Alcatel-Lucent Q1 2007 Earnings Call Transcript

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Alcatel-Lucent (ALU)

Q1 2007 Earnings Call

May 11, 2007 7:00 am ET


Pascal Bantegnie - VP of IR

Patricia Russo - CEO

Jean-Pascal Beaufret - CFO


Kulbinder Garcha - Credit Suisse

Mark Sue - RBC Capital Markets

Tim Boddy - Goldman Sachs

Remi Thomas - Cheuvreux

Jeffrey Schlesinger - UBS

Paul Sagawa - Bernstein

Alexandre Peterc - Exane BNP Paribas

Simon Leopold - Morgan Keegan

Phil Cusick - Bear Stearns

Jason Mauricio - Arete Research

Gareth Jenkins - Deutsche Bank

Frank Maccary - IXIS



Ladies and gentlemen, thank you for standing by, and welcome to the Alcatel-Lucent 2007 First Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session (Operator Instructions).

And, as a reminder, this conference is being recorded. I would now like to turn the conference over to your host Mr. Pascal Bantegnie. Please go ahead.

Pascal Bantegnie

Thank you, Rashya (ph). Hello, to everyone and welcome to our first quarter 2007 earnings call. With me today on the call are Patricia Russo, Alcatel-Lucent Chief Executive Officer, and Jean-Pascal Beaufret, Chief Financial Officer. Pat and Jean-Pascal will provide an overview of first quarter results and discuss the market and company’s outlook.

Later in the call, we'll conduct a Q&A session. Please restrict yourself to one question and no follow-up, please. If anyone has not yet seen a copy of our earnings release or the slide deck for this webcasted call, it is available on our website at

Before we begin, I would like to remind you that certain statements we will be making today maybe considered forward looking. Please refer to the Safe Harbor Statement contained in today's releases.

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


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Patricia Russo

Thank you, Pascal. Hello, everyone. Thank you for joining us. As you know, earlier today we announced our audited results for the first quarter of 2007, which is in fact our first full quarter of operations as a combined company.

Jean-Pascal Beaufret will go over the numbers in a few minutes but I thought I would start by giving you some context around the quarter and let me start with the snapshot. While our first quarter financial results were lower than we could have liked, we are encouraged by the progress that we've made in several key areas during the quarter.

First, we worked very hard to reduce the uncertainty that accompanied the merger. You'll recall we commented on this in our fourth quarter review. As is normal in these situations, uncertainty can be felt by our employees, our customers and our partners in the weeks leading up to and following the merger.

During this quarter, we took several actions to address each of these important constituents. Internally, we brought further clarity to our organizational model, our operating model, and stepped up to work with our HR folks to communicate as much information as possible about each employee's role in the new company.

That work is ongoing. And we essentially finalized our product and technology roadmaps and we have been aggressively communicating the details around these decisions with our customers. And that communication is ongoing as well.

Secondly, with an increased external focus on selling and greater certainty around the portfolio and, as well, the sales team stability, we saw good momentum in our order flow across the businesses, which resulted in an improving order backlog with a book-to-bill at 1.3. We recognize this is based off of a lower revenue base, but it is still strong.

That said, as we had anticipated, our first quarter revenues declined as a result of lower volumes in wireless and core networks, and this of course occurred at a time when we continue to make considerable investments in the next generations of these technologies. Our wireline business grew on a constant basis and our enterprise business grew, and I'll make some comments on those in a minute.

Thirdly, in the quarter, we continued to sharpen the focus of the company and completed, on April 10th, the transfer of our satellite shareholdings to Thales. This is in addition to the transfer of the railway signaling business and our integration in services activities for mission critical commercial systems, which were transferred in January.

We have an ongoing partnership with Thales, which will include commercial cooperation for such markets as defense, security, energy and transportation. So I think, as you look at these, we've made good progress in positioning the company for growth in what is a highly competitive market and, at the same time, starting to build some good business momentum.

Let me comment on that. In addition to what we observe in the book-to-bill, we signed and announced several key contracts during the quarter. The point I would make about these is that they span geography and they span our entire portfolio and I think speak to the power of the combination represented now by the combined portfolio.

And they include a $6 billion agreement with Verizon Wireless, this is for EV-DO Rev. A, in addition to IMS and IP routing solutions, an agreement with China Mobile where Alcatel Shanghai Bell and our partner Datang will participate in deploying TD-SCDMA networks, a contract with E-Plus to operate and manage its cellular network in Germany.

An agreement with Verizon to deploy our GPON technology in its Fiber-to-the-Home network. We announced several submarine contracts, including wins with Telstra and Mediterranean Nautilus. And we announced a large contract with Globacom to supply and install the first UMTS/HSDPA network in West Africa and, lastly, our first UMTS/HSDPA win in Western Europe, and that was with SFR.

As I said, our enterprise business recorded a 12% increase in revenues at a constant exchange rate. The voice and data business contributed to the segment's growth, due to good momentum in IP technology for large, medium and small businesses.

In fact, the IP penetration rate among our enterprise customers now represents more than 40%, compared to 30% in the same period last year. Additionally, Genesys, our contact center activity, continued to be a strong driver for that segment's revenue growth in the quarter and outperformed the market once again.

So as you can see, our sales momentum has picked up. You can see it in the numbers and I can actually feel it in the business, and we feel good about the fact that it's beginning to build. Our goal, of course, is to continue to execute on our integration plans, while maintaining the focus on our sales momentum.

Let me now comment on our integration plans and update you on our efforts. First, I would say our integration plans are on track. We've made good progress on the further definition in specificity of our plans. Our senior leadership team has come together nicely and is focused on executing those. We've essentially finalized our portfolio and, as I said, we're communicating the details of those decisions.

Our portfolio, I would remind you, is aligned with where we see the industry's key areas of growth, including IT, network transformation both fixed and mobile, convergence, IMS, 3G mobile networks, next generation optical, wireless and wireline broadband access, in addition to a number of opportunities in the services market.

We've rationalized completely our sales team. We can see the increase of this increased focus and attention and I would just point you to the sales momentum I referenced earlier.

We are progressing in the implementation of our operating model, with a regional structure that enables us to have global reach while maintaining our understanding of local markets. Our discussions with the European workers' councils are progressing and those conversations are being managed consistent with the appropriate process and procedure, and we're managing those with care.

During Q1, we achieved cost savings in line with our full year 2007 target. Most of the savings in Q1 came from improvements in procurement, IT and R&D. Net headcount reductions, before the impact of our managed services wins, were approximately 1,900 during the quarter. This represents about 15% of our three-year target of 12,500.

A good part of those reductions came late in the quarter and the benefits of those actions will be realized in subsequent quarters. As a result of this, we remain on track for at least €600 million in savings for fiscal 2007, which is in line with our target of €1.7 billion within three years.

We will strategically reinvest some of these savings in markets and technologies that we believe will enhance our footprint and our market position going forward. Before I turn it over to Jean-Pascal, I'll make just a few comments on the market.

We continue to see the market providing good opportunities for us and aligned with our portfolio. This is evidenced in the continued shift we see to all IP networks, which is happening all around the world at various levels of degree and pace.

We continue to see emphasis and investment in fixed and mobile broadband expansion. We continue to see good demand for applications and network services, particularly services to help customers deal with the complexity. In the enterprise space, by the way, we continue to see an emphasis on communications-based capability that will enhance productivity and efficiency.

At the same time, our market, as you know, is one that is highly competitive. The pricing environment remains challenging. That is not new. We continue to have some uncertainty, of course, in anticipation of the technology choices and licenses for 3G in China.

We believe that the fact that we provide CDMA, wideband CDMA and TD-SCDMA certainly positions us well for when those decisions are finalized. We continue to see a bit of the effect of the carrier consolidation in North America - you'll see that in the North America results - and a bit of that in Latin America.

Having said all that, we continue to see good opportunities for growth in the market. We maintain our view for the carrier market to grow in the mid single digits and we expect that we will sequentially increase our revenue through the year and grow at that rate. So with that, let me turn it over to Jean-Pascal, and he can provide you more detail.

Jean-Pascal Beaufret

Thank you, Pat. So good afternoon and good morning, everyone. I will walk you through a dozen charts, giving us a summary of what happened in Q1 '07.

First of all, similar to what we did in the prior quarter, we are, as you know, presenting reported results that include the non-cash impact from purchase price allocations entries, which are subsequent to the merger with Lucent.

So in addition to the reported results, we are also willing to present adjusted results to provide a meaningful comparison basis for which we can evaluate the economic performance of the company in telecom during the period.

By the way, you have on page 26 of this presentation a re-presentation of all quarters of 2006 on the P&L items as well as per business segment, so as to give you a comparable base line.

Our revenues during the first quarter were €3.882 million, same of course for both reported and adjusted revenues. And our adjusted earnings were $0.09 per share where they were $0.13 per share in the same comparisons of Q1 '06 last year.

Please could you note that the Space business that was just divested to Thales on April 10 this year is shown today in discontinued activities, while other activities, such as railway signaling or integration and service activities for mission critical systems, that have been contributed to Thales on January 5, 2007 were not included in first quarter 2007 results.

So you can see that the purchase allocation entries were 338 million in total in the quarter. We are providing on page 24 in the appendix of this presentation a forecast in the next three quarters of all purchase price accounting entries.

So focusing now on the adjusted P&L - this is page 10. As a preliminary remark, I would like to point out that two important elements have to be borne in mind when looking at the results this quarter when comparing Q1 '06 and Q1 '07.

The first one is, as Pat said, the important translation impact from euro dollar rates. We had €1 equals $1.20 as an average rate in Q1 '06, where we had €1 equals $1.31 as an average rate in Q1 '07, which impacts both unfavorably the top line and favorably the costs and expenses.

And the second important point to be noted is the scope of our consolidated activities, which in particular have included operating expenses for the newly-acquired UMTS radio access business beginning January 1, 2007, which in the same time limited revenue contribution in this quarter.

So looking at the top line now, our revenues for the first quarter '07 were €3.882, down 8% at constant rate. This is basically stemming from the Wireless and core network sales, which have decreased at a time when we are continuing to make considerable investment in the next generation of these technologies. Wireline and Enterprise business, conversely, grew year on year, at constant rate, significantly.

Our adjusted gross profit, €1.335 million, or 34.4% of sales, from the 32.7% in the December quarter and from 39.6% in the last year quarter, represents a margin decrease of 5.2 percentage points. This decrease is mostly explained by significant items, which are related to the investment the Group has continued to make in product convergence, portfolio rationalization, which have accounted for €130 million, i.e. 3.3 points of the decline.

This is mostly about future swaps of products that will happen on those product lines that we do not terminate and therefore do not book as restructuring charges. We have experienced, as well, less favorable environments in some geographies and, for some products, we have continued competitive conditions, experienced especially in the GSM Wireless in some emerging countries.

We have made investments. We've continued to make investments in markets and technologies, because the company intends to secure its footprint in those markets.

Having said that, we have seen as well a very positive evolution in some of the segments in Wireline and in CDMA, EV-DO, especially, as well and we have experienced some first savings in the cost of sales from increasing purchasing power of the company.

So the company's operating expenses, though stable. I will show that in a minute. So stable at constant rate and with comparable business group have increased at actual rates, with our new, enlarged scope of activities, to €1.579 million. Consequently, we have recorded an operating loss of €244 million during the quarter.

For the year-on-year comparison, let me call your attention on the unfavorable impact of net R&D capitalization. We had a positive capitalization effect of €31 million in Q1 '06, where we have a negative of 11 in Q1 '07. And that is basically related to the decisions we have made to shorten some amortization periods, or no longer to capitalize some products, because we believe that the lifecycle of the products has shortened.

For the year on year comparison, we need as well to take account of the one-off capital gains, which we have mentioned, in Q1 '06 for an amount of €42 million, which could distort the comparison.

Now, let me provide you some comment on each business segment. The Carrier segment revenues for the quarter were down 10% at constant exchange rates to €2.839 million. And clearly, because of the remaining uncertainty factors that we have already discussed in last quarter, this operating loss of 194 we had these losses of 194 in this Carrier segment, but, out of this loss, all the significant items that I mentioned earlier have contributed for the majority of this operating loss.

In the Carrier segment, we show that Wireline business groups were up 1% at €1.287 million. Business group sales is still capturing, a good market share, due to the comprehensive portfolio in the markets and the strong product offering it had.

During the quarter, Wireline revenues were very positively impacted by IP routing, optical transfers, mostly terrestrial, principally driven by the IP network transformation into video and IP across the world. Conversely, the access revenues were lower this quarter than the first quarter 2006, which included particularly strong results in North America.

The Wireless group revenues declined 15%, €1.204 million in this quarter, which is largely driven by the lower volumes, which we have experienced, especially in the GSM radio in some markets.

In UMTS/WCDMA, the transition of some of the customer base to a newly merged portfolio resulted clearly in lower revenues, without fully having the benefits of the former, the synergies between the former three portfolios of ex-Alcatel, ex-Lucent and ex-Nortel. CDMA remained really steady in North America, while, with continued EV-DO Rev A upgrades and growth in the subscriber base, CDMA went down, and significantly down, in China and Latin America.

Looking at the Convergence business now, the revenues were €348 million, down 28% at constant exchange rate, and they were mostly negatively impacted by the decline of sales in the legacy core, which has continued to outpace the revenues of the next generation solutions.

We've seen also revenues negatively impacted by the declining market in prepaid payment solutions in the multimedia and payment business. But we are building and we are making important R&D investments in advance of the expected ramp-up in this business.

Enterprise, as mentioned by Pat, experienced a very, very strong growth of 12%. Genesys call center business, with double-digit growth, outpaced the market in IP, voice and data networking activities. And in the Service segment, finally, lastly, revenues, at €626 compared to €674, were down 3%.

We have seen network operation and hosted services going up significantly, with especially a landmark deal with E-Plus, which became effective in the quarter. We've seen, as well, maintenance and deployment service revenues relatively, slightly weaker or stable. A good view of Alcatel-Lucent is given by the breakdown, the geographical breakdown of our sales in the quarter.

As you can see from chart 12, we've continued to benefit from a fairly balanced geographical distribution of revenues, with about 37% being realized in North America, 33% in Europe and the balance of 30% in the rest of the world. The Asia Pac region, representing about 15% of our overall revenues, reported a very strong growth of 13%, mainly driven by two businesses, wireline and continued strong performance in GSM.

In Europe, the business increased by 1%, which is basically across all the wireless, Enterprise and Service activities. Rest of the world, which, as you know, includes Africa, Middle East, India, Indian continent and Central and South America, declined by 16%, primarily due to the 2G wireless in the class core business. This was the consequence of a quite low order intake in the last months of prior year.

North America revenues went down, at constant exchange rate, 17%. This is basically from the high comparable base reported in Q1 '06, with high access revenues, notably in wireline and, as well, from the temporary factors we have already mentioned in the last, in the December earnings calls, namely deferred spending due to carrier consolidation and some uncertainty regarding our product formats.

Coming now to the operating expenses evolution and comment on R&D and SG&A, I'd like to present this chart for you, which is a summary of our own tracking analysis and which we obviously will refine over the next quarters.

But in order to provide a meaningful analysis of these expenses, we need to do it on a comparable basis. So reporting actuals of €1579 billion requires to adjust those nominal figures by the impact of the UMTS radio access and some more acquisitions done or closed after March 2006.

It requires as well to adjust it from the significant euro U.S. dollar exchange rate variation among the periods, which impacted favorably the cost evolution. It requires as well to adjust it from the changes in R&D capitalization from €31 million in last year and minus €11 million this year, as I said, and requires to adjust it from some one-offs, like capital gains, as we used to identify them.

The outcome of that is, on a comparable line, that all costs or expenses in Q1 '07 declined sequentially by 1.3% and were basically flattish compared to the same period last year. Key takeaway, for me, from this chart is that, on a comparable basis, we have already taken cost out in R&D expenses as a result of the very speedy decisions on the rationalization of our product portfolio. R&D, in particular, reduced by 4.3% sequentially.

In SG&A, the cost savings have not yet shown up and will start materializing in the coming quarters in the organization, while processes and systems become harmonized, allowing elimination of duplicated resources.

But basically, the trend has to be seen in the position -- number of positions in the Group, which is shown in the operational heads line. Looking at the evolution, they are clearly going down by 1,900 sequentially, before the impact of the recently announced managed services contracts that have entailed 750 positions, high end of 750 new positions.

Three comments on the total net income and earnings per share. €320 million restructuring costs, I will provide more details on that on the next chart. Finance costs are a positive of €129 million from our pension and OPEB situation and, basically, most of the rest is the carrying cost of debt for €40 million.

And income from discontinued activities has been boosted in the quarter by capital gains of €677 million in the quarter, reflecting the after-tax related to the Thales transaction, which was announced prior to these earnings.

One word on the significant line item of restructuring costs. €320 million booked in Q1 '07, which is, by the way, 20% of total merger-related restructuring costs, which we have announced for a three-year period. The significant part, almost two-thirds, of the Q1 '07 restructuring provision is to cover 2,500-headcount reduction, first of all.

Primarily, these headcount reductions are located in developed countries. Other known headcount-related restructuring costs, which have been booked over the period include an update of swap costs for product rationalization and other monetary costs, such as real estate associated costs.

In terms of cash outlines in the quarter, we spent €83 million over the period, which you will see has been reflected partially first in our cash flow statement and in the number of the positions. And our estimate of restructuring cash outlines for the full year 2007 remains at €900 million that we guided on earlier in the next call.

So the total restructuring cost booked in the quarter gives you an idea of the speed with which we make decisions regarding the implementation of our integration plans. We remain confident that, therefore, we can realize the €600 million of pre-tax cost savings, with the majority of the benefits recognized in the second half of this year, which are part of the €1.7 billion of pre-tax cost savings within three years.

As an example, we are showing some progresses, let's say clear progresses, of these integration plans to date. First of all, at the business group level, product roadmap strategy. The decisions of product rationalization, essentially completed, are entailing in certain cases, namely Wireless, ongoing product developments to meet rationalization roadmaps. This is clear, but with that accomplished we have been able to train 4,500 sales people on the combined portfolio.

At the regions level, the merger of legal units in various countries is well underway today, with consolidation in ten countries, six of which being tier one countries, and this is already completed. Further than that, the harmonization of regional processes, systems and tools has been launched, such as a pipeline of order management tools from IS and IT perspective. The rationalization of sales teams is being performed.

At corporate function level, the procurement -- in terms of procurement, we are starting, as I said commenting on the gross margin, to benefit from enhanced purchase power. We have completed negotiations with over 200 of our top suppliers.

We are changing, at corporate function level, in IS/IT. We are saving money today and we are implementing a new organization. We have, as well, in real estate, already closed 15 locations and the facility consolidation is going on.

One word about operating working capital. If adjusting from the remaining non-cash inventory step-up, our operating working capital remained fairly stable over the quarter, representing 8% of revenues over the trailing 12 months.

Inventory turns have decreased, at 4.7%, compared to last quarter. This is mostly explained by anticipated revenue growth, in preparation of the growth. We have gained two days in DSOs.

And for 2007, all that makes us comfortable that our operating working capital could remain in the range of 8% to 12% of the last trailing 12 months, with possible fluctuation from the quarter to another quarter.

Turning now to cash flow, on an adjusted basis -- and it's difficult to compare cash flow with something which is something completely pro forma in Q1 '06, but, on an adjusted basis, Alcatel-Lucent generated cash flow from operations of €21 million before restructuring and operating working capital in the quarter.

Investments in working capital were €104 million, on a cash basis, in working capital and other working capital. This is seasonal and normal. Interest were very high, €114 million, but this is seasonally high, because an important portion of our coupon interest payment falls in this period of the year, in Q1, actually about roughly 50%.

Taxes were quite small, as expected - €19 million and restructuring cash outlays were €83 million, as I said before, and capital expenditures were €177 million, including the R&D capitalization.

So basically, the cash flow for the Q1 '07 is reflecting the earnings as they were and the seasonality of our cycle.

One word on the balance sheet, because I'd like to point out something, as a preliminary remark, that we've proceeded to apply, with retroactive effect on January 1, 2007, a new method for pension accounting, which is called the SORIE method, or Statement of Recognizing Income and Expenses. This is the amended IAS19 consequences, so you will see the detail of that in the note to the financial statements, which we are providing.

But briefly, the SORIE method allows to immediately recognize all actuarial gains and losses and any adjustments arising from assets ceiling net of deferred tax assets in that period in which they occur. And it allows us to recognize it outside profit and loss account.

Previously, Alcatel-Lucent applied another method, which was called the corridor method, that impacted the profit and loss account, but over an extended period of years - 15 years.

So we believe that this treatment is preferable, because it will more fairly present the fair value of assets and liabilities related to retirement benefits in the balance sheet and it will eliminate, as well, significant volatility in the result of operations.

So there are various other readjustments of the balance sheet, because you know that, by the end of 2007, we will readjust quarterly the opening balance sheet of the merger, but you will find details of that.

One other point I would like to mention is that, during the period, we continued to repurchase debt in advance and the company reduced its cost debt by about €650 million, mainly resulting from the advanced repayment of the former -- the ex-Lucent 8% debenture with a nominal value of €360 million, which we repaid end of March, and we will always be impacted by the regular repayment of our normal debt.

A last word about balance sheet and cash, because we will present it quarterly, given, by the way, the methodology used in the SORIE method. Funded status of our overall pension and OPEB improved by €1 billion over the quarter. This is the result of a decrease -- an increase of discount rates following the U.S. Treasury rates and, as well, an excess of earnings of -- or assets versus spending. So now, I can turn it back to Pat for the conclusion.

Patricia Russo

Thanks, Jean-Pascal. Just a couple of comments on the outlook. We indicated in our press release that we anticipate solid sequential growth as the year progresses, with our second quarter reflecting approximately 10% growth from the first quarter, and that is at a constant rate.

Just as a reminder, the better than 50% of our business is in dollars or dollar-denominated rates, and so it's important that we be explicit about the use of constant rate when we share these views.

We continue to expect that we will progress through the year and grow at the carrier growth rate, which we believe to be in the mid single digits. I will just close by saying that the positive long-term benefits of the merger and the growth potential for us remain strong, notwithstanding the results we just went through.

The order pipeline is gaining momentum. Our external focus continues to improve and, to capitalize on this, we know and we will continue to focus on delivering the kinds of solutions and services that our customers are demanding, and, at the same time, make sure that we keep our eyes on executing our integration plans. So with that, we'll stop and open it up for questions.

Questions-and-Answers Session


(Operator Instructions) Our first question comes from the line of Kulbinder Garcha of Credit Suisse. Please go ahead.

Kulbinder Garcha - Credit Suisse

Thanks very much. Just a couple of related questions. First of all, you make this comment that you're going to be reinvesting part of your savings into continued product rationalization and investments in the business for the long term.

Could you give us a sense of just what magnitude that is? And does that also apply to the long-term €1.7 billion of savings you want to make, as in, of that €1.7 billion, how much might you actually -- how much might shareholders see benefit at the bottom line, so for this year and over the longer term?

Patricia Russo

Okay, I'll comment on this. First of all, I won't comment specifically. I think it's important to appreciate that the markets that we're in, especially some of the emerging markets, are currently very dynamic. And we see the need and the opportunity to selectively make some decisions to invest in areas that we believe the footprint is strategic and important for our long-term growth, and so that's one dynamic.

At the same time, I would add that, as we merge the companies, execute our plans, get to see better additional opportunities, we will also be constantly working to continue to improve our competitiveness and our cost profile.

So we have a lot of moving pieces here. We just thought it was appropriate to note that we remain committed to the €1.7 billion over three years, but that we would expect that, along the way, we will make some selective choices to invest where we think it makes long-term strategic value-creating benefit for the company.


Okay, thank you. The next question comes from the line of Mark Sue, RBC Capital Markets. Please go ahead.

Mark Sue - RBC Capital Markets

Thank you. I'm just trying to see to what point is the component of the book-to-bill related to pent-up demand and what does the book-to-bill foretell for the back half of the year?

Do you think it's really just timing, or do you really -- do you get the sense that there's strengthening industry trends? Thank you.

Patricia Russo

Mark, let me try to answer that this way. I think there's no question that some of our book-to-bill is reflective of the period of uncertainty that we went through as we were so internally focused on a lot of the merger planning activity and the uncertainty that that represented for not just our people, but obviously our customers. So some of what we saw is a return to more external focus, increasing certainty and, therefore, increasing sales momentum.

It's our expectation -- So I would not take what we are saying about our momentum and translate it into strengthening industry growth. We continue to believe that the carrier market is growing in the mid single digits and, really, what I see us doing is, frankly, regaining momentum.

We have a strong portfolio. We're spending more time and energy on selling. And it's my hope and expectation that that continues and we continue to build a backlog that will allow us to grow as we go forward. And so that's how I would interpret it. Do you want to add anything, Jean-Pascal?

Jean-Pascal Beaufret

No, we would probably -- This is a very, very good signal for the book-to-bill, because below that we've seen an increased momentum in the way the customers were interested by the solutions.

We jumped in December just to propose them. We will probably not continue to provide the book-to-bill quarter after quarter. This was an exceptional quarter, with resumption of the order intake and the flow of new orders.


Okay, thank you. The next question comes from the line of Tim Boddy, Goldman Sachs. Please go ahead.

Tim Boddy - Goldman Sachs

Yes, thanks very much. I just wanted to ask a little bit more about the scale of the improvement in your gross margin, which over the fourth quarter is obviously quite dramatic when you exclude the €130 million of significant items.

As we move forward, you've both talked about very strong progress on procurement, but you've also talked, of course, about reinvesting. Should we expect to see the savings benefit the gross margin more than the extent to which you reinvest? In other words, what sort of trajectory should we anticipate for gross margin moving forward?

Jean-Pascal Beaufret

First of all, we don't provide guidance for the gross margin in the current environment. I said very precisely that we went up from the December Q4, because the December Q4 has been marked by a lot of uncertainty, which we had said in the earning calls.

We were, as well, down -- net of the significant items, we were as well down from the Q1 '06 restated margins. And we see pressures in some areas and some geographies, but improvements in some of the businesses in some geographies.

So I wouldn't provide any more specific guidance than that, saying that there are businesses where the competition is quite tough, remains quite tough, especially in current circumstances, and that there are areas and businesses where we are doing well, thanks to our improved portfolio.


Thank you. The next question comes from the line of Remi Thomas of Cheuvreux. Please go ahead.

Remi Thomas - Cheuvreux

Thanks very much. Actually, two quick questions, if I may. Pat, you mentioned that pricing remained challenging. Am I right, though, in assuming that the most aggressive competitors are no longer your Nordic friends but, as witnessed in the recent SFR contract, the most aggressive guys seem to be the Chinese folks these days?

And secondly, when I calculate what you've booked in terms of orders in Q1, I come up with a number of around €5 billion. Without being too precise, can you just simply tell us if the projected gross margin on these orders that you've booked in Q1 is roughly above, at the same level, or below the 37.7% that you achieved in Q1? Thank you.

Patricia Russo

I'll take the first question and I'll punt the second question to Jean-Pascal. The aggressiveness of our competitors, based upon my own knowledge and involvement in some key deals, moves around depending on the deal.

I would not say that there has been a wholesale shift. I really do -- I have seen contracts where the most competitive bidders have changed from who you might think. And so I really do think it depends on how important is that customer and that market to any company's individual strategic plans for geographic footprint and customer and market positioning.

Jean-Pascal Beaufret

So you are right, Remi. This is absolutely right. We have had a book close to €5 billion orders, so the number is right. Now, the anticipation of gross margin cannot be deducted simply from such an order backlog.

I am referring to slide -- you to slide five, because you can deduct from this slide five, in the building business momentum, where the geographies and where the product may generate higher gross margin or lower gross margin.

And basically you have four circles, you have the names of a lot of customers, and you know them quite well, so as to anticipate what will be the margin generated by this new business.


Thank you. The next question comes from the line of Jeffrey Schlesinger of UBS. Please go ahead.

Jeffrey Schlesinger - UBS

Yes. Jean-Pascal, two questions. One is the special items you refer to with an impact to the gross margin for the investments in customers, is the bulk of that behind us now in the first quarter? Do you expect similar costs in the second and third quarters, or could you give us a sense of the magnitude?

And also on the mobile business, going back to the competitiveness issue that's been raised, some of your competitors are seeing quite extended payments and using working capital to win this business. Is that hurting you in the emerging markets, the ability to use your working capital more aggressively and winning some of these deals? Thank you.

Jean-Pascal Beaufret

About the similar level of cost, significant items which are related to portfolio rationalization, no. We don't see today, in the next one or two quarters, such similar expenses to be posted in our earnings.

We've made investments just to rationalize the portfolio and to converge our products. And some of these investments are made under the restructuring lines. Some have to be made under the operating profit line, because these are the nature of these costs.

When you do not terminate the product lines and when you improve the current product lines but to migrate them to new technology, you are forced, you are obliged to post them under an operational normal line.

On the second question, whether we see our operating working capital grow just because of the GSM business in emerging countries, I'd like to say that we've been supported massively, significantly, by all export credit agencies worldwide, globally. And this is reducing our exposure in terms of capital used for this business in a quite significant manner.

So we've never had a tremendous use of capital in those areas, because we've been able to build financial schemes, which allow that to offload it from the balance sheet.

Now, whether we have inventories or receivables or not, receivables no, because of the leads Inventories, yes. We can build inventories when we see growth. And by the way, it has been continuous over some prior quarters to see inventories building when the order book is building. This is what happened, by the way, in Q1 '07.


Thank you. The next question comes from the line of Paul Sagawa of Bernstein. Please go ahead.

Paul Sagawa - Bernstein

Yes, so, obviously a very strong order quarter. If we look back in the year ago quarter, can you give us an idea of kind of where the overall backlog might stand today versus where it might have been a year ago, since I would imagine prior to this, you may have had a handful of weaker order quarters, so just a sense of where you stand?

And as we look into the back half of 2007, on an average, how long does it take for orders to flow through the process into revenue? Obviously, these are not products that you just pull off a shelf and book as revenue right after getting an order. My belief is that that is roughly a six-month process, but, if you could give us a little bit better picture of that, it would be appreciated. Thank you.

Jean-Pascal Beaufret

Okay, Paul. About the backlog of last year, I believe that the ratio, the flows, the order intake that we faced in the Q1 '06 being lower than what it has been in Q1 '07. No doubt. Of course, we have to recognize that the level of sales have been unusually low, but the level of orders as well, as being compared to the current activity, unusually high. So this order intake and this backlog today supports our forecast and our guidance for the Q2 quarter, which we are saying is 10% sequentially.

Then, you were asking about the cycle of our order book. I would say that, for most of the business, with the exception of long-term business, cycle of order is materialized into two to three quarters. So this gives you the length of the visibility given by an order, with, once again, the exception of long-term businesses, such as some line deployments or other businesses, which have a longer term, the backlog of which is lasting and generating sales for a longer period.


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

Alexandre Peterc - Exane BNP Paribas

Yes, hi. I would like to come back to the issue of strategically investing part of your savings. I was wondering, firstly, are you are going to report the savings on a quarterly basis, as of, say, next quarter or second half, net of those strategic reinvestments that you are making, or are you going to give us gross savings?

And then, still related to the same question, I was wondering if you could give us some focus areas of R&D where that investment will be made, or if you could be more precise about, which geographies or which type of markets you intend to invest in. Thanks.

Jean-Pascal Beaufret

I take the first part of the question.

Patricia Russo


Jean-Pascal Beaufret

Reporting the savings is basically done in this very high-level summary but which gives a lot, Alexandre, if I may. You have the sequential evolutions of two types of expenses and you have the year on year evolutions of two types of expenses. We should be able to show, when the savings are popping up in those expenses, which we are showing in this table, in line with the headcount reduction.

So this is, for me, one of the best tracking tools which we can have, again, because these are published accounts, even when adjusted from the real events and the real scope or currency events. By the way, the currency has had a very, very important impact of about 5% of all costs year on year from Q1 '06 to Q1 '07, which we have, of course, updated and restated. We are giving you a cost level, which is reflecting the volumes.

Whether we should mention where the investments, strategic investments are, probably not, because this will be seen in the margins. We are doing our utmost just to give you all the exceptional or significant items in the cost of sales, in the margins. And if we add significant items in the fixed expenses, we would certainly disclose it as well.

Patricia Russo

And I'll just comment on the question about where might we make a decision to make an investment. From a geographic standpoint, I would just ask you to think about it in the following way. We walk away from business because we conclude that it is, a, not strategic, b, it's not going to provide for a lot of growth, c, it doesn't have a lot of extension into other parts of our business.

And so the flip side of that is we would make selective choices in cases where we believe that the footprint and the position with the customer will lead to considerable growth or considerable expansion into other properties that that customer may own in other countries or into other aspects of our portfolio that would allow for us to pull through products or services that would enhance that particular opportunity set. So those are the kinds of judgments that get made, week-by-week, based upon what's going on in the market.

But, again, I would punctuate selectivity and strategic, such that we believe that there is value creation potential, either because of size or expansion or pull-through opportunities.


Thank you. And the next question comes from the line of Simon Leopold of Morgan, Keegan. Please go ahead.

Simon Leopold - Morgan Keegan

Thank you very much. I was hoping we could drill down a little bit on some of the trends in the mobility business. I think your commentary emphasized some of the 2G GSM market. We've seen some North American weakness, but the outlook in North America, particularly on your CDMA customers, looks pretty strong, with sprint particularly very light in the first quarter on their spending. So if you could drill down and talk about the trends by market and technology, that might be helpful in understanding where the book of business is coming from in the remainder of the year. Thank you.

Patricia Russo

Okay, let me take a crack at this, and I have Etienne here to help me if I miss something. Let's talk about North America. I think you're right. What we said this quarter was the CDMA business, which, as you know, is the predominance of our CDMA business in North America, is steady. We continue to see investments for subscriber growth and EV-DO upgrades to support bandwidth.

In the GSM space, I think we saw some declines in GSM as a result of a low backlog in the second half of last year. We are seeing that come back in emerging markets, in China, in a number of markets, and we are seeing that reflected in our backlogs. And I think our participation there, as you know, is predominantly in the emerging markets. And we continue to see opportunity there and that's reflected in our backlog.

Wideband CDMA, for us, I think the market is growing consistent with the market rates. We are not yet seeing that, because we are clearly in a transition period of consolidating the platforms. And therefore, we are not seeing the volume at this point, because of the replacements that are going on, yet we're absorbing the costs of three companies' portfolios. And so that's a transition process. But we continue to see that the opportunity in the wideband CDMA market is growing.

WiMAX is beginning to move from trials to some commercial contracts. We've had about 40 trials underway. And by the way, this is in not just developing or emerging markets, but also in some developed markets where wireless operators are exercising the opportunity to use WiMAX as a fixed broadband alternative.

We've had about 40 trials going on in most parts of the world. We've contracted with six customers. Not all of those are announced. And so we see opportunity there, but we really see that growing and gaining as we move through 2007 and more prevalent in 2008.

I'm not sure if that's exactly what you're looking for, but that's a flyover view, if you will, of the wireless market. I would say one other thing, and Jean-Pascal touched on this. For CDMA for us, we did see some decline in Latin America and in China and, depending upon what happens in China with the 3G licenses, that could be an opportunity for us.

And, of course, in Latin America, as you know, there is some GSM replacement, if you will. It's not that the CDMA networks are being taken out. It's just that the growth is going to GSM and a couple of the operators there. So obviously we saw some decline, though not a huge part of our business.


Okay, thank you. The next question comes from the line of Phil Cusick with Bear Stearns. Please go ahead.

Phil Cusick - Bear Stearns

Hi, thanks for taking my question. I just wonder if you could help us out. One, just a follow up, how long do you think the EV-DO Rev spending will last? I've got to think that's a pretty high-margin software business.

And second of all, what's the latest on UMTS swap-outs? I know you're swapping one piece of equipment for another as you consolidate these businesses. What's the company thinking there overtime? Thank you.

Patricia Russo

You want to answer the UMTS? Okay, I'll comment on EV-DO and Etienne Fouques will comment on the -- Etienne heads the Carrier group. He'll comment on the UMTS swap-out question.

I think the EV-DO spend is really linked to the adoption and utilization of high-speed data services. And so we said, when we had a very large quarter in the third calendar quarter of '06, that was an initial major deployment and we saw that reflected in our results.

That kind of settled down and we continue to see investment in EV-DO. And we expect to continue to see deployment of that, not unlike you'd see deployment of capacity associated with subscriber growth and subscriber usage.

So, without being able to quantify specifically, I think we continue to see the opportunity for DO, depending upon how much broadband is absorbed and the capacity that is required to support that.

Etienne Fouques

Yes. To answer your question on UMTS swap, we are doing, this year, all the swap of the previous Alcatel installed base, replacing by Nortel product. This will be totally finished end of this year. For the replacement of the MNC of Cingular, it will be done on the second quarter next year.

And everything will be totally finished, replaced by compatible Nortel products, I would say, because we will not replace the base station on the Cingular side. They will be adapted to the MNC of Nortel. And everything will be finished end of next year.

It's a bit long, but we have also to extend the network. We have also to serve a new customer. And our resources are limited and we try to do everything in cooperation with the customer. And on the side of Alcatel replacement, it goes very well and we don't have any problem.

On the side of Cingular, we are just adapting the MNC of Nortel to accept the Node B of previous Lucent. So it will be done next year, as I told you.


Okay, thank you. The next question comes from the line of Jason Mauricio of Arete. Please go ahead.

Jason Mauricio - Arete Research

Yes, hi there. Pat, when you announced the fourth quarter '06 Lucent numbers, in explaining the big jump in CDMA business, you indicated that there was going to be another software release or software upgrade coming in second quarter of '07.

Could you just update us on the status of that? Is that a big component in the backlog at this point? And could there be some other software releases in the pipeline for later this year?

Patricia Russo

I'm sorry, I don't recall talking about a release of EV-DO Rev. A in Q2, so we'll have to get back to you on that. I mean, we've got EV-DO Rev. A and then, of course, there's planned Rev. B and Rev. C. No I am right? Yes. But I don't specifically recall noting a particular release that was coming out in Q2.

I'm sorry, we'll have to get back to you specifically on that. I'll have Pascal follow up.

Jason Mauricio - Arete Research

Okay, and maybe if I can get another quick question in. You're talking about some product transition issues in the fourth quarter and first quarter on the wireline side, notably in optics. You're also indicating that there's been some delays in consolidation by your customers in purchasing decisions.

As we look to your guidance for the full year, what has to change, from the customer side or from an Alcatel-Lucent side, in order to realize a re-ramp or an acceleration of wireline growth this year?

Patricia Russo

Let me try to answer that this way. We experienced a combination, particularly in North America, which we talked about in fourth quarter, of the impact of a consolidating customer base that was pretty significant and the still uncertainty about the portfolio coming together in the wireline side and obviously the uncertainty amongst our people.

And the cumulative affect of that, as you all saw, in Q4, was pretty significant. So what is happening? The consolidating effect of the customers is mitigating with time, as you would expect it would, once operations come together, responsibilities and roles are clear, plans get refined, and engagements continue. And I would tell you we are actively engaged in a fair amount of opportunities that we think will affect our second half in North America.

The portfolio is clear now and has, in fact, been communicated. And we can see, underlying the wireline numbers, that the optical business is growing greater than the 1% you saw in the overall wireline business. So our optical and our IP business are growing, obviously, in excess of the 1% growth you saw.

And the access business, largely contributed to a tough compare in North America for Q1 of '06 versus Q1 of '07, the access business is down. So my own view is that I think the factors are in place for us to continue to grow the optical business as we go through the year and, in particular, obviously seeing some of that in the second half in North America.


Okay, thank you. The next question comes from the line of Gareth Jenkins of Deutsche Bank. Please go ahead.

Gareth Jenkins - Deutsche Bank

Yes, hi. Thanks very much. Two very quick ones, if I could. One is on the phasing of synergies through this year. I think you mentioned that, obviously, you took the heads out of the end of the quarter. I just wondered whether you could quantify how the synergies phase through this year to that €600 million.

And then secondly, just on the costs related to some of these large managed services contracts, I just wondered whether there is any employee protection schemes in there, what the cost of the additional 750 employees coming in is. Thank you.

Jean-Pascal Beaufret

Gareth, could you ask me again? The first question, the first part of your question, is related to the base of the synergies throughout the year?

Gareth Jenkins - Deutsche Bank

That's right, yes.

Jean-Pascal Beaufret

The phasing?

Patricia Russo

No, he's talking about the 1,900 people. I think it was related to –

Gareth Jenkins - Deutsche Bank

Just related to the €600 million and how that phases through the course of this year. You said that you took the heads out at the end of the quarter, so I am just trying to understand how the phasing of the €600 million occurs through the rest of the year.

Jean-Pascal Beaufret

Yes. I start answering this first question. We always have said that those synergies will take a full pace and rhythm at the end of the, in second part of the year, and we are saying it again. And it will go up quarter after quarter throughout 2007.

This is by nature, because, if you look at the main areas where we are making synergies, first of all, part of the synergies are headcount-related and therefore, in some geographies, are related to the pace of execution of the restructuring plan, which we know in Europe will take place mostly in the second half of the year. This is point one.

For realistic synergies, this has to do with the contracts, which is current contracts which are outstanding, which you cannot bridge in a jiffy like that. This comes quarter-after-quarter. And what is coming earlier than anything else is clearly what we are seeing today, starting in synergies in procurement, provided the contract with suppliers could be changed.

And the second thing is that contracts with suppliers or contractors in IS/IT could significantly start in the first half of the year. But we are confirming that most of the synergies will take place in Q3 and Q4. About the number of the costs of the managed contract services, we are regarding those managed contracts or outsourcing contracts as something special, because these is very important contract for us.

This is an area of strategic investment for Alcatel-Lucent. We are gaining ground. We are seeing our market share growing in this area. But those contracts are basically related to in-sourcing teams, people, contracts, contractors, just to serve better, on a geographical basis, those networks and those customers, which we want to partner with.

Specially, those contracts have low margin initially and could, of course, improve their profitability with time and especially with all the relations which are developed with the customers.


Okay, thank you. And the final question comes from the line of Frank Maccary of IXIS. Please go ahead.

Frank Maccary - IXIS

Thank you. Could you comment a little bit on the U.S. situation in broadband access? How do you see Q2 in comparison of Q1, for instance? And when, more precisely, on GPON, do you expect GPON business to be more significant in the second half of the year? And just one clarification about the capital gains. How do you see the cash tax regarding these capital gains?

Jean-Pascal Beaufret

Maybe I start the third part of your question, Frank, because the net capital gains, since we've booked it at €677 million is net of tax. So we have had a slight, let's say a small, percentage of taxes in some geographies where we have sold these businesses. But the gross capital gains are higher by about €70 million of just in taxes. What we are booking here is net of tax plus tax capital gains of €677 million. About access, we are going..

Patricia Russo

You want to comment on access?

Jean-Pascal Beaufret


Patricia Russo

The second part of your question, which is about GPON and do we expect to see the impact of that more in the second half of the year, the answer is yes.

With respect to broadband access, the Q1 '06 results were very strong in North America for the former Alcatel business. And that was a result of purchases that were being made by the large customers there. Obviously, that is down this year. We continue to see broadband access being invested in, with a shift more to IP, the IP DSLAMs. But the real phenomena, as I understand it, between last year and this year, is just a very strong quarter in Q1 of '06.

We believe, by the way, given what's going on with our customers there and who the big customers and spenders are, we are very well-positioned with respect to the investments that are being made in the next generation access networks.

Pascal Bantegnie

Okay, thank you. This concludes our call and the Investor Relations team remains at your disposal for any follow up questions. Thank you.


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