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Executives

Bernardus Johannes Maria Verwaayen - Chief Executive Officer, Director and Member of Management Committee

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

Unknown Executive -

Philippe Keryer - Executive Vice President, President of Networks Group, Member of Management Committee and Member of Technology Committee

Analysts

Kai Korschelt - Deutsche Bank AG, Research Division

Sebastien Sztabowicz - Kepler Capital Markets, Research Division

Achal Sultania

Unknown Analyst

Zahid S. Hussein - Citigroup Inc, Research Division

Eric Beaudet - Natixis S.A., Research Division

Alexander Peterc - Exane BNP Paribas, Research Division

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

Eric Blain

Anuj Krishan - UBS Investment Bank, Research Division

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Odon de Laporte - CA Cheuvreux, Research Division

Alcatel-Lucent (ALU) Q1 2012 Earnings Call April 26, 2012 7:00 AM ET

Bernardus Johannes Maria Verwaayen

So good morning, good afternoon, good evening depending on where you are. Thank you for joining us at the Q1 results. If we look to the market, if you look to the fundamentals of the market, nothing has changed. People still build out networks. People are making plans for fiber networks around the world. Governments are looking to building a digital infrastructure. And still, Q1 from a CapEx position from customers around the world, was not a very strong quarter, and we had a slow start. So maybe it's good that we talk about those 2 issues when we talk about the numbers.

Before that, let's look to this famous chart. People worked very hard to make it happen, so please take a look, and let's see where Alcatel-Lucent plays in this environment that I just described. Because basically, if you look to the number of smartphones or tablets sold in the U.S., AT&T announced that 60% of all of their equipment -- all the end-user equipment is now smartphone or tablet. And in Verizon, it is, I believe, almost 50%. And people are working on the assumption to build out and need to build out.

And at the same time, of course, in certain markets like in China, we saw a massive calendarization issue around some of our biggest programs around GSM, where they decided that the central bids would not be in Q1, but in Q2. And therefore you see that, for example, on that particular issue, we had a 90% drop in our revenue in GSM in China.

So calendarization, cautiousness -- if you look to Europe, clearly, where companies have to choose between CapEx on one side and the demands for CapEx and dividends on the other side, uncertainty of the climate and simply, CapEx against promises made by those companies. If you look for the global picture, the CapEx for 2012, as relevant to us, is approximately the same as that for 2011. So that's for the picture in total.

And how have we done? Well, it depends how you look to it. If you look from an operations point of view, we have discussed many times the need for us to get better discipline and a better control on cost and cash. On both issues, I think we have performed very well. If you look to the cash part, for example, on working capital, we've done a pretty good job, and it is not a onetime. It's a more solidified, repeatable capability that we're building in the organization.

If you look to operating working capital, it generated EUR 255 million in this quarter. And I'm pretty sure that Paul will say a few more words about it. But also if you look to the other lines where we seldom talk about, like tax and interest and pensions, we did EUR 37 million better. So the ability for the organization to look to the cash as a managerial item, where you need to have the systems and the capabilities, much better.

On costs, same story. We talked about costs for many, many times. We gave you targets. We have taken over the last 3 years, as we discussed at the end of Q4, EUR 1 billion out of our costs. But there's much more work we need to do. And we gave you an ambitious plan for 2012, and we are on track to deliver that plan. EUR 100 million this quarter.

And the important thing is that there was a lot of question marks around, "Are you able to attack your SG&A base?" In this quarter, out of the EUR 100 million, 77% is about reduction on SG&A. So I think we're making very good progress in changing the way our cost structure is there, and that will help.

But if you do a good job on the costs, you do a good job on the cash, and you have a backdrop of low volumes and you have a backdrop, maybe even as imported off an unfavorable mix, it pays negatively into your margin. And we're at the trough of the margin. So why the margin -- we come back to it later -- why the margin is so low, the explanation. But leave the explanation aside. But where we are at the 30.3% in the quarter, with the cost savings that we have, you have to say, "Okay, what is now happening in the markets? Is this a onetime or is this a fundamental change that you see in your mix?" And we don't think it's fundamental at all. So that's important to note, and we come back to the explanation of why it was in this particular quarter, the 30.3%.

But if you look to, as Frank always talks about, surprises, I don't think it is a surprise, but it is -- if you look to trends, you have negative trends, positive trends and you'll have neutral ones. The neutral one is maybe a surprise. It's CDMA. CDMA in Q1 equals that of Q4. So you may look to the numbers in the fourth

[indiscernible]

and say, "Ah, that's a CDMA problem." Year-over-year it is, but if you look quarter-over-quarter, it is not. So the negatives is in GSM where we didn't foresee that the Chinese would decide what they have decided.

It's in Services, where some of the contracts, as you see with Services sometimes happens, did not meet their due date, and therefore were not included in the numbers. And the mix was let's say, more towards the lower end of our margin scale than up at the higher end. And if you look to Network Applications, you will see that we're doing well when it comes to Customer Experience because that matters for people to make an investment. But on some of the other more legacy type of activities, we did not so well.

And if you look to the positive surprise, we have the best quarter ever in LTE, 3x that of last year. And if you look to Wireline, amazing as it may sound, but Wireline -- Paul said something that is literally impossible, but he said the fiber is on fire. That's physically impossible, but what he makes very well clear to everybody is there is a new trend coming around fiber. So it's the same -- it's a mixed picture. And if you see the increasing demand in selected markets, you can also see that people choose where to put their money at work.

So how are we doing in networks? Well, the first one is IP. IP is going from Francs to Francs. By the way, if you have a possibility to come to our Investor Relations meeting in Silicon Valley on the May 22, 23, I'm pretty sure that you will be delighted to know that we're going to talk a lot about our IP portfolio. We're going to talk about innovation, about new opportunities that will be realized pretty soon.

So if you look to the IP performance, 23%, 23.5% to be correct, growth in the quarter is -- it's only leading to one conclusion: we are taking share. And it is a very, very positive, strong innovation pipeline, and the order book looks even better. It's a important point to make because IP is going to be the dominant technology throughout networks wherever you go and look.

Wireless, the story of Wireless is a minus, approximately 30% for the quarter. We talked already about China and GSM. If you look to CDMA, it was -- it was flat quarter-over-quarter. If you look to Wideband-CDMA, there is traction on Wideband-CDMA capacity regions, both in China and in North America. And if you look to what we have to do on LTE, more than 20 contracts now and I think truly attraction in the build-out. In the U.S., it's not just Verizon and AT&T. Everybody is building out or starting to build out the network, so this will continue.

Optics is one of those sectors of technology where companies have choice. They have a choice to invest when, not -- if they have to invest, they will. But you can turn it hot; you can drive it harder. And that's what you see. I mean, on Optics, it hasn't -- it has, worldwide, not been a great quarter, minus 25%. All technologies participated in that. The only exception where you see that innovation does make a difference, an important difference, is if you see a traction on the 100G, especially a extended product that will expand the capacity of over optical portfolio and now our photonics offering, which fourfold and basically prepares for 400G. Those type of new products clearly makes us a market leader in that segment. But overall, whether it is terrestrial or submarine, this was not a great quarter revenue-wise for our optical division.

And Wireline, not too long ago, actually 2 quarters ago, it was 21% fiber and 79% copper in Wireline business. Today, it's only -- it's almost 50-50, so a tremendous choice. We see build-out in Latin America, in Mexico, in Brazil, in Australia, in New Zealand, in China, and we are very well positioned. And I think this is going to be an extended life, and it certainly contributes to this picture when you can see that now for the first time, in spite of Frank's effort to exclude some of the business in this picture on HLN, that HLN is now almost 60% of what we do.

And if you look to the order book, the order book for HLN, so the next generation innovative product, is much better than the order book for the older part of the business. So I think this will continue the line.

Now we talked already about Services. Services being a significant part of the low-margin issue. You can't judge Services on 1 quarter. And we have said that many times, but the numbers are the numbers for the quarter. But if you look to the picture, the picture is not telling by what -- by looking at 1 quarter, the picture around Services.

There are 2 major shifts. We are more picky on where to go on Managed Services. And especially if it's about managing workforces, we are very cautious. It's all about looking to added value to relationships with our capability throughout the business and not just the single approach to basically get a contract. This is about the added value that you can bring. It's gearing much more to Professional Services. And if you look to the Services number, if we would exclude network build, which is basically very much focused on the Middle East and Africa part of the world, if you would have excluded that, this segment would have grown around 4%. So we were in the portfolio, not just on the total line, in the portfolio, so seeing a shift. And the shift is going much more to Professional Services, and we are going to ensure that, that shift will continue.

If you look to the more important part of the Network Applications, you also can see that where it's about payables or about messaging, that has been a -- especially the legal in the legacy part of the business, have been a very weak quarter. If you look, however, to Customer Experience, where our new innovation is, you will see that it has been a pretty strong quarter. I think that what you will see is that the profitability will be helped going forward by the ongoing expense reduction programs that we have in this particular part of the business.

If you look to our Enterprise business, the story is very clear. Voice had a very difficult quarter because voice is very much geared to, what I would call, the southern part of Europe. And it's no surprise for you, I'm sure, to know that in the southern part of Europe the activity were not particularly exciting. And therefore, that was a difficult part of the business.

When you look, however, to the data part, especially the OmniSwitch LG, it's doing very fine. Very, very well. And we think that there are new opportunities going forward in the U.S., for example, with our data product portfolio. But our profitability in this part has -- will go hand in hand with volume. That's the nature of the business here.

So we've described the market. We don't see that the year will change. We think that calendarization is an issue that people will take decisions based on their risk analysis that they have in their own portfolio. And therefore, it is truly important that we do a really excellent job on our own operations. That is, so to say, the safety net that we have. And I think that if you look to the numbers and you look to the trends, you will see that we are better and better in doing those things. Whether it's on the gross margin that we talked about, whether it's in the cost savings, whether it's on the cash management. And that's truly important as the uncertainty in the market goes up, the capabilities you have in-house to do your operations really well and to be on top of all parts of the operations better. We first had to make the churn. You remember that to make us from a loss-making company to a profitable company, that's what is done. And now you have to make it from a profitable company into a robust company, and that's the process we're in.

If you can deal with the circumstances from the outside, whatever they may be, and that you are not going to be just simply translating what the outside world is doing every single time in your numbers. So the robustness will go hand in hand with the capabilities that we have from an operational point of view. And I'm pretty sure that Paul, you will go to 1 or 2 of those items again to explain.

So if that's all happening, what's the "So, what?" of that? Well, we looked at that, and we have decided that we will -- that we leave our guidance unchanged, and that we will have better visibility on the profitability at the end of Q2.

So with that in mind, Paul, the floor is yours.

Paul J. Tufano

Thank you, Ben. Good afternoon. What I'd like to do is do a little more color on the numbers. Obviously, we reported, including the purchase price adjustments, a profit of EUR 398 million. You know that, that is really due to the capital gain on the Genesys sale. Genesys closed on January 31. We received over -- almost EUR 1.1 billion of cash proceeds, and the capital gain on that was in excess of EUR 600 million. When you eliminate that and you look at adjusted operating profit, the quarter was, as Ben indicated, a loss of EUR 221 million. So we've spent some time talking about that.

Now clearly, revenue came in at EUR 3.2 billion for the quarter. It was a 12% decline at actual rate. When you adjust for currency, it's about a 15% decline, year-over-year. We'll go through the details of that drive. Margins dropped 500 basis points year-on-year and about 400 basis points quarter-on-quarter. I'm going to spend some time to take you through the margin erosion on the next slide.

Overall expenses are down, 7.5% year-on-year at actual rate. When you adjust for currency, that's 9.6%. You see that expenses increased fourth quarter to first quarter. When you adjust for currency, that increase is about 2%, and it is all accrual.

As you know, we have a vacation policy in the United States that is, if you don't consume your vacation in 1 year, you lose it. You have to accrue it at the beginning of the year. It comes down to the second half of the year. So you see a lot of accrual activity that will change over the course of the year. It is not real reduction. You'll see real reduction is down dramatically quarter-on-quarter.

So if you go through the gross margin -- because this is probably the most compelling question in everybody's mind: "What happened to your gross margins?" So in the fourth quarter, we did 34.4 points of gross margin. That was an almost EUR 4 billion of revenue. We dropped 400 basis points quarter-on-quarter. 250 basis points is attributable to pure volume and the inability to absorb fixed costs. There's EUR 1 billion of revenue delta between the fourth quarter and the first quarter. Now we always knew -- it's traditional that the first quarter is lower than the fourth. This was a little more -- down a little further than normal and because of that, we weren't able to absorb all our fixed costs, even though you continue to see cost reduction in the fixed costs base. Now obviously, we think the fourth -- the first quarter is the lowest revenue quarter of the year. So as that revenue starts to increase, this volume impact will right.

The second thing that was critical was mix. We had 100 basis points of mix impact. And when you look at that, it came primarily out of Services. Now, when we look at our segment data in the next couple of charts, you'll see Services are down quarter-on-quarter. In our Network Applications, over 30%. Those are rich-margin products. That was part of the mix. In addition, in our Managed Service business, we had more in some of the lower margin accounts than we did in some of the more higher-margin activities, like special services, and that's another mix effect. That's 100 basis points.

Now, we did see in networks a positive mix benefit, primarily driven by the growth of IP. IP was up 23% quarter-on-quarter, year-on-year, quarter-on-quarter, and that is helping the mix impact. And then finally, there's about 60 basis points that's currency and a few other things. That explains the 400 basis points.

Now, we have to be honest that our desire was not to be at 30.3%. We thought we could be somewhere around 33%, about 1.5 erosion. So what's the gap between what our expectations were and where we wound up? And it's really 3 things. About 1/3 of it, it's volume. We didn't get the volume we wanted, especially out at China. As Ben indicated, GSM was down dramatically. The central bid activity in China has been deferred. We don't believe that's a loss for the year. We believe that is a re-calendarization of that, but it was less than we had anticipated.

The other 1/3 comes from Services. We thought there were be going to be 100 basis points better than we did on Services. Here, we honestly thought that we'd get a little bit more in our Network Applications and Professional Services in terms of mix effect. We still think that, that order book is pretty good, and it's a question of calendarization.

And finally, there's Enterprise business. Enterprise, even though it's small revenue, is high margin. It was tracking well in the beginning. As activity in Europe began to become more and more challenging, it fell off at the end of the period. That's the other 100 basis points. And obviously, the diversification of our product line into other geographies will help sustain that.

We believe the first quarter is the low point for gross margin, and you will see gross margin improvements in the second quarter and continuing through the second half. On expenses, I think this is a positive note. This chart represents fixed costs and expense with no -- at constant currency, constant assumptions on variable compensation and compares it year-on-year. What you have on the red and the pinkish bars are the actuals for 2011 by quarter. Now this is more than SG&A and R&D. It includes fixed operations costs, includes all the real estate and IT, some of which get allocated up into margin lines. But this is the way we look at it because it is the totality of our people cost, our discretionary spending on outside vendors and our real estate cost. Year-on-year, you can see that, that is down EUR 100 million, 7%. And if we look at where that's emanating from, 54% of that is from SG&A. That's in the totality. When you look at OpEx, it's 77%.

In the first quarter, we told you what our plans were for the full year, and we said that 50% of our expense reductions for the full year would come from SG&A. This is proving that out. 20% is coming from infrastructure reduction, primarily in real estate and IT. And you will see both of these continue through 2012 as we quarterize it out. So I think we are tracking well to the fixed costs and expense reduction plan, and I think that's a positive.

As we look at our operating segment revenue, Ben went through a lot of these numbers. I'll just give you some highlights. Overall, networks were down about 21% year-on-year at constant currency. That was offset by good growth in IPD, but off in Optics and in Wireless. And in Wireless, on a year-on-year basis, significantly on GSM and CDMA in the first quarter. CDMA, in particular. We saw our GPON products grow dramatically, over 100% growth on a year-on-year, driven by the build-out that Ben talked about.

You can see here on the Services side, that while Services were relatively flat on a year-on-year basis, they're down 27% quarter-on-quarter with the majority of that coming from Network Applications. Again, that's part of the mix shift we talked about, Network Applications, as most software products, are higher margin. And in the fourth quarter, you usually see a big build-out.

The order book, as I said, was pretty strong on network apps, and we should see that continuing to materialize into revenue and margin in the remainder part of the year. From an operating segment standpoint, because of the lower volume across the board, all segments are unprofitable for the mixed reasons we talked about.

If I go to revenue -- and I think this is an issue we're starting to look at, overall, the group's revenue was down 15% year-on-year. If you look at North America, North America was down 15%. Now you got to remember that in the fourth quarter of 2010, the first quarter of 2011 and the second quarter of 2011, we had a significant build-out in North America. As we came into the second half of 2011, that moderated to some degree. It was against a very high comparison mark. So you see a 15% reduction against that high number.

In APAC, you see roughly a 11% reduction. It is primarily because of China. China has paused slightly in the first quarter, especially in their central bid activity. It is driving the majority of the APAC shortfall. We think that will continue -- that will reverse in the second quarter and accelerate in the third and fourth. Interesting enough, in Australia we saw very good growth, 57% growth due to our position with NBN and also some contracts we have won in the strategic industry space.

If I go to EMEA, obviously EMEA is down 22%. Western Europe is 20 -- same number. We all know what's going on in Europe. Europe is a challenging market. And the rest of the world, you see that, that's flat. It's really 2 different numbers. In Latin America and South America, we have grown 26% year-on-year. And in Brazil, that number is approximately 6%. But in Mexico, we're over 211% growth, primarily because of the build-outs of fiber and also the new work we're doing on Wireless. Very strong in South and Latin America, and we believe we have even more opportunity there in 2012 in remaining quarters.

Middle East was down approximately 20%. Obviously, as we said before in the past, North Africa is a big market for us. The challenges in North Africa are still prevailing, but I think overall, we'll see that change in the second half.

If we turn to our balance sheet, the -- no key points on the balance sheet. Most of the changes by line item are either currency or in the case of pensions, a switch in pensions between a positive impact on shareholder equity and a negative impact on pension liability as our underfunded status is reduced, and I'll go through that. Probably the most important thing on the balance sheet is a change in working capital. You see here it's a minus EUR 310 million.

If we turn to the working capital on the next slide, the EUR 310 million reduction working capital came primarily from a reduction of net receivables of EUR 370 million. Inventory grew approximately EUR 84 million, and payables went up slightly by EUR 24 million. When we adjust for currency, we get about the same distribution. And I think there's some positive news in the working capital numbers. If you look at the inventory, inventory growth -- I'm going to give this to you at constant currency -- it was about EUR 100 million, which was primarily in the Americas and APAC supporting build-outs of customer networks. So I think that's pretty good.

EMEA had its inventory coming down. Our operations teams reduced their inventory quarter-on-quarter through better execution in our ASP factory in China, as well as better optimization in supply chain. So I think the actions that we took working on inventory management back last year are starting to really take hold, and that's a positive.

As you can see from our receivables, the receivable number came down. I'll also note that global discounting came down by EUR 100 million. And our payables, while up slightly, really, we had more prepayments from customers. Our trade payables were slightly down. But all in all, I think good performance on working capital.

From a cash flow standpoint, in the quarter, we consumed EUR 163 million of cash despite dry -- a EUR 221 million operating margin decline. That EUR 310 million of operating working capital change generated EUR 225 million of cash. And as you can see from the chart, made operating cash flow positive at EUR 168 million. And we did pretty well at containing those noncash items like CapEx where we could, restructuring.

We ended the quarter with EUR 5.2 billion of cash and marketable securities. You can see that we closed the Genesys deal, net proceeds were about EUR 1 billion. We paid down EUR 134 million of debt, of which $115 million worth of face value on the [indiscernible] due next year.

On April 5 of this year, our credit facility, the first tranche expired. It's about 540 -- EUR 560 million, excuse me. We currently have EUR 840 million. That will continue through June of '13, and we are currently thinking about how to proceed with that.

And finally, on the pensions, the underfunded status of our pension, from an accounting standpoint, improved by EUR 639 million quarter-on-quarter. That was primarily due to a increase in the discount rate of about 30 basis points, dropping our liabilities. But we also saw a good appreciation of our portfolio of securities increase in fair market value. As we've told you before, we believe that from a funding standpoint under ERISA, there will be no funding required in the U.S. pensions through, at least, early 2014. We still believe that today.

I'm going to conclude simply by wrapping up with the guidance Ben talked about. We leave our full year guidance unchanged, and we expect to have better visibility and profitability as we go through the course of this quarter. And with that, I'll turn it over to Ben and myself, and we'll take some questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Unknown Executive

We're going to start this afternoon with the questions with -- a question from the bridge, if we may.

Operator

The first question comes from Kai Korschelt from Deutsche Bank.

Kai Korschelt - Deutsche Bank AG, Research Division

My first question was just on Europe and Wireline. Just wondering what trends you're seeing there? Is it starting to stabilize, maybe on a year-on-year basis? Or is it getting worse? That's the first one. The second one is just really on the Enterprise business. Obviously, demand environment isn't great on the voice side. You have a pretty good product on the data side, but it ultimately, potentially is sort of lacking scale on the global level. So I'm just wondering if your thoughts process around potentially selling off that division has changed? Or if there are any thoughts around that?

Bernardus Johannes Maria Verwaayen

So your first question is about Wireline in Europe. And that's, of course, the question about the fact that we have this famous 2020 plan to give everybody access to at least 30 MB, and that would require a massive fibering of Europe. To be honest, I think that there are not too many people around that believe that the 2020 targets will be met. And there's certainly not in our plan that, that will be met, so we take a very realistic approach. There are a number of initiatives in Europe. There are some of our customers that look also to new life on copper. I think that regulation will be more technology neutral, which would be good news for us. And I think that what you will see is not so much the industrialized rollout over Europe, but much more focused on regional interest, different scenarios and different plans with different ownerships. I think that we are going to see the first wave of practice of working together in a different way than we have seen in the past. That's what I think that will happen. As a business, the Wireline business is truly a global business because there are very different passions and very different fuels in Latin America and Asia Pacific as we know. And there we are really taking a very strong position. Now your second question is about Enterprise. Our Enterprise business is totally focused on the combination that they have of their distribution model, which is very close to using the service providers as outlets, trying to get the leverage on the Alcatel-Lucent portfolio to make it truly end to end. And the fact that we have, let's say, a adverse market situation, especially in Southern Europe now for the voice product, I'm not so sure that single fact should change the strategy that we have around Enterprise. So they're absolutely focused to execute our plan. And as you know, we have a new young team in place there, and I would like to give them the support that they need.

Unknown Executive

We'll take the next question from inside the room.

Sebastien Sztabowicz - Kepler Capital Markets, Research Division

Sebastien Sztabowicz with Kepler. Could you please make an update on your patent initiative with RPX? And also one other question with your seasonality, what do you expect in terms of seasonality for Q2? Had in mind that usually your sales are up about 10% sequentially, is it the case for this quarter?

Bernardus Johannes Maria Verwaayen

So which one do you like?

Paul J. Tufano

I'll take the RPX.

Bernardus Johannes Maria Verwaayen

Okay, that's fine.

Paul J. Tufano

On the sales patents, 2 things. First, initial reaction from potential licensees is very favorable. We are working now in marketing that. We should start negotiations in the next coming weeks, if not, next month or so. As we said before, we won't really have firm indication where we are until we probably get to July. And at the July call, we'll give you a better indication.

Bernardus Johannes Maria Verwaayen

So on the seasonality, I think this year, we'll -- let's go back 1 year. Last year, we had mixed emotions in this room and mixed emotions given quarters, because the volatility in quarters was substantial. And it was, more or less, plus/minus, plus/minus, that type of thing. I think this year, you will see equally volatility. We started with volatility and not because we like it, but because that's the reality of the market. I think that therefore, the logical connection in numbers that you make may not be your most excellent guide. It could be that it would -- that the volatility is somewhat higher and somewhat lower in other quarters. But very clear if you listen to what we give you as an explanation, I think it is clear to say Q2 will be better than Q1. Otherwise, we couldn't have the guidance, let's be brutally honest. And I think that 10% is a number that you use. It's not the number that we would use.

Unknown Executive

We'll take the next question from the bridge, please.

Operator

The next question comes from Achal Sultania from Credit Suisse.

Achal Sultania

A couple of questions, if I may. In terms of gross margins, just to be sure, should we look for quarter-on-quarter improvements in gross margins as we go through the next 3 quarters? And then where -- how should we look at the different mechanics driving that improvement? And the second one is on China. Judging by your revenues and also your competitors in Europe, it seems that sales in China are coming -- obviously are coming under significant pressure. How should we look at the overall CapEx environment in China? Is it to do with the spending from carriers declining, or is it to do with the mix moving away from 2G to 3G, where it seems that you might have a lower share compared to local vendors?

Bernardus Johannes Maria Verwaayen

I'll take China, you take the first one.

Paul J. Tufano

I think on the gross margin, you should expect sequential improvement between the first and the second quarter. And hopefully, you'll see that improvement continue in the second half. The question is the rate of change off the second quarter, which -- we'll have to wait and see. But we do expect to see sequential improvement. Now what's going to drive that? I think number 1 will be higher volumes. The higher volumes will give us better fixed-cost absorption. Secondly, I think the mix will improve. You'll see much stronger mix continue in IP. I think our applications will provide better mix, and I think that you'll see better mix on next-generation products, especially in Optics, as well as the continued growth of LTE.

Bernardus Johannes Maria Verwaayen

So and -- I'm also going to surprise you a little bit about my answer probably about China. I don't think there is anything else than calendarization issue here. If you look to the program in China, there is the broadband rollout. It's a very strong program and it is absolutely funded. So you will see great traction on that program. You will see GSM build-out going, continuing as planned, be it that the central bidding for, let's say, internal Chinese regions was postponed from Q1 to Q2. Now, other than another part of the world, the time between bidding and the award and the revenues is very different than in other parts of the world. I just want you to understand a little bit, the mechanics there. I don't think that we're losing share in China at all, to be honest. Share of wallet, absolutely not. If you look to what our competitors have reported about China, we are absolutely in line. And I think that you will see China be a very strong part of our numbers going forward after this quarter.

Unknown Executive

We'll take the next question from inside the room.

Unknown Analyst

[indiscernible] Two quick ones. The first is China. How are you so confident on the acceleration in Q2? You think we do not have to wait for the Chinese election in September before seeing a catch-up? And regarding the mix effect in Services, maybe -- in Q4, we had a positive surprise on margin, so illustrating the new strategy to be able to say no on poor contracts. And in Q1, we had a bad surprise, so how do we either cross this bad surprise and when do you expect the poor amount, poor contract fading from the mix?

Bernardus Johannes Maria Verwaayen

So on China. It's undeniable. I mean, that's not exclusively for China, if I may say so in Paris, that elections have an impact on the economic environment. They do. That doesn't mean that therefore, the business has to be on hold until everything is done. Q1 was a particular low quarter. I mean, if you lose 90% of GSM, that's not because of market's realities. That's because of somebody says, "Stop," for a reason. It's -- it's more or less, let's say, a managed action. It's not a market action. And that will come back after the central bidding, and it will come back very strongly in Q2. So I don't think we have to wait until September.

Paul J. Tufano

With regard to the Services, I think if you look at the fourth quarter, fourth quarter was a very positive quarter for the overall Services business, both Network Applications, as well as Services defined by maintenance, Managed Services and Professional Services. And you had very good mix from Network Applications, very good mix from Professional Services. In the first quarter, as we saw from the quarter-on-quarter change, we saw a significant reduction, about 36%, on Network Applications. So that had a negative margin impact. Now I believe our Network Applications will continue through the course of the year to grow because there, it's about the timing of the conversion of the order. And as we look at the traction we have in Network Applications with our Customer Experience management motive doing exceptionally well, a number of handsets controlled by motive. The number of installations by operators around the world continues to grow. In our charging and maintenance businesses in IMS continuing to grow. And in our digital media store, Optism continuing to grow. So that's going to take place. Unfortunately in the first quarter, we weren't able to have those order conversions as much, but I think you'll see that calendarize. Now the same time in our Managed Service business, we are being very prudent about how we're approaching it. We obviously want to drive as much Professional Services as we can, especially in network transformation. And we are being very critical about picking new deals on managed service offerings where it's primarily the operating and maintaining the field force of an operator. And we are working on existing contracts that don't meet our expectations to either get them to the levels that are accessible to us, or renegotiate them such as that we can get there. So I think on the Services business, on an annual basis, I think you'll be pleasantly surprised. I think on a quarterly basis, there's some volatility as the mix changes. I think the actions we have in place will yield the annual result as we expect it.

Unknown Executive

Paul, we'll go to the bridge for the next question.

Operator

The next question comes from Zahid Hussein from Citigroup.

Zahid S. Hussein - Citigroup Inc, Research Division

Really one on gross margin again. If you're looking at CDMA being flat quarter-on-quarter from 4Q to 1Q and assuming that we will see a decline in CDMA this year, how does that factor into your gross margin analysis in terms of an offset for that? And really in terms of future contracts, if you can just give us some sort of color in terms of lightRadio. Now that you've announced improvements to the portfolio, can you just give us some sort of color in terms of what carriers are saying and when we maybe could see some actual revenue coming from lightRadio?

Paul J. Tufano

The first one? So on the first one, on margin. We've -- well, we've admitted pretty up front saying that we know CDMA is going to decline year-on-year. And we actually saw it decline from the first quarter of 2010 -- '11, excuse me, to the fourth quarter of 2011. And quarter-on-quarter, it's about neutral. So we factored in and appreciate the CDMA decline that will take place. And as we've always said, we will backfill that with the growth of other products, such as IP, the extension of the IP product line with regard to high -- or next-generation optical, LTE, the small cells and metro cells and our Wireline business. So we've already -- we appreciate the CDMA decline. I think to some degree, it's factored in. And now, it's a question of us growing the volume back to get the absorption and the mix that I just talked about.

Bernardus Johannes Maria Verwaayen

Yes, the more the total grows, the better it is also to mitigate. And one of the growth issues, you're right, is lightRadio. It's -- we announced a further part of the offering with the WiFi around lightRadio. I think that the product has been remarkably fast to being developed into a product family. We are engaged in some very promising contract negotiations, discussions. It has been set in the roadmap of several of the existing contracts already. And it will be, I think, a meaningful contributor in 2013. I would not think that the numbers -- we will have it commercially deployed in 2012, but I don't think it will be meaningful in the sense that we would mention it in the list of compensations for CDMA up until 2013. But that in itself is already remarkably fast.

Unknown Executive

We'll take the next question from the room.

Eric Beaudet - Natixis S.A., Research Division

Eric Beaudet from Natixis. Two quick questions, if I may. The first one is a follow-up on Services. I noticed your -- you had very weak network build-out this year, and I understand these have lower margins than the average of the division. So by considering that you targeted improvement in your service margin going forward, does that mean that you will be willing to let go some of the sales and growing your network build-out just to keep your margin? And the question being really, how do you see sales versus margins? Is it really more you're -- you're ready to let go some of sales just to make sure your margins improve? And my second question concerns your guidance. You said you'll have more visibility on your full year guidance at the end of Q2. Could you just give us an idea what exactly are you looking for over the next few months to make sure you will be able to fulfill your guidance, and when -- what can we look for? Is it a strong U.S. rebound in H2? Is that the GSM contracts in China will actually fill in? Or what exactly will you be looking for over the next 3 months that will reassure you on your ability to reach your full year targets?

Bernardus Johannes Maria Verwaayen

So which part you like?

Paul J. Tufano

Why don't you take the last, and I'll take the margin?

Bernardus Johannes Maria Verwaayen

Good.

Paul J. Tufano

So, obviously our goal is to improve our overall margins. And we've been pretty frank that margin expansion is the key even at the expense of revenue growth. And in the Managed Service arena, I think it's a classic. You can get a lot of revenue, but you can get very thin margins. But more importantly, unless you execute properly, you have a dissatisfaction of that with the customer. So I think it makes a lot of sense to prioritize for margin, and at the same time, prioritize for customer satisfaction. So you'll see us continue on that track. I think that, that is progressively working down the ranks of the organization as the fact that you have to -- you deliver on the margin.

Bernardus Johannes Maria Verwaayen

If you look to a forecast, what do you do with forecast? Well, you start to look to the order book. If your order book is -- and our order book is higher than a book to bill to 1, which is good. And you look to where -- and you look to, what are the circumstances? And I think you would want us to be very prudent. We live for a large extent in our markets here in Europe. Now if you know what happened in Europe between now and 6 months, you probably wouldn't be here today, because you will be extraordinary in demand in other places. So we have to be cautious, and what we say to you is, we will be cautious. We will be cautious. We're not trying to say the things that you like to hear. We're going to say the things that we think at the time. And I think it's only prudent that we tell you from what we see today, we are confident in the pipeline to come back. We're confident in what's happening -- that we understand what happened. That's why we gave you so much of the background. We understand clearly what happened in Q1. We understand clearly the robustness needed in the operation, and we see great traction there. So we have better handle on a lot of the things. But we have to be prudent. And there are certain things that can happen in Europe in the macro environment that will have an impact on the willingness of people to invest. So I thought it was only more than prudent to say to you, we're not going to change up our forecast right now. And we're going to make sure that at the end of Q2, we have a better visibility.

Unknown Executive

Then we're going to go to the bridge for the next question, please.

Operator

The next question comes from Alexander Peterc from Exane BNP Paribas.

Alexander Peterc - Exane BNP Paribas, Research Division

I had a question about the operating working capital movement. Clearly, there was a big release of cash from trade receivables and other receivables, which is probably seasonal, right? Because it's down to the lower activity in the quarter. But then you also had a significant level of customers' deposits and advances. Is that going to back to snap back to a more normal level, or is there any one-off we should be aware of? Just to have [indiscernible] on that.

Paul J. Tufano

Okay, on the prepayments. In the first quarter, we have some contracts that are paid on a full year basis. So it's historically that way in the first quarter. As we move forward, the prepayment activity will be a function of 2 things: how we -- the number of large projects we do, especially in submarine and in a few other areas and what does that it mean to our prepayment profile. And so I think that it may be less than what it is in the first quarter, but you'll continue to see us have prepayments.

Unknown Executive

We're going to take 1 more call from the bridge, and then we'll come back to a question in the room.

Operator

The next question comes from Stuart Jeffrey from Nomura.

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

I had a question on your Optics business. You mentioned that there's a quite a bit of weakness worldwide. I was hoping you could, perhaps, expand a little bit on that and whether or not you've got concrete contracts due to ship quite quickly? Or whether this is something that you think could continue to struggle for the rest of this year? And then if you're saying that GPON on fiber access is on fire, what kind of [indiscernible] might there be from the Wireline business into the Optics business from that?

Bernardus Johannes Maria Verwaayen

All right. I'm looking to whether Philippe wanted to say something. But -- okay. I think if you look at the Optical business, there are 2 main trends. First of all, the trend is clearly to innovation. So there, where we make a difference, as I said on the 100G, we gain traction. It is true that on the -- at the bottom side of the market, it is more commoditized. And I would say the more commoditized, the less of a market it is that you can think of will come back very quickly, because that's mainly driven by price. And I think that the second quarter of this year will be better than the first quarter when it comes to Optical. And that also has to do with some of the contracts when they turn out. But you will see a shift, and I hope for us, quite rapidly from the low end to the higher end. Yes? I'm [indiscernible], so that's good.

Unknown Executive

We'll take the next question here in the room.

Eric Blain

Eric Blain, Tradition Securities. Just, I would like to know about the working capital. Did you change your strategy in the factoring of pricing you have? I mean is it more -- have you more factorings than the last quarter? And the other question is about the convertible bonds you bought back. I think it's around more than 100 off nominal. Can you say at what level you bought back these convertible bonds? And the last point: as the cash is EUR 700 million, market cap is less than EUR 3 billion now. Do you intend -- or is it crazy to think about a share buyback program?

Paul J. Tufano

Okay, let me try to answer those questions. With regard to the level of discounting, the discounting came down quarter-on-quarter by EUR 100 million. Now we use our discounting program on a relatively flexible basis. So we could have maintained it where it was or even exceeded where it was in the fourth quarter. We chose to dial it down, but I think it shows our capability to have flexibility there. With regard to the convert, we did purchase 115 million at face value. I won't tell you how much we purchased them for, but they were below par. I think with regard to your second -- third question with regard to, would we entertain an equity buyback? I'm going to give you my view, because obviously, it's up to the board to do it. But my recommendation to the board is first we buy back our debt, then we think about equity. We have to reduce the debt level of the company.

Eric Blain

[indiscernible]

Paul J. Tufano

Yes, we have convertible bonds.

Eric Blain

[indiscernible]

Paul J. Tufano

You could, you could. But I think we've got to -- we'll look at our maturities in '13 and '14 first.

Unknown Executive

We'll go to the bridge for the next question, please.

Operator

The next question comes from Anuj Krishan from UBS.

Anuj Krishan - UBS Investment Bank, Research Division

Ben, you mentioned in your remarks that the CapEx pool relevant for Alcatel-Lucent this year appears to be flat from your perspective. Is it possible that given that scenario and given that you're not losing market share, revenues could also be flat this year? And just related to that, as we look at some of the CapEx spending, particularly by the U.S. operators, it seems there's going to be a pretty significant acceleration from Q2 onwards. So in that scenario, should we be expecting a significant snapback in revenues for yourself?

Bernardus Johannes Maria Verwaayen

So, there are all kinds of scenarios that you can think of. And I think you -- I'm not going to comment on all the aspects, because then I would give you almost a Q-by-Q forecast, but what I would say is this. As Paul said just a minute ago, our first aim is margin. So it's not revenues that we're after; we're after the right revenue. So the mix of revenue is a very important part. It is also true that the U.S. for us -- and we have a very strong order book in the U.S., so that in itself is a good indication that it's better to have an order book there than in some of the other parts of the world. And that's true, but we also have -- I'll give you one example. In Japan, our IP business grew 150%. That's very important because as you know, that's a country if you're in a program, you're in a program. And so I'm looking more to the strategic nature of where we are from the revenue perspective. I think that CapEx flat for the year is -- this was meant to be a positive signal. And if you look to where we are in share, it matters what type of share. And I tell you that in the higher-margin share, we're gaining market share. And if that means that we may lose some market share in the lower-margin end, so be it.

Unknown Executive

We'll take the next question, please, from the bridge.

Operator

The next question comes from Sandeep Deshpande from JPMorgan.

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Just a quick clarification. Can we understand -- I mean, you had a problem in recognizing in terms of revenue recognition on GSM in China? I mean -- is there a -- I mean -- and you have a problem in the past -- I mean, CDMA is turning down. I mean, these are all legacy technologies: CDMA, GSM, et cetera. So I mean, going forward on your margin, your growth is going to have to come from LTE. I mean, can you comment on the difference in the margin between LTE and W-CDMA versus these older technologies, which probably are very high margins?

Paul J. Tufano

So if you look at GSM, I think, number 1, I don't think we have a problem converting GSM. I think we have a timing issue. If you're looking at GSM, we think GSM will do quite well this year, primarily because of demand coming out of China. As we said, we think it's more of a calendar issue than an annual issue.

Bernardus Johannes Maria Verwaayen

It's certainly not a, as you said, a recognition issue.

Paul J. Tufano

Right. It's -- the orders are not there yet. They will be there. We're very confident of that. So I think that GSM will be -- do quite well in 2012. It will probably be more starting in the second quarter and accelerating, but I think it will be there. We also have W-CDMA growth, and W-CDMA growth will come in China as well, as well as some other geographies. But the new generation technology, which is LTE, we're doing well in. We've got significant LTE growth in the U.S. That will only continue. And as we work in other parts of the world on LTE contracts, we have 20 LTE contracts, you'll see that continue to grow. So as is normal, you have technology transitions. And I think that we're well positioned to ride the growth of the new technology transitions, especially LTE.

Bernardus Johannes Maria Verwaayen

Margin.

Paul J. Tufano

Now on a margin standpoint, if you look at margin and LTE, it is, quite honestly, better than we had anticipated. That's a positive, and is not too dissimilar from some of the technologies you mentioned. Now some of the older legacy technologies do have a better margin profile. I won't give you the delta, but they do. But LTE is doing exceptionally well.

Unknown Executive

We'll take one more please from the bridge.

Operator

The next question comes from Odon de Laporte from Cheavreaux.

Odon de Laporte - CA Cheuvreux, Research Division

I have a follow-up question on Optics. It looks like there is a competitive issue looking at market share developments in the -- for past years. And I thought -- last year, you hosted a presentation about WDM and a great outlook in WDM. It looks to be a good market, and I'm very surprised you don't ride on this opportunity. So could you maybe address this, what could be this competitive issue in Optics?

Bernardus Johannes Maria Verwaayen

To be honest, I don't think there's a competitive issue. If you look to the other guys in the Optics, they have said something similar that we have said. So it's not that we're losing share here or that we, all of a sudden, have a problem in the portfolio. And Philippe, you want to add something to it?

Philippe Keryer

Yes, and maybe to give a little bit more color there. I believe you have a double transition in Optics, so you need to split by two and then by two. You have, as we said, the market, which is more, 1 part is legacy, 1 part is more going together with IP, which is the WDM section. And we see this transition between, I would say, the old and the new going into more of the IP space. And then when you look inside the WDM segment, you have again 2 segments. You have a segment of metro, which is more what Ben was referring to as of a more off-the-shelf shipped technology. And then you have the part of the segment which is a more of a long haul in which you can apply the differentiation, as well as the new techniques 100G and the launch that we have done with the 400G coming forward. So you need to really to split in 2, and this is really in that segment that you are really seeing, I would say, the better -- the differentiation, and therefore, the products where we can position as well as the growth from our perspective.

Unknown Executive

Okay, thank you very much. Well, that brings us to the end of our press conference and analyst conference today. Thank you very much for attending, and we look forward to seeing you the next quarter. Thank you.

Bernardus Johannes Maria Verwaayen

Thank you.

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