's one. Second, we do not have yet the clarity on the regulatory point of view, and I think that was not very much helped, to be quite honest and frank with you, with the copper consultation that happened. I mean, if you want to make sure that people are scratching their head, that was a very good one. But maybe that was not what was needed. So we are what we are. So we have to deal with it, and we're dealing in the best possible way, and I'm pretty sure that we will work around it. But it was not, at that particular point in time, the most helpful thing to happen just at the heels of a program that was about to give people the incentive to go, okay, and go and do it. Yes, so that's the second thing. And the third thing is if you look to some of the ways that people look to added value which would be over the top and themselves and the relationship that they have in making the contracts work, there are different models that they have to examine at the same time. So there are 3 massive incentives to say, wait a minute, with the exception of where you are banging customers on the door, that says I want the capacity and I need to go and deal with the Wireless networks. That's what's happening in Europe.

Operator

Our next question comes from Stuart Jeffrey from Nomura.

Stuart Jeffrey - Nomura Securities Co. Ltd., Research Division

Just a quick clarification. The focus for next year is on breakeven on free cash flow. So should that mean that when it comes to your market share, expectations for next year, that you're basically reducing those in order to prioritize free cash flow? And then somewhat into that, given that we do have a tougher market environment with operators sitting on their hands a bit, how do you think pricing develops in that environment? And what benefit do you see from component cost reductions, for example, to offset that?

Ben Verwaayen

So if you want to make this work, you have to look to the totality, and I think your question is an excellent question because you have to make some choices. And the choice is that we will double down on our strengths. That means that by definition, there are also certain parts that you do less. For example, I think we will be less inclined to take loss-making business in order to build something for the longer term. And that's the reality that you have to deal with. I think that we will be more focused on what it will mean, for example, in our capability to do end-to-end with our customers. I think that if you look, for example, to our Services contracts, they will be much more linked to what we do for our own product position. I think that we also will have customers in certain geographies getting, let's say, somewhat more attention than in others. That is going to happen. And I think that's, in itself, a healthy exercise to go through. We haven't said that this will be painless, but I don't think that losing market share is on the top of my list at all. If you look to what we do in optical, what we do in optical IP, what we do in IP and what we do in Wireless, I think the end of 2012 should bring us in a better position than we are today, not in a lesser position. So yes, it will be on cost. Yes, it will be a lot about the structure around our cost, which is some of the complexity in the organization. It will be, I think for our customers, also an encouraging activity that we are going through.

Operator

The next question comes from Achal Sultania from Credit Suisse.

Achal Sultania

A couple, if I may. First on revenues for Q4. How should we think about the seasonality going into Q4 given the historic seasonality has been around 17% quarter-on-quarter? And then secondly, on restructuring, your OpEx seems to be down around EUR 80 million year-on-year in the first 9 months of this year in spite of the ongoing efforts on the cost cutting side. So how should we see the impact of these newly announced restructuring efforts on your profitability in terms of timing? Is it something we can expect in the second half of next year or probably 2013?

Paul J. Tufano

So on the cost and expense, as we said earlier, this year's cost and expense is back-end loaded because of how we were trying to reduce our people-related expenses in certain parts of the world. That has been accelerating over the course of the last -- of the third quarter into the fourth quarter. Now we envision it accelerating or continuing to accelerate into the first half of 2012, so it should get a more full year benefit. So that's how I would characterize you on a modeling standpoint on that point.

Ben Verwaayen

I would add to that. You could -- if I would look to what we're going to do, it will be more first-half based than second-half based because we have -- I think we've learned a little bit to deal now with the instruments that we have and what we need to do.

Sebastien Sztabowicz - Kepler Capital Markets, Research Division

Sebastien Sztabowicz with Kepler in Paris. You have a free cash flow, but you've been targeting your budget for next year. Can you share with us what could be your margin target in your budget for next year as well, please?

Ben Verwaayen

It's a very good question, and I think there are a few other questions you also could ask. Good questions. I fully understand. But we're going to build a budget in a way that we can present to you then at the end of our Q4 presentation. So make sure that we don't forget about that when we do our Q4. And I'm pretty sure that you will get from us a pretty good picture of what we think for 2012. Seriously, I think that one of the things that I think is the strength of our company is we are global. We have the ability also to work with our customers pretty intensive. That is very different than when we arrived in 2008. I have to say to you, building the budget together with our customers is a much better exercise than what we have been doing a couple of years ago. So I think we will owe you an answer by the time that we meet again.

Operator

We have a question from Sandeep Deshpande from JPMorgan.

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Just as a follow-on to Francois' question. I mean, you responded to him saying that you think your margin next year would be higher than 4%. I mean, when you consider -- is this including the disposal of Genesys? Or I mean, also in your calculation, are you assuming that there will be a substantial impact from the cost-cutting plan that you are undertaking given that there has not been such a big impact in the first 9 months of this year?

Ben Verwaayen

I have to admire you for the way you're asking the question, and I'm not going to give you the guidance for 2012. That would be -- I think will be not appropriate. What we have told you is what the core of our thinking is around building the 2012 plan. I gave an answer to a question that made some assumptions, and I said maybe some of the assumptions are the right assumptions to make it work. But I think it will be wrong for me now to go and speculate together with you about how we're going to build the picture in the 2012 plan. I think we have given you a good indication of our determination, our not being happy where we are on the cash front. I'm pretty happy where we are -- to be honest, I'm very happy where we are with our customer front. I think we have, therefore, a solid base to work the issues that we have in front of us. If you have everything fluid, it's probably very difficult to do. But with some of the solidity that we have now gained, I think we have a task ahead of us that is I won't say easy, but it's a thing that we are determined to do.

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Maybe I'll ask it in a slightly different way. I mean, following up on another question. I mean, you're not going to do end-to-end, you're only going to be focusing on some businesses where you have very strong market positions. So are you going to actually restructure such that you're going to be in only some of these very strong businesses and get out of some of the other businesses where you don't have the kind of margin position?

Ben Verwaayen

I think we are known for our customers to be an end-to-end business. I think it will be very difficult to be a product-based business again. That will be wrong. It's not where our future is. So nothing has changed from that perspective. It is pruning, it is not changing our strategy. Our strategy, nothing is wrong with our strategy. We have an issue with timing of our execution. It's not the execution even itself. It's the timing of the execution and the intensity with which we have done it. And I think that is very clear. The market hasn't changed. The market is still looking for the same capabilities, more even so than in 2011. So I think that from that perspective, no, we are not going to change the fabric of the organization. We're going to execute.

Operator

Our next question comes from Gareth Jenkins from UBS.

Gareth Jenkins - UBS Investment Bank, Research Division

Yes, I have a couple, if I could. First, I just wondered, Paul, how much cash is locked up in assets around the world, so particularly Alcatel Shanghai Bell, whether you can give us a sense of actually how much cash you can actually access. Secondly, I just wonder that given the inventory situation, I think you said that the inventory situation will continue. I just wonder whether you'll see the need to actually write down any inventories into Q4 or beyond. And then finally, just going back to the question asked earlier. I'm not sure I heard the answer. So apologies if that's the case. But could you just confirm what your cash cost of restructuring are in total, please, for the next 12 months?

Paul J. Tufano

With regards to cash that we don't have ready access to. There's about EUR 1 billion, roughly, that we don't have ready access to. That's primarily in Alcatel Shanghai Bell. I will tell you that we're working with our Chinese partners, and you will see us repatriate some of that cash over the course of the next several months. So it is accessible. With regard to the inventory, the inventory on the balance sheet is all good inventory. I don't anticipate any write-down of inventory. It's a question of converting that into revenue. Most of that inventory is sitting in front of customers or in customer networks that have not yet been recognized by -- for revenue because of their Ts&Cs. So it's not as if it's absolute inventory. Our inventory reserves cover that. And with regards to the restructuring, we said this year, at the beginning of 2012, that we'd look to have restructuring of EUR 400 million. It will be slightly below that at the end of this year. I think that answers your questions.

Frank Maccary

Okay. Thank you very much. That concludes the press conference and analyst conference for today. We look forward to seeing you again soon. Thank you.

Ben Verwaayen

Thank you.

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