3Q98 Lucent Conference Call:
Financial Summary
Net Icome 435 million or 32 cent per share excluding
one time charge of 668 million for the write off of
in process R and D related to the acquisitions of
Yurie Systems and Optima.
Including these charges we reported a loss of 232 million
or 17 cents per share.
Remainder of report will exclude these charges,
Results also include a 50 million per tax and
32 million dollar after tax reversal of some
business re-structuring charges.
Earnings were more than double year ago results
for the Q of 213 million and EPS increased 88 percent
over the 3Q97. Results reflect higher revenues and
favourable sales mix combined with a continued focus
on operational discipline.
For the Q revenues were 7.2 billion up 19.2 percent
on a continuing operations basis and up 14 pecent
when compares to the overall revenues in 1997.
Continuing revenues excludes revenues from the former
consumer products division which became part of the
Phillips communications venture and the ATS business
a small government services business which we sold.
Operating income was 766 million more than double
the 380 million of year ago period.
Operating margin improved to 10.6 percent from 6 percent
of revenue a year ago.
Gross margin was 45.4 percent reflecting continuing
favourable mix of products and services and improved
management of cost.
SG&A expenses were about 1.6 billion or 21.7 percent of sales
versus 22.1 percent of sales last year.
R&D expenses were 947 million or 13.1 perent of sales
compared to 12.9 percent last year.
As we have said the last 2 Q's R&D expenses has increased
to take advantage of high growth opportunities in wireless systems,
data networking, optical networking, as well as switching
and access system. Customer needs are driving R&D spending and
we believe this will pay off as new products come to market.
Cash at 1 billion dollars as of June 30. Inventory
up 47 million or 1.6 percent to about 3 billion dollars
while contract and in progress contracts have increased 359 million
to just about 1.4 billion due to the continued built out
for some of the large contracts. Accounts receivable
increased by 419 million or 7.7 percent to 6 billion
dollars. Shareholder equity is up by about 45.3 percent
since September or about 5 billion dollars partially due to
the increase in paid in capital as a result of the Livingston
and Promnet(sp?) acquisitions as well as the
net income of the 9 months.
Business Units:
Growth in revenues is evidence of our efforts to smooth out
seasonality in our business. We continue to see strength in
the US market and sales outside the US grew 26 percent
driven by increased sales to service providers and
enterprise customer. This is very encouraging in light
of the softness of the market due to problems in the
Asia-Pacific region.
Moving to the results for our largest group of
operations, systems for network operators, revenues
grew 629 million dollars in Q3 a 16.6 increase over 3Q97.
In addition to growth in traditional RBOC and long distance
customers, we saw increases in sales to CLEC and wireless providers.
Increased revenues were lead by increases sales of switched and
wireless systems. We doubled our sales of data networking systems
to service providers. This includes sales from the acquired
Livingston Enterprises.
Non-US sales to service providers were strong, up 28 percent.
Increased sales were lead by higher sales in Europe/Midddle East/Africa
region, Carribean-Latin America, Canada and China.
Major wins for the wireless division with serveral outside the
US. Yesterday we announced a 810 million dollar deal with
the Saudi Telecommunications company with 669 million
for the expansion of their GSM network and 111 million for
switching.
Also a 60 million dollar GSM contract with Germany's
largest cellular operator Tee-Mobile(sp?).
100 million CDMA ontract with TelCell (sp?) Venezwala's (sp?)
largest wireless service provider.
We have strengthen our business in China by signing service,
and optical system network contracts including DWDM.
We remian focused on the rest of Asia-Pacific. We won
several of the very few contracts awarded otuside of China
this year. We did this by leveraging our broad product portfolio
to win a switching and wireless contract in the Philipines
and Taiwan, and an optical network in Japan and Korea.
We are convinced that our committment to region despite
the economic uncertainties will be ultimately recognized
and rewarded by our customers.
In the US we won several strategic contracts. Yesterday
we announced a 5-year agreement with SBC Communications
worth up to 2.4 billion dollars. We will be deploying state
of the art switching equipment including our flag ship
5ESS 2000 media switch through SBC's 7 state territory.
Also CDR(?) group selected LU to supply land based
optical networking equipment. software and power systems
and professional services for a high capacity
global under sea cable network called
project Oxygen. We expect sales of of optical
networking system, network management systems
and other products to reach 1 billion dollars
over 4 years.
Bell Atlantic has selected us to supply equipment and
software for their next generation data packet switched
long distance network. This is a 5 year agreement worth
more than 200 million dollars.
A 3 year agreement with Sprint PCS for the next phase of
their nation wide wireless network. This could be worth
up to 700 million dollars.
A 280 million dollar CDMA contract with Telecorp (SP?)
AT&T 's largest affiliate.
In business communication systems, revenue increased
by 436 million dollars in the Q, a 28 percent increase
with strong revenue growth inside and outside the US.
Revenues were primaryily driven by increased sales of
Definity systems, messaging systems including sales from
the recently acquired Octel, enterprise data networking
system, System X networking systems and services.
Sales outside the US were up 46 percent with
increases in all major regions.
As sales of data networking systems through enterprise
customers expand we contine to take action to improve
our offering to these customers. Earlier this month we
announced the acquistion of Lenit(sp?) a leading supplier
of next generation ethernet solutions and ATM solutions
for LAN's. Lenit which is based in Isreal has a strong
presence in Europe and has distribution agreements
and customers around the world. We gain additional
data networking strength and a broader global reach.
Micro-electroncis revenues were 736 million dollars,
up 7.1 percent driven by increased sales of customized
chips for communications and computing, including
components for wirless telehpones, LAN's , data networking
and I.N. computer work stations. We also saw higher sales
of power systems and optical electronic components.
Clearly revenues in this division has been impacted
by softness in the overall market particularly in
the mass storage, disk drive and modem market.
However we believe this division is out pacing the industry
average. During the Q we announced an agreement with MOT
to design an advanced DSP technology and cross license each
others DSP architecture. The alliance will allow us to
deliver the next generation DSP's faster for a variety of industries.
including communications, transportation and consumer electronics.
For the first 3 Q's we grew revenues by 19.4 percent
on a continuing operation basis and increased
net income by 53 percent. We improved gross margins
by 2.9 percentage points. SG&A is 20.8 percent of sales
compared to 21.4 for the first 9 months of last year.
R&D increased to 12.2 percent of sales in order to provide
timely release of products to the high growth markets that we are
targeting including wireless systems. optical networking,
data networking, as well as switching and access systems.
We reduced our tax rate by 2.5 percentage points.
Results show a balance in LU product lines by product
and geographic regions. We believe the depth of
LU's portfolio has given us market strength and
performance predictability.
Question: Comment on areas of strength that produced the gross
margin? Specifically software? Comment on sustainability of gross
margins? For international markets you showed incredible strength
this Q, in future what percentage of sales will come from
international markets in a few years? What area geogrpahical
has the biggest opportunity?
Answer: Pricing is not a factor in improved gross margins.
We are seeing the same kinds of pressure we have seen for
the last few years in terms of a downward trend. What is
driving improved gross margin is due to product mix.
Our mix has been favour by the demand pattern in
North America in some of our traditional products
but also in wireless and software as you suggested.
Software mix is a little favorably this Q but this
is a mix story too. Our independent software did
pretty well. Our 5E software was just OK. I can't
really point to software as the driver of this result.
But overall core infrastructure strength which was driving
result. We believe that demand for our infrastructure
products will built as internet demand and second line
demand increases. We don't see any decrease in demand.
But, in dicussions over budgets with sales personnel
we don't see continuing strongs margins going forward
with any kind of upward trend. We don't see an change
in guidance. Long term we don't see any substantially
increased gross margin level over what we have seen
in the past.
In international markets we are seeing global trends.
We are seeing covergenece in all markets. There
may be delay of a few years in some of the markets.
It gives us an enormous opportunities. We are seeing
new relationships being developed with service providers
around the globe with the de-regulation. We see this
a major opprotunity as a result of this trend.
This is an opportunity in Europe, Latin America, Asia.
You have to factor in the effect of the major players
in those markets. If you look to Europe you see a
number of LEC coming up quickly. We are in discussion
with all major players around the globe. This is a change
from a few years ago. We are seen as a major strategic supplier
of solutions in the convergent technology market.
Micro-electronics division already has over 50 percent of the
business outside the US. PCS is going fast outside the US.
I have no reason to see why this trend will not continue.
In 2000, ideally we would like to have a balance where the
revenue distribution reflects growth. We expect to
maintain a strong position in the US. If you factor in Asia
we see at least 60 percent of the growth coming from international
sales. Convergence will drive this, but international standards
and proprietary standards where providers will not wait for
a standard but go for the best solutions will also drive growth.
In the service provider market the notion of quality of service
and the need for the quality of service and managabiity of networks
will be a great advantage to us because data networks will be expected
to have the same quality of service as voice networks.
Question: What are international market share goals? What about
Europe in 5 years time? Toughest competitors in Europe?
Profit expectations with move into Europe? Acquisitions?
Answer: Market share is not as it should be.
We see a good opportunity to
grow. There are strong major suppliers there already.
LU will bring a different perspective and set of solutions.
Convergence will produce a new set of requirements
that the move to the data side will require. They will
need a quality of service in the data world that is
equivalent to the quality of service on the voice
side because their customers will expect that.
In Europe we see strong players with global
aspirations. Those customers are looking for
solutions that span the globe. I think LU
with its breadth of products will make
them an attractive supplier. As a result we will
see LU growing substantially in the next few
years in market share and dollar terms. This
is a compettive market so it is difficult to
predict where margins will be. Margins
are also a reflection of the business
mix. We will need to grow our markets, compete
will other supplier and maintain a healthy
margin.
Question: What opportunities do you see with the wireless
market, CLEC and ILEC in Europe? Specifically where do you
expect LU to most successful and where LU needs work?
Update us on Oxygen consortium in bid its to raise capital.
In recent contracts LU has been more agressive on vendor
financing while competitors have focused on price to
achieve wins. Why the preference for balance sheet risk
versus gross margin risk?
Answer: We won't comment on behalf of CTR ( Oxygen project).
We have a good relationship with them though.
In regards to European wireless , we are late with GSM in the
market, we are making progress with 3G. we are the world
leader in wide band CDMA this will help us there. Data world
in wireless in Europe is potential interesting as is fixed
wireless. It is a broad arena. There are many licenses up for
sale in Europe. Everyone understands there is money to
be made, so many of the new players will be a opportunity
for LU. We look to Europe in respect to the global market.
The wireless players in Europe are connected with
global players. It is important opportunity looking forward
in the coming years.
On margin versus vendor financing. We did not looking
at it this way. We look at it from a profitability
point of view. We have the best in class margins.
We intend to keep those up as we enter new markets
and grow market share. On vendor financing our
policy has not changed. We take paper that we
think is fundable , though in some cases the provider
needs to built out the infrastructure and get some
revenues before the market is ready for the paper.
We hold very little of our own financing. Our
objective is to have this continue. We think we
are in a good position to judge project risk.
As a result balance sheet risk is transitory
while a price concession will mean we would
have to live with that price forever.
The strategy allows us to grow and hold our
margins.
Question: Size the business in China? Growth rates?
Market condition and position of local suppliers
there? Reserve amount left and timing of reversal
descisions?
Answer: We don't give specifics for a region.
The contracts in Q is a clear signal of the more
strategic role we are playing in the Chinese
market. We are changing from a vendor to a
strategic supplier. We are seeing health growth
in China. We expect that to get better.
Despite the fact that local supplier will become
more important than today , our strength in intellectual
property , knowledge of networks and our ability
to deploy them in a timely fashion. Local suppliers
and LU will go together very well in the expansion that
will take place. They add an RBOC per year in
their already very large network in China.
Business restructuring reserves at the end of the Q
was just over 300 million. We started with 2.4 billion
and the projects that required those funds by definition
are now 85 percent complete. We don't expect it to be
zero by Sept,but we will continue to utilize it.
We don't intend to reverse this back into income.
We will use it to continue to improve the business.
We will deal with risk and exposure on a current basis.
We will not carry forward problems. Although
we have seen good progress in de-leveraging the
company and building equity account we are dealing
quickly with any financial exposure and will continue
to do so.
Question: What were the new significant new customers
added during the Q? Which contracts allowed you to
increase peneratration of existing customers?
SBC was one. What is the revenue growth of AT&T
compared to overall company growth in 1998
looking like? What is the switching and wireless
spending pattern at At&T?
Answer: We have significant wins with new LEC's both
in the US and in outside the US. Our product portfolio
is not attractive only to established players but to
revolutionary networks. CTR is a new approach with them
being the carrier of carriers. It will reach all continents
except Antartica. If you look at present customers
our depth of our involvement in the data area is the
most significant step we have taken in this Q. Both
ATM and IP based announcement in the Q made us a data
equipment supplier as the traffic in networks evolves.
It is the potential to grow as LU grows it product
portfolio that will be of strategic importance.
We don't provide AT&T sales data except on an annual basis.
AT&T is still our largest customers. Our relationship is fine.
We will grow as they grow.
Question: On interest in Any media switch especially out
of SBC, to what extend is demand for it related to it being
viewed as a data gateway and the data feature on it? On China,
in the wireline side there are a lot of entrenched domestic
and European vendors. On the wireless side the first and second
rounds went to a lot of European vendors. How are you
then going to pursue the market?
Answer: On the 5ESS we will add the port master 4 this Q to
allow the switch to operate as a data switch. This will allow
SBC to evolve their network as demand evolves so they
can deploy new services and get a new revenue base.
In China, we expect to grow as the market is growing.
There is a huge re-organization going on in China.
This will allow Great Wall and Unicom to re-position themselves
in different competitive markets. NPT will be broken up into
31 regional carriers ( one in each province ) and allow
NPT to be more market oriented. This will open a lot
of new opportunities. Services will determine revenues
and revenues will determine their potential to invest.
We will not just be going with the new carriers , we have
a strong relationship with NPT (China Telecom as it now called).
Question: If you look at operating expenses, year over year it
was flat so most profits came from the gross margin expansion.
Is there any more room on the SG&A side to improve margins?
Answer: Yes, thers is . It will be difficult to say we are world class
cost structures. We have not taken all the productivity gains
on our R&D expenditures.
Question: On PCS there was some product delivery problems.
Have those be solved? Most of the growth in international
PCS has been in the 40 percent range most of that
from Octel, once we are past the September Q what
kind of normalized level should we expect.
Answer: Delivery and installation problems were a result of
very high growth in the Q. We have improved our installation
and delivery capabiities. If we exceed our current growth rates
we will have a similar problem. But with current projections we
can deliver and install.
Outside the US it is not only Octel. The Definity product is
doing outstanding. We have messageing opportunities that will
include Octel. In the data world, we are doing very well.
In Europe and Asia our call center capabilities are first
class and unique. Call centers in those regions are behind
those of the US so we are looking for future growth.
Installation was a transitory issue. We do not expect
it to come back as an issue.
Question: For Network systems is the growth rate of central
office switching growing at or above the level of that for
networking systems? In the PCS business without Octel is this
a mid-teens growth business?
Answer: Central office business is one of the core engines for
our growth. This is to be expected given the rate of
growth especially in the US given the growth of 2'nd
lines and longer hold time impacting the network.
In PCS, growth rate in the mid-teens if you looks at last
years result and this directional correct.
Question: For system for network operator, what was the mix
of hardware to software? Are LU potential customers
in Europe similar to NT's which are new carrriers are can
you leverage you old contacts to get business to win some
PTT contracts in Europe.
Answer: There are two kinds of software in systems for network
operators. The first is the standalone, the vendor independent
software , and this was very strong for the Q. The second is the
embedded software for the systems and this was a little weaker
this Q because of the mix and the timing of some of the contracts.
This gives a mixed picture for software sales. We are optimistic
though.
In Europe, we think products and technologies will help
us make sales not personnal relationships. We have products
that will appeal to traditional PTT and newcomers. We will
go with major players and new players at the same time.
Question: The growth rate in business communications systems
was in the mid-teens without Octel, if we look at all the
acquisitions I see low double digits growth. Is this true?
Did Octel show up in the result for a full Q in the September
or the December Q of last year? In the micro-electronics
division the growth was 7 percent. This area is going
through tough times. Can LU get back to teen growth rates
or are we more likely to see less than 10 percent for the
next few Q's?
Answer: In the BCS division, I think the growth rates would
be the same even if we were talking about one or all of the
acqusitions. In terms of Octel timing it was included
starting Oct 1 so the December Q was ths first full Q.
On micro-electronics, we focus on the telecommunications market
and this is strong than all the other markets. Predictions
of the industry indicate a recovery some time in 1999.
I think it would very disappointing if we are not in double
digits next year.
Question: Indicate LU positioning on 3G issue, particular on
backward compatibility on CDMA? On SBC contract, LU will
be seeing more data sales which has higher gross margins,
but SBC is telling the analysts that it size will
give it more pricing power. What will the gross margin
for this contract?
Answer: On 3G we are not supporting any one standard. Backward
compatibility will be necessary to get a 3G systems up fast.
LU is trying to position themselves so that they can supply
to existing carriers. THe 3G debate has focused on the technology
side. There is an economic side. The economic sides will
show itself as the pilots come up. We expect the standards to
come closer and closer. We expect 1 or 2 standards on 3G,
but not more than that.
SBC contract is a win/win situation. They are aggressive in their
purchasing habits. We will need to manage our cost.
Question: Any developments on your Any media product?
On schedule for deployment? Any new features?
Answer: We are adding more and more features. We can
customize to a customer so they can discriminate themeselves
in the market place. We are on schedule for deployment.
ATM, IP and bandwidth management features will allow a
provider to discriminate themselves in the market place.
Question: Consensus opinion is that LU must make a large
acquisition. Most acqusitions to date have been small.
Is there a change in strategy coming and how much
dilution would LU accept.
Answer: We have traditionally positioned ourselved
so that acquisition further our business only. There
is not change in strategy.
Our goal is shareholder value, we are not trying to build the
biggest company in terms of revenue and employee. Dilution is
alway an issue in all acquisitions.
Closing comments: I have been here one year. I am impressed
by the introduction of speed into the Bell Lab's structure.
We think we can compete globally as a result of the
globalization of standards. This is a new shift since as recently
as 5 years ago each carrier had their own standard. We are
one of the first to recognize and benefit from this. |
