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Alcatel-Lucent (NYSE:ALU)

Q3 2012 Earnings Call

November 02, 2012, 08:00 am ET

Executives

Ben Verwaayen - CEO

Paul Tufano - CFO

Analysts

Alexander Peterc - BNP Paribas

Sandeep Deshpande - JPMorgan

Kai Korschelt - Deutsche Bank

Anuj Krishan - UBS

Sebastien Sztabowicz - Landsbanki Keppler

Vincent Maulay - Oddo Securities

Francois Meunier - Morgan Stanley

Odon de Laporte - Cheuvreux

Ben Verwaayen

So, good afternoon, good morning, good evening, depending on where you are. Thank you for joining us for our Q3 results. As always, I am going to point you to the Safe Harbor statements and I hope that you will read it at your leisure.

So the story about Q3 is a story about transition of the market and transformation of the company and those two things coming together. If you look to our three most important objectives, it’s of course number one, the improvement of our margins, both on the gross margin and the operating margin. At the same time, it is about maintaining and even building on the core value of the company which is to be an R&D innovation company and during I think the presentation I hope that I can give you the proof that it is recognized and increasingly recognized by the market. And of course, last but not least is the strengthening of our balance sheet. So those are the three main transformation points in our agenda and we cover today with the results.

Let me start with the improvement of our gross margin and operating margin. Of course crucial in that element is what we do in our performance plan, the cost improvement plan. Now I don't have to remind you of all the various elements to it, but one of the most immediate points to focus on is the timeline. It is the act immediately and you will see during the presentation that it is already the fact that we are focused tremendously on bringing our cost base down with great urgency.

So I want to go through all those six points to discuss with you where we are. First one is on the cost. The cost reduction was as you remember for 2012, euro 500 million and we added that euro 750 million for 2013, so by the end of ’13 we need to have a cost reduction realized of at least euro 1.25 billion. It’s good to announce to you year to date we have achieved 35% and I would say we have achieved that in the places where it matters. For example, our SG&A is down year-over-year 12%.

So that was one of the sticky items maybe in the past; we are focusing very much on the cost improvement there where it matters; our real estate cost, our IT costs are down 5% year-over-year and all-in-all, we have done a third of what we need to do for a whole period of 24 months year-to-date. It's about fixed cost and it's about variable cost. In the variable cost, half of it is better negotiations and renegotiations with our suppliers and third-parties and half of it is in I would say productivity improvement internally. Issues like the cost of ticket, the handling of repair, the process that we have on looking to the fine detail of getting things done for a much more focused and I would say across the business organized way that will generate a lot of cost savings.

So 35% at the end of September means that we are not just delivering on the totality of the euro 1.25 billion, it also will tell you that for the target of 2012, 90% is done by the end of the third quarter, which gives you an opportunity to over achieve on the cost issues for the whole year. The focus on cost is truly throughout the organization.

Now one of the issues around cost of course is people. You have seen us detailing our reduction program a couple of weeks ago and we are focusing on not just the 5,500 that we have announced as a reduction in headcount, in ALU headcount, over and above that we have a reduction on contractors, historically the company has a lot of [bad] [ph] contractors and amidst its operations you will see a similar program there and we have of course the opportunity to reduce costs by addressing some of our managed service contracts.

So overall the total headcount reduction will be of a different nature than the 5,500, but focusing on the 5,500 is important. That is addressing the issue where it matters; 60% plus will be in Europe. So it’s not that we try to go to the territories where it’s easy to adjust your headcount, we will try to address it and we will address it, there where it matters and 60% is in SG&A. So it is very clear for the organization that the improvements that we are going to make in headcount are real, the faster we do it the better it is and we are I think engaged in all the necessary regulatory and legal processes and negotiations.

At the same time, we are going to cut pretty deep in our corporate executive population with a reduction of over 30% and we are going to cut two layers in the organization. So from the people perspective, this is quite a drastic step that we are taking. The same that we do when it comes to contracts and as I said last time, if you look to our managed service contracts, 25% of that is not up to the standard that we need to be, that is a substantial bleeder for the organization; we need to address it as soon as possible. We have taken all the actions necessary to have the information which allows us to be capable to address those issues and a third of those issues will be addressed by the end of the year. And I think the good thing here is that it will gradually improve our results starting early in 2013.

Now the same is with geographies, not easy to deal with. One of the things that you always have to bear in mind is that people are of course more and more globalizing their business. So it’s not that you can just pinpoint a customer on one single location, they are wandering around the world so to say, if you want to follow them, you have to be in places that maybe on its own you wouldn’t choose to be.

Having said that, we are going to be very focused on our go-to-market strategy and it means that we are going to address [in round 1 45] [ph] countries to go to a channel service organization and further markets will be more to a sales organization than a full fledged support organization. You can expect us to have a positive impact on capital employed on this pretty soon and you can also expect us to do this with the urgency that is needed.

One of the issues of course that is important is to look to our assets. There are two issues here, let me start by the divestiture, because people like to speculate of course about what are you going to do with your assets and your non-core assets, do we have non-core assets, of course we do have them. Although we have a much simplified organization, it still is a broad spectrum of activities that we have, so you can make choices, every choice you make will have a consequences, there are no easy decisions to make, but you can make and we will make decisions around our assets; of course these are subjects that everything I say further than that will not be very helpful for the organization. So the thing that we would like to underline here is that we have the capacity and the capability to make choices here.

On our patent portfolio, we have raised the bar a little bit; we have talked to you about RPX. The outcome of RPX was actually pretty promising in the sense that we got a clear picture of let's say the appreciation of our portfolio which is very, very strong, independent research that we have done over the last couple of months is also an underlining of the vast, I would say, theoretical value that you can have on your patents. In order to monetize it, there’s something that we have learned over the last couple of months that we need to show a little bit more of the appetite to challenge.

So we have changed our organization from a support organization to a profit organization. We will announce within days a new head of that organization and you can expect that the level of interest that was in the market translated into amounts was not sufficient for us to be a let's say an enthusiastic taker of those types of offers. And by sharpening our pen and our approach, we are absolutely sure that we will get a better deal for shareholders going forward and you can expect us therefore to do two things, we've changed the arrangements with RPX from an exclusive one to a modified one and we have also changed our tactic to be a little more sharper to the market you can expect us to engage with third parties very actively.

So then about the performance plan, the performance plan is managed I’d like to underline that with an executive on the executive committee whose job it is a 100% to go after every single aspect. This is a top priority for the company to reduce our costs, to reduce the costs where it matters, which is mainly in Europe in our fixed costs and in our support costs.

At the same time, we will be raising the bar when it comes to the need to look to business from a profitability perspective. So we will be making sure that everything we do from here on has a profile that fits the needs of the organization and the company. Now we do that in a market that is not easy. Let me be very clear about it. The market is not easy. So let's talk a little bit about the market. There are two things in the market. First of all it’s the macroeconomic situation and then there's transition situation. The transition is basically a technology transition, and there are three ones that are truly important. The first one is on optical.

In optics there are two things, if you look to terrestrial optics, the legacy business is one that you can postpone. If you want to postpone anything, this is the thing to postpone. So in Europe massively this is postponed.

Now there is another trend, and as we go to a very rich data and video world, in the rich video and data world you need to have the next generation optics. So when you look to the 1830 and our capabilities there which is the 100G capabilities, we are doing very, very, very well. We are doing very well on two fronts, on new systems and orders and on line cards that we can ship because it fits into the family of products that we have. So you can see that we are in next generation optical a very strong player, some even say the strongest in the market. I believe that there is a company called Infonetics, thank you very much, Infonetics, but if you look to the totality, it is on the terrestrial a difficult market and submarine is in a cycle. It's in the trough of the cycle. When you look to the signing for going forward, it looks pretty promising, but we are where we are from that perspective in the cycle, we are at the trough of the cycle in the submarine.

Now if you look to wireless, it is the main point and I am sure Paul you will talk about it, so I’ll leave that for you. But the shift from 3G to 4G in the US and in China actually from to 2G to 4G is pretty dramatic. It's going faster than we anticipated and it has an impact on the margin structure in the organization.

It's here to stay. If you look to what happened with 4G, the launch of the iPhone 5 in New York in three working days, it had 6% of the total traffic. So there is a huge appetite for all rich new information capabilities. It will have an impact also on other markets. I am pretty sure it is also the reason why you see in China with all the new equipment coming in the market, an extension of what they call trials. The trials in China have a size that many, many markets will be very jealous of to call to market and we have been awarded a substantial part of those trials, of their extension trials.

In wireline, I have to say, if I would have made a guess 18 months ago, I wouldn’t have made this guess where we are today. It is quite remarkable. Our fiber business grew 80%; our fiber business is now much bigger than our copper business. You can see that the next generation copper is taking off very, very nicely, vectoring is going to be a major force here in Europe probably also in other parts of the world. It gives a new life to fiber and we announced quite recently what we call zero touch factoring would basically mean you don’t have to go in every house and change every modem there which is an absolute must do if you want to make this market anywhere near feasible to expanding and we grew at year-over-year something like 25%, the whole wireline business, 26%, and I think that we are just at the start of our new life in the wireline business there.

So that is the market trends. If you look to the translation in HLN, it means that in Philips business more than half today is HLN and by the way that business grew in Q3 10%. So overall year-over-year we had the minus 2.8, but this grew 10%, and more important than that our other portfolio grew 20%. So the message is very loud and clear from the market, give me a product that does what I need to do in a video rich environment that I can implement in the market relatively easy and that is what I really want, anything else where I can wait and see in doing kind of maintenance around these networks, please can we postpone it. And we see the same trend in our enterprise business; enterprise business is of course not part of the HLN, but if you see our OmniSwitch and our data portfolio and enterprise grew 5% which is totally against the trend, as you can see in the marketing spend today and overall enterprise was down because of a distribution model that we discontinued. But if you look to the real business it shows very much anything that touches data video in a network in an integrated network capability has a market.

So if you talk about repositioning of Alcatel-Lucent here are the strong elements, the first one is IP, another quarter that we grew double-digits, this time 20%. If you then look to under the hood, where is that 20% coming from back haul being very, very important, growth in China, in Japan, in the American regions, actually with the exception of Europe, we grew everywhere.

And more important than that for me, personally I think is the fact that our core routing we have announced one contract with a customer. We have signed six contracts and we have more than doubled that in trials just in the quarter. So we have strong demand, very strong demand for routing capability going forward.

If you look to optics I already talked about the 100G coherent technology. It is clearly a winner in the market and the combination between what we do with IP and optical from a customer perspective I can tell you, we got pretty warm receptions.

On wireless, it’s of course the change to LTE that's with the exception of Europe a done deal so to say. That's where we’re going. Our win with LTE-TD in China is of course very important, because the message around wireless for Alcatel-Lucent is this. We can't be with the size that we have, the investments that we can make, a global player being everything for everybody, everywhere, we can't be. So you have to focus, and we choose to focus on the US, on China and selective markets. So we have some selective markets where we really can make a difference, that's where we want to play. Where we can't make a difference, where it’s too difficult from where we are today to see an entry on a very short period of time we will simply disengage from that. And that gives us - the focus and the choice, gives us a position in wireless where we can take advantage of the two trends that you will see, the first trend is LTE, the second trend is small cells. If you would hear anybody that's - the Sprint Award in Q3 for small cells is indicative for what's going to happen. If you talk to the people in the US market, you will see that the metro cell environment will be strong focus going forward.

We already talked about wireline. It is about the new technology, it is not about the old DSLAMs it’s about the new technologies, it’s about bringing the background for a rich video media environment.

Now if you then translate that into where are we with customers, because you could be fooled easily and say, the company has to deal with issues on the balance sheet, we will address those issues, but at the same time they are still there, there's a lot of speculation. If you look to the share price, I mean that's not lost to our customers as well. So there is uncertainty around it. In an uncertain world, how do you behave with your customers? Well, it shows you these are just a few examples of them. It shows you that we get a lot of support from our key customers.

Our US customers have been extraordinarily supportive with us and they are extraordinarily supportive also in planning with us 2013. The same I can say with some of the customers that you find here on the list. It is based on the strengths that we have in the market and the conviction that they have that we are very serious in addressing both the cost issue and the balance sheet issue.

So with that in mind, of course you know that our outlook is that we will do better in margin in the second half of the year than in the first half. We have Q4 in front of us. Everybody knows that Q4 historically always has been the strongest quarter of the year, and fortunately that's the nature of our market, nature of our business. We've tried to change that, sometimes with brute force and the reality is it is what it is. This is where the market, how the market behaves. So Q4 will be a strong quarter for the industry as such and therefore also for Alcatel-Lucent and we are targeting positive net cash for the end of 2012. Paul?

Paul Tufano

Thank you, Ben. Good afternoon. What I'll do is take you through the details of the financials. And we probably should start with the reported results. Clearly reported results including purchase price adjustments, especially with the merger was a total net income loss of 146 million, that's 0.06 a share negative. Clearly you can see restructuring charges of 61 million that was a major detractor. Two-thirds of that is social costs associated with our restructuring plans primarily in Western Europe. We did get a gain of financial income from the asset increase of our pension funds at 71 million and the result is an adjusted operating loss of 125.

So we turn to that adjusting operating profit page. Clearly we see our revenue of 3.6 billion that is up or down 2.8% year-on-year at actual rates and slightly positive quarter-on-quarter actual rate. When you normalize for currency, it’s about a 10% reduction year-on-year and it is essentially flat quarter-on-quarter. As you will see in the next couple of slides, we saw a decline in most geographies year-on-year except for CALA.

If I turn to the expense line very simply, you can see that on the chart we're down in total OpEx about 2.6% year-on-year. When you adjust for currency that becomes 8%, with SG&A down almost 14% year-on-year. Year-on-year actual at constant currency, we will shed over a 100 million from the operating expenses. But I think probably the most important number on the chart is the gross margin number. As you can see, our gross margin slid from 35% in the year ago quarter to about 28% today. The majority of that is product mix. Probably the most important one to talk about is the quarter-on-quarter change of almost 4 points.

So as we look at that, we did 31.7 points of gross margin in the second quarter. We had already seen the effects of technology transition year-on-year as we are in this quarter, and today we posted 27.9. So that’s 3.8 points of margin erosions. We want to go through what's driving that. So first and foremost, about 110 basis points is the result of increase in reserves. And they come in two flavors. One is operating reserves, which is about slightly less than half of the 1.1 points and that is attributable to some activity in the field and more importantly as we see demand slowing down in the quarters ahead, we have to revaluate inventory, especially on specific components that are used only for individual customers.

That's the remainder, that’s the bulk of that reserve change. In addition, as we are working through and disengaging in managed service contracts, we are seeing some additional costs as we attempt to wind those down, and that’s the other driver of that 1.1. So it’s almost equally split between reserve changes for operations and managed service contracts. The biggest driver is product and business mix, 240 basis points and that 240 basis points almost the entirety is the change of our wireless mix.

From the year ago quarter, we saw a significant erosion in sales of both CDMA but also in GSM and GSM is coming out of China. And that is over two points of the 240 basis point erosion quarter-on-quarter. We also saw a buildup of some networks especially in the Americas, so our network build activity has increased and that’s another 30 basis points of erosion. So that’s the most - the entirety of the 240. Now we did see good growth in IPD that offset some other business areas. Then finally we saw 30 points of erosion primarily from foreign exchange. So the net result is the 27.9.

As I look at the chart obviously 27.9 is not a sustainable gross margin level. Our desire is to drive back up into the 30s. You can see that part of that reserve change could be a one-time item, and so as we work on our performance plan to not only one, drive the mix of better products to those products that are above corporate average IPD, 100 gigawatt optics, professional services and certain applications you will see that moving up and as we take down our overall cost and expense structure especially in fixed operations cost. So we understand the need to return those margins into the 30s and we are actively pursuing that.

If I look at expense as Ben indicated, good progress has been made in reducing our expense structure, this is a chart for reminding you of our fixed cost and expense, it is at constant currency, with constant assumptions on variable compensation, it shows year-on-year. This quarter we are almost a 100 million down from the quarter before, year-to-date we are in excess of 300 million on fixed cost savings.

When you add that to our variable cost savings, you get to the 450 million that Ben quoted, which is about more than a third of the 1.25 billion reduction. You will see this expense reduction especially in SG&A as well as infrastructure accelerate as we move through the next several quarters.

If you look at our revenue by segment, clearly the network segment has been the most impacted, it’s down almost 12 points year-on-year at constant currency. When you peel that back, you do see that those products that are on the leading edge are driving growth, legacy products are the ones that are falling back.

So IPD has at constant currency a 20% growth rate, when you peel that back the IP (inaudible) product line is the entirety of the growth, and at actual rate that’s more like 30%. And with the advent of the core router we believe that will continue to grow. I believe this is the 7th consecutive quarter of continued growth on IPD.

If you look at our optics business it is down 21% year-on-year, as you know we have our submarine business and our terrestrial optics business. Our Submarine is down 33% year-on-year. Submarine is a cyclical business, we’re at the low end of the cycle. As we look at the order books, especially new contract awards, we are very encouraged by the build of the order book going into ’13 and ’14.

Terrestrial Optics was down 17% year-on-year at constant currency. The entirety of that reduction is primarily in legacy products. Our WDM product line was flat at constant currency; it grew 5% at actual rate and we saw growth in WDM in EMEA and APAC.

Looking at Wireless, here you can obviously see the big deterioration; 27% reduction in wireless with GSM and CDMA in excess of that 27% amount. And then finally the good news on Wireline, you see a 16% growth year-on-year. When you take out the legacy products and look at PON only, that was 63% growth year-on-year at constant currency.

Services continue to perform well, it’s about flat at constant currency with the services business primarily maintenance driving that growth. And our Network Applications were down 15%, that's primarily in our advanced communications and here it’s a timing issue, you'll see recognition of a number of projects in the fourth quarter.

And finally in Enterprise, I think the point I’d note is Enterprise was down 17% year-on-year at constant currency. When you peel that back, it was primarily data and some voice data had in it a year before, some resell for wireless LAN products in Asia; we are no longer doing that. When you normalize for that, you actually see big data growth. And quarter-on-quarter data has grown 3% at constant currency and the OmniSwitch 10K continues to do exceptionally well in markets around the world.

If I turn to segment breakdown, clearly a euro 125 million operating loss for the quarter, you could see that the entirety of it is in the Networks Division at euro 149 million. And in that Euro 149 million the majority if not the entirety is in wireless. And so the year-to-year and quarter-to-quarter changes that you see are primarily driven by that product line. We've seen good growth in some of the other product lines, but given the change in the technology, purchasing of customers from older technologies to new technologies we are seeing that margin compression.

If you look at the services and solutions, you can see that that is a euro 55 million profit for the quarter; that euro 55 million profit is primarily driven by services and primarily by maintenance.

If I turn to revenue and revenue distribution next slide, across the board, we saw weakness in most geographies. In North America the comparison was stronger year ago period as major customers were building out. It was down 10% at budget rate, actual rate was up 2%, but we saw quarter-to-quarter growth of 2% and we think the Americas of all the markets remained most resilient. Our top two customers were AT&T and Verizon; both were 10% of the overall revenue of the corporation.

If I look to Asia Pacific you can see that it is down 10% year-on-year. That 10% year-on-year reduction is primarily driven by China. China was down 18% year-on-year at constant currency. We actually saw good growth out of Australia during the period.

In Europe, the reduction was 16% year-on-year. Western Europe is the predominance of that. Western Europe is down 17%, Eastern Europe is down less. We saw very strong growth in Russia, where we were up [15%] [ph] year-on-year.

And finally the rest of the world is up 6%. If you look at that 6%, it was driven by Latin and South America; Latin and South America were up year-on-year 10% at budget rate. This is I believe the eight consecutive quarter of growth for that region and it's probably growth coming out of both Brazil and Mexico where we are well positioned.

If I look to the balance sheet, no real changes on the balance sheet. Most of the changes in the various balance sheet items are because of foreign exchange. So there is not much I am talking about here.

Going to operating working capital, we did see positive contribution from operating working capital reduction in the quarter. At actual rate, it was about euro 26 million. When you adjust for currency, it increases slightly to about euro 30 million reduction. That euro 30 million reduction was primarily attributed to the fact that we were able to collect or discount more receivables and that offset the reduction in payables.

Inventory was about flat. If you look at our inventory, we had good reduction in our operations inventory, almost by euro 50 million, quarter-on-quarter. That was offset by growth in our regions, primarily in the Americas as we continue to have a large build out and as we move through the course of next several quarters, you will see that I believe to get to a steady state and you will see the ability to take inventory down in the next couple of quarters.

From a receivable standpoint, we reduced receivables by euro 220 million. In that euro 220 million, half of it was gross collections, half of it was additional discounting. And finally in payables, we reduced our payables by euro 200 million, the net being the net change of operating working capital of euro 30 million at budget rate.

If I turn to the cash flow statement, during the course of the quarter we consumed euro 360 million of cash; a big driver of that was the adjusted operating margin of euro 125 million. We actually contributed cash from operations from our working capital change of about euro 14 million. You will see on the chart that there is change in other working capital of consumption of euro 121 million and let me just talk about that for a minute.

A good portion of that is for wages and social charges, as you know in the third quarter there is a lot of vacations that are taken during the year and you take those vacations, it shows up in the operating line; since it’s a non-cash item you have to offset it; that offset is in the other charges line. In addition, there is some, there are VAT tax payments that were made in the third quarter, since our sales were not equal to what we took in, that will normalize as we move into the fourth quarter.

From the other non-cash items, other cash items obviously interest was a little higher this quarter than last primarily because we have our semiannual interest payments. So it’s the same as it was in the first quarter. Pensions were euro 31 million, year-to-date we have consumed [128] [ph] in pensions; we [said we’ve about] [ph] euro 200 million, it will be there.

If you look at restructuring, restructuring was euro 93 million, the bulk of which was social charges. Year-to-date, we are euro 255 million cash consumed for restructuring; it should be about euro 335 million to euro 350 million for the full year; below our euro 400 million low end guidance that we gave you at the beginning of the year.

CapEx will be, it was euro 143 million of CapEx through the three quarters that is slightly below euro 400 million. Our guidance was euro 600 million or below; we will be below euro 600 million. At the end of the quarter, we ended with euro 4.7 billion of cash and marketable securities. And the revolver was undrawn, but the covenants were met, and that's the majority of the cash explanations.

If we turn to pensions and pension funds, we actually saw an improvement in the pension fund. Pension fund, the funded status improved by euro 216 million on a quarter-on-quarter basis. If you look at that, fair value of our assets increased almost euro 1.1 billion that was offset by about euro 900 million of liability growth, that liability growth was a function of further reduction of the discount rate of 20 basis points or about euro 650 million and some service cost charges for interest for another euro 300 million.

Currency was negligible in the quarter; it was about euro 33 million. So we take the gain in the assets, the pension - obligation increased because the discount rate in currency gives the 216. As I remind you, this is a accounting view of our pensions. In July of this year in the U.S. a new legislation was passed, that gave flexibility for how you calculate discount rates. As a result of that legislation we now run our funded status calculation. While we were over funded for both our management and occupational plans under the old regime, under the new regime we will become significantly over funded. And therefore, we believe there is no funding requirement for U.S. pension through at least 216 at the minimum.

In addition, that new bill contain the ability to use excess pension funds to pay employee healthcare; they extended it till 2012. That is a significant benefit for us as a lot of the OPEB you see in the delta is in the occupational plan, therefore we use this surplus funds in that plan to pay OPEB and more importantly they allow us now to pay retiree life insurance from that as well and so even adding more degrees of freedom to reasons why we will not fund those pensions.

One last thing, we did offer to certain employees in the US the ability to take lump sum payments. We expect that by the end of the year, we will see about euro 100 million of liabilities reduced because of that with almost all of it being in the fourth quarter.

With that I will end the presentation and we will take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

Unidentified Company Representative

We are going to start the question-and-answer with a question from the bridge please.

Operator

Thank you. The first question comes from Alexander Peterc from BNP Paribas. Please go ahead.

Alexander Peterc - BNP Paribas

I would just like to dwell a little bit on the gross margin, can you maybe comment to what extent the current low point in gross margins is a reflection of a permanent change in your business mix and to what extent it may be cyclical, looking out over the next 12 months. I did hear your comment on why that (inaudible) it would stand to reason to believe there's neither GSM nor CDMA would recover in the near-term. So would you perhaps add a little bit of color on the evolution in the next 12 months? Thanks a lot.

Paul Tufano

Most definitely. Clearly, the technology shifts we are seeing in wireless from legacy GSM and CDMA platforms which were at their highest margin mark because of their age will not recover. And so we see, for us I think and for the rest of industry, a reset in margin targets as a result of that. Consequently, we need to drive a higher percentage of ourselves in those products that will be higher than the average margin of the group. As I said before that's primarily in IPD, it’s in advanced optics. It’s in parts of our applications portfolio and it’s in few other areas. And at the same time we will de-emphasize those product lines and areas that are below the corporate average. That will drive up the overall gross margins as we go through the course of the next several quarters. Now, will they ever return back to 35%? I hope they will, but we have to take our expense structure down faster to give us time to recover those margins.

Alexander Peterc - BNP Paribas

Can I just ask a quick follow-up on disposals? I would like to understand whether you can actually sell assets without impairing long-term profitability prospects of the company? Thanks.

Paul Tufano

So I think on the relation of selling assets, we can sell some assets. Obviously we are looking at that. Some of them are below the corporate average, some of them are above the corporate average and so we’ll look to dispose off assets in the most optimal way possible and it will have some impact, the impact will depend on what the asset is.

Unidentified Company Representative

We will take the next question from inside the room please.

Vincent Maulay - Oddo Securities

Vincent Maulay from Oddo. Two quick ones. First on the net cash position expected at the end of 2012, due to the [pro] [ph] gross margin evaluation, it means according to me that you need at least euro 400 million positive impact of working capital in Q4. So why are you so confident? And the second question on the impact of renegotiation of the managed services contract on margin and sales, on gross margin, how long the negative exceptional item will impact gross margin, up to Q2 or up to Q1 2013? And on sales, do we have to expect suddenly a drop of sales at the group level, not have any tangible impact?

Paul Tufano

So let me try to take those questions in the reverse order. As it relates to the managed services contracts, clearly as we begin to phase out those contracts, you will see a top line reduction. That top line reduction over the course of the next 24 months could be euro 400 million or more, but as that happens, it’ll actually I think bring up the overall gross margin of the group and actually improve the overall absolute margin number, number one.

As we go through the renegotiation of these contracts, another - a number of them have stipulated expiration dates. And so for a lot of them we work to the end of the expiration date, sometime there is renewal clause for three months or six months. Other cases we work with clients to transfer them to other parties hands and that’s the work that’s being done by the team as it relates to those contracts, and I apologize I forgot your first question. On the cash?

Unidentified Company Representative

On free cash?

Paul Tufano

So if you look at the overall cash position, the fourth quarter is always a strong quarter for us. And obviously, we still expect it to be a strong quarter and we are doing everything we can to ensure that the cash generation in the fourth quarter gets us to at a minimum net debt positive breakeven position - at a minimum.

Unidentified Company Representative

Thank you. We will take the next question from the bridge please.

Operator

Thank you. The next question comes from Sandeep Deshpande from JPMorgan. Please ago ahead.

Sandeep Deshpande - JPMorgan

If again if I go to the wireless business, can we talk about how that mix in wireless is going to change going forward from here? How should we be modeling say 2014 in wireless particularly with China TD LTE is ramping up probably the margin initially in TD LTE will be low and how that margin will shift in the US as the US ramp in LTE continues given that you particularly don’t have that wireless scale in other markets to the extent that you have in China and the US? And I have one follow-up.

Ben Verwaayen

So if you look to the next generation you take LTE, we are building footprint in LTE in Latin America, in the US, in China and in selective other markets. That over time will have to go through and will go through the same type of maturity as you saw in other technologies, so that’s one. The issue there is that the variations of LTE from a radio perspective are more diverse than what we have seen in 3G which is an interesting phenomenon because of the spectrum policies of many different countries around the world. You also will see a drive to metro cells and small cells that’s in the nature - you talked 2014. In 2014, our metro cells and small cells will be a visible part of the total mix in wireless. There will be some investments in the let’s say maintenance part of the existing networks because networks don't disappear.

So there will be a kind of level on GSM, CDMA but that will be in a kind of maintenance type of mode. The expansion will all go to LTE small cells, metro cells type of environment; that is a safe assumption to make.

Now we are talking with our customers very, very intensely on where that market is going and how, what type of other products to support this capability because they don't do it because they want new technology, they do it because their customer base is consuming a very different set of services.

And in that type of services, there are adjacent territories that you need to cover than just simply the base station. We talked very much still about the base station business. In the base stations happen what I’ve just said. But in the network environment you will see a whole variety of supporting network capabilities, backhaul capabilities and service capabilities are needed to support the offer why they make all these investments in the first place.

So the nature of the wireless business from that point of view will also change, but if you bring it down simply to the base station environment and the mode of environment then it’s LTE and metro that will be growing in dominance in 2014, 2015.

Sandeep Deshpande - JPMorgan

And then if I ask a question on the balance sheet, I mean you’ve talked about potential disposal, you have talked about ways to strengthen the balance sheet, one of those which was the patent deal. Can you give an update on what's happening exactly on the RPX deal in terms of how long it is going to take to monetize that and what extent you think at this point it could generate in terms of cash and secondly, if there were to be disposals I mean, given that within the Corp. is it going to be that Alcatel-Lucent is going to become a smaller company or they are going to be minor disposals associated with businesses that Alcatel-Lucent doesn't think as core to the long-term future of the company?

Ben Verwaayen

So I don't think that is wise for me to go and speculate about disposals and the nature of disposals and other things. So I'm not going to do that. I will respectfully decline that invitation. It’s clear that what we as Paul said, what we will do is we will have a clinical view on what we will contribute, on what's necessary to strengthen our balance sheet and it’s the same with our patents. Actually, we could have made some patent deals already. We've chosen not to do it because it didn't give to our view the right value. So rather than trying to do something to please five minutes let's say the perception, we want to do what's right. I think we have also a program that gives us enough of confidence that we know what we need to do to strengthen the balance sheet and to reduce our cost and to reduce our portfolio to the right direction. So we are confident enough to say we only go for the good deals.

I'm not going to give you an exact timeline but we are working very hard on all of those elements and you should expect us to be very conscious of the fact that what we are going to do needs not just to be good on the very, very short-term, it needs to also strengthen this organization on an ongoing basis.

Unidentified Company Representative

Thank you, Ben. We will take the next question from inside the room please.

Francois Meunier - Morgan Stanley

Thank you. It’s Francois from Morgan Stanley. The first question if I may would be on the submarine business. I have heard you twice during the introduction remarks saying this business was at a cyclical low, what's the normal size of this business [cycle] [ph] and what are the normalized margins if you can answer on that.

The next question would be on the CapEx [thrust] [ph] for Q4. How do you feel about it? Do you think it’s going to be as strong as usual or maybe less strong given what AT&T and Verizon have recently said regarding CapEx? And then I am sorry I have to do it like (inaudible) but I have to try to think about [the options][ph] as well. In the past 10 years we've seen Ericsson taking tough decision of doing a rights issue which actually proved to be a pretty good decision. We've seen Marconi doing debt-to-equity swap, and it was actually a pretty good decision as well. Do you think those options are valid?

Ben Verwaayen

So I'm not going to comment about what Ericsson did or Marconi did or any other company. So (inaudible) you should ask other people and I don't think that it is anywhere near wise for us to go into talk about speculations. What we've said is we will do what's right for the company. We will do the right things on the balance sheet and I think that we have a lot of things that we can do, we have a lot of opportunities and we are working them one-by-one. We are making sure that we choose the right set of activities that we can do.

There are certain things we have to do in any case, in any case, and that is look to the realities of the market from cost, not assuming Europe to come back next year, so we will be pretty harsh on ourselves on the expectations in Europe because that I think is the safe thing to do, and you have seen it we have been now from now on prudency is the number one. So we are more prudent than prudent.

We will be more conservative to ourselves than we were in the past because clearly you cannot take anything for granted and that means that we will take every single step that’s necessary. Our Board is, we are very intensive working with the Board on all those issues. They are – it’s not, let’s say, what I signed up for time wise in the past. So they spend a lot of time with us, which is a good thing. I think we're very much aligned on what we need to do, and we will do what's required on the short-term and the long-term, not just on the short-term.

We do the right things for the company and I think that we have plenty of options to work with and we're doing that and we will not shy away from what's necessary to go and do. So that’s the only thing I can say.

And the same is with the assets. There are people who said have you kind of made up your mind on what is possible or not possible. It is very, very clear, we will take a very good deep look but with urgency on what we need to do and how we need to do it and how we need to frame it in a way that is not just as I said short-term but also longer-term in the best interest of the company. Anything to add?

Paul Tufano

I think I’ll add that on the submarine business, to your earlier question I’ll not give you the specifics but submarine or underwater cable to transport large amounts of data is a market that will increase in time over the next several years just because of data traffic. We have one of the few businesses in the world that’s totally integrated with the breadth and scope and so we're in extremely strong market position. These cycles last a couple of two years, three years, we are at a low point, as we look at contracts being awarded and our ability to win those contracts, we are gaining more than our fair share. So we believe that this is an extremely attractive business and you have to look at it over the cycle type of profitability.

Unidentified Company Speaker

Thank you very much. We are going to take the next question from the bridge please.

Operator

Thank you. The next question comes from Kai Korschelt from Deutsche Bank. Please go ahead.

Kai Korschelt - Deutsche Bank

A couple please and thanks for taking my question, the first one was if I just look at the receivable sold or refactoring, looks like it increased euro 100 million it’s now about a quarter of revenues, so I am just wondering how far do you think you can potentially extend from the current run rate as a means of short-term financing?

And then my second question is on the - have you ever looked at the potential revenue leakage or loss post the restructuring; I am not only referring to managed service I think you have a given us a number but on the equipment side I presume there would also be some losses on the revenue side as you exit some markets and may be some customers? Thank you.

Ben Verwaayen

So let me start with the last one. I think that strangely enough it could be the reverse because we may lose - and certainly from a profitability it’ll be the reverse because as we said last time if you look to the tail end, our tail end is extraordinary thin. So I don’t think that will be any significant loss on the top line, it will certainly improve on the cost side. And you take the first…

Paul Tufano

On the discounting, we are relatively flexible in how much we discount. We’ve discounted average between euro 700 million, euro 800 million to a euro 1 billion, euro 1.1 billion, euro 1.2 billion and we have the wherewithal to do that and so we will continue to work within those ranges and so we are pretty confident in our ability to continue to leverage the discounting programs.

Unidentified Company Representative

Thank you very much. We will take the next question from the room please.

Odon de Laporte - Cheuvreux

This is Odon de Laporte with Cheuvreux. Another follow-up question regarding your wireless business, I appreciates that wireless is not only base station but some also service capabilities on router, stuff like that, but if you insulate the base station business, do you expect even a slight improvement in profitability going forward, I mean in the foreseeable future?

Ben Verwaayen

So, if you look to the base station business at such, it depends on the mix that you have within the product. As the mix goes from 3G to 4G on the short-term, you will have a loss because 3G was the better margin product given the lifecycle where that's in. As long as you realize that a winning company spends as much time to innovate as to cost [reduce] [ph]. And one of the things that you have to realize is that we had been stretched to the extent that the cost improvement part was not getting the same type of focus that you will find with some of our competitors.

So by reducing that focus, it also increase our capability to do some severe work that's needed and possible and capable of cost reduction, that will not happen in two weeks, those effects, but if I look to where we are today, you should look to a business that is in transition and in transformation at the same time; the technology in the market changes and the way that we look to that business also changes. So per product per unit, I would say it’s a kind of (inaudible) that you will need to see.

Unidentified Company Speaker

Thank you very much, and we are going to take the next question from the bridge and then we will come back to the room in a moment.

Operator

Thank you. The next question comes from Anuj Krishan from UBS. Please go ahead.

Anuj Krishan - UBS

Ben, first of all if I can just ask you your views currently on fiber build out in Europe, I mean there have been some comments from operators talking about cutting their dividends but investing in networks particularly fiber. There have also been some positive regulatory noises out of Brussels. How do you sort of see this spanning out over the next few years?

And secondly, Paul perhaps if you can talk about your ability to tap the bond markets at this point in time. Do you think there is any scope to refinance some of debt and also if you can provide an update on the renegotiation of the credit facility please?

Ben Verwaayen

So why don't you start, because I start probably with something positive which may not be…

Paul Tufano

So I think there are opportunities, there are a number of opportunities to address the debt profile. We are actively exploring them and I think as we do that, it can have a material impact on how people view our liquidity. As we do that it could also be in concert with the RCF.

Ben Verwaayen

I am still to answer my question on, but I apologize to be optimistic, because I am pretty optimistic that the combination of new regulatory environment and public pressure and promises now made by major operators in Europe will indeed make sure that 2013 will be a good year for vectoring and fiber roll outs in Europe increasingly so in 2014.

Anuj Krishan - UBS

And in that business Ben, how would you see your sort of market position right now given just how much market share the Chinese vendors have taken up over time?

Ben Verwaayen

Well, let me take the risk of being twice optimistic in one meeting. I think we have a very, very, very good position. We are the only one in vectoring to be honest right now that is deployed. And I cannot recall but one order that we missed, just one over the last three months in this domain and that was for different reasons. In fiber I think we are one of 2.5, and if you would give us a position I would say we are sharing the gold medal there. So we are really in a good position. Now that is business that has the same characteristics, I have to be brutally honest with you, as we just discussed in wireless base stations. You need to make sure that you put as much money into the improvement of your margin structure there and the cost as you can do in the product innovation. But I can say that we have done a good job in that part of the business. It’s a good job and there is substantial growth there.

Anuj Krishan - UBS

Okay thank you very much.

Unidentified Company Speaker

Thank you very much. Question.

Sebastien Sztabowicz - Landsbanki Keppler

Hello Sebastien Sztabowicz with Keppler. I know it is a bit early but could you please give some color on your market evolution for 2013, where do you see the market trending next year?

Ben Verwaayen

So we normally have this great habit that we give a forecast for 2013 at the end of the year when we talk about 2012. So I'm not going to give you any forecast, but I will give you some color about what's happening around in. As I said earlier we do a lot of talking with our customers and especially since it is not lost upon them that we may need some help in certain areas to understand what we need to make our investments, they are quite willing to do so with us and especially also in the US. So I think we have a pretty good look to where the world is going and I wouldn't make the bets that 2013 will be dramatically different than 2012.

Unidentified Company Representative

Okay. Thank you very much Ben. That concludes today's conference. We thank you for your time joining us by bridge and here in the room, and we look forward to seeing you again soon. Thank you.

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