Pat Russo - CEO
Jean-Pascal Beaufret - CFO
Tim Boddy - Goldman Sachs
Tim Long - Banc of America
Stuart Jeffrey - Lehman Brothers
Alexandre Peterc - Exane BNP Paribas
Andrew Griffin - Merrill Lynch
Phil Cusick - Bear Stearns
Kulbinder Garcha - Credit Suisse
Simon Leopold - Morgan Keegan
Remi Thomas - Cheuvreux
Paul Sagawa - Bernstein
Francois Duhen - CM-CIC Securities
Ken Muth - Robert Baird
Nikos Theodosopoulos - UBS
Alcatel-Lucent (ALU) Q3 2007 Earnings Call October 31, 2007 8:30 AM ET
Hello to everybody. And welcome to our Third Quarter 2007 Earnings Call. With me today on the call are Pat Russo, Alcatel-Lucent--CEO; Jean-Pascal Beaufret - CFO, and other members of the management team. Pat and Jean-Pascal will provide an overview of our third quarter results and discuss the market and company outlook. Later in the call, we will conduct a question-and-answer session. Please restrict yourself to one question and no follow-up questions, please.
If anybody has not seen a copy of our earnings; please refer to our website at www.alcatellucent.com. Before we start, 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’d like to turn the floor over to Pat.
Thank you, Scott. Hello everyone. Thanks for joining us. As you know, earlier today, we announced our audited results for the third quarter of 2007. Our results this quarter were essentially in line with the update we provided on September 13th in a few areas a bit better. However, they are still not at the level that we are satisfied with and I will be talking with you about our going forward plan after we go through the results.
Jean-Pascal will now review those quarterly results in more detail and then, as I said, I will get into some detail with respect to the three-part action plan that we are putting in place to improve the profitability and the top line of the company. Jean-Pascal?
Thank you, Pat. I am on chart 5. Good afternoon and good morning everyone. As usual, I will present our earnings on an adjusted basis net of what you know as main purchase price accounting entries for which we are giving details in the appendices.
When looking at this result this quarter and comparing with them, we saw last year’s pro-forma adjusted September results; we also need to bear in mind that there is a significant translation impact from [overhead] changes. We were 127 as average in Q3 ‘06 to 137 average rate in Q3 ‘07 and this, as you know, impacts our top line and our costs and expenses line.
Inline with the update that we provided on September 13th, revenue for the current third quarter were 4.350 billion. They were up sequentially 2.3% at constant rate, which is 0.6% on an actual rate basis, and showed a negative 7.8% growth year-over-year.
Our gross profit of 1.486 billion, or 34.2% of sales, represented margin increase compared to the 33.4% margin last year, the Q2, the June quarter of 0.8 percentage points. But that sequential margin increase goes up to 1.3 points if we were to normalize the 34 million or 0.5 points, which was a positive significant item, in fact reported in the June quarter.
You remember this was a favorable litigation settlement. So, this is sequentially encasing our adjusted gross margin of 1 points to 3 points should be primarily attributed to lower fixed durations and installation cost, lower reserves, which are more than offsetting a negative mix impact and the price erosions, which we are experiencing in those quarters.
We believe this represents a positive trend going forward on Q2 to Q3 and so, we may still see quarterly fluctuation due to geographical and product mix. This is a positive trend June to September. The company’s adjusted operating income for the quarter was 70 million or 99 million improvement sequentially resulting from both the gross margin increase that we just discussed, and the success of the ongoing streamlining efforts in our cost structures.
I would like to note as well that the operating income as progressively improved throughout the year from Q1 to Q3, and I remind you that it was €244 million negative in Q1, and €19 million negative in Q2, and it goes to a €70 million positive in Q3, which bodes well for the recovery of our results of financials during the year. It’s turning now into positive territory and is due basically to cost margin consolidation and cost reduction efforts.
On chart number 6, we are showing here the adjusted operating expenses evolution and I believe that we can say that in the September quarter, we have made big progresses in reducing our OpEx base sequentially, our reported operating expenses reduced by EUR 50 million.
Remember that in terms of scope, we look at operating expenses on a comparable basis, which is actually the only way to properly analyze the year-over-year evolution and which means that we are taking into consideration the change of scope with significant acquisitions such as the Nortel Wireless portfolio at the end of 2006.
However, the impact of R&D capitalization, or some one off mentioned last year, and we are taking account of the Euro - US dollar exchange rate valuation, which are positive from the cost. As a reminder, 137 in Q3 ‘07 compares with 127 in Q3 ‘06 and 135 in Q2 ‘07
So, what does it lead us to? We observe that Q3 comparable operating expenses, the September ‘07 comparable expenses declined 5.6%, as you can see on the bottom part of the chart, or 87 million relative to the same period last year, and also declined sequentially by 3.4% or 47 million versus June quarter.
Over the last three quarters, since the end of 2006, our comparable operating expenses have steadily decreased. To date, the cumulative savings, which we have recorded at this level, is on a comparable basis approximately 160 million. As we said earlier in the year, OpEx reductions are positively accelerating and they are becoming more visible in the second half of the year.
In R&D, for example, the year-on-year comparable OpEx reduction was 8.3% in the September quarter compared to 3.8% reduction in Q2 ‘07, and 0.6% reduction in Q1 ‘07 versus the same period of ‘06. In sales and marketing, general and administrative expenses year-on-year reductions were 3.2% compared to 2.3% reduction in Q2 versus the same period of last year. So, we are confirming that there is an acceleration, which makes our operating savings more visible in the second half of the year.
The remaining item in our scorecard is concerned, of course, with the operating headcount. In the third quarter, we recorded a reduction of about 1000 positions in our net operating heads, which makes the net reduction since January 1st at 3,700, which the net of 5,000 execution of our savings and 1,300 heads due to the in-sourcing movements that we have recorded in the 2007 year.
Now, let me provide some comment on our operating segment, which is on chart number 7. The Carrier Segment, overall -- the revenues for the quarter -- were 3,142 million, which is 12% decline year-on-year, but a 2% increase sequentially those are of course at constant exchange rate.
Adjusted operating profit for the Carrier Segment was 22 million, 0.7 operating margin. The investments, of which we have spoken about in both geographic end-markets and technology particularly in wireless and convergence, over the past quarters, clearly still impact this business segment as the execution of our new complex take a few quarter.
Going into detail of each business group performance, this is good performance. We can state today that Wireline Business Group had a EUR 1,520 million 8% increase versus a year ago quarter, 2% increased sequentially. Optical networking demonstrated very strong double-digit growth year-on-year, with growth both in terrestrial and a robust double-digit growth in submarine.
Broadband access in terms of volumes registered 8 million DSL lines delivered in the quarter, which is plus 20% year-on-year. IP DSLAM platforms two-third of the over whole line shipments in the quarter.
And IP data showed another very dynamic quarter with strong revenue growth year-over-year, with continued double-digit growth in IP more than offsetting the decline of the market in [MS1] portfolios.
Wireless Business Group had revenues in the September quarter of 1.276 billion, 20% decline compared to year ago quarter, that a 4% increase sequentially. The year-over-year revenue decline is largely due to comparison, which was exceptional with the strong CDMA revenues in North America that we booked in the year ago September quarter, when we booked deployment of Rely 27, EV-DO Rev. A following the commercial availability of the related softwares in September ‘06.
But if you see in CDMA decline year-over-year, significant decline we see sequentially CDMA revenues grow slightly CDMA gains outside North America and primarily in India more than offset the declines that we see in North America.
WCDMA revenue increased over the year ago September quarter and GSM declined from the year ago quarter, but continue to gain traction with a second consecutive double-digit sequential increase and this is not [represents] to the renewed product offering, which is as you know, we call Twin TRX and ATCA based BSC. Because we believe that the mobile Operators migrate to all-IP architectures or migrating today into all-IP architectures.
We will show now new numerous WiMax commercial contracts in Q3 such Pakistan Mobilink, such as VSE Net in Germany, such as Far EasTone in Taiwan, such as Russia’s Synterra. And if it not reflected in the sales of the quarter it bodes well for the growth we are expecting in this very, very interesting period.
Convergence Business Group revenues were EUR 346, 39% decline year-on-year, 3% decline sequentially.
I will turn now to the Enterprise Segment, which with revenue of 380 million grew 8% year-over-year and 2% sequentially. This is taking place across all part of the enterprise business with a very, very significant performance in Asia-Pac. Adjusted operating income was 29 million, with a 7.5% operating margin; this is the continued improvement in profitability quarter after quarter and an increase in profit in the enterprise segment from the year ago quarter.
Finally Services Business Segments went well in the September quarter, revenue were 777, which is an increase of 3% year-over-year, 4% sequentially. Adjusted operating income was 40 million, with a 5.2% operating margin. This segment also improved their profitability for the September quarter, plus there is a 3.9% operating margin they had in Q2 and negative in Q1 ‘07.
So, here we have several movements which are implemented. First of all, network operation is growing very sharp. Network Integration Services is we are continuing to focus on growth areas such as IP transformation, application integrations are doing as well, and we have seen multi-vendor maintenance as well.
We are worried about restructuring cost. The cost of goods provides, as you know, an idea of speed at which we’re executing our integration plan. So, we have booked 307 million restructuring cost, practically all our in many (inaudible). This is representing 803 million year-to-date, which is about 50% for initial three year targets, cash restructuring costs target. And the vast majority of these provisions were covering separation cost in our restructuring plan in developed primarily in Europe.
You may recall that we signed an agreement with the French Unions on September 13th, and in Germany we are continuing to execute the voluntary program. We have seen over the September quarter real acceleration in the number of departures in high growth countries. We have at the end of the quarter 903 million reserves, as we have provided for 903 million, and we have utilized during the quarter 128 million. Out of this 300; we have spent 310 since January 1st ‘07.
As we are doing usually, I would like to give you some example of the implementation of our plans. The major thing, I would like to point out is at the Business Group Level, we are streamlining our business operations better today. You know that we have built a Carrier Business Segment, which is being simplified under Michel Rahier’s lead today by eliminating the intermediate business co-player, which we have called Wireline, Wireless and Convergence and we are reducing from 11 to 7 the number of business divisions.
The seven fully empowered profit centers operating business divisions, worldwide P&L accountability, [know-how] applications, CDMA networks, fixed access, IP networks, mobile access, multicore and optics. Its basically want -- about technology segment.
In Procurement, we will exceed our annual savings objective. So, we have implemented for example generalization of E-auction. So, we are comfortable that we can exceed our savings in procurement this year.
We are doing significant progress in the optimization of R&D expenses especially derived from the product rationalization. We are taking some additional actions to size the R&D investments with the new market dynamics we do see.
On short-term, I would like to just to mention that we are at comfort level announced the closure of two additional facilities in North America for manufacturing. We are well advanced in IS/IT we believe that we will achieve more than the initial savings that we intended to execute this year.
In finance we have consolidated one shared service center into Europe by taking out shared service center in Dublin and growing one shared service center in Romania. And in real estate, the quarter has been the occasion to significant in the execution on our plan. We have taken out and we discontinued 350,000 square meters, which is year-to-date from January 1st, which is about 8% of the total square meters of the company.
Now coming to cash and working capital and balance sheet, I’d say that the main event in the quarter, and I will briefly comment on that is, we have working capital, which is representing 10% of our trailing 12 months revenues. This is standing in the 8% to 12% range that we have been indicating for 2007, with possible fluctuation from quarter-to-quarter. The increase in the operating capital ratio is mainly due primarily due to an increase in inventories and is reflecting strongly seasonality expected in the Q4.
We have to mention as well that we have reduced the amount of receivables that we had factored by about 175 million sequentially, which explains part of the increase in the operating working capital.
In terms of cash flow Alcatel-Lucent in the September quarter generated cash flow from operation of 206 million before restructuring working cap, interests and taxes and CapEx. We have experience a sudden -- we had experienced in the Q2 ‘07 a significant amount of reserves in the provisions part of it being upfront.
So, we don’t find them again in terms of cash and we have seen, on the other hand, a utilization of this reserves in Q3 ‘07, which explains the decrease from 280 to 206. Restructuring cash outlays, as I said, increased to EUR 128 million from the EUR 99 million in the June quarter, intangible CapEx and R&D capitalization were EUR 190. Overall resulting in a negative free cash flow of more than EUR 9 million.
The last word and the last message related to the funded status of OPEB pension and now that the postretirement benefits. Some of you may have been be concerned about possible implication of the recent sub-prime casing. So, I’m not giving you here the share value of the assets that we have recorded from June 30th to September 30th, and given the important devaluation expense but the [occurrence] by the dollar against the euro this is also given in dollars.
So, we see that the total assets have increased from $39.7 billion on June 30 to $40.3 billion at September so this which is a growth of 1.4%. While the benefit obligation remains fairly stable in US dollar at $37.7 billion, no material change in discounting interest rate was reported over the quarter.
So, the funding status of OPEB pension and OPEB obligations continued to improve quarter-after-quarter standing at the end of September at $3,453 million. So, one last thing, if I may, is that we are providing in appendix to this debt, to this earning course. The 2006 adjusted pro forma income statement, which is restated for some minor reclassification issues. But it would be the last time that we redo 2006 pro-forma account.
With that I believe that I should turn it back to Pat.
Okay. Thank you, Jean-Pascal. And that concludes our review of the results today. I would like to turn our attention to our plans going forward. And I will address the issues that I know are foremost in a number of your minds that is with respect to our portfolio, whatever we doing profitably grow and address the financials under performance in some areas of our business.
And whatever we doing with respect to the cost structure and driving to fit that competitive financial profile. So and then I will also spend sometime talking about the management structure we are putting in place to create a more efficient and focused operating model.
So I will spend the rest of this call talking about our plan of action, which was fully supported by our Board of Directors yesterday. Just a couple of contextual comments. The work for this plan began back in the July timeframe. It reflects a lot of thoughtful work by the management team. It is not a plan that is solely focused on costs, but also focused on selective profitable growth opportunities that we are pursuing. And it’s a plan where the ownership for execution is clear.
Three parts, that I would to talk about first. We are streamlining our core carrier business in a number of ways, as there are a number of efforts that Michel is leading, including aggressive product cost reductions and improvements and greater focus in R&D priorities that supports the IP transformation that is not only going on in wireline, but now we see beginning in the wireless networks.
Second part of this plan is about enhancing our growth by developing an offensive strategy to address the sectors of the market that we see that offer strong potential and that align well with our assets and our capabilities. And the third aspect of this plan is the streamlined organization into a more simplified model with a focused management committee that has clear accountabilities and ownership for execution of the plan.
Next chart really just speaks to and I won’t go through all of these, these are really the macro trends that we see that affect both our Carrier and our Enterprise business and that really inform our strategy and our investment. And so, without going through all of these, I think it’s important only because it’s our view that these are the trends in the market that really underpin our convictions about what is going to take to really compete over the long-term, as a Tier 1 player in this space.
The next chart is merely just provides a size of the opportunities. And I think, the good news is that the Carrier Segment is large and while in the aggregate it is a slower growing segment, there are a number of faster growing opportunities such as optical and data, and Jean-Pascal shared with you the kind of results we are seeing there, and we intend to continue to invest in that area that offset somewhat the decline in the legacy infrastructure spending.
Services, is the large segment. It’s an area that we are strategically committed to and we have been making progress there with more to do. Applications, while a smaller market has very good opportunity for growth and I will say more about that and obviously the enterprise market is one that is also a large market. We have a good business. It’s been growing nicely, performing well and we believe we have opportunities there.
On the one hand, it’s always good to look at the opportunities in the macro trends and the opportunities in our market are encouraging, at the same time I think you all know that the market is quite challenging and changing. And so these are the market disruptors if you will that we operate within.
The only point I would make here, is that it’s very clear, that the work we do, the plans we have and the plans we will execute had got to provide improvements on all of our line items in a way that offsets the impact of some of these market dynamics. And the only other point I would make is that, while driving cost structure improvements, is the clear priority for us and our plan clearly contemplates that. At the same time, we have recognized, we need to drive profitable top line growth at the same time.
Next chart is a, really a simple pictorial of our strategy. What it basically says, is that we believe we have great value in the carrier business. Clearly, we need to fix the underperforming aspects of it. But there is no doubt in our mind, that the assets that we have, the technology leadership that we have, in areas like IP and broadband access and optics and this IP transformation. We are able to leverage across fixed and mobile networks.
At the same time, we are looking to branch out and do more in the area of services and applications, and as well in the area of enterprise and what we are calling the industry and public sector markets which are industry segments that are unique in that base they need complex mission critical communication systems that really span our Carrier and our Enterprise portfolio. So, let me move on now and just speak a little bit more specifically about each element of the plan.
The first element of the plan is the streamlining of our core carrier business, as I said with an increased portfolio focus on IP transformation. We extensively reviewed our portfolio and we do believe looking back to the macro trends we talked about to what we see our customer needs to be, but it aligns with where the market is going and enables us to really deliver an end-to-end set of capabilities.
Our IP expertise, which has been developed in our wireline business, has board application across our wireless business and so not withstanding some underperformance in some areas, the breadth of our portfolio is an asset. So, we have made the decision not to exit any major areas of the portfolio. So, if that’s the case what are we doing in order to drive improvement? Michel has a very aggressive and accelerated effort underway to improve product costs.
He has an intense focus on R&D and the opportunity to be more aggressive around the use of common platforms across the portfolio and also focusing R&D in a way that differentiates parts of our portfolio, such as Wideband CDMA with the newer technologies, where we have leadership positions, such as the Femto and the BSR.
At the same time, we are streamlining the carrier organization as Jean-Pascal described. Michel is also streamlining the operation such as in the supply chain and the collapse of 11 business divisions into 7. The efficiencies we gained from these actions and others will allow us to improve gross margins in a measured way in our Carrier Group.
Let me move to the next chart that focuses on wireless. There is obviously been a lot of discussion in speculation and commentary regarding our wireless business. Let me be clear about our convictions and about the facts. In terms of convictions, here is what we see. If you look at the big picture, what’s it take is the evolution to 4G and what that evolution will look like.
We think that the rules of the game are changing. As IP transformation is just beginning with mobile networks. For example, fixed technology such as IP and Optics products are already being used in mobile networks for IP based aggregation and backlog. And that’s why we believe we can leverage our extensive IP capabilities and proven leadership in these key technology areas for the IP transformation that is yet to come and will take place in wireless.
So, to be a leader in the world of 4G and to be preparing to be a leader in the world of 4G, we are service providers and more and more combining of fixed and mobile assets. It’s essential for us to be a participant and a leading participant in both Wireline and Wireless.
Now, let me share just a few facts about our Wireless portfolio. For GSM, we have a refreshed portfolio. It is gaining solid traction. We see that in the results this quarter and the order backlog. This is a profitable business and we will continue to pursue new opportunities here. By the end of 2007, we expected more than that the majority of the GSM products, we ship will be based on the new portfolio, which began shipping in the second quarter and we expect to further gain share in 2008.
In CDMA, as you know, this is a profitable business and a mature market that is starting to decline. And as with any product that reaches a mature point in its lifecycle, we will moderate our R&D investments in the current generation of CDMA to reflect the declines that will naturally take place. Let me assent to add that where there are new opportunities such as in voice-over-IP and the next revisions of CDMA, we will continue to investment to support our customers’ migrations plan and take advantage of the opportunity in the marketplace.
The IP capabilities of EV-DO are key and provide another example of the IP transformation that’s happening in mobile networks. For CDMA to the area that has come under a lot of scrutiny. There is no question that 2007 has been a year of investments. As we have taken three portfolios and began the work in January to converge them down to one.
By now, we have completed the convergence from three platforms to two, and we will have a single and highly competitive converged platform by the third quarter of 2008. What kind of progress are we making commercially? Since the merger we continued to make progress, we have signed a significant part of the Wideband CDMA contracts that have been awarded since the beginning of 2007, including SFR, ANCEL, Globalcom, Telecom New Zealand
We were one of the first worldwide to demonstrate and introduce HSUPA commercially, and recently HSUPA introductions were made with us by two of our customers: SFR and Orange. Going forward, we will continue to rationalize the R&D investment. We will boost our investments to leverage the growth opportunity we have in the instance in the area of Femto Cells. For example, Softbank recently selected our Wideband CDMA Base Station Router Femto for trial of high-speed mobile in-building solutions.
And based on our flat IP architecture, this Femto flattens the mobile network by integrating and collapsing the radio access network elements, including the base station and radio network controller into a single small unit about the size of a TV. So to sum it up, we have a number of things underway to improve our performance here in terms of R&D efficiency, simplicity of the moving toward a converged platform. We know this scale matters in this business and we will selectively pursue additional Wideband CDMA opportunities balancing our intent to grow share with the focus on profitable growth.
4G and LTE, were really in the investment phase one comment on WiMax, we are market leader there with more than 15 commercial contracts and the underlying technologies of WiMax, which is OFDM for example play a key role in the evolution of 4G. Quickly the wireless roadmap chart really just hands to point out that the next generation of wireless technology is based on some fundamental evolutions of things like OSDM, MIMO and IP all of which are already available in WiMax.
And we believe that this will give us a competitive advantage, as we leverage our R&D efforts across the multiple technologies we are participating in. And our common platform approach will allow us to help customers migrate from any wireless technology to any wireless technology.
Now, wireline portfolio, I really won’t say much here rather than we are performing well. And we intend to continue to improve the performance in this business. Our integration has proceeded quite well. Our strategy is simple. We have well recognized market leadership with considerable strengths and capabilities in access, IP and optics.
And we are going to continue to leverage those, as we pursue the end-to-end place, while, we are well positioned in this space. We have an accelerated product cost improvement plan to generate savings that should lead to gross margin performance enhancements. In our core NGN business, which has underperformed this year, we are making refinements to narrow the portfolio and allow us to leverage a common SIP and IP based infrastructure for both fixed and mobile networks. This is a revision beyond our original plans.
So, let me move on now to the data about the portfolio. I would like to talk briefly about some of the areas on which we are focused for growth. I said we were developing an offensive strategy to address some sectors that offer good potential for us. The first is those, that I would talk about is a services, there is really two points. If you look at the growth of our services business and the growth of our product business, you can see increasingly some growing disconnection that means, we are winning business that is not necessarily product attached or attached to our product business that consistent with what we been trying to do.
We continue to see terrific opportunities and what we call high value services, integration services and professional services. And we will continue to increase our resources to grow there. At the same time managed services is a different picture. There is no doubt, that the trend in the market is to move to more -- Operators are moving more and more to outsourcing some of their operations.
Our game plan here is to take a disciplined and selective approach, when pursuing these new managed service opportunities. The interesting thing here is, there is a significant amount of growth opportunity, but we’ve got to be balanced in our appetite for participating in these, given the impact in year-over-year that they have on margins. So we will be selective. We will be strategic as we assess this.
In the applications area, this is an area that has not got enough attention from us this year in terms of our go-to market. We will be doubling the resources that we dedicate to this area. We have a good portfolio. We are streamlining the portfolio, which means we are really only got a focus on the areas that offer the greatest market potential. So, streamlining the portfolio, which means we will be reducing it somewhat and dedicated doubling of the resources to go after this.
The margins in this space are generally higher than the average of the company. In the Enterprise space, two things really to talk about. Our Enterprise business has been performing well. We see opportunities to enhance our growth here. There are some organizational changes we are making inside the enterprise business to dedicate more selling resources. We believe this will help with our top-line growth, as we go into 2008.
And I want to be clear again because there is lots of speculation. We have no intention to sell or exit this business. In fact we are looking at what opportunities, we have to expand this business and believe we can play more broadly. We need to do that in a smart and creative way. But this is an area of strategic importance for us.
Another segment that we have pursued and this is another area, where we will be significantly increasing our resources, as we shift them from lower growth opportunities is in what we call the industry and public sector markets. We have five industry segments that we are pursuing. These are generally 10 point higher margin opportunities for us because they integrate Enterprise, Carrier and Professional services.
They are usually large complex deals with long sale cycles. We have been investing in this through ‘07. We see good traction, and we see the opportunity with even more resource to accelerate our growth here. So, that encapsulates the areas that we are strategically attacking from a growth standpoint.
Let me now speak to the third aspect of the plan, which is the streamlining of our organization, the simplification and the establishment of a focused management committee. We already took the action around the Carrier Group, which we have described -- I will belabor that, but that’s a major set of changes for us. At the same time, today we announced a simplification of our regional structure from 4 to 2.
We will have the Americas, and then the second is Europe, Middle East, Africa and Asia. And this two we will put into effect as we go into 2008, but it should allow us to continue to simply and streamline our organization. Another action that we are taking is we are combining the all of the innovation and research capabilities that we have. The two organizations Bell Labs and the Alcatel Research and Innovation. This does not mean a shift to where people are, but it does will enable us to drive more synergies.
And lastly, we are modifying our go-to market strategy in certain countries, where our margins are poor. Today we operate in about 130 countries. We done an analysis and there are somewhere around 15 to 20, where it is clear that the revenues are small and we are not profitable, given the level of business that we have there. And so, we are adopting for each one of those an alternative go-to market strategy that allows us to continue to support customers but do it through a different means.
The last point I would make is the establishment of management committee, where if you think about the plan I’ve just taken you through, this is where the clear accountability and ownership for the execution of these plans resides. This is a team that will oversee the company strategy, direction, organization all of the things that you would expect.
These are folks that I have selected, who will make sure, who own the plan and they will make sure that the plan gets executed. Everyone is the members of this team is here not only because of his or her responsibility, but because they bring a good deal of expertise. So, with that I will just close by commenting on the fact that we have been asked a number of times for what are some longer-term targets that we should think about for the company.
As we did the work on this plan and moved it forward if you will, we are targeting, as we come out of the integration period. Gross margins in the high 30s and operating expense to revenues in the high 20s such that we are able to deliver an operating profit in the 10% plus range, as we finalize the integration of the companies.
So, I have shared with you kind of a three part plan that I think puts this company on a path to continued improving profitability as well as growth for the future. We are committed to and confident about our ability to execute this and the potential that it creates for us.
So, with that, I will stop and we can open it up for questions.
Thank you. (Operator Instructions) And we’ll take our first question from the line of Tim Boddy from Goldman Sachs. Please go ahead.
Tim Boddy - Goldman Sachs
Yes. Thanks for taking the question. I first want you to ask about the commitment to the Wireless business, and we just understand much of the dynamics there. It was a very pleasant surprise to learn that GSM is actually profitable. But that of course means that obviously imagine CMDA continues to be profitable. That means that the losses in WCDMA must be almost as biggest sales line.
It will be very helpful to understand, how you see the profitability of the WCDMA business unfolding and what portion of those losses being currently represents or if you like one-time related to the platform transformation or migrations, where you are sorting out customers other similar activities. So you mentioned mid '08 this is turning point, but finally one portfolio. If I get understand those dynamics best that will be helpful.
Okay. I mention and I would Michel comment here in terms of more specific. I mentioned mid '08 third quarter ’08 is when we expect to have completed the work to converge down to one converged platform right. And so we clearly would expect that the R&D investments that will change pretty significantly as we’ve now going from 3 to 2 and then down to 2 to 1.
Our expectation is that the combination of aggressive product cost reduction work, R&D, improved R&D as a percent of revenue give the expectations we have to able to grow after this initial year of transition as well as the selectivity we expect to reply to going forward business, we will make improvement year-over-year in the financial performance of this part of the business. Michel anything you want to add?
Tim Boddy - Goldman Sachs
Just to clarify, do you think the business will actually be profitable in ‘08 or ’09 that we’re looking at for the WCDMA business?
Yeah. I won’t give you specifics around profitability of the business. I will say though that in 2007, there is some onetime impact on the current profitability of that business given what we’ve described earlier in the year around some of the swap work that we are doing and the fact that it is not captured under restructuring, but rather falls into expense. But what you should expect is improvement clear improvement, as a result of the consolidation of the platform and all the other work that we are doing. But this is not going to be a one year plan.
Tim Boddy - Goldman Sachs
Okay. Thanks very much.
Our next question is from the line of Tim Long from Banc of America. Please go ahead.
Tim Long - Banc of America
Thank you. Just a question, as it relates to the new restructurings, as well. You did mention in the release and on the call here that not all of the gross margin savings in '07 are not being retained but the OpEx are. What complexity do you have that as we go into '08 and '09 something will change either in the industry in your product portfolio that will allow those gross margin savings that you’re expecting to flow through to the bottom-line? So, what do we need to see change from an industry or company perspective to feel better about the flow through of those costs? Thank you.
I think the difficulty of course this year it's hard to see savings on a gross margin line. Obviously, when your gross margins are down year-to-year, even if you are actually achieving the savings. The combination of factors that have to occur is actually improvement in gross margin from where we are and we demonstrated some improvement this quarter over last quarter.
We are working hard to work at very aggressive product cost reductions. So that will be an excess of what we think is needed, given the price erosion in the industry. We continue to expect to get additional procurement savings carry through as we go into 2008 and 2009. And we expect that the fixed cost is that, affect the gross margin line. Obviously, we are working to improve.
So, we have lots of efforts to improve the cost structure of all of the things that affect the gross margin line. And all else being equal, you’d like to see some measured improvement. What is unknown as this always the case in gross margin is what’s happening in terms of price intensity in the industry and obviously with mix?
So, if you think about what I said, we are focused on growing in the areas where we have more opportunity for profitable growth. We think that will help somewhat again. These are not short-term plans. They are short-medium and longer-term plans. But, I would hope that with some gross margin progress, we would start to be able to see the impacts of our synergies that affect gross margin.
Tim Long - Banc of America
Just a follow up is there a risk that pricing needs to be more firm for Alcatel and therefore, there would be a further top line impact or is your expectation that all of it, what will come on the cost savings side?
I am sorry. Tim, I didn’t understand that.
Tim Long - Banc of America
Is there a risk that to get to the better gross margin, you going to be need to be more firm on pricing and therefore risk losing business and have a top line impact?
Yeah, just to be clear. We have no doubt; we came into 2007 in the very early stages of the merger. We were very clear about what we saw in terms of exacerbated competitive pricing activity that clearly affected us and that we responded to. And you all know, we are not the only one that was affected by that pricing behavior because there is really no free launch, so to speak, when you get into these kinds of things in the market.
We continue to anticipate that there will be price erosion that has been the case in our industry steadily year-over-year. We intend to be better balanced than we had to be in the early stages of this year. We intend to be better balanced around profit and growth. And you always run the risk that you have some slight impact on the top-line because it’s hard not to have that to be the case, a perfect example is managed services. We could get a lot more growth. But obviously, we would have a pretty significant impact on the gross margin line and that’s why I’ve said it’s always a matter of judgment and a matter of balance.
Thanks. Your next question is from Stuart Jeffrey from Lehman Brothers. Please go ahead.
Stuart Jeffrey - Lehman Brothers
Hi, thank you very much. I got a question also on the margin structure, maybe kind enough to give your gross margin OpEx revenue and margin targets. And I guess, the concern externally is the gross margin target given that everybody else in the industry struggling to do the high 30s.
So, I’m assuming the one thing you can’t control is the OpEx revenue numbers. And so, if the market continues to be very challenging and gross margins continue to be a problem. I was just trying to get a feel for how much scope, you still feel there is for you to be able to reduce OpEx further without needing to start pruning away some of your business activities?
Yeah, of course it's right to see that in an industry where the situation in pricing and confidence are high, you also rely on the virtue of the company in terms of season marketing courses and you rely on the support functions. But we are seeing is given the current level of activities we have probably not envision so far in the merging plan as many as reduction of cost and as we would have done.
Look at our earnings for the three first quarters we have rate of OpEx, we have to say which are above 50% and it subsequently that in the industry, which is quite competitive this rate of OpEx to sales should get reduced by much lower than 30%. So, this is what we are seeing is the plan with the significant numbers of both of sales reductions from to some 6 to some 7 to some 9. We believe that it will not hit our business. It will not harm our competitiveness. It will not prevent us from very being successful in all our market.
Our next question is from Alexandre Peterc from Exane BNP Paribas. Please go ahead.
Alexandre Peterc - Exane BNP Paribas
Yes, hello. I would like to get a clarification on the quarter-on-quarter evolution by business area. At the time of September warning, it seems that the wireless, particularly slowing down in North America. That was the main reason for the down grade of expectations.
However, now looking at the quarter-on-quarter evolution; your [board] figures at constant effect. We see that both wireless and wireline increased by the same amount and which looks small for wireline and looks quite significantly better than what I would think for the wireless business, and so looking at really specifically at Wireline, I can’t reconcile your positive comments on segments within Wireline, there is optics, IP routing and so on even DSL with this more sequential growth. So, could you maybe make this a little bit clear for us?
And then the second question would be pertaining to what is going on at your major competitor. You’ve probably wants to what was going on at Ericsson and maybe you’ve some comments to share with us on that subject in particular. Would you anticipate less pricing pressure and less territory practices in the market on behalf of the Wireless infrastructure leader. Is this part of your relative optimism on gross margin restoration for the medium term? Thank you very much.
Alex, yeah, I believe that your first question is about the geography in Wireless.
Alexandre Peterc - Exane BNP Paribas
So, what happened in the September quarter basically it’s I think that what we can say is, we are in line with what we’ve said in the September announcement of this September 13th announcement, we’ve seen in CDMA, a slight decrease in the sequential North American revenues line more than compensated by the fact that CDMA worldwide went 12 and what significantly up.
We have seen in GSM, a very significant up tick from the June quarter to the September quarter, which was a clear explanation of the ramp up in the core wireless sales. And it’s basically the momentum that we’ve signaled higher in the year; it means we’ve been in momentum in the first quarter, in the second quarter, in our older backlog in GSM. That it answer your question.
Yeah. Alexandre, I would said the same thing. The wireless is just a matter of geographic mix and contracts we had in GSM and CDMA outside of North America, because if you look at the North America numbers for the quarter, obviously there are down certainly down year-to-year. With respect to your second question about anticipating some relief in price pressure, I would hope so.
Our next question is from line of Andrew Griffin form Merrill Lynch. Please go ahead.
Andrew Griffin - Merrill Lynch
Thanks very much. I have question about the management changes, you announced today with reduction of the number of business group and the regional structure change, how long will that take, still it’s down through the organization. Because I assume if people on the top are changing will also mean some of the teams will be changing underneath that is well?
The carrier group work started, what Michel six weeks ago and that’s.
End of August, yes.
End of August and so that is progressing well with respect to the regional changes. We will not do anything really other than Fréd Rose takes responsibility and Olivier Picard continues to support the European and South region. And so there will really be no changes in that as we get through quarter, where we have a pretty significant ramp and then anything that we do going forward we would do as the year begins.
So in each of these cases, the timing is dependent upon the circumstances and the rational pace that which we can get these things done. Obviously, as quickly as we can, but we care for the business, our customers and executing our plans.
Thank you. Our next question is from Phil Cusick from Bear Stearns. Please go ahead.
Phil Cusick - Bear Stearns
Hi, thanks for taking my question. If you can talk about the guidance on synergies, it seems like long-term margins are pretty conservative. Do you feel like versus where you are a year ago in terms of giving guidance or you being more cautious this time around given the lack of visibility over the last year versus the internal base plan? And then has the visibility improved and neither the short or long-term from a year ago. Thanks.
Let me answer your second part first has visibility improved from a year ago. We've been combined now for 11 months. I think it's fair to say that as you bring the two companies together, as large and complex as ours of course you learn and see as you progress. So, I think the answer to that is absolutely yes.
With respect to the stakes that we are putting in the ground for long-term targets, we are, I don’t believe, we’re being overly cautious. We are trying to be realistic about the value of the actions we've so far identified. The expectation that we will continue to find ways to be more efficient and a realization that this is an industry that’s got an awful lot of change that we are going through. Our customers are going through. We are the suppliers are going through.
There are major technological transitions that are occurring with this move to all IP, with the evolution from 3G to 4G, and the competitive landscape from our customers is changing. So, based on everything we know that’s our current best view of the stakes that we are confident and comfortable and putting in the ground once we get through the merger period.
Thank you. Our next question is from Kulbinder Garcha from Credit Suisse. Please go ahead.
Kulbinder Garcha - Credit Suisse
Hi. Yes. And just a question on I guess the difficulty how is the revenue visibility above in Q3 and with reduction you’ve just made to Q4. Are you mentioned in the past your profitability even an idea, what are the order books still about EUR 5 billion higher or smaller, any indication there. And then just one very quick factual question, what is the expected cash restructuring now going to be over the period 2007 to ’09 is about EUR 2 billion, EUR 2.1 billion of cash restructuring we should expect? Thanks
First of all could be in the cash restructuring we have both from EUR 1.6 billion cash restructuring target for the total ’07 or ’09 to EUR 2.1 with the additional plans that we are visioning that we are executing on to-date. This is the answer number one for the ’07 or ’09 period of time.
By the way you’ve seen that we have cashed out for the time is being, 300 million and our plan will probably exceeding the Q4 with a high, there will be high outlets in Q4. But we probably will not exceed the target, which meet the targets that we have in ’07 cash outlets in terms of restructuring.
There is another plan we are now building includes 2.1 billion total cash of restructuring. For the visibility of Q4, we have backlog. The backlog will have increase at the end of ’07 by significant amount versus the end of ’06. So, we are relying. We are in our forecast relying on a backlog numbers and then order book, which is stay in the overview of sales.
Thank you. Our next question is from Simon Leopold from Morgan Keegan. Please go ahead.
Simon Leopold - Morgan Keegan
Thank you. This question is for Pat. I wanted to see in terms of assessing the prospects going forward, if we were able to go back and you have the situation of being able to change something at the beginning of this year to put us in a better position today nine months later three quarters into year. What would you have done differently nine months ago, had you sort of been able to see what was going to transpire in the competitive landscape as well as the integration process? Thank you.
Simon, your question presumes, I had -- when you say that if you were able to see what was going to transpire so that itself, acknowledges the difficulty when you go through a merger and anticipating exactly what your competitors might do, and what's going on with respect to customers.
I think in retrospect, we always learn along the way. I think the one thing that if I, I mean, there is a lots of things you always want to do differently. I think that knowing what I know now and assessing the situation I think I would have moved to streamline and simplify some of these aspects of our organization earlier in the year. And so, and perhaps to do over again, I’d, certainly that’s probably the area that I point to.
Your next question is from Remi Thomas from Cheuvreux. Please go ahead.
Remi Thomas - Cheuvreux
Thanks. Couple of questions, if I may. The first one is to Michel. Michel, when I saw you a month ago you basically told me that in all the product solutions, where you thought actually some was not able to differentiate itself enough. You would actually consider a make or buy strategy, when I actually look at the presentation today, it doesn’t seem that is many products range always been the case. I get the feeling it’s going to be the case maybe some of the software application and some of the softswitches but anywhere else it doesn’t seem to be the case. Can you elaborate it? And a question for Pat. I’m hearing that there still growing frustration both among the salespeople as well as some of your clients as regard the organization, whereby the project management part of a wireless project is handled by the Alcatel-Lucent service organization.
I’m also hearing that you running into some technical issues with the regular network control that the Wideband-CDMA RNC innovated from Nortel, which is affecting your performances of some of your clients. Can you comment on that?
I will answer your first question let me. First of all, what you understood a month ago about willingness necessity to differentiate our public portfolio is absolutely embedded into the plan that Pat was outlining before.
So we are in different segments being Wideband-CDMA being NGN make ensure that the strength of Alcatel-Lucent in terms of happy transformations from both wireline customers and also wireless customers going forward. That this strength, these strong points absolutely leverage.
Examples of that what we are doing in Wideband-CDMA around Femto Cells, around Femto BSR architecture, which is an area, where definitely we are differentiated and positively differentiated vis-à-vis a lot of our competitor. So we are reinforcing our R&D in those areas.
If you are looking at NGN, we are putting stake in the ground, which we go through the IP/SIP service, which we believe is the way to go for fixed service providers right now and mobile service providers going forward.
So this differentiation aspect is absolutely there. You were speaking about the willingness to work with 5% to go for made by an analysis on a systematic basis, they are sure that the costs that carries probably for UMTS is being done and there are many examples where we are working with third-parties in order to make sure that we are able to reinforce opportunities.
So, those elements are absolutely part of the strategy outlined by -- but you mentioned also that in the second part of your questions that we would have difficulties with the, and seasons so on coming for the Nortel. I want to tell you very clearly, as part of plan before that our strategy with regard to wideband CDMA is based on the common product portfolio that which we are working and we are making big progress on that.
The finalization of that plan is for the third quarter of 2008. At that point in time the, converge portfolio will be available on a worldwide basis and all the work is progressing according to plan. So, there are no special difficulties with regard to what you are saying at this point of time.
And Remi actually one of the parts of your question had to do with frustration or the project management function. I’ll tell you, there are many parts of the organization. Well, I hear nothing about this other than people are working and it’s working just fine.
I think, there are a few areas where there is either some lack of clarity about roles and responsibilities or frankly somebody just doesn’t like the way it’s organized, which sometime happens. So, it’s always important to distinguish is the frustration because someone doesn’t like the way it is or is the frustration really legitimate.
So, we are working hard to make sure there is real clarity. I think this organizational alignment that we are proceeding with will help that. But for the vast majority of this set of activities, I’m not aware that there is any great frustration. People are working pretty hard because we are going a lot to do this quarter.
Your next question is from Paul Sagawa from Bernstein. Please go ahead.
Paul Sagawa - Bernstein
First, if you could talk a little bit about the impact of currency not just on the top, when you talked about, but about margins how that flows through the bottom line since your costs are incurred all over the world as well. Also if you really quickly comment obviously Ericsson had to have difficult results in their quarter for more understand they’re didn’t quite aggressive in bidding for contracts.
You noticed since their public comments are being perhaps more concentrating on the profitability of each contract, any difference in the way the bidding is happening on the street right now, as suppose to say three months ago? Thank you.
About the currency impact on the top line and in our margins, we giving for the top line quite fair amount of details on the impact of the currency. Because we are giving top line at constant Euro dollar rate, which means that we are anticipating all real slippages or movements between most of currencies, most of the practical currency in which we are doing business.
So, I’m quite sure that in Euros a decrease in dollar as a strong impact, of course, but we are connecting our top line on this element. On the margin, two levels of margin at operating margins level, normally there is almost no impact of currencies. Because we are either naturally hedged or financially hedged.
So there should not be any major operating impact with the exception of the portion of those margins which are made in Dollar, which should be slightly reduced, when translating in Euros. But which is these exceptions, which is small, there is no real impact of currency operating margin.
In return on the other hand, at gross margin level, there is an impact of currency because if you are making most of your gross margin in products and businesses, which are denominating with their revenues and their cost of dollars then the translation of margin has an impact. For example, this type of impact was in the Q3 '07 versus Q3 '06 of the order of magnitude of 0.5 points. But on the other hand, we are recording that in terms of cost. So, there is no major impact.
In response to your question about we are seeing any difference post the announcement that Ericsson made. I’d say this isn’t specific to any one competitor. It’s just kind of general anecdote in terms of how it feels. I would say, there is bit of easing that we might be seeing. But make no mistake it continues to be very priced competitive in the industry that’s got a lot of price pressures. But there may be a slight bit of easing subsequent to the last couple of months.
Thank you. Our next question is from Francois Duhen from CM-CIC Securities. Please go ahead.
Francois Duhen - CM-CIC Securities
Hello. I’ve got in fact two questions. The first is one for Jean-Pascal Beaufret. Could you maybe share with us the reason behind your decision to leave the company? My second question will talk about the headcount reductions, you mentioned that lot of people have now left the companies. When should we expect to see that with a full aspect on that, on your margin, because I’ve seen either time line always. As a sub-lines about reporting, should we see change in reporting that I’d like to merge divisions and business unit? Thanks.
Okay, for the first question I would not comment too much, but just would like to say that, I have really spent with, I can tell you center few years which are the most thrilling years in my professional life time repeat, the rollercoaster is only always something easy. So, it has been, there was a nice for very great pleasure for me to learn so much from this company.
So, and I would like as well as to say that I have been absolutely delighted to work on the, where to be, too tight to be instrumental. For the first and most important comes edition in this industry. So, I believe that the merger was the right move and I’ve been pleased it’s been part of that.
But I believe as well that in a merger it’s common place to a management team changing somewhere at some point in time. So, the management which is put in place in the now by and we feel are the right one to execute on the (inaudible). So, I am quite please with that.
Its easier to answer may be the question of reporting. The BUBD change will not change any type of reporting. While I report to carrier group and will have positive ability as well as the enterprise business segment and the service business segment.
And about the head count head our trends I believe that what counts at the end is clearly the impact in terms of costs, because head count is a proxy but not may be the best proxy in terms of costs. This is so even why we are giving you comparable cost which you do see reducing gradually and increasingly quarter over quarter from 2006 to 2007. So, you are seeing acceleration in the cost reduction, and this is what matters more than the number of hedge, which is impacted by some in sourcing contracts or some of the moves. It’s one of the metrics, which is not a metrics, which counts most. What counts most is the reduction of OpEx cost of someone year to the other year.
Thank you. Your next question is Ken Muth from Robert Baird. Please go ahead.
Ken Muth - Robert Baird
Hi, good morning. You talked about kind of new strategy in the IP and upgrades, kind of some of the thoughts on there. Will this be assuming that you would have a lot more products to launch in 2008 and if so kind of in what direction of the market segments? Thanks.
So, on your question, I confirm that with the migration of wireless network towards IP, we see effectively quite a lot of traction and this is coming with new products that are going to be launched from starting now and going on into 2008 and beyond. In fact, we are going to follow that quite similar approach and strategy as the one, we’ve been, the execution around the IP transformation for fixed networks, we add triple play service delivery architecture of Alcatel-Lucent was launched in 2004 and has evolved significantly overtime with new products and new operating software [devices] being launched regularly three or four times a year.
So, we have in the Broadband World Forum in Berlin at the beginning of October, we’ve started with this and just as an example of this IP transformation of wireless networks coming all the way from the core through the access parts, we are for instance, introducing IP in micro products.
So, more on the access part of the full wireless network the end-to-end dialers and wireless network that’s an example of probably there are other ones like small service hub that are serving specifically the wireless customers. So, this mobile evolution transport architecture, this is which is a little bit the equivalent of the TPSDA for mobile is coming absolutely with a lot of new products.
And top of that we have lot of further functionalities coming into all our wireless products. Pat was speaking about EV-DO evolution, Voice-over-IP and the like that is coming on CDMA just as an example, this is bringing quite lot of new service, new features, new applications that will be delivered in 2008 and beyond.
Thank you. And our last question comes from Nikos Theodosopoulos from UBS. Please go ahead.
Nikos Theodosopoulos - UBS
Yes. Thank you. I wanted to follow up on a prior question and then just ask one more. There was a specific question on the book-to-bill in the third quarter. I don’t think it was answered if you can give some clarity on that? And then my question is out of the 4,000 new headcount reduction can you elaborate by main product area and/or geography where these additional headcount reductions will come? Thank you.
So, (inaudible) we've said at the end of Q1 we’ve given at that time a number the new order intake into March quarter versus [set] in the March quarter. We did say so that we would not give it again because it would not reflect necessarily the evolution of sales.
We did that in the March quarter you remember that because we wanted to show you that after the merger issue weeks after the merger we had very quickly reconnected before markets and before customers in a way that made us believe that we would regain tractions and regain from the low Q4 quarter in ’06.
Whether, we would give any detail or any specifics about the 4000 certainly not. We’ve not given that. We’ve not given that for the 12,500 plan. So, we won’t give that for the 4000. You wait and see that developing in certain action plans or a certain detail affection plan. But certainly not by currency, which was fueled by business unit.
Okay, that was the last question. Let me just take a minute and wrap up with just a couple of comments. We shared the plan of action that we put in place. I just want to reiterate that I believe the choices we are making are the right ones. Given what we see happening in the markets and I believe they will enable us to be the leader in delivering end-to-end solutions.
And so, while we are clearly pruning our portfolio and refocusing some of our R&D investment, we are remaining in the key segments that we believe are necessary for us to be successful and we will obviously improve the performance of all of those businesses or any businesses that are underperforming and at the pace that which we do that obviously will be as fast as we can.
I think that, when you think about the evolution of networks, I believe that of all of our traditional competitors, we have the strongest position in IP, which is foundational for how networks are evolving. And I hope, you heard today from us and from Michel that we’ve every intension of leveraging what we’ve done and what we’ve learned in the wireline space into the mobile space.
The plan that we’ve advanced with respect to how to improve the cost structure is one that we are committed to, and the team that, that I’ve identified is absolutely committed to executing that and we believe as we move through the merger we can deliver a financial profile that will have us in ranges that we indicated.
Before we close, I would just like to acknowledge and thanks Jean-Pascal Beaufret. He is a terrific professional, who has done a yeoman’s job, as we move through the first phase of this merger. Jean-Pascal will work with us on a transitional basis for the coming couple of months. But I did wanted Jean-Pascal thank you and acknowledge you with this community in particular with whom you had relationships. Thanks for your attention. And I look forward to talking with you after next quarter.
Thank you. Ladies and gentlemen, this conference will be available for replay and after 15 PM France time today through midnight November 4.
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