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AS FILED WITH THE SEC ON AUGUST 13, 2002
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________to _____________
Commission file number 001-11639
LUCENT TECHNOLOGIES INC.
A Delaware I.R.S. Employer
Corporation No. 22-3408857
600 Mountain Avenue, Murray Hill, New Jersey 07974
Telephone Number: 908-582-8500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
At July 31, 2002, 3,432,688,763 common shares were outstanding.
2
PART 1 - Financial Information
Item 1. Financial Statements.
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
Three months ended Nine months ended
June 30, June 30,
2002 2001 2002 2001
------- ------- -------- --------
Revenues $ 2,949 $ 5,886 $10,044 $16,139
Costs 2,298 5,057 8,156 14,144
------- ------- ------- -------
Gross margin 651 829 1,888 1,995
Operating expenses:
Selling, general and administrative 871 2,046 2,992 6,049
Research and development 480 793 1,625 2,775
Business restructuring charges and asset impairments, net 1,602 541 1,464 2,715
------- ------- ------- -------
Total operating expenses 2,953 3,380 6,081 11,539
Operating loss (2,302) (2,551) (4,193) (9,544)
Other income (expense), net (261) (179) 242 (296)
Interest expense 107 115 284 395
------- ------- ------- -------
Loss from continuing operations before income taxes (2,670) (2,845) (4,235) (10,235)
Provision (benefit) for income taxes 5,329 (967) 4,782 (3,394)
------- ------- ------- -------
Loss from continuing operations (7,999) (1,878) (9,017) (6,841)
Income (loss) from discontinued operations, net (27) (1,360) 73 (1,673)
------- ------- ------- -------
Loss before extraordinary item and cumulative effect of
accounting changes (8,026) (3,238) (8,944) (8,514)
Extraordinary gain, net - - - 1,154
Cumulative effect of accounting changes, net - - - (38)
------- ------- ------- -------
Net loss (8,026) (3,238) (8,944) (7,398)
Preferred stock dividends and accretion (42) - (124) -
------- ------- ------- -------
Loss applicable to common shareowners $(8,068) $(3,238) $(9,068) $(7,398)
======= ======= ======= =======
Loss per common share - basic and diluted
Loss from continuing operations $ (2.34) $ (0.55) $ (2.67) $ (2.01)
Net loss applicable to common shareowners $ (2.35) $ (0.95) $ (2.65) $ (2.18)
Weighted average number of common shares
outstanding - basic and diluted 3,428.5 3,405.2 3,422.5 3,396.9
See Notes to Consolidated Financial Statements.
3
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
June 30, September 30,
2002 2001
-------- ------------
ASSETS
Cash and cash equivalents $ 4,556 $ 2,390
Short-term investments 867 -
Receivables, less allowance of $517 at June 30, 2002, and $634 at September
30, 2001 2,245 4,594
Inventories 1,981 3,646
Contracts in process, net of progress billings of $9,824 at June 30, 2002,
and $7,841 at September 30, 2001 230 1,027
Deferred income taxes, net - 2,658
Other current assets 1,287 1,788
-------- --------
Total current assets 11,166 16,103
Property, plant and equipment, net 2,519 4,416
Prepaid pension costs 4,945 4,958
Deferred income taxes, net - 2,695
Goodwill and other acquired intangibles, net of accumulated amortization of $617
at June 30, 2002, and $832 at September 30, 2001 367 1,466
Other assets 2,364 2,724
Net long-term assets of discontinued operations - 1,302
-------- --------
Total assets $ 21,361 $ 33,664
======== ========
LIABILITIES
Accounts payable $ 1,245 $ 1,844
Payroll and benefit-related liabilities 1,058 1,500
Debt maturing within one year 173 1,135
Other current liabilities 4,240 5,285
Net current liabilities of discontinued operations - 405
-------- --------
Total current liabilities 6,716 10,169
Postretirement and postemployment benefit liabilities 5,127 5,481
Long-term debt 3,237 3,274
Company-obligated 7.75% mandatorily redeemable convertible preferred
securities of subsidiary trust 1,750 -
Deferred income taxes, net 11 152
Other liabilities 1,753 1,731
-------- --------
Total liabilities 18,594 20,807
Commitments and contingencies
8.00% redeemable convertible preferred stock 1,847 1,834
SHAREOWNERS' EQUITY
Preferred stock - par value $1.00 per share;
Authorized shares: 250,000,000;
issued and outstanding shares: none - -
Common stock - par value $.01 per share;
Authorized shares: 10,000,000,000; 3,433,270,277 issued and 3,432,603,658
outstanding shares at June 30, 2002, and 3,414,815,908 issued and
3,414,167,155 outstanding shares at September 30, 2001 34 34
Additional paid-in capital 20,468 21,702
Accumulated deficit (19,216) (10,272)
Accumulated other comprehensive loss (366) (441)
-------- --------
Total shareowners' equity 920 11,023
-------- --------
Total liabilities, redeemable convertible preferred stock and
shareowners' equity $ 21,361 $ 33,664
======== ========
See Notes to Consolidated Financial Statements.
4
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Nine months ended
June 30,
2002 2001
------- --------
Operating Activities
Net loss $(8,944) $(7,398)
Less: Income (loss) from discontinued operations 73 (1,673)
Extraordinary gain - 1,154
Cumulative effect of accounting changes - (38)
------- -------
Loss from continuing operations (9,017) (6,841)
Adjustments to reconcile loss from continuing operations to net cash used in
operating activities, net of effects of dispositions of businesses and
manufacturing operations:
Non-cash portion of business restructuring charges 434 2,636
Asset impairment charges 837 -
Depreciation and amortization 1,189 1,955
Provision for bad debts and customer financings 829 1,950
Deferred income taxes 5,285 (3,072)
Net pension and postretirement benefit credit (719) (820)
Gains on sales of businesses (583) (56)
Other adjustments for non-cash items 287 375
Changes in operating assets and liabilities:
Decrease in receivables 2,008 3,790
Decrease (increase) in inventories and contracts in process 1,870 (369)
Decrease in accounts payable (592) (673)
Changes in other operating assets and liabilities (1,782) (1,810)
------- -------
Net cash provided by (used in) operating activities from continuing
operations 46 (2,935)
------- -------
Investing Activities
Capital expenditures (312) (1,102)
Purchases of short-term investments (865) -
Dispositions of businesses and manufacturing operations 2,543 2,494
Other investing activities 108 (43)
------- -------
Net cash provided by investing activities from continuing operations 1,474 1,349
------- -------
Financing Activities
Issuance of company-obligated 7.75% mandatorily redeemable convertible
preferred securities of subsidiary trust 1,750 -
(Repayments of) proceeds from credit facilities (1,000) 4,800
Net repayments of other short-term borrowings (45) (2,065)
Payment of preferred stock dividends (73) -
Other financing activities (3) (97)
------- -------
Net cash provided by financing activities from continuing operations 629 2,638
Effect of exchange rate changes on cash and cash equivalents 28 (25)
------- -------
Net cash provided by continuing operations 2,177 1,027
Net cash used in discontinued operations (11) (209)
------- -------
Net increase in cash and cash equivalents 2,166 818
Cash and cash equivalents at beginning of year 2,390 1,467
------- -------
Cash and cash equivalents at end of period $ 4,556 $ 2,285
======= =======
See Notes to Consolidated Financial Statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
1. BASIS OF PRESENTATION
Lucent Technologies Inc.'s ("Lucent" or the "Company") unaudited consolidated
financial statements reflect all adjustments (consisting of normal recurring
accruals) that the Company considered necessary for a fair presentation of
results of operations, financial position and cash flows as of and for the
periods presented.
The consolidated financial statements are prepared in conformity with generally
accepted accounting principles. Management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and revenues and expenses during the periods reported. Actual results
could differ from those estimates. Among other things, estimates are used in
accounting for long-term contracts, allowances for bad debts and customer
financings, inventory obsolescence, restructuring reserves, product warranty,
depreciation, employee benefits, income taxes, contingencies and loss reserves
for discontinued operations. Estimates and assumptions are periodically reviewed
and the effects of any material revisions are reflected in the consolidated
financial statements in the period that they are determined to be necessary.
The Company believes that adequate disclosures are made to keep the information
presented from being misleading. The results for the periods presented are not
necessarily indicative of the results for the full year and should be read in
conjunction with the audited consolidated financial statements included in
Lucent's Current Report on Form 8-K, filed on June 17, 2002, for the year ended
September 30, 2001.
Certain reclassifications were made to conform to the current period
presentation.
2. BUSINESS RESTRUCTURING CHARGES AND ASSET IMPAIRMENTS, NET
Due to the continuing decline and uncertainty in the telecommunications market,
Lucent committed to additional restructuring actions to align the business with
market opportunities. As a result, Lucent recorded net business restructuring
charges and asset impairments of $808 in the three months ended June 30, 2002.
The charges were primarily comprised of further headcount reductions, facility
consolidation and asset write-downs, $335 of which will result in future cash
outlays. Included in the net asset write-downs were net charges for inventory of
$43, which were included in costs. The components of the net charges included:
o net employee separation charges of $358 for approximately 7,000
employees, of which $124 is expected to impact cash. The remainder of
the charge was for pension termination benefits of $101 for certain U.S.
employees expected to be funded through Lucent's pension assets and $133
for pension, postretirement and postemployment benefit curtailment
charges (see Employee separations below for additional information on
headcount reductions);
o charges for facility closings of $159, including $41 related to new
plans and $118 for revisions to prior plans. The revisions were due to
changes in estimates as to the amount and timing of expected sublease
rental income as a result of changes in the current commercial real
estate market;
o contract settlements and other liabilities of $52 and other asset
write-downs of $169. The charge for asset write-downs is net of $41 of
reversals primarily for adjustments to estimates for inventory charges
from prior plans. Since Lucent's restructuring program is an aggregation
of many individual plans that are currently being executed, actual costs
have differed from estimated amounts and the individual plans may be
different in the future. Asset write-downs were primarily for inventory,
property, plant and equipment, goodwill, and capitalized software
largely associated with additional product exits in certain switching,
access and optical networking products in the Integrated Network
Solutions ("INS") segment; and
o a loss of approximately $70 related to business dispositions, including
the enterprise professional services business. The loss was included in
business restructuring as the disposition of these businesses were
contemplated as part of Lucent's overall restructuring program.
In addition to the net charge recorded in the three months ended June 30, 2002,
the nine months ended June 30, 2002, included a net reversal of business
restructuring charges and asset impairments of $128, including net charges for
inventory of $10 reflected in costs. The net reversal included:
o a $110 gain realized from the sale of the billing and customer care
business. The gain was included in business restructuring as this
business disposition was contemplated as part of Lucent's overall
restructuring program;
o a net reversal for existing plans of $304, which consisted of $82 of
additional charges primarily related to changes in estimated inventory
provisions for certain existing restructuring plans and reversals of
reserves for existing plans of $386. The reversal included revised
estimates of $119, primarily for settling certain purchase commitments
for amounts lower than originally planned, $126 for employee separation
costs, $77 for excess inventory reserves and other reserve reductions of
$64. The reversal of employee
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
separation reserves was due to higher than assumed attrition rates,
which reduced the number of employees to be terminated by 1,700. In
addition, although reasonable cost estimates were used upon the initial
recording of the charge, the actual severance cost per person was lower
than the original estimates upon the execution of many plans covering
many countries. In establishing the initial charge for inventory, Lucent
included an estimate of amounts relating to products rationalized or
discontinued that were not required to fulfill existing customer
obligations. To the extent the fulfillment of those customer obligations
differed from amounts estimated, additional inventory charges or reserve
reductions were required; and
o charges for new plans of $286, which included employee separation
charges for approximately 1,600 employees of $62, net of a
postemployment benefit curtailment credit of $21, lease termination fees
and other contractual obligations under operating leases associated with
additional facility consolidations of $82, contract settlements of $8,
other liabilities of $23 and asset write-downs of $111. Asset
write-downs are primarily for property, plant and equipment associated
with the disposition of a manufacturing operation.
Employee separations
Including the additional 7,000 headcount reductions discussed above, the total
voluntary and involuntary employee separations associated with the employee
separations net charge recorded in fiscal 2001 and through the nine months ended
June 30, 2002, were 45,700. As of June 30, 2002, approximately 37,500 were
completed, with approximately 1,500 completed in the three months ended June 30,
2002. The completed and future employee separations affect all business groups
and geographic regions. Approximately two-thirds of these separations were
related to management employees and were involuntary. Lucent expects that the
majority of the remaining separations will be completed by the end of the first
fiscal quarter of 2003. In addition, since December 31, 2000, 15,500 of employee
separations were achieved through attrition and divestitures of businesses.
Lucent continues to evaluate the current restructuring reserve as plans are
being executed. As a result, there may be additional charges/reversals. This
table displays the activity of the restructuring reserve for the nine months
ended June 30, 2002, the balance at June 30, 2002, and the components of the net
charges for the nine months ended June 30, 2002:
September 30, Net charges/ June 30, 2002
2001 reserve (reversals) Deductions reserve
----------- ------------ ---------- -------
Restructuring costs
Employee separations $ 588 $ 294 (a) $ (641)(a) $ 241
Contract settlements 610 (38) (300) 272
Facility closings 296 217 (83) 430
Other 125 14 (70) 69
------ ------ ------- ------
Total restructuring costs $1,619 $ 487 $(1,094)(b) $1,012
------ ------ ------- ------
Asset write-downs
Property, plant and equipment 121
Capitalized software 58
Inventory 53 (c)
Other 1
------
Total asset write-downs 233
Net gain on sales (40)
------
Total net charges/(reversals) for
business restructuring $ 680
------
Impairment of goodwill and other assets $ 837
-------
Total $1,517
=======
- ---------
(a) Includes non-cash charges of $120 of pension termination benefits to
certain U.S. employees expected to be funded through Lucent's pension
assets, $142 pension and postretirement benefit curtailment cost and
$21 postemployment benefit curtailment credit.
(b) Includes cash payments of $811 for the nine months ended June 30,
2002, and other non-cash settlements.
(c) At June 30, 2002, the reserves for inventory related restructuring
were $235.
Impairment of goodwill and other assets
The continued and more recent sharp decline in the telecommunications market
prompted an assessment of all key assumptions underlying our goodwill valuation
judgments, including those relating to short and longer-term growth rates. As a
result of our analysis, we determined that an impairment charge of $837 was
required because the forecasted undiscounted cash flows was less than the book
values of the goodwill and other intangible assets of certain businesses. The
charge was measured on the basis of comparison of estimated fair values with
corresponding book
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
values and relates primarily to goodwill recorded in connection with our
September 2000 acquisition of Spring Tide. Fair values were determined on the
basis of discounted cash flows. After the impairment, total goodwill and other
acquired intangibles at June 30, 2002 was $367, primarily related to the
remaining goodwill and other acquired intangibles for Spring Tide and Yurie
Systems, Inc.
3. INCOME TAXES
Statement of Financial Accounting Standards ("SFAS") No. 109 "Accounting for
Income Taxes" ("SFAS 109") requires that a valuation allowance be established
when it is "more likely than not" that all or a portion of deferred tax assets
will not be realized. A review of all available positive and negative evidence
needs to be considered, including a company's performance, the market
environment in which the company operates, the utilization of past tax credits,
length of carryback and carryforward periods, existing contracts or sales
backlog that will result in future profits, etc.
It further states that forming a conclusion that a valuation allowance is not
needed is difficult when there is negative evidence such as cumulative losses in
recent years. Therefore, cumulative losses weigh heavily in the overall
assessment. As a result of the review undertaken at June 30, 2002, Lucent
concluded that it was appropriate to establish a full valuation allowance for
its net deferred tax assets. Throughout fiscal year 2002, we also established
valuation allowances for future tax benefits with relatively short carryforward
periods related to foreign tax credits, state and foreign net operating losses
and capital losses. As a result, the valuation allowance for deferred tax assets
increased from $742 at September 30, 2001, to approximately $7,500 at June 30,
2002. In addition, Lucent expects to provide a full valuation allowance on
future tax benefits until it can sustain a level of profitability that
demonstrates its ability to utilize the assets. For additional information see
APPLICATION OF CRITICAL ACCOUNTING POLICIES in Management's Discussion and
Analysis of Results of Operations and Financial Condition.
4. DISCONTINUED OPERATIONS
On June 1, 2002, Lucent completed its spin-off of Agere Systems Inc. ("Agere")
by distributing its remaining 37.0 million shares of Agere Class A common stock
and 908.1 million shares of Agere Class B common stock to Lucent's common
shareowners of record on May 3, 2002. Each Lucent shareowner received one share
of Agere Class A common stock for every 92.768991 shares of Lucent's common
stock held and one share of Agere Class B common stock for every 3.779818 shares
of Lucent's common stock held. The historical carrying amount of the net assets
transferred to Agere of $1,183 was recorded as a stock dividend reflected in
additional paid-in capital.
The income (loss) from discontinued operations includes the results of
operations for Lucent's former power systems business through the date of sale
of December 29, 2000, and Agere through the initial measurement date of March
31, 2001. The income (loss) on disposal of Agere includes Lucent's share of
Agere's net losses from the initial measurement date through the spin-off date.
Three months ended Nine months ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Agere and power systems revenues $307 $ 814 $1,247 $ 3,303
==== ======= ====== =======
Loss from discontinued operations (net of taxes) $ - $ - $ - $ (151)
Income (loss) on disposal of Agere (27) (1,360) 73 (1,522)
---- ------- ------ -------
Total income (loss) from discontinued operations(a) $ (27) $(1,360) $ 73 $(1,673)
===== ======= ====== =======
- -------
(a) Net of tax provision of $1 and $133 for the three months ended June 30,
2002 and 2001, respectively, and tax provision of $34 and $146 for the nine
months ended June 30, 2002 and 2001, respectively.
In connection with the spin-off of Agere, the Company re-measured its pension
and postretirement plans on June 1, 2002. The actuarial assumptions used were
the same as those assumptions used at September 30, 2001. The re-measurement is
not expected to have a material effect on our results of operations. In
addition, included in discontinued operations for the three months ending June
30, 2002, are pension termination benefit charges of $57, relating to business
restructuring actions taken by Agere prior to the spin-off.
Subject to final adjustment, which is not expected to be materially different,
the prepaid pension and postretirement liability amounts transferred to Agere on
June 1, 2002, were $216 and $89, respectively.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
The net assets of Agere as of September 30, 2001 were as follows:
Current assets $4,022
Current liabilities 4,427 (a)
------
Net current liabilities of discontinued operations $ 405
Long-term assets $2,625
Long-term liabilities 1,323 (b)
------
Net long-term assets of discontinued operations $1,302
======
- -------
(a) Includes $2,500 of short-term debt assumed by Agere on April 2, 2001, and
$565 of reserves associated with Lucent's share of Agere's estimated future
losses through the spin-off date.
(b) Amount is shown net of the minority interest in the net assets of Agere of
$1,026.
5. BUSINESS DISPOSITIONS AND SALE OF MANUFACTURING OPERATIONS
On May 31, 2002, Lucent completed its agreement with Solectron Corporation to
sell certain manufacturing equipment and inventory for approximately $100,
subject to post closing adjustments, and commenced a three-year supply agreement
with Solectron for certain optical networking products. Due to continuing market
uncertainties, Lucent and Solectron are currently in discussions that may result
in changes to these agreements.
On February 28, 2002, Lucent completed the sale of its billing and customer care
business to CSG Systems International, Inc. for approximately $260, subject to
certain post closing purchase price adjustments. The transaction resulted in a
gain of $110 and was included in business restructuring charges and asset
impairments, net for the nine months ended June 30, 2002.
On November 16, 2001, Lucent completed the sale of its optical fiber business
("OFS") to The Furukawa Electric Co., Ltd. for approximately $2,300, of which
$173 was in CommScope, Inc. common stock. The transaction resulted in a gain of
$523, which was included in other income (expense) in the nine months ended June
30, 2002. In addition, Lucent entered into an agreement on July 24, 2001, to
sell two China-based joint ventures -- Lucent Technologies Shanghai Fiber Optic
Co., Ltd. and Lucent Technologies Beijing Fiber Optic Cable Co., Ltd. -- to
Corning Incorporated for $225. Lucent and Corning are discussing whether a
portion of the proceeds may be paid in Corning common stock, and if so, under
what terms. This transaction, which is subject to approval by Lucent's partners
in the joint ventures, foreign governmental approvals and other customary
closing conditions, is expected to close during the fourth quarter of fiscal
2002.
6. SHORT-TERM INVESTMENTS
During the three months ended June 30, 2002, Lucent purchased debt securities of
$865; primarily consisting of treasury bills and notes and mortgage backed
funds, with original maturities greater than three months and with maturities
less than one year. These investments are of investment grade quality and are
not subject to significant market risk. These investments are designated as
available-for-sale, and are recorded at fair value, which approximates their
cost. Any unrealized holding gains or losses are excluded from net loss and are
reported as a component of comprehensive loss.
7. INVENTORIES
June 30, September 30,
2002 2001
-------- -------------
Completed goods $1,171 $2,023
Work in process 122 432
Raw materials 688 1,191
------ ------
Inventories $1,981 $3,646
====== ======
8. DEBT
June 30, September 30,
2002 2001
-------- -------------
Revolving credit facilities $ - $1,000
Other 173 135
------ ------
Debt maturing within one year 173 1,135
Long-term debt 3,237 3,274
Company-obligated 7.75% mandatorily
redeemable convertible preferred
securities of subsidiary trust 1,750 -
------ ------
Total debt $5,160 $4,409
====== ======
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
On March 19, 2002, Lucent Technologies Capital Trust I ("the trust") completed
the sale of 1,750,000 7.75% cumulative convertible trust preferred securities
for an initial price of $1,000 per share for an aggregate amount of $1,750.
Lucent owns all of the common securities of the trust. The trust used the
proceeds to purchase 7.75% convertible subordinated debentures issued by Lucent
due March 15, 2017, which represent all of the trust's assets. Since the trust
preferred securities are being treated as debt, the distributions on the
securities are included in interest expense. The terms of the trust preferred
securities are substantially the same as the terms of the debentures. Lucent may
redeem the debentures, in whole or in part, for cash at premiums ranging from
103.88% beginning March 20, 2007, to 100.00% on March 20, 2012, and thereafter.
To the extent Lucent redeems debentures, the trust is required to redeem a
corresponding amount of trust-preferred securities. Lucent has irrevocably and
unconditionally guaranteed, on a subordinated basis, the payments due on the
trust preferred securities to the extent Lucent makes payments on the debentures
to the trust. In connection with this transaction, Lucent incurred approximately
$46 of expenses that are deferred and are being amortized over the life of the
debentures.
Holders of trust preferred securities are entitled to receive quarterly cash
distributions commencing June 15, 2002. The ability of the trust to pay
dividends depends on the receipt of interest payments on the debentures. Lucent
has the right to defer payments of interest on the debentures for up to 20
consecutive quarters. If Lucent defers the payment of interest on the
debentures, the trust will defer the quarterly distributions on the trust
preferred securities for a corresponding period. Deferred interest accrues at an
annual rate of 9.25%. Each trust preferred security is convertible at the option
of the holder into 206.6116 shares of Lucent common stock, which takes into
account the adjustment of the Agere spin-off and subject to additional
adjustment under certain circumstances.
9. COMPREHENSIVE LOSS
The components of comprehensive loss are reflected net of tax, except for
foreign currency translation adjustments, which are generally not adjusted for
income taxes as they relate to indefinite investments in non-U.S. subsidiaries.
Three months ended Nine months ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Net loss $(8,026) $(3,238) $(8,944) $(7,398)
Other comprehensive loss:
Foreign currency translation adjustments 71 (69) 111 (117)
Reclassification adjustments to foreign currency translation for
sale of foreign entities (6) - (6) (3)
Unrealized holding (losses) gains on investments (1) 87 (20) (34)
Reclassification adjustments for realized gains and impairment losses
on investments 19 3 - 46
Cumulative effect of accounting change - - - 11
Unrealized losses and reclassification adjustments on derivative
instruments - (5) (10) (4)
------- ------- ------- -------
Comprehensive loss $(7,943) $(3,222) $(8,869) $(7,499)
======= ======= ======= =======
10. LOSS PER COMMON SHARE
Basic and diluted loss per common share is calculated by dividing net loss
applicable to common shareowners by the weighted average number of common shares
outstanding during the period. Amounts applicable to common shareowners reflect
the dividends and accretion on the redeemable convertible preferred stock.
Three months ended Nine months ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Loss per common share basic and diluted:
Loss from continuing operations $(2.34) $(0.55) $(2.67) $(2.01)
Income (loss) from discontinued operations (0.01) (0.40) 0.02 (0.50)
Extraordinary gain - - - 0.34
Cumulative effect of accounting changes - - - (0.01)
------ ------ ------ ------
Net loss applicable to common shareowners $(2.35) $(0.95) $(2.65) $(2.18)
====== ====== ====== ======
Dividends declared per common share $ - $ 0.02 $ - $ 0.06
====== ====== ====== ======
Weighted average number of common shares - basic and
diluted (in millions) 3,428.5 3,405.2 3,422.5 3,396.9
Potential common shares were excluded from the calculation of diluted loss per
share because their
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
effect would reduce the loss per share from continuing operations. In addition,
most stock options were excluded from the calculation of diluted loss per share
because their exercise price was greater than the average market price of the
common shares.
Three months ended Nine months ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Potential common shares excluded from the calculation of diluted
loss per share (in millions):(a)
Redeemable convertible preferred stock 591.6 - 591.6 -
Company-obligated 7.75% mandatorily redeemable convertible preferred
securities of subsidiary trust(b) 361.6 - 136.4 -
Stock options 3.6 13.8 8.1 35.6
----- ----- ----- -----
Total 956.8 13.8 736.1 35.6
===== ===== ===== =====
Stock options excluded from the calculation of diluted loss per share
because the exercise price was greater than the average market price
of the common shares (in millions)(a) 372.3 611.6 532.9 455.1
===== ===== ===== =====
- -------
(a) Adjusted to reflect the spin-off of Agere.
(b) Had these securities been outstanding for the entire nine months ended
June 30, 2002, the amount of shares excluded from the calculation for
each period would have been 361.6 common shares.
11. OPERATING SEGMENTS
Lucent designs and delivers networks for the world's largest communications
service providers through two customer-focused operating segments, Integrated
Network Solutions ("INS") and Mobility Solutions ("Mobility"). These reportable
segments are managed separately. The INS segment focuses on global, wireline
service providers, including long distance carriers, traditional local telephone
companies and Internet service providers, and provides offerings comprising a
broad range of switching, access, and optical networking products. The Mobility
segment focuses on global wireless service providers and offers products to
support the needs of its customers for radio access and core networks. Both
segments offer network management and application and service delivery products.
In addition, Lucent supports its segments through its global services
organization.
Performance measurement and resource allocation for the reportable segments are
based on many factors. The primary financial measure is operating income (loss),
which includes the revenues, costs and expenses directly controlled by each
reportable segment, as well as an allocation of costs and operating expenses,
which are not managed at a segment level, but are related to the products or
services sold to its customers. Operating income (loss) for reportable segments
excludes the following:
o goodwill and other acquired intangibles amortization;
o business restructuring and asset impairments;
o the results of the optical fiber business through the date of its sale;
o the results from billing and customer care software products through the
date of its sale, messaging products and other smaller units;
o certain personnel costs and benefits, including a portion of those related
to pension and postretirement benefits and differences between the actual
and standard allocated benefit rates;
o certain other costs related to shared services such as general corporate
functions, which are managed on a common basis in order to realize
economies of scale and efficient use of resources; and
o certain other general and miscellaneous costs and expenses not directly
used in assessing the performance of the operating segments.
The accounting policies of the reportable segments are the same as those applied
in the consolidated financial statements to the extent that the related items
are included within segment operating income (loss).
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
The following tables present revenues and operating income (loss) by reportable
segment and a reconciliation of the segment's operating income (loss) to
consolidated operating loss.
Three months Nine months
ended June 30, ended June 30,
2002 2001 2002 2001
---- ---- ---- ----
External Revenues
INS $ 1,411 $ 3,654 $ 5,086 $ 9,644
Mobility 1,451 1,483 4,498 4,192
------- ------- ------- -------
Total reportable segments 2,862 5,137 9,584 13,836
Optical fiber business - 521 114 1,620
Other 87 228 346 683
------- ------- ------- -------
Total external revenues $ 2,949 $ 5,886 $10,044 $16,139
======= ======= ======= =======
Operating income (loss)
INS $ (541) $ (697) $ (1,892) $(3,651)
Mobility 152 (996) 183 (1,477)
------- ------- ------- -------
Total reportable segments (389) (1,693) (1,709) (5,128)
Goodwill and other acquired intangibles amortization (75) (233) (218) (743)
Business restructuring and asset impairments, net(a) (1,645) (684) (1,517) (3,394)
Optical fiber business - 179 (68) 513
Unallocated personnel costs and benefits 371 705 1,190 1,878
Shared services such as general corporate functions (393) (631) (1,239) (1,997)
Other (171) (194) (632) (673)
------- ------- ------- -------
Total operating loss $(2,302) $(2,551) $(4,193) $(9,544)
======= ======= ======== =======
(a) For the three months ended June 30, 2002, business restructuring and asset
impairments, net include a $808 net business restructuring charge and a
$837 impairment charge primarily related to goodwill recorded in connection
with the September 2000 acquisition of Spring Tide. For the nine months
ended June 30, 2002, business restructuring and asset impairments, net
include a $680 net business restructuring charge and the $837 impairment
charge noted above.
Results by reportable segment include service revenues of $630 and $2,132 for
the three and nine months ended June 30, 2002, and $1,137 and $3,163 for the
three and nine months ended June 30, 2001, respectively. Service costs were $549
and $1,752 for the three and nine months ended June 30, 2002, and $934 and
$2,825 for the three and nine months ended June 30, 2001, respectively.
12. COMMITMENTS AND CONTINGENCIES
In the normal course of business, Lucent is subject to proceedings, lawsuits and
other claims, including proceedings under laws and government regulations
related to securities, environmental, labor, product and other matters. Such
matters are subject to many uncertainties, and outcomes are not predictable with
assurance. Consequently, the ultimate aggregate amount of monetary liability or
financial impact with respect to these matters at June 30, 2002, cannot be
ascertained. While these matters could affect the operating results of any one
quarter when resolved in future periods, and while there can be no assurance
with respect thereto, management believes that after final disposition, any
monetary liability or financial impact to Lucent, from matters other than those
described in the next four paragraphs, beyond that provided for at June 30,
2002, would not be material to the consolidated financial statements.
Lucent and certain of its former officers are defendants in several purported
shareowner class action lawsuits for alleged violations of federal securities
laws, which have been consolidated in a single action pending in U.S. District
Court in New Jersey captioned In re Lucent Technologies Inc. Securities
Litigation. Specifically, the complaint alleges, among other things, that
beginning in late October 1999, Lucent and certain of its officers
misrepresented Lucent's financial condition and failed to disclose material
facts that would have an adverse impact on Lucent's future earnings and
prospects for growth. This action seeks compensatory and other damages, and
costs and expenses associated with the litigation. Lucent is defending this
action vigorously. Lucent made a motion to dismiss the complaint, which was
denied in June 2002, and the case is proceeding with discovery.
In July 2001, a purported class action complaint was filed under ERISA alleging,
among other things, that Lucent and certain unnamed officers breached their
fiduciary duties with respect to Lucent's employee savings plans claiming that
the defendants were aware that Lucent stock was inappropriate for retirement
investment and continued to offer such stock as a plan investment option. The
complaint seeks damages, injunctive and equitable relief, interest and fees and
expenses associated with the litigation. In August 2001, a separate purported
class action complaint was filed under ERISA alleging, among other things, that
Lucent breached its fiduciary duties with respect to its employee benefit and
compensation plans by offering Lucent stock as an
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
investment to employees participating in the plans despite the fact that Lucent
allegedly knew it was experiencing significant business problems. The August
action was dismissed without prejudice on June 12, 2002. The July action is in
the discovery stage. Lucent is defending the action vigorously. The case is
pending in the U.S. District Court in New Jersey and is captioned Reinhart et
al. v. Lucent Technologies.
In March 2002, Lucent was named as a defendant in a case captioned In re Winstar
Communications Securities Litigation, pending in U.S. District Court for the
Southern District of New York. The case is a putative class action on behalf of
purchasers of common stock of Winstar Communications, Inc. ('Winstar'), which
filed for bankruptcy in April 2001, against several former officers and
directors of Winstar, Winstar's outside auditors, and Lucent. In addition, in
April 2002, a case captioned Preferred Life Insurance Co. of New York et al. v.
Lucent Technologies Inc. was filed in New Jersey state court against Lucent.
The plaintiffs in the New Jersey case are institutional investors, many of
which are affiliated with each other, that purchased the common stock of
Winstar. In both actions, the plaintiffs claim that Lucent caused or contributed
to money lost by the plaintiffs in connection with their investments in Winstar
stock. In the New York action, the plaintiffs claim that Lucent violated federal
securities laws in connection with plaintiffs' purchases of Winstar stock.
Lucent has moved to dismiss the claims in the New York action during June 2002.
In the New Jersey action, the plaintiffs claim that Lucent committed common law
fraud, negligent misrepresentation, conspiracy to commit fraud and aiding and
abetting fraud in connection with plaintiffs' purchases of Winstar stock. Both
cases are in the early stages, and Lucent intends to defend the cases
vigorously. Lucent is also a defendant in an adversary proceeding filed in U.S.
Bankruptcy Court in Delaware by Winstar and Winstar Wireless, Inc. in connection
with the bankruptcy of Winstar and various related entities. The complaint
asserts claims for breach of contract and fraudulent inducement against Lucent
and seeks monetary damages and injunctive relief, as well as costs and expenses
associated with litigation. Lucent filed a motion to dismiss certain of the
claims asserted by plaintiffs. However, the plaintiffs have indicated to the
court that they intend to file an amended complaint. Lucent intends to defend
the case vigorously.
Lucent and certain current and former officers and directors of Lucent are
defendants in a proceeding in Texas state court captioned Obtek, et al. v.
Lucent Technologies Inc., et al., for alleged violation of federal securities
laws, the Texas Securities Act and other claims. The court has denied a motion
to dismiss the claims against individual defendants and has set a trial date for
February 2003. The case is currently proceeding with discovery. Lucent is
defending this action vigorously.
Sparks, et al. v. AT&T and Lucent Technologies Inc. et al., is a class action
lawsuit filed in 1996 in Illinois state court under the name of Crain v. Lucent
Technologies. The complaint seeks damages on behalf of present and former
customers based on a claim that the AT&T Consumer Products business (which
became part of Lucent in 1996) and Lucent had defrauded and misled customers who
leased telephones, resulting in payments in excess of the cost to purchase the
telephones. Similar consumer class actions pending in various state courts have
been stayed pending the outcome of the Sparks case and, in July 2001, the
Illinois court certified a nationwide class of plaintiffs. Lucent filed pretrial
motions for, among other things, decertification of the class and summary
judgment in Lucent's favor. On July 29, 2002, the judge denied Lucent's motions,
and set trial to begin on August 5, 2002.
After extensive negotiations subsequent to Lucent's July 23, 2002 earnings
release, a settlement proposal was submitted to the court on August 9, 2002, to
settle the litigation for up to $300 in cash plus pre-paid calling cards
redeemable for minutes of long distance service. The settlement will be reviewed
by the court and must be approved before the settlement becomes final. Lucent
and AT&T deny they have defrauded or misled their customers, but have decided
to settle this matter to avoid the uncertainty of litigation and the diversion
of resources and personnel that the continuation of pursuing this matter would
require. The class claimants will apply for reimbursement from the settlement
fund, and will be required to demonstrate their entitlement through a claims
form to be provided to a claims administrator. Depending upon the number of
claims submitted and accepted, the actual cost of the settlement to the
defendants may be less than the stated amount, but it is not possible to
estimate the amount at this time.
Lucent is a party to various separation and distribution agreements, which
provide for contribution from formerly affiliated third parties for a portion of
any liability (including any settlement) in this case. However, Lucent would
remain responsible for a majority of any such liability or settlement. As a
result, Lucent recognized a $162 charge recorded in other income (expense),
which is net of expected third party contributions.
Other Commitments
On July 17, 2002, Lucent and Agere amended the purchase agreement between them,
dated as of February 1, 2001, pursuant to which, among other things, Lucent had
agreed to purchase $2,800 in products from Agere over a three year period ending
January 31, 2004. Under the amendment, Lucent's first year purchases of $411
through January 31, 2002, are deemed to be full satisfaction of its initial
year's $800 obligation under the original agreement. In addition, Lucent has
agreed, for an extended period that ends on September 30, 2006, provided Agere
is competitive with other potential suppliers as to price, delivery interval and
technological merit, to purchase 90% of its requirements for products it
currently purchases from Agere and 60%
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
of its requirements for other products that Agere can supply. At a minimum,
Lucent has also agreed to purchase $250 of products from Agere during the fiscal
year ended September 30, 2002, $188 of which were purchased as of June 30, 2002.
Lucent has also agreed to proceed first with Agere on all joint product
development projects where Agere meets Lucent's criteria. Lucent has also agreed
to transfer certain patents, patent applications and patent license agreements
to Agere.
Lucent has exited certain of its manufacturing operations and has increased its
use of contract manufacturers. Except for systems integration and final assembly
of its wireless products and systems integration, assembly and testing for
selected optical products, it is currently using a sole-source supplier for a
majority of the switching and wireless product lines and another sole-source
supplier for the optical product line. In addition, several other contract
manufacturers produce the majority of other products. Lucent is generally not
committed to unconditional purchase obligations, except for a commitment that
requires annual purchases of certain wireless components ranging from $275 to
$425 over the next three years. However, Lucent is exposed to short-term
purchase commitment levels. These short-term commitment levels are evaluated and
established on a quarterly basis. As a result, any sudden and significant
changes in forecasted demand requirements could adversely affect its results of
operations and cash flows.
Environmental Matters
Lucent's current and historical operations are subject to a wide range of
environmental protection laws. In the United States, these laws often require
parties to fund remedial action regardless of fault. Lucent has remedial and
investigatory activities under way at numerous current and former facilities.
Additional information and background on Lucent's environmental liabilities and
obligations are set forth in the footnotes to Lucent's consolidated financial
statements for the year ended September 30, 2001. It is often difficult to
estimate the future impact of environmental matters, including potential
liabilities. Lucent records an environmental reserve when it is probable that a
liability has been incurred and the amount of the liability is reasonably
estimable. Although Lucent believes that its reserves are adequate, there can be
no assurance that the amount of capital expenditures and other expenses that
will be required relating to remedial actions and compliance with applicable
environmental laws will not exceed the amounts reflected in Lucent's reserves or
will not have a material adverse effect on Lucent's financial condition, results
of operations or cash flows. Any possible loss or range of possible loss that
may be incurred in excess of that provided for at June 30, 2002, cannot be
reasonably estimated.
13. RECENT PRONOUNCEMENTS
Lucent is currently evaluating the impacts of SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), SFAS No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS 143"), SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS 144") and SFAS No. 146, "Accounting for
Exit or Disposal Activities" ("SFAS 146") to determine the effect, if any, they
may have on the consolidated financial position and results of operations.
Lucent is required to adopt each of these standards effective with the first
quarter of fiscal 2003, except SFAS 146, which will be effective with the second
quarter of fiscal 2003.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142
under which pre-existing goodwill will no longer be amortized. Identifiable
intangible assets will continue to be amortized over their useful lives. The
criteria for recognizing an intangible asset have also been revised. As a
result, the Company is in the process of reassessing the classification and
useful lives of its previously acquired goodwill and other intangible assets.
SFAS 142 also requires that goodwill be tested for impairment initially within
one year of adoption and at least annually thereafter. If an impairment loss
exists as a result of the transitional goodwill impairment test, the
implementation of SFAS 142 could result in a one-time charge to earnings as a
cumulative effect of accounting change. The goodwill impairment test is a
two-step process that requires goodwill to be allocated to reporting units which
are reviewed by its segment managers. In the first step, the fair value of the
reporting unit is compared with the carrying value of the reporting unit. If the
fair value of the reporting unit is less than the carrying value of the
reporting unit, goodwill impairment may exist, and the second step of the test
is performed. In the second step, the implied fair value of the goodwill is
compared with the carrying value of the goodwill and an impairment loss will be
recognized to the extent that the carrying value of the goodwill exceeds the
implied fair value of the goodwill. As of June 30, 2002, there was approximately
$259 of net goodwill primarily within the INS segment that will be subject to
this new pronouncement and will no longer be amortized.
In June 2001, the FASB issued SFAS 143, which establishes accounting standards
for recognition and measurement of a liability for the costs of asset retirement
obligations. Under SFAS 143, the future costs of retiring a tangible long-lived
asset will be recorded as a liability at their present value when the retirement
obligation arises, and will be amortized to expense over the life of the asset.
Lucent is in the process of identifying assets with retirement obligations,
including leased properties that contractually obligate the Company to remove
leasehold improvements and restore the properties to the original condition.
The Company does not expect that SFAS 143 will materially affect our
consolidated financial statements.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
In August 2001, the FASB issued SFAS 144, which addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and
discontinued operations. SFAS No. 144 supersedes SFAS No. 121 and the accounting
and reporting provisions of Accounting Principles Board Opinion No. 30 ("APB
30") for the disposal of a segment of a business. SFAS No. 144 retains the basic
principles of SFAS No. 121 for long-lived assets to be disposed of by sale or
held and used and modifies the accounting and disclosure rules for discontinued
operations.
In July 2002, the FASB issued SFAS 146, which addresses significant issues
regarding the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including restructuring activities
that are currently accounted for pursuant to the guidance that the Emerging
Issues Task Force ("EITF") has set forth in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". SFAS 146
revises the accounting for certain lease termination costs and employee
termination benefits, which are generally recognized in connection with
restructuring activities.
14. STOCK OPTION EXCHANGE OFFER
On April 22, 2002, Lucent commenced a voluntary offer to eligible employees to
exchange certain outstanding stock options to purchase shares of Lucent common
stock, including all stock options issued during the six-month period ended
April 22, 2002, for Lucent's promise to grant a new stock option on or about
November 25, 2002. Employees who participated in the offer tendered stock
options to purchase an aggregate of 213.2 million shares of Lucent common stock,
which have been cancelled, in exchange for Lucent's promises to grant new stock
options to purchase up to an aggregate of 123.2 million shares of Lucent common
stock. The exercise price of the new stock options will be at least equal to the
fair market value of Lucent's common stock on the date of grant.
15
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
OVERVIEW
We design and deliver networks for the world's largest communications service
providers. Backed by Bell Labs research and development, we rely on our
strengths in mobility, optical, data and voice networking technologies, as well
as software and services, to develop next-generation networks. Our systems,
services and software are designed to help customers quickly deploy and better
manage their networks and create new, revenue-generating services that help
businesses and consumers.
OUR RESTRUCTURING PROGRAM
Since beginning our restructuring program during the quarter ended March 31,
2001, we have realigned our resources for the opportunities that we currently
believe to be the most profitable for us -- the large service provider market.
We evaluated our manufacturing operations and decided to sell or otherwise lease
certain of our manufacturing facilities and make greater use of contract
manufacturers. We assessed our product portfolio and associated research and
development ("R&D"), made decisions based on the needs of our largest service
provider customers, deployed our resources to meet those needs and then
streamlined the rest of our operations to support those reassessments. We
eliminated some marginally profitable or non-strategic product lines; merged
certain technology platforms; consolidated development activities; eliminated
management positions and eliminated many duplications in marketing functions and
programs and centralized our sales support functions, which resulted in reduced
associated product development costs. We sold the assets relating to a number of
product lines whose products did not support our large service provider
customers or our strategy. We initiated actions to close facilities and reduce
the workforces in about 40 of the approximately 60 countries in which we
operated at the end of fiscal 2000. Due to continuing market declines, we have
committed to additional restructuring actions that resulted in a net business
restructuring charge of $808 million in the current quarter. These restructuring
actions were designed to enable us to achieve earnings per share ("EPS")
breakeven at a quarterly revenue level of $3.5 billion with a gross margin rate
in the low 30 percent range. Additional restructuring actions are being
developed to further reduce our EPS breakeven to below the $3.5 billion
quarterly revenue level during fiscal 2003, which will likely result in a
restructuring charge in the fourth fiscal quarter of 2002. We generally expect
to complete each restructuring plan within 12 months of committing to it.
MARKET ENVIRONMENT AND STRATEGIC DIRECTION
During fiscal 2001, the global telecommunications market deteriorated,
reflecting a significant decrease in the competitive local exchange carrier
market and a significant reduction in capital spending by established service
providers. This trend has continued during the first nine months of fiscal 2002
and is expected to continue at least throughout calendar 2002. We estimate that
large service providers continue to reduce their calendar year-over-year capital
spending budgets by more than 20%, primarily in the wireline market. Reasons for
this reduction include the economic slowdown, network overcapacity, customer
bankruptcies, network build-out delays and limited capital availability. As a
result, our sales and results of operations have been adversely affected.
During this prolonged market downturn, we have concentrated on the things we can
control, such as working closely with our customers to position the full breadth
of our products and services, significantly reducing our cost structure,
reducing our breakeven revenue figure and improving our balance sheet. However,
if capital investment levels continue to decline, or if the telecommunications
market does not improve or improves at a slower pace than we anticipate, our
revenues and profitability will continue to be adversely affected. In addition,
if our sales volume and product mix does not improve, or we do not continue to
realize cost reductions or reduce inventory related charges, our gross margin
percentage may not improve as much as we have targeted, resulting in lower than
expected results of operations.
The significant slowdown in capital spending in our target markets has created
uncertainty as to the level of demand in those markets. In addition, the level
of demand can change quickly and can vary over short periods of time, including
from month to month. As a result of the uncertainty and variations in our
markets, accurately forecasting future results, earnings and cash flow is
increasingly difficult.
We restructured our operations into distinct wireline and wireless units, and
began to target the large service providers in each segment, which we believe
offer us the best opportunity for future growth and stable revenue. We believe
structuring our business along customer lines - wireline and wireless - enables
us to better serve and anticipate the needs of our large service provider
customers.
Our wireline segment, Integrated Network Solutions ("INS"), focuses on global
wireline service providers, including long distance carriers and both
traditional local telephone companies and Internet service providers. INS
primarily sells and services core switching, access and optical networking
products. Our wireless segment, Mobility Solutions, offers products to support
the needs of its customers for radio access and core networks and primarily
sells and services wireless products to wireless service providers. Both
segments offer network management and application and service delivery products.
We support these two new segments through a number of
16
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
central organizations, including our services organization and our corporate
headquarters. Manufacturing and supply chain functions have been consolidated
into a single global supply chain networks organization that manages the
materials and activities necessary to produce and deliver products and services
to our customers.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are based on the selection and application
of significant accounting policies, which require management to make significant
estimates and assumptions. We believe that the following are some of the more
critical judgment areas in the application of our accounting policies that
affect our financial condition and results of operations.
Most of our sales are generated from complex contractual arrangements, which
require significant revenue recognition judgments, particularly in the areas of
multiple element arrangements and collectibility. Revenue from contracts with
multiple element arrangements, such as those including installation and
integration services, are recognized as each element is earned based on
objective evidence of the relative fair values of each element and when there
are no undelivered elements that are essential to the functionality of the
delivered elements. We have determined that most of our equipment can be
installed by the customer or a third party, and as a result, revenue may be
recognized upon delivery of the equipment in those situations, provided all
other revenue recognition criteria are met. The assessment of collectibility is
particularly critical in determining whether revenue should be recognized in the
current market environment. As part of the revenue recognition process, we
determine whether trade and notes receivables are reasonably assured of
collection based on various factors, including our ability to sell these
receivables and whether there has been deterioration in the credit quality of
our customers that could result in our being unable to collect or sell the
receivables. In situations where we have the ability to sell the receivable,
revenue is recognized to the extent of the value we could reasonably expect to
realize from the sale. We will defer revenue and related costs if we are
uncertain as to whether we will be able to sell or collect the receivable. We
will defer revenue and recognize costs when we determine that the collection or
sale of the receivable is unlikely. For sales generated from long-term
contracts, primarily those related to customized network solutions and network
build-outs, we generally use the percentage of completion method of accounting.
In connection therewith, we make important judgments in estimating revenue and
cost and in measuring progress towards completion. These judgments underlie our
determinations regarding overall contract value, contract profitability and
timing of revenue recognition. Revenue and cost estimates are revised
periodically based on changes in circumstances; any losses on contracts are
recognized immediately. We also sell products through multiple distribution
channels, including resellers and distributors. For products sold through these
channels, revenue is generally recognized when the reseller or distributor sells
the product to the end user. The total amount of deferred income, including
deferrals relating to collectibility concerns, at June 30, 2002, was $653
million.
We are required to estimate the collectibility of our trade receivables and
notes receivable. A considerable amount of judgment is required in assessing the
realization of these receivables, including the current creditworthiness of each
customer and related aging of the past due balances. Our provisions for bad debt
and customer financing during fiscal 2001 and for the nine months ended June 30,
2002, amounted to $2.2 billion and $829 million, respectively. Our June 30,
2002, reserves included in the $2.2 billion of trade receivables was $517
million and there were approximately $790 million of reserves on the $1.2
billion of drawn commitments under our customer financing program. We evaluate
specific accounts when we become aware of a situation where a customer may not
be able to meet its financial obligations due to a deterioration of its
financial viability, credit ratings or bankruptcy. The reserve requirements are
based on the best facts available to us and reevaluated and adjusted as
additional information is received. Our reserves also are determined by using
percentages applied to certain aged receivable categories. (Refer to LIQUIDITY
AND CAPITAL RESOURCES - Customer finance commitments for additional discussion
on procedures performed related to customer financing.) Significant increases in
reserves have been recorded in recent periods and may occur in the future due to
the current market environment. In addition, we currently have approximately
$640 million of net assets included in receivables, contracts in process and
other assets from long-term projects that have been winding down in Saudi
Arabia. We have concluded that these net assets are realizable based on our
contractual rights and past collection history.
We are required to state our inventories at the lower of cost or market. In
assessing the ultimate realization of inventories, we are required to make
judgments as to future demand requirements and compare that with the current or
committed inventory levels. Our reserve requirements generally increase as our
projected demand requirements decrease due to market conditions, technological
and product life cycle changes as well as longer than previously expected usage
periods. We have experienced significant changes in required reserves in recent
periods due to changes in strategic direction, such as discontinuances of
product lines as well as declining market conditions. As a result, we incurred
inventory charges of $2.4 billion and approximately $350 million during fiscal
2001 and the nine months ended June 30, 2002, respectively. Inventories of $2.0
billion at June 30, 2002, are net of reserves of approximately $1.5 billion. It
is possible that significant changes in required inventory reserves may continue
to occur in the future if there is a further decline in market conditions and if
additional
17
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
restructuring actions are taken.
We currently have significant deferred tax assets resulting from tax credit
carryforwards, anticipated net operating losses and other deductible temporary
differences, which will reduce taxable income in future periods. We established
a full valuation allowance for our remaining deferred tax assets and recognized
a $5.9 billion charge during the current quarter. We had previously provided
valuation allowances only for future tax benefits resulting from foreign tax
credits, most state and foreign net operating losses and capital losses with
relatively short carryforward periods. We believed it was more likely than not
that the remaining net deferred tax assets of $5.2 billion at March 31, 2002
would be realized principally based upon forecasted taxable income, generally
within the twenty-year R&D credit and net operating loss carryforward periods,
giving consideration to substantial benefits realized to date through our
restrucuturing program. SFAS No. 109 requires a valuation allowance be
established when it is "more likely than not" that all or a portion of deferred
tax assets will not be realized and that it is difficult to conclude that a
valuation allowance is not needed when there is negative evidence such as
cumulative losses in recent years. Therefore, cumulative losses weigh heavily in
the overall assessment. We identified several significant developments which we
considered in determining the need for a full valuation allowance recorded in
the current quarter, including the continuing and more recent severe market
decline, uncertainty and lack of visibility in the telecommunications market as
a whole, a significant decrease in sequential quarterly revenue levels, a
decrease in sequential earnings after several quarters of sequential improvement
and the necessity for further restructuring and cost reduction actions to attain
profitability. As a result of our assessment, we increased our total valuation
allowance on deferred tax assets to approximately $7.5 billion resulting in the
$5.9 billion charge. We expect to record a full valuation allowance on future
tax benefits until we can sustain an appropriate level of profitability and
until such time, we would not expect to recognize any significant tax benefits
in our future results of operations.
We currently have intangible assets, including goodwill and other acquired
intangibles of $367 million, primarily within the INS segment, and capitalized
software development costs of $820 million. The determination of related
estimated useful lives and whether these assets are impaired involves
significant judgments based upon short- and long-term projections of future
performance. Certain of these forecasts reflect assumptions regarding our
ability to successfully develop and ultimately commercialize acquired
technology. Changes in strategy and/or market conditions may result in
adjustments to recorded asset balances. For example, we had taken significant
impairment charges, including $4.1 billion related to goodwill and other
acquired intangibles and $362 million related to capitalized software under our
restructuring program during fiscal 2001. The continued and more recent sharp
decline in the telecommunications market prompted an assessment of all key
assumptions underlying our goodwill valuation judgments, including those
relating to short and longer-term growth rates. As a result of our analysis, we
determined that an impairment charge of $837 million was required because the
forecasted undiscounted cash flows was less than the book values of certain
businesses. The charge was measured on the basis of comparison of estimated fair
values with corresponding book values and relates primarily to goodwill recorded
in connection with our September 2000 acquisition of Spring Tide. Fair values
were determined on the basis of discounted cash flows. Goodwill and other
acquired intangibles at June 30, 2002 primarily relates to the remaining $113
million of goodwill and other acquired intangibles for Spring Tide and the
remaining $128 million balance of goodwill and other acquired intangibles
relating to our acquisition of Yurie Systems, Inc., which provides Asynchronous
Transfer Mode access equipment. We have concluded that this amount is realizable
based upon projected undiscounted cash flows through 2006. Due to uncertain
market conditions and potential changes in our strategy and product portfolio,
it is possible that forecasts used to support our intangible assets may change
in the future, which could result in additional non-cash charges that would
adversely affect our results of operations and financial condition.
We have significant pension and postretirement benefit costs and credits, which
are developed from actuarial valuations. Inherent in these valuations are key
assumptions, including discount rates and expected return on plan assets, which
are usually updated on an annual basis at the beginning of each fiscal year. We
are required to consider current market conditions, including changes in
interest rates, in selecting these assumptions. Changes in the related pension
and postretirement benefit costs or credits may occur in the future due to
changes in the assumptions. Our current assumptions include a 7% discount rate,
a 9% expected return on plan assets and a 4.5% rate of compensation increase.
These are consistent with the prior year assumptions except that the discount
rate was reduced by one-half of a percent due to current market conditions.
Compared with the prior year interim period, our net pension and postretirement
benefit credit has been reduced by $101 million to $719 million in the nine
months ended June 30, 2002. Holding all other assumptions constant, a one-half
percent increase or decrease in the discount rate would increase or decrease
annual fiscal 2002 pre-tax income by approximately $125 million. Likewise, a
one-half percent increase or decrease in the expected return on plan assets
would increase or decrease annual fiscal 2002 pre-tax income by $200 million.
Subsequent to June 30, 2002, the estimated accumulated benefit obligation
("ABO") related to the management employees' pension plan has at times exceeded
the fair value of its plan assets. If the ABO exceeds the fair value of the plan
assets at September 30, 2002, we will be required to establish a minimum
liability for the difference and record a direct
18
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
charge to equity to the extent the minimum liability exceeds the unrecognized
prior service cost. However, this charge would not impact our results of
operations.
During fiscal 2001 and fiscal 2002, we recorded significant charges in
connection with our restructuring program. The related reserves reflect many
estimates, including those pertaining to separation costs, inventory,
settlements of contractual obligations and proceeds from asset sales.
We reassess the reserve requirements to complete each individual plan under
our restructuring program at the end of each reporting period. Actual
experience has been and may continue to be different from these estimates.
For example, we reflected a net reversal of $222 million for plans existing
as of September 30, 2001, and have reflected charges of $942 million for
new plans. As of June 30, 2002, and September 30, 2001, liabilities
associated with our restructuring program were $1 billion and $1.6
billion, respectively. For more information, see Note 2 to the unaudited
consolidated financial statements.
We are subject to proceedings, lawsuits and other claims, including proceedings
under laws and government regulations related to securities, environmental,
labor, product and other matters. We are required to assess the likelihood of
any adverse judgments or outcomes to these matters, as well as potential ranges
of probable losses. A determination of the amount of reserves required, if any,
for these contingencies is based on a careful analysis of each individual issue
with the assistance of outside legal counsel. The required reserves may change
in the future due to new developments in each matter or changes in approach such
as a change in settlement strategy in dealing with these matters. For more
information, see Note 12 to the unaudited consolidated financial statements.
The impact of changes in the estimates and judgments pertaining to revenue
recognition, receivables and inventories is directly reflected in our segments'
operating income (loss). Although any charges related to our net deferred tax
assets and goodwill and other acquired intangibles are not reflected in the
segment results, the long-term forecasts supporting the realization of those
assets and changes in them are significantly affected by the actual and expected
results of each segment. Generally, the changes in estimates related to pension
and postretirement benefits, our restructuring program and litigation will not
affect our segment results, although execution of the restructuring plans by
each segment may cause related changes in the estimates.
We have discussed the application of these critical accounting policies with our
board of directors and Audit and Finance Committee. There was no initial
adoption of any accounting policies during the nine months ended June 30, 2002.
CONSOLIDATED RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED JUNE 30, 2002,
VERSUS THREE AND NINE MONTHS ENDED JUNE 30, 2001
Revenues
The following table presents our U.S. and non-U.S. revenues and the approximate
percentage of total revenues (dollars in millions):
Three months ended June 30, Nine months ended June 30,
----------------------------------- --------------------------------
2002 2001 % change 2002 2001 % change
---- ---- -------- ---- ---- ---------
U.S. $2,051 $3,817 (46.3%) $ 6,710 $10,638 (36.9%)
Non-U.S. 898 2,069 (56.6%) 3,334 5,501 (39.4%)
------ ------ ------- -------
Total revenues $2,949 $5,886 (50.0%) $10,044 $16,139 (37.8%)
====== ====== ====== ======= ======= ======
Percentage of total revenues Percentage of total revenues
------------------------------------ -----------------------------------
U.S. 69.5% 64.8% 66.8% 65.9%
Non-U.S. 30.5% 35.2% 33.2% 34.1%
Continued reductions in capital spending by large service providers, primarily
affecting our INS segment, and business dispositions were the primary reasons
why the interim fiscal 2002 revenues were lower than the similar periods of the
prior year. The revenue decline resulting from business dispositions was $644
million for the three months ended June 30, 2002, and $1.8 billion for the nine
months ended June 30, 2002. The optical fiber business ("OFS"), which was sold
during the first fiscal quarter of 2002, accounted for approximately 80% and 85%
of the revenue decline associated with business dispositions for the three and
nine months ended June 30, 2002, respectively. The impact of product
rationalizations and discontinuances under our restructuring program has not had
a significant effect on our overall trend of revenues.
19
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Gross Margin
The following table presents our gross margin and the percentage to total
revenues (dollars in millions):
Three months ended Nine months ended
June 30, June 30,
---------------------- ---------------------
2002 2001 2002 2001
---- ---- ---- -----
Gross margin $ 651 $ 829 $1,888 $1,995
Gross margin rate 22.1% 14.1% 18.8% 12.4%
Changes in gross margin rate in the current interim fiscal periods as compared
with the prior interim periods primarily resulted from:
o the gross margin rate was higher in the current interim fiscal year
periods as a result of significantly lower inventory related charges as
compared with the prior interim fiscal year periods. These charges
primarily resulted from weak market conditions that caused a sudden and
significant decrease in demand for our products. As a result of lower
inventory levels from our strategy of focusing on large service providers
and improved inventory management, we reduced the amount of these charges
in the current interim fiscal year periods. In addition, the prior interim
fiscal year periods were adversely affected by higher warranty costs due
to certain product performance issues not occurring in the current interim
periods. These two factors improved gross margin rates by about 14 points
for the three months ended June 30, 2002, and about 9 points for the nine
months ended June 30, 2002;
o gross margin includes a net charge of $43 million and $53 million for the
three and nine months ended June 30, 2002, respectively, and $143 million
and $679 million for the three and nine months ended June 30, 2001,
respectively, for inventory charges associated with product line
rationalizations and product line discontinuance under our restructuring
program. The decrease in these net charges resulted in about a 1 point
improvement in the gross margin rate for the three months ended June 30,
2002 and a 4 point improvement for the nine months ended June 30, 2002;
o we reduced our fixed costs in response to the deterioration of global
telecommunications market conditions, however, when combined with
significantly lower revenue volumes, our fixed costs resulted in about a 4
point decline in the gross margin rate for the three months ended June 30,
2002 and about a 3 point decline for the nine months ended June 30, 2002;
and
o the sale of OFS negatively affected gross margin as a percentage of
revenues by approximately 3 points for the three and nine months ended
June 30, 2002.
To maintain or improve our current gross margin level depends upon market
pricing, as well as our ability to improve sales volume and product mix, limit
inventory related charges, continue cost reductions and market and product
rationalization work, and introduce new products.
Operating Expenses
The following table presents our operating expenses (dollars in millions):
Three months ended June 30, Nine months ended June 30,
----------------------------- -------------------------------
2002 2001 % change 2002 2001 % change
------- ------- -------- ------- -------- --------
Selling, general and administrative ("SG&A")
expenses, excluding the following two items: $ 610 $ 936 (34.8%) $1,945 $ 3,356 (42.0%)
Provision for bad debts and customer
financings 186 877 (78.8%) 829 1,950 (57.5%)
Amortization of goodwill and other acquired
intangibles 75 233 (67.8%) 218 743 (70.7%)
------ ------ ------ ----- ------- ------
Total SG&A 871 2,046 (57.4%) 2,992 6,049 (50.5%)
R&D 480 793 (39.5%) 1,625 2,775 (41.4%)
Business restructuring charges and asset
impairments, net 1,602 541 196.1% 1,464 2,715 (46.1%)
------ ------ ------ ----- ------- ------
Operating expenses $2,953 $3,380 (12.6%) $6,081 $11,539 (47.3%)
====== ====== ====== ====== ======= ======
SG&A expenses
Excluding provisions for bad debts and customer financings and amortization of
goodwill and other acquired intangibles, SG&A expenses decreased by 35% and 42%
during the three and nine month periods, respectively, primarily from headcount
reductions under our restructuring program and other cost savings initiatives
that limited discretionary spending.
20
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Provision for bad debts and customer financings
Many of our customers have been negatively affected by the continued decline in
telecommunications market conditions. This has resulted in a decline in the
creditworthiness of certain customers resulting in some having to file for
bankruptcy or having been declared insolvent. As a result, we have provided
reserves for certain trade and notes receivable and sold others at significant
discounts in the interim periods presented. We may have to record additional
reserves or write-offs in the future.
During the three and nine months ended June 30, 2002, the provisions included
approximately $83 million and $393 million, respectively, related to customer
financing with the balance for trade receivables. In addition, during the three
and nine months ended June 30, 2002, approximately 66% and 76% of the total
provisions were related to our INS customers and 30% and 24% were related to our
Mobility customers. The remaining balances were not related to our reportable
segments.
Provisions associated with two vendor finance projects, including One.Tel Ltd.,
accounted for a significant portion of the provision for the three months ended
June 30, 2001. The provision for the nine months ended June 30, 2001, included
provisions related to Winstar Communications, Inc., which filed for Chapter 11
protection on April 18, 2001.
Amortization of goodwill and other acquired intangibles
Amortization of goodwill and other acquired intangibles for the current interim
periods was significantly lower than the prior year interim periods due to the
write-down in fiscal 2001 of goodwill and other acquired intangibles, in
particular, the discontinuance of the Chromatis product portfolio in connection
with our restructuring program. As a result of the goodwill impairment charge in
the three months ended June 30, 2002 (see Note 2 to the unaudited consolidated
financial statements), amortization expense will be significantly lower in the
fourth fiscal quarter of 2002 as compared with the current fiscal quarter.
R&D
The decrease in R&D expenses for the three and nine months ended June 30, 2002,
as compared with the fiscal 2001 interim periods was primarily due to headcount
reductions and product rationalizations under our restructuring program.
During the nine months ended June 30, 2002, 55% of our R&D was attributable to
our INS segment and most of the remaining amounts were attributable to our
Mobility segment. The INS spending was primarily related to next-generation
products, including optical products for both long haul and metro networks,
multi-service switches that can handle both Internet protocol services and
multiple network traffic protocols, network operations software solutions, and
digital subscriber line products. The Mobility spending was primarily related to
next-generation Code Division Multiple Access ("CDMA") and Universal Mobile
Telecommunications System technology ("UMTS").
Business restructuring charges and asset impairments, net
During the three months ended June 30, 2002, we recorded in operating expenses
net business restructuring charges and asset impairments of $765 million , and
an impairment charge of $837 million primarily related to Spring Tide goodwill
(see Note 2 to the unaudited consolidated financial statements and APPLICATION
OF CRITICAL ACCOUNTING POLICIES). This compares to $541 million of net business
restructuring charges and asset impairments recorded during the three months
ended June 30, 2001.
In addition to the net charges discussed above, operating expenses for the nine
months ended June 30, 2002, included a net reversal of business restructuring
charges and asset impairments of $138 million. This compares to $2.7 billion of
net business restructuring charges and asset impairments recorded during the
nine months ended June 30, 2001. For additional information on the current
fiscal year progress see LIQUIDITY AND CAPITAL RESOURCES - Cash Requirements.
Other income (expense), net
The current quarter's other expense was largely related to a $162 million legal
settlement (see Note 12 to the unaudited consolidated financial statements),
investment write-downs of $64 million, primarily due to an other-than-temporary
write-down of our investment in Commscope, and a legal settlement with Vtech
(see Part II, Item 1. Legal Proceedings). Additionally, the nine months ended
June 30, 2002, included $581 million of gains from business dispositions,
primarily related to a $523 million gain realized from the sale of OFS, and
interest income related to a tax settlement of $73 million. Subsequent to June
30, 2002, our equity investment in Commscope has continued to devalue. If this
decline is considered other-than-temporary, we will incur an additional
impairment charge in the fourth fiscal quarter of 2002.
Other income (expense) for the three months ended June 30, 2001, consisted of
charges of approximately $72 million related to write-downs of certain equity
investments, a charge of approximately $42 million related to the write-off of
an embedded derivative asset due to the
21
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
credit risk and uncollectibility associated with One.Tel and other miscellaneous
write-offs, partially offset by interest income of $56 million. Other income
(expense) for the nine months ended June 30, 2001 primarily consisted of $277
million of write-downs of equity investments and the write-off associated with
One.Tel noted above, partially offset by interest income of $203 million.
Interest Expense
Interest expense for the three months ended June 30, 2002 decreased slightly as
compared with the prior year interim period. Lower interest expense resulted
from a significant reduction in short-term debt. This was partially offset by
interest related to our trust preferred securities, which were issued in March
2002. Due to the timing of the issuance, the trust preferred securities had a
lesser impact on interest expense for the nine months ended June 30, 2002.
Provision (Benefit) for Income Taxes
The following table presents our provision (benefit) for income taxes and the
related effective tax provision (benefit) rates (dollars in millions):
Three months ended June 30, Nine months ended June 30,
--------------------------- -----------------------------
2002 2001 2002 2001
---------- --------- -------- -------
Provision (benefit) for income taxes $5,329 $ (967) $4,782 $(3,394)
Effective tax provision (benefit)
rate 199.6% (34.0%) 112.9% (33.2%)
As discussed in more detail under "APPLICATION OF CRITICAL ACCOUNTING POLICIES",
the effective tax provision rate for the current quarter was significantly more
than the U.S. statutory rate due to a non-cash charge of $5.9 billion to provide
a full valuation allowance on our remaining net deferred tax assets at June 30,
2002. The effective tax benefit rate excluding this charge would have been
21.0%, which was substantially lower than the U.S. statutory rate primarily due
to the impact of certain non-tax deductible charges for business restructuring
and asset impairment charges on the pre-tax loss.
The effective tax benefit rate on a year to date basis excluding the $5.9
billion charge discussed above would have been 26.1% which is less than the U.S.
statutory rate due to the impact of certain non-tax deductible charges for
certain business restructuring and asset impairment charges on the pretax loss,
a $208 million charge for valuation allowances on foreign tax credit
carryforwards that arose due to recent net operating loss carrybacks under new
legislation and that are more likely than not to expire unused, offset by a $60
million favorable tax settlement and the tax impact from the gain on the sale of
our optical fiber business, which had a low effective tax rate due to
differences in the book and tax basis of the assets sold. The new legislation
extended the net operating loss carryback period from two to five years.
However, since the net operating loss carryforward provisions were not coupled
with foreign tax credit carryforward relief, the additional valuation allowances
were required. This change in the tax legislation resulted in a tax refund of
$616 million in April 2002. Also affecting the effective tax benefit rate were
non-deductible goodwill amortization and valuation allowances on certain state
net operating loss carryforwards, offset in part by research and development tax
credits and a low effective tax rate on the non-U.S. portion of the gain
realized from the sale of our billing and customer care business.
The effective tax benefit rates for the three and nine months ended June 30,
2001, were lower than the U.S. statutory rate, primarily from the impact of
non-tax deductible goodwill amortization and certain non-tax deductible charges
for business restructuring and related asset impairments on the pre-tax loss,
offset in part by research and development tax credits.
Loss from Continuing Operations
As a result of the above, loss from continuing operations and loss per common
share amounts are as follows (amounts in millions, except per share amounts):
Three months ended June 30, Nine months ended June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
-------- ------- ------- -------
Loss from continuing operations $(7,999) $(1,878) $(9,017) $(6,841)
Basic and diluted loss per common share from
continuing operations $ (2.34) $ (0.55) $ (2.67) $ (2.01)
Weighted average number of common shares outstanding -
basic and diluted 3,428.5 3,405.2 3,422.5 3,396.9
22
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Other
The income (loss) from discontinued operations during the three and nine months
ended June 30, 2002, relates to revised estimates of our share of the expected
loss on disposal of Agere Systems Inc. ("Agere") through the spin-off date of
June 1, 2002. The loss from discontinued operations during the three and nine
months ended June 30, 2001, relates to Agere and our power systems business (see
Note 4 to the unaudited consolidated financial statements).
During the nine months ended June 30, 2001, we realized an extraordinary gain of
$1.2 billion, net of a $762 million tax provision, or $0.34 per basic and
diluted share, from the sale of our power systems business.
Effective October 1, 2000, we recognized a net $38 million charge for the
cumulative effect of certain accounting changes. This was comprised of a $30
million earnings credit ($0.01 per basic and diluted share) from the adoption of
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" and a $68 million charge to earnings ($0.02
per basic and diluted share) from the adoption of Securities and Exchange
Commission ("SEC") Staff Accounting Bulletin 101, "Revenue Recognition in
Financial Statements."
RESULTS OF OPERATIONS BY SEGMENT - THREE AND NINE MONTHS ENDED JUNE 30, 2002,
VERSUS THREE AND NINE MONTHS ENDED JUNE 30, 2001
INS
The following table presents external revenues, U.S. and non-U.S., and operating
loss (dollars in millions):
Three months ended June 30, Nine months ended June 30,
--------------------------------------------- -------------------------------------------
2002 2001 % change 2002 2001 % change
----- ---- -------- ---- ---- ---------
U.S. $ 770 $2,114 (63.6%) $ 2,775 $ 5,763 (51.8%)
Non-U.S. 641 1,540 (58.4%) 2,311 3,881 (40.5%)
------ ------ ------- --------
Total INS revenues $1,411 $3,654 (61.4%) $ 5,086 $ 9,644 (47.3%)
====== ====== ======= ========
Operating loss $(541) $(697) (22.4%) $(1,892) $(3,651) (48.2%)
====== ====== ======= ========
Return on sales (38.3%) (19.1%) (19.2 points) (37.2%) (37.9%) 0.7 points
====== ====== ======= ========
During the three and nine months ended June 30, 2002, INS revenues declined as
compared with the prior interim fiscal year periods by 61% and 47%. The declines
resulted from continuing reductions and delays in capital spending by large
service providers and were reflected in all product lines and geographic
regions, except for China during the nine-month interim period. The
deterioration of creditworthiness or financial condition of certain service
providers also adversely affected revenues, although to a much lesser degree.
Two-thirds of the decline was in the United States, and about one-third
internationally, primarily in EMEA (Europe, Middle East and Africa). The five
largest INS customers represented about 40% of its revenues during the nine
months ended June 30, 2002, and about 50% of the revenue decline compared with
the prior year interim period.
During the current quarter, the operating loss as compared with the prior fiscal
year period reduced by $156 million to $541 million. This improvement was driven
by a reduction in operating expenses of $615 million, partially offset by a
reduction in gross margin of $459 million. The gross margin rate significantly
declined primarily due to the large decrease in sales volume, partially offset
by lower inventory charges and cost reductions. The reduction in operating
expenses resulted from $569 million of lower expenses, primarily due to
headcount reductions and less discretionary spending and $46 million of lower
provisions for bad debts and customer financing.
During the nine months ended June 30, 2002, the operating loss declined as
compared with the prior fiscal year period by $1.8 billion to an operating loss
of approximately $1.9 billion. The improvement was due to significant decreases
in operating expenses of approximately $2.6 billion, partially offset by
reductions in gross margin of $838 million. The reasons for the decline in gross
margin and the reduction in operating expenses were similar to those described
above for the current quarter. In addition, provisions for bad debts and
customer financing were lower by $583 million primarily due to the significant
charges incurred for amounts due from Winstar in the prior year interim period.
23
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Mobility
The following table presents external revenues, U.S. and non-U.S., and operating
income (loss) (dollars in millions):
Three months ended June 30, Nine months ended June 30,
---------------------------------------- ------------------------------------------
2002 2001 % change 2002 2001 % change
---- ---- -------- ---- ---- --------
U.S. $1,218 $1,248 (2.4%) $3,637 $ 3,394 7.2%
Non-U.S. 233 235 (0.9%) 861 798 7.9%
------ ------ ------ -------
Total Mobility revenues
$1,451 $1,483 (2.2%) $4,498 $ 4,192 7.3%
====== ====== ====== =======
Operating income (loss)
$ 152 $(996) 115.3% $ 183 $(1,477) 112.4%
====== ====== ====== =======
Return on sales 10.5% (67.2%) 77.7 points 4.1% (35.2%) 39.3 points
====== ====== ====== =======
During the three months ended June 30, 2002, Mobility revenues as compared with
the prior fiscal year period decreased by 2%. During the nine months ended June
30, 2002, Mobility revenues as compared with the prior fiscal year periods
increased by 7%. The increase in the U.S. resulted from growth in products and
services sold to certain service providers as they built out their wireless
networks. The increase in non-U.S. revenues for the nine months ended June 30,
2002, resulted from higher revenues in China, partially offset by reductions in
the Asia Pacific region primarily due to a loss of revenues from One.Tel in
fiscal 2002, which went into receivership during 2001. The five largest Mobility
customers represented 75% of its revenues during the nine months ended June 30,
2002, and substantially all of the revenue increase compared with the prior year
interim period.
During the current quarter, operating income improved as compared with the prior
fiscal year period by $1.1 billion, to $152 million. Increases in gross margin
of $400 million and decreases in operating expenses of $748 million drove this
improvement. The gross margin rate increased significantly due to lower
inventory and warranty-related charges and cost reductions. The reduction in
operating expenses resulted from a reduction in provisions for bad debts and
customer financings of $611 million as well as headcount reductions and less
discretionary spending. In the prior year, the Mobility segment incurred
significant provisions for bad debts and customer financings for amounts due
from One.Tel and another customer that experienced financial difficulties.
During the nine months ended June 30, 2002, operating income improved as
compared with the prior fiscal year interim period by $1.7 billion to $183
million. Increases in gross margin of $693 million and decreases in operating
expenses of $967 million drove the improvement. The reasons for the higher gross
margin and reduction in operating expenses were similar to those described above
for the current quarter.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow for the nine months ended June 30, 2002
Net cash provided by (used in) operating activities
Net cash provided by (used in) operating activities was $46 million for the nine
months ended June 30, 2002. This primarily resulted from a loss from continuing
operations of $1.5 billion (adjusted for non-cash items) and changes in other
operating assets and liabilities of $1.8 billion, offset by a reduction in
working capital requirements (accounts receivable, inventories and contracts in
process and accounts payable) of $3.3 billion. The reduction in working
capital primarily resulted from the decrease in sales volume during the current
quarter compared with the fourth quarter of fiscal 2001. A significant
reduction in working capital was a $2.0 billion decrease in receivables.
Consistent with the decrease in receivables during the nine-month period, the
average receivable days sales outstanding decreased from 80 days at September
30, 2001, to 78 days at June 30, 2002. Improvements in inventory and contracts
in process also resulted from our continued efforts to streamline inventory
supply chain operations and higher billings for our long-term contracts. The
changes in other operating assets and liabilities include cash outlays under our
restructuring program of $811 million and a reduction in other operating assets
and liabilities due to the decrease in sales volume and lower headcount. Tax
refunds received in the second and third quarter of fiscal 2002 amounted to $953
million.
Net cash provided by investing activities
The net cash provided by investing activities of $1.5 billion for the nine
months ended June 30, 2002, was primarily from the $2.1 billion of cash proceeds
received from the sale of our optical fiber business and approximately $400
million of cash proceeds from other business dispositions and sale of certain
manufacturing operations, partially offset by $865 million of purchases of
short-term investments and capital expenditures of $312 million.
24
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Net cash provided by financing activities
Net cash provided by financing activities of $629 million for the nine months
ended June 30, 2002, was primarily due to $1.75 billion of proceeds received
from the sale of trust preferred securities in March 2002, partially offset by
repayments under our credit facilities of $1.0 billion and preferred stock
dividend payments of $73 million.
Cash Requirements
Our cash requirements over the next 12 months are primarily to fund:
o operations, including spending on R&D;
o restructuring requirements;
o capital expenditures;
o capital requirements in connection with our existing customer financing
commitments; and
o debt service and preferred dividend requirements.
Restructuring
The additional actions we committed to in the third quarter of fiscal 2002 are
expected to yield an annual cash savings of $700 million, $400 million of which
is expected from operating expenses.
Total cash requirements under the restructuring program, are expected to be
approximately $2.3 billion. Approximately $1.3 billion was paid through June 30,
2002, with the majority of the remainder to be paid over the next 12 months,
except for lease obligations of $430 million, which will be paid over a longer
period. Our future cash requirements will also be impacted by our additional
restructuring actions that are being developed.
We expect to complete most of the restructuring actions initiated through June
30, 2002, by the first quarter of fiscal 2003. If implemented in the manner and
on the timeline we intend, we expect to realize most of the benefits of our
restructuring program by the second quarter of fiscal 2003. However, there can
be no assurance that our restructuring program will achieve all of the cost and
expense reductions and other benefits we anticipate or on the timetable
contemplated.
Customer finance commitments
The following table presents our customer financing commitments at June 30,
2002, and September 30, 2001, (dollars in billions):
June 30, 2002 September 30, 2001
--------------------------------------------- ---------------------------------------------
Total loans Total loans
and and
guarantees Loans Guarantees guarantees Loans Guarantees
------------ ----- ---------- -------------- ----- ----------
Drawn commitments $1.2 $0.9 $0.3 $3.0 $2.6 $0.4
Available but not drawn 0.6 0.6 - 1.4 1.4 -
Not available 0.2 0.2 - 0.9 0.6 0.3
---- ---- ---- ---- ---- ----
Total commitments $2.0 $1.7 $0.3 $5.3 $4.6 $0.7
==== ==== ==== ==== ==== ====
Some of our customers worldwide require their suppliers to arrange or provide
long-term financing for them as a condition of obtaining or bidding on
infrastructure projects. These projects may require financing in amounts ranging
from modest sums to more than a billion dollars. We use a disciplined credit
evaluation and business review process that takes into account the credit
quality of individual borrowers and their related business plans, as well as
market conditions. We consider requests for financing on a case-by-case basis
and offer financing only after careful review. As market conditions permit, our
intention is to sell or transfer these long-term financing arrangements, which
may include both commitments and drawn-down borrowings, to financial
institutions and other investors. This enables us to reduce the amount of our
commitments and free up additional financing capacity. As part of the revenue
recognition process, we determine whether the notes receivable under these
contracts are reasonably assured of collection based on various factors,
including our ability to sell these notes. Deterioration in the credit quality
of our customers may further increase our capital needs if we are unable to sell
the notes representing existing customer financings or to transfer future
funding commitments to financial institutions and investors on acceptable terms
and in the expected timeframes. We expect that approximately one-half of the
$751 million undrawn commitments at June 30, 2002, may be drawn during the next
12 to 15 months, and the rest will likely expire undrawn. In addition, our
capital needs associated with customer financing may increase if our ability to
sell the notes representing existing customer financing, or transfer future
funding commitments, on acceptable terms to financial institutions and investors
is limited by a deterioration in the credit quality of the customers to which we
have extended financing.
25
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
In September 2000, we and a third party created a non-consolidated Special
Purpose Trust ("Trust") for the purpose of allowing us from time to time to sell
on a limited-recourse basis customer finance loans and receivables ("Loans") at
any given point in time. Due to our credit downgrade in February 2001, we are
unable to sell additional Loans to the Trust. As of June 30, 2002, the Trust
held approximately $350 million of customer financing loans and receivables. For
additional information, see "Special Purpose Entities."
As part of our credit process we monitor the drawn and undrawn commitments and
guarantees of debt to our customers. Customers are reviewed on a quarterly or
annual basis depending upon their risk profile. As part of our review, we assess
the customer's short-term and long-term liquidity position, current operating
performance versus plan, execution challenges facing the company, changes in
competitive landscape, industry and macroeconomic conditions, and changes in
management and sponsors. Depending upon the extent of any deterioration of a
customer's credit profile or non-compliance with our legal documentation, we
undertake actions that could include canceling the commitment, compelling the
borrower to take corrective measures, and increasing efforts to mitigate
potential losses. These actions are designed to mitigate unexpected events that
could have an impact on our future results of operations and cash flows.
However, there can be no assurance that this will be the case. Adverse industry
conditions have negatively affected the creditworthiness of several customers
that participate in our customer-financing program. The decrease in the drawn
and total commitments from September 30, 2001, was primarily due to the removal
of approximately $1 billion of fully reserved accounts, sales of loans and
cancellations, partially offset by drawdowns. Reserves associated with total
drawn commitments, including guarantees, were approximately $790 million
reflecting a net exposure of approximately $400 million.
Our overall customer financing exposure, coupled with a continued decline in
telecommunications market conditions, negatively affected results of operations
and cash flows in fiscal 2001 and has continued through fiscal 2002. We will
continue to provide or commit to financing, on a more limited basis, where
appropriate for our business. Our ability to arrange or provide financing for
our customers will depend on a number of factors, including our capital
structure, credit rating and level of available credit, and our continued
ability to sell or transfer commitments and drawn-down borrowings on acceptable
terms. Due to recent economic uncertainties and reduced demand for financings in
capital and bank markets, we may be required to continue to hold certain
customer financing obligations for longer periods prior to the sale to
third-party lenders. In addition, specific risks associated with customer
financing, including the risks associated with new technologies, new network
construction, market demand and competition, customer business plan viability
and funding risks have required us to hold certain customer financing
obligations and retain the related credit risk over a longer term. Any
unexpected developments in our customer financing arrangements could negatively
affect revenue, results of operations and cash flows in the future. In addition,
we may be required to record additional reserves related to customer financing
in the future.
Debt service and preferred dividend requirements
Debt service primarily represents interest payments on our short- and long-term
debt and trust preferred securities. Preferred dividend requirements represent
payments on our redeemable convertible preferred stock. We expect these
requirements over the next 12 months to be in the range of $500 million to $600
million.
Sources of Cash
We expect to fund our cash requirements over the next 12 months through a
combination of the following sources:
o cash and cash equivalents as of June 30, 2002;
o short-term investments as of June 30, 2002;
o available credit under our credit facility (see Credit facility);
o business dispositions and asset sales;
o capital market transactions; and
o accounts receivable securitization facility.
Our net liquidity was approximately $6.9 billion on June 30, 2002, which
consisted of cash and cash equivalents of $4.6 billion, short-term investments
of $867 million and availability under our credit facility of $1.5 billion. As
of June 30, 2002, no amounts were outstanding under our credit facility.
Credit facility
As a result of undertaking certain debt reduction transactions and generating
funds from certain specified non-operating sources in fiscal 2001 and 2002, the
total lending commitment under our credit facility was reduced to $1.5 billion.
The credit facility is secured by liens on substantially all of our assets. Our
ability to access our credit facility is subject to our compliance with its
terms and conditions, including
26
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
financial covenants. These financial covenants require us to have minimum
earnings before interest, taxes, depreciation, amortization ("EBITDA") and
certain other items and minimum net worth (each as defined and amended under the
credit facility) measured at the end of each fiscal quarter. As of June 30,
2002, we were in compliance with these covenants, however, we are required to
sustain or improve our financial performance in future quarters to remain in
compliance. On June 11, 2002, we entered into an amendment to our credit
facility that expires in February 2003. The amendment provided additional
flexibility to meet or exceed minimum quarterly EBITDA levels. The consolidated
quarterly EBITDA levels were amended to an EBITDA loss of $325 million and $300
million for the next two fiscal quarters, respectively. A continued downturn in
our principal markets could make it more difficult for us to satisfy these
requirements, which could result in a default under our credit facility.
We cannot resume payment of dividends on our common stock unless we achieve
certain credit ratings or EBITDA levels and no event of default exists under the
credit facility. Payment of dividends on our common stock is limited to the rate
of dividends paid prior to the discontinuation of the cash dividend. We are
permitted to pay cash dividends on our convertible preferred stock and
distributions on our convertible trust preferred securities if no event of
default exists under the credit facility.
Our credit facility matures in February 2003. We expect to replace this facility
prior to maturity, however, we cannot assure you that we will be able to do so
on acceptable terms.
Capital market transaction
On March 19, 2002, we sold 1,750,000 of 7.75% cumulative convertible trust
preferred securities for an aggregate amount of $1.75 billion. Fees paid in
connection with this transaction were approximately $46 million. We intend to
use the net proceeds for general corporate purposes, which over time may be used
to fund certain items discussed in "Cash requirements," however, we do not
currently anticipate using a significant amount of these proceeds to satisfy
these cash requirements in the near term. We invested the net proceeds in
investment grade, interest-bearing securities. For additional information on the
sale, see Note 8 to the unaudited consolidated financial statements.
Business dispositions, asset sales and sale of manufacturing operations
The following summarizes the significant dispositions during the current fiscal
year. These dispositions are not expected to have a significant impact on our
future results of operations except for the sale of OFS, which had revenues and
pretax income of $2 billion and $541 million, respectively, during fiscal 2001.
On November 16, 2001, we completed the sale of OFS to The Furukawa Electric Co.,
Ltd. for $2.3 billion, $173 million of which was paid to us in CommScope, Inc.
common stock. In addition, we entered into an agreement on July 24, 2001, to
sell two China-based joint ventures -- Lucent Technologies Shanghai Fiber Optic
Co., Ltd. and Lucent Technologies Beijing Fiber Optic Cable Co., Ltd. -- to
Corning Incorporated for $225 million. We are discussing with Corning whether a
portion of the proceeds may be paid in Corning common stock, and if so, under
what terms. This transaction, which is subject to approval by our partners in
the joint ventures, foreign governmental approvals and other customary closing
conditions, is expected to close during the fourth quarter of fiscal 2002.
On December 3, 2001, we completed the sale of our voice enhancement and echo
cancellation business to NMS Communications for $60 million in cash.
On December 21, 2001, we created a new venture capital partnership named New
Venture Partners II LP with Coller Capital of London, an international
specialist investment manager. Under the terms of the agreement, we sold
approximately 80% of our equity stake in our former New Ventures Group business
to Coller Capital for $93 million in cash.
On February 28, 2002, we completed the sale of our billing and customer care
business to CSG Systems International, Inc. for approximately $260 million in
cash, subject to certain post closing purchase price adjustments.
On May 31, 2002, we completed an agreement with Solectron Corporation to sell
certain manufacturing equipment and inventory for approximately $100 million in
cash, subject to post closing adjustments, and commenced a three-year supply
agreement with Solectron for certain optical networking products. Due to
continuing market uncertainties, Lucent and Solectron are currently in
discussions that may result in changes to these agreements.
On July 31, 2002, we completed the sale of the enterprise professional services
portion of our services business to International Network Services Inc. for
$11 million in cash.
Accounts receivable securitization facility
At June 30, 2002, $20 million was outstanding under our $500 million
securitization facility that expires in June 2004. However, continued
availability of this facility is contingent on the
27
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
annual renewal of certain bank commitments to fund incremental purchases under
certain circumstances. Our ability to obtain additional proceeds depends on a
combination of factors, including our credit ratings and increasing the level of
our eligible accounts receivable available for securitization. As of June 30,
2002, the total ownership rights in the receivables (undivided interest) in the
securitization were collateralized by $897 million of accounts receivable.
Future capital requirements
We believe our cash and cash equivalents, short-term investments, availability
under our credit facility and other planned sources of liquidity are currently
sufficient to meet our requirements over the next 12 months. However, we cannot
assure that these sources of liquidity will be available when needed
or that our actual cash requirements will not be greater than we currently
expect. As market conditions permit, we may raise additional capital, which
would include raising funds through equity or debt offerings. In addition, our
credit facility matures in February 2003. Although we expect to replace this
facility prior to maturity, we cannot assure that we will be able to do so on
acceptable terms for the same amount or at all. If our sources of liquidity are
not available or if we cannot generate positive cash flow from operations, we
might be required to obtain additional sources of funds through additional
operating improvements, asset sales and financing from third parties, or a
combination thereof. Although we believe that we have the ability to take these
actions, we cannot assure that these additional sources of funds, if available,
would have reasonable terms.
Credit ratings
Our credit ratings as of August 9, 2002, are as follows:
Convertible Trust
Long-term preferred preferred
Rating Agency debt stock securities Last update
- ------------- --------- ------------ ---------- -------------
Standard & Poor's B+ (n) CCC+ CCC+ August 5, 2002
Moody's B2 (n) Caa2 Caa1 March 22, 2002
Fitch B+ (n) CCC+ CCC+ June 13, 2002
- ---------
(n) Ratings outlook is negative.
Our credit ratings are below investment grade. As a result of past downgrades,
we no longer have the ability to participate in the commercial paper market and
are unable to sell trade and notes receivables to the Trust (see Customer
finance commitments). In addition, a credit downgrade affects our ability to
enter into and maintain certain contracts on favorable terms, and increases our
cost of borrowing.
Agere Spin-off Update
Effective June 1, 2002, we completed our spin-off of Agere. For additional
information on the spin-off, see Note 4 to the unaudited consolidated financial
statements.
Letters of Credit
Letters of credit are purchased guarantees that ensure Lucent's performance or
payment to third parties in accordance with specified terms and conditions. At
June 30, 2002 and September 30, 2001, $783 million and $900 million were
outstanding.
Special Purpose Entities
We have used special purpose entities for the sales and securitizations of
receivables and in real estate financing arrangements. The Financial Accounting
Standards Board is currently proposing amendments to existing accounting
standards that will require the consolidation of certain special purpose
entities. If these proposed amendments are approved in their existing form, it
may require us to consolidate the Trust that we have used to sell certain
customer finance loans and receivables to and this will result in adding
approximately $350 million of long-term notes receivable and debt obligations to
our balance sheet. In addition, we are a lessee under a synthetic lease
agreement for real properties whereby a non-consolidated special purpose entity
may require consolidation, which will result in adding approximately $100
million of land and buildings and debt obligations to our balance sheet. We are
currently analyzing these proposed amendments to existing accounting standards,
and if they are adopted in their existing form, we believe we will be required
to consolidate the aforementioned special purpose entities beginning April 1,
2003.
RISK MANAGEMENT
We are exposed to market risk from changes in foreign currency exchange rates,
interest rates and equity prices that could affect our results of operations and
financial condition. We manage our
28
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
exposure to these market risks through our regular operating and financing
activities and, when deemed appropriate, hedge these risks through the use of
derivative financial instruments. We use the term hedge to mean a strategy
designed to manage risks of price or rate movements on certain assets,
liabilities or anticipated transactions and by creating a relationship in which
gains or losses on derivative instruments are expected to counterbalance the
losses or gains on the assets, liabilities or anticipated transactions exposed
to such market risks. We use derivative financial instruments as risk management
tools and not for trading or speculative purposes. In addition, derivative
financial instruments are entered into with a diversified group of major
financial institutions in order to manage our exposure to nonperformance on such
instruments. Our risk management objective is to minimize the effects of
volatility on our cash flows by identifying the recognized assets and
liabilities or forecasted transactions exposed to these risks and appropriately
hedging them with either forward contracts or, to a lesser extent, option
contracts, swap derivatives or by embedding terms into certain contracts that
affect the ultimate amount of cash flows under the contract. We generally do not
hedge our credit risk on customer receivables.
Foreign Currency Risk
We use foreign exchange forward contracts and, to a lesser extent, option
contracts to minimize exposure to the risk that the eventual net cash inflows
and outflows resulting from the sale of products to non-U.S. customers and
purchases from non-U.S. suppliers will be adversely affected by changes in
exchange rates. Foreign exchange forward and option contracts are utilized for
recognized receivables and payables, firmly committed or anticipated cash
inflows and outflows. The use of these derivative financial instruments allows
us to reduce our overall exposure to exchange rate movements, since the gains
and losses on these contracts substantially offset losses and gains on the
assets, liabilities and transactions being hedged. Cash inflows and outflows
denominated in the same foreign currency are netted on a legal entity basis and
the corresponding net cash flow exposure is appropriately hedged. We do not
hedge our net investment in non-U.S. entities because we view those investments
as long-term in nature.
We have not changed our foreign exchange risk management strategy since the year
ended September 30, 2001. However, during the second fiscal quarter we modified
our policy to no longer designate certain freestanding foreign currency
derivatives as hedging instruments for accounting purposes against our
intercompany and external foreign-currency-denominated loans. This modification
did not materially impact our results of operations. We will continue to hedge
all types of foreign currency risk to preserve our economic cash flows but
generally do not expect to designate related derivative instruments as hedges
under current accounting standards for cost/benefit reasons unless the benefits
of doing so are material. We are currently in the process of further
centralizing the foreign exchange and liquidity management needs of many of our
operating subsidiaries under the model of an in-house bank. While this
implementation would not change the fundamental objective of our foreign
currency risk management policy, it is expected to yield benefits by way of
economic efficiency, process efficiency and improved visibility of financial
flows.
Interest Rate Risk
We use a combination of financial instruments, including medium-term and
short-term financings, variable-rate debt instruments and, to a lesser extent,
interest rate swaps to manage the interest rate mix of our total debt portfolio
and related cash flows. To manage this mix, we may enter into interest rate swap
agreements in which we agree to exchange various combinations of fixed and/or
floating interest rates based on agreed-upon notional amounts. We had interest
rate swap agreements with an aggregate notional amount of $400 million in effect
at June 30, 2002, that hedge a portion of a long-term, fixed-rate debt
obligation due in July 2006. Under these swaps, we receive a fixed interest rate
of 7.25% and pay an average floating rate of LIBOR plus 2.73%. As of
June 30, 2002, LIBOR was approximately 1.87%. The fair value of these interest
swaps at June 30, 2002, was not material. The objective of maintaining the mix
of fixed and floating rate debt is to mitigate the variability of cash flows
resulting from interest rate fluctuations, as well as reduce the cash flows
attributable to debt instruments. Our portfolio of customer finance notes
receivable predominantly comprises variable-rate notes at LIBOR plus a stated
percentage and subjects us to variability in cash flows and earnings for the
effect of changes in LIBOR. We do not enter into derivative transactions on our
cash equivalents and short-term investments, since their relatively short
maturities do not create significant risk. We have not changed our interest rate
risk management strategy since September 30, 2001, and do not foresee or expect
any significant changes in our exposure to interest rate fluctuations.
Equity Price Risk
Our investment portfolio consists of equity investments accounted for under the
cost and equity methods as well as equity investments in publicly-held companies
that are classified as available-for-sale. These available-for-sale securities
are exposed to price fluctuations and are generally concentrated in the
high-technology and the telecommunications industries, many of which are small
capitalization stocks. At June 30, 2002, the fair value of one
available-for-sale security totaled $128 million out of a total
available-for-sale portfolio of $153 million. Due to the continued weak economic
conditions in the technology sector, we may, from time to time, record
impairment losses and write down the carrying value of certain equity
investments when the
29
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
declines in fair value are other than temporary. The impairment losses recorded
were $56 million and $114 million for the three months and nine months ended
June 30, 2002, respectively. We generally do not hedge our equity price risk,
and as of June 30, 2002, we had no outstanding hedge instruments for our equity
price risk.
OTHER INFORMATION
On November 21, 2000, we announced that we had identified an issue affecting
revenue in the fourth fiscal quarter of 2000. We informed the SEC and initiated
a review by our outside counsel and outside auditors. In late December 2000, we
announced the results of the review, which resulted in certain adjustments to
our fourth fiscal quarter of 2000 results. We are cooperating fully with the
SEC's investigation of these matters.
RECENT PRONOUNCEMENTS
See discussion in Note 13 to the unaudited consolidated financial statements.
LEGAL PROCEEDINGS AND ENVIRONMENTAL MATTERS
See discussion in Note 12 to the unaudited consolidated financial statements.
FORWARD-LOOKING STATEMENTS AND RISKS RELATED TO OUR BUSINESS
This quarterly report on Form 10-Q and other documents we file with the SEC
contain forward-looking statements that are based on current expectations,
estimates, forecasts and projections about us, our future performance, the
industries in which we operate, our beliefs and our management's assumptions. In
addition, other written or oral statements that constitute forward-looking
statements may be made by or on behalf of us. Words such as 'expects,'
'anticipates,' 'targets,' 'goals,' 'projects,' 'intends,' 'plans,' 'believes,'
'seeks,' 'estimates,' variations of such words and similar expressions are
intended to identify such forward-looking statements. These statements are not
guarantees of future performance and involve certain risks, uncertainties and
assumptions that are difficult to predict. Therefore, actual outcomes and
results may differ materially from what is expressed or forecast in such
forward-looking statements. Except as required under the federal securities laws
and the rules and regulations of the SEC, we do not have any intention or
obligation to update publicly any forward-looking statements after the
distribution of this Form 10-Q, whether as a result of new information, future
events, changes in assumptions, or otherwise.
The following items are representative of the risks, uncertainties and
assumptions that could affect the outcome of the forward-looking statements. In
addition, such forward-looking statements could be affected by general industry
and market conditions and growth rates, general U.S. and non-U.S. economic and
political conditions, including the global economic slowdown and interest rate
and currency exchange rate fluctuations and other future events or otherwise.
IF THE TELECOMMUNICATIONS MARKET DOES NOT IMPROVE, OR IMPROVES AT A SLOWER PACE
THAN WE ANTICIPATE, OUR RESULTS OF OPERATIONS WILL CONTINUE TO SUFFER.
During fiscal 2001, the global telecommunications market deteriorated,
reflecting a significant decrease in the competitive local exchange carrier
market and a significant reduction in capital spending by established service
providers. This trend has continued during the first nine months of fiscal 2002
and is expected to continue at least throughout calendar 2002. As a result, our
sales and results of operations have been adversely affected.
If capital investment levels continue to decline, or if the telecommunications
market does not improve or improves at a slower pace than we anticipate, our
revenues and profitability will continue to be adversely affected. In addition,
if our sales volume and product mix does not improve, our gross margin
percentage may not improve as much as we expect, resulting in lower than
expected results of operations.
The significant slowdown in capital spending in our target markets has created
uncertainty as to the level of demand in those markets. In addition, the level
of demand can change quickly and can vary over short periods of time, including
from month to month. As a result of the uncertainty and variations in our
markets, accurately forecasting future results, earnings and cash flow is
increasingly difficult.
WE INCURRED A NET LOSS IN FISCAL 2001 AND IN THE FIRST NINE MONTHS OF FISCAL
2002 AND WE MAY CONTINUE TO INCUR NET LOSSES IN THE FUTURE. IF WE CONTINUE TO
INCUR NET LOSSES, WE MAY BE UNABLE TO COMPLY WITH OUR DEBT COVENANTS, AND OUR
LEGALLY AVAILABLE SURPLUS MAY BE REDUCED.
We incurred net losses of $16.2 billion and $8.9 billion in fiscal 2001 and for
the first nine months of fiscal 2002, respectively. In addition, our U.S. and
international revenues declined in the first nine months of fiscal 2002,
primarily as a result of the decline in our customers' spending. If our
customers' spending does not increase or if we fail to generate the benefits we
30
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
seek from our shift in strategic direction and restructuring program, our
revenues may continue to decline, and we may not be able to return to and
maintain profitability. In such event, we will have difficulty complying with
certain provisions in our credit facility.
In addition, under Delaware law we generally can pay dividends on or acquire
shares of our capital stock (including our 8.00% redeemable convertible
preferred stock) only from our legally available surplus, as defined by
Delaware law. If we experience significant reductions to our surplus, this could
adversely affect our ability to pay dividends or to redeem or otherwise acquire
our capital stock.
OUR STRATEGIC DIRECTION AND RESTRUCTURING PROGRAM MAY NOT YIELD THE BENEFITS WE
EXPECT AND COULD EVEN HARM OUR FINANCIAL CONDITION, REPUTATION AND PROSPECTS.
In connection with implementing our strategic direction and restructuring
program, we have, or are in the process of, exiting certain product lines,
outsourcing the manufacturing of certain of our products, selectively disposing
of certain of our businesses and facilities, reducing the number of countries in
which we operate, and significantly reducing our workforce. These activities may
not yield the benefits we expect, and may raise product costs, delay product
production and service delivery, result in or exacerbate labor disruptions and
labor-related legal actions against us, and create inefficiencies in our
business.
Our strategic direction and restructuring program also may give rise to
unforeseen costs, which could wholly or partially offset any expense reductions
or other financial benefits we attain as a result of the changes to our
business. In addition, if the markets for our products do not improve, we will
take additional restructuring actions to address these market conditions. Any
such additional actions could result in additional restructuring charges.
WE HAVE SUBSTANTIAL CASH REQUIREMENTS AND MAY REQUIRE ADDITIONAL SOURCES OF
FUNDS IF OUR SOURCES OF LIQUIDITY ARE UNAVAILABLE OR INSUFFICIENT TO SATISFY
THESE REQUIREMENTS. THERE IS NO ASSURANCE THAT THE ADDITIONAL SOURCES OF FUNDS
WOULD BE AVAILABLE OR AVAILABLE ON REASONABLE TERMS.
We have substantial cash requirements in connection with our operations, capital
expenditures, restructuring and customer financing programs, debt service
obligations and, if we elect to pay such dividends or redemptions in cash,
preferred stock dividend requirements and redemptions. In addition, new product
development, which is key to the success of our business, is capital intensive.
If the cash we generate from our operations or that we can access under our
credit facility or from our other sources is not available when needed or is
insufficient to satisfy our requirements, we may require additional sources of
funds.
Our credit facility matures in February 2003. While we expect to be able to
replace our credit facility prior to maturity, we cannot assure you that we will
be able to do so on acceptable terms for the same amount or at all. We also
cannot assure you that any required additional sources of funds would be
available or available on reasonable terms. If we do not generate sufficient
amounts of capital to meet our cash requirements at the times and on the terms
required by us, our business will likely be adversely affected.
OUR CREDIT FACILITY IMPOSES SIGNIFICANT OPERATING AND FINANCIAL RESTRICTIONS ON
US, AND IN THE EVENT THAT WE DEFAULT UNDER OUR CREDIT FACILITY, ANY OF OUR
OUTSTANDING BORROWINGS UNDER THE CREDIT FACILITY WOULD BECOME IMMEDIATELY DUE
AND PAYABLE.
Our credit facility imposes operating and other restrictions on us and on many
of our subsidiaries. The credit facility also requires us to have minimum
earnings before interest, taxes, depreciation, amortization and certain other
items (EBITDA) and net worth (each defined under the credit facility) measured
at the end of each fiscal quarter. Our credit facility matures in February 2003,
and we may in the future enter into new credit facilities or other transactions
that impose similar or even more stringent restrictions and financial tests. Our
ability to meet those financial tests is dependent upon a variety of factors,
many of which are beyond our control. There can be no assurance that we will be
able to comply with the restrictions and financial tests of our credit facility,
any new credit facilities, or other transactions.
The restrictions contained in our credit facility or any new credit facility
could limit our ability to plan for or react to market conditions or meet
capital needs or otherwise restrict our activities or business plans and
adversely affect our ability to finance operations, strategic acquisitions,
investments or alliances or to engage in other business activities that would be
in our interest. Some of the current financial tests in our credit facility
require improving financial performance by us over time. A continuing downturn
in our principal markets could make it more difficult for us to satisfy these
financial tests. A breach of any of the restrictive
31
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
covenants or our inability to comply with the required financial tests could
result in a default under the credit facility. If any such default occurs, the
lenders under the credit facility may elect to declare all outstanding
borrowings, together with accrued interest and other fees, to be immediately due
and payable. The lenders will also have the right in these circumstances to
terminate any commitments they have to provide further borrowings, which would
reduce the liquidity available to us.
OUR CREDIT RATINGS MAY BE REVIEWED FOR DOWNGRADE, PUT ON CREDIT WATCH OR
DOWNGRADED, WHICH COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Declines in our credit ratings have resulted in increased costs on certain of
our credit facility and other financing arrangements. In addition, we have
experienced reduced access to credit markets and declines in the price of Lucent
common stock. There can be no assurance that our credit ratings will not be
reduced in the future by Moody's, S&P, Fitch or any other ratings agency.
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY. OUR FAILURE TO COMPETE EFFECTIVELY
WOULD HARM OUR BUSINESS.
The industry in which we operate is highly competitive and we expect that the
level of competition on pricing and product offerings will intensify as
equipment manufacturers seek to strengthen their relationships with large
service providers and as the telecommunications industry undergoes
consolidation. The factors that could affect our ability to compete successfully
in the industry include: the quality, performance, reliability, mix and market
acceptance of our products; market acceptance of our competitors' products;
efficiency and quality of the production and implementation of our products; and
our customer support and reputation.
We have a number of existing competitors, some of which are very large with
substantial technological and financial resources and brand recognition. In
addition, new competitors may enter the industry as a result of shifts in
technology. These new competitors, as well as existing competitors, may include
entrants from the telecommunications, computer software, data networking, and
semiconductor industries. We cannot assure that we will be able to compete
successfully against existing or future competitors. Competitors may be able to
offer lower prices, additional or a more attractive mix of products or services,
or services or other incentives that we cannot match or do not offer. These
competitors may be in a stronger position to respond quickly to new or emerging
technologies and may be able to undertake more extensive marketing campaigns,
adopt more aggressive pricing policies, and make more attractive offers to
potential customers, employees, and strategic partners. Because we have a
unionized workforce at some locations and many of our main competitors are not
unionized to the same extent, or at all, our costs may be higher and our
profitability may be lower than those competitors. In addition, because we may
have less liquidity and a more limited access to the capital markets as a result
of our credit ratings than some of our competitors, these competitors may be
better positioned to withstand a prolonged downturn in the industry or in the
economy as a whole.
A LIMITED NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR
REVENUES, AND THE LOSS OF ONE OR MORE KEY CUSTOMERS COULD SIGNIFICANTLY REDUCE
OUR REVENUES, PROFITABILITY AND CASH FLOW.
We rely on a limited number of large customers to provide a substantial portion
of our revenues. These customers include: AT&T, AT&T Wireless, BellSouth,
Cingular, SBC, Sprint, Verizon and Verizon Wireless. A reduction, delay or
cancellation of orders from one or more of our significant customers or the loss
of one or more significant customers in any period could have an adverse effect
on our revenues, profitability and cash flow. For example, certain of our U.S.-
based Mobility customers are pursuing alternatives to our Time Division Multiple
Access technology.
As part of our strategic direction, we are targeting our products and services
to the world's largest service providers. In addition, the telecommunications
industry has recently experienced a consolidation of both U.S. and non-U.S.
companies. As a result of these factors, it is likely that in fiscal 2002 and
subsequent years an even greater percentage of our revenues will be attributable
to a limited number of large service providers than in years past. Larger than
expected decreases in spending by these large service providers, or a loss of
any of them as a customer, could have an adverse effect on our revenues,
profitability and cash flow.
WE ARE EXPOSED TO THE CREDIT RISK OF OUR CUSTOMERS AS A RESULT OF OUR CUSTOMER
FINANCING ARRANGEMENTS AND ACCOUNTS RECEIVABLES.
Our customer financing arrangements and accounts receivable make us vulnerable
to downturns in the economy and the industry in general, and to adverse changes
in our customers' businesses in particular. Many of the customers to whom we
provide funding or with whom we have contracts have been negatively affected by
the continued softening in the telecommunications market, and some have filed
for bankruptcy or been declared insolvent. As a result, we wrote off certain
customer financings and receivables and sold others at significant discounts. We
also recorded reserves or write-offs in our financial statements and may have to
record additional reserves or write-offs
32
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
in the future. Deterioration in the credit quality of our customers may increase
our capital needs if we are unable to sell the notes representing existing
customer financings or to transfer future funding commitments to financial
institutions and investors on acceptable terms and in the expected timeframes.
WE HAVE DEVELOPED OUTSOURCING ARRANGEMENTS FOR THE MANUFACTURE OF SOME OF OUR
PRODUCTS. IF THESE THIRD PARTIES FAIL TO DELIVER QUALITY PRODUCTS AND COMPONENTS
AT REASONABLE PRICES ON A TIMELY BASIS, WE MAY ALIENATE SOME OF OUR CUSTOMERS,
AND OUR REVENUES, PROFITABILITY AND CASH FLOW MAY DECLINE.
As part of our strategic direction, we are increasing our use of contract
manufacturers as an alternative to our own manufacture of products. If, in
implementing this initiative, we are unable to identify contract manufacturers
willing to contract with us on competitive terms and to devote adequate
resources to fulfill their obligations to us, or if we do not properly manage
these relationships, our existing customer relationships may suffer. In
addition, by undertaking these activities, we run the risk that the reputation
and competitiveness of our products and services may deteriorate as a result of
the reduction of our control over quality and delivery schedules. We also may
experience supply interruptions, cost escalations and competitive disadvantages
if our contract manufacturers fail to develop, implement, or maintain
manufacturing methods appropriate for our products and customers.
If any of these risks is realized, our revenues, profitability and cash flow may
decline. In addition, as we come to rely more heavily on contract manufacturers,
we may have fewer personnel resources with expertise to manage problems that may
arise from these third-party arrangements.
WE HAVE LONG-TERM SALES AGREEMENTS WITH A NUMBER OF OUR LARGE CUSTOMERS. SOME OF
THESE AGREEMENTS MAY PROVE UNPROFITABLE AS OUR COSTS AND PRODUCT MIX SHIFT OVER
THE LIVES OF THE AGREEMENTS.
We have entered into long-term sales agreements with a number of our large
customers. Some of these sales agreements require us to sell products and
services at fixed prices over the lives of the agreements, and some require us
to sell products and services that we would otherwise discontinue, thereby
diverting our resources from the development of more profitable or strategically
important products. The costs we incur in fulfilling certain of our sales
agreements may vary substantially from our initial cost estimates. Any cost
overruns that we cannot pass on to our customers could adversely affect our
results of operations by reducing or eliminating our profit margins.
IF WE FAIL TO MAINTAIN A PRODUCT PORTFOLIO THAT IS ATTRACTIVE TO OUR CUSTOMERS,
ENHANCE OUR EXISTING PRODUCTS AND KEEP PACE WITH TECHNOLOGICAL ADVANCES IN OUR
INDUSTRIES OR IF WE PURSUE TECHNOLOGIES THAT DO NOT BECOME COMMERCIALLY
ACCEPTED, CUSTOMERS MAY NOT BUY OUR PRODUCTS, AND OUR REVENUES, PROFITABILITY
AND CASH FLOW MAY BE ADVERSELY AFFECTED.
The demand for our products can change quickly and in ways that we may not
anticipate because markets for our principal products are characterized by:
rapid, and sometimes disruptive, technological developments; evolving industry
and certification standards; frequent new product introductions and
enhancements; changes in customer requirements and a limited ability to
accurately forecast future customer orders; evolving methods of building and
operating communications systems for our service provider and other customers;
and short product life cycles with declining prices over the life cycle of a
product.
Our operating results depend, to a significant extent, on our ability to
maintain a product mix that is attractive to our customers, enhance our existing
products and continue to successfully introduce new products on a timely basis.
New technological innovations generally require a substantial investment before
any assurance is available as to their commercial viability, including, in some
cases, certification by U.S. and non-U.S. standards-setting bodies.
If we fail to make sufficient investments or we focus on technologies that do
not become widely adopted, new technologies could render our current and planned
products obsolete, resulting in the need to change the focus of our research and
development and our product strategies. This will disrupt our business
significantly. Even if we develop the appropriate technology, we may not bring
our products successfully or timely to market or achieve market acceptance of
them. Being one of the first to make products available is important to the
success of a new product, and any delays in bringing a new product to market
could have a negative effect on our results of operations.
MANY OF OUR CURRENT AND PLANNED PRODUCTS ARE HIGHLY COMPLEX AND MAY CONTAIN
DEFECTS OR ERRORS THAT ARE DETECTED ONLY AFTER DEPLOYMENT IN COMMUNICATIONS
NETWORKS. IF THAT OCCURS, OUR REPUTATION MAY BE HARMED.
Our products are highly complex and can only be fully tested when deployed in
communications networks and other equipment. From time to time, our products
have contained undetected defects, errors or failures. The occurrence of any
defects, errors or failures could result in cancellation of orders, product
returns, diversion of our resources, legal actions by our customers or our
customers' end-users and other losses to us or to our customers or end-users.
33
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Any of these occurrences could also result in the loss of or delay in market
acceptance of our products and loss of sales, which would harm our business and
adversely affect our revenue and profitability.
OUR SUCCESS DEPENDS ON OUR ABILITY TO RETAIN AND RECRUIT KEY PERSONNEL.
Our success depends in large part on our ability to recruit and retain highly
skilled technical, managerial, sales and marketing personnel. In spite of the
economic slowdown, competition for these personnel remains intense. In addition,
our recent workforce reductions have increased our dependence on our remaining
workforce, as we are relying on our current personnel to assume additional
responsibilities. The loss of services of any of our key personnel or our
failure to retain and attract qualified personnel in the future could make it
difficult for us to meet our key objectives, such as timely product
introductions.
WE ARE A PARTY TO LAWSUITS, WHICH, IF DETERMINED ADVERSELY TO US, COULD RESULT
IN THE IMPOSITION OF DAMAGES AGAINST US AND COULD HARM OUR BUSINESS AND
FINANCIAL CONDITION.
We and certain of our former officers and current and former members of our
board of directors are subject to various lawsuits brought by shareowners and
classes of shareowners, customers and participants in certain of our employee
benefit plans, alleging, among other things, violations of federal and state
securities laws, ERISA, consumer fraud laws and breaches of various fiduciary
obligations. The deterioration in the overall telecommunications market, the
decline of our results of operations in fiscal 2001, and the consequent impact
on Lucent common stock prices, have increased the number and nature of the
actions being brought and the damages claimed against us. In addition, our
substantial workforce reductions appear to have been the catalyst for employment
related actions against us. The actions and allegations made against us may
increase as we continue to implement our restructuring program, which may
involve asset dispositions and workforce reductions. There can be no assurance
that actions that have been or will be brought against us will be resolved in
our favor. Any losses resulting from these claims could adversely affect our
profitability and cash flow.
IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR BUSINESS AND
PROSPECTS MAY BE HARMED.
If we fail to protect our intellectual property, it could seriously harm our
businesses and prospects because we believe that developing new products and
technology that are unique to us is critical to our success. Although we have
numerous United States and foreign patents and numerous pending patents, there
can be no assurance that any patents, whether issued or pending, will provide us
with any competitive advantage, or will not be challenged by third parties.
Moreover, our competitors may already have applied for patents that, once
issued, will prevail over our patent rights or otherwise limit our ability to
sell our products. Our competitors also may attempt to design around our patents
or copy or otherwise obtain and use our proprietary technology. In addition, the
patent applications that we have currently pending may not be granted. If we do
not receive the patents we seek, or if we otherwise fail to secure international
protection for our intellectual property, our competitiveness could be
significantly impaired, which would limit our future revenues.
WE ARE SUBJECT TO INTELLECTUAL PROPERTY LITIGATION AND INFRINGEMENT CLAIMS,
WHICH COULD CAUSE US TO INCUR SIGNIFICANT EXPENSES OR PREVENT US FROM SELLING
OUR PRODUCTS.
There can be no assurance that third parties will not claim that our proprietary
or licensed products, systems and software are infringing their intellectual
property rights or that we do not in fact infringe those intellectual property
rights. From time to time, we receive notices from third parties of potential
infringement and receive claims of potential infringement when we attempt to
license our intellectual property to others. Intellectual property litigation
can be costly and time consuming and divert the attention of management and key
personnel from other business issues. The complexity of the technology involved
and the uncertainty of intellectual property litigation increase these risks. A
successful claim of patent or other intellectual property infringement could
compel us to enter into costly royalty or license agreements or force us to pay
significant damages and may even require us to stop the sale of certain of our
products.
WE ARE SUBJECT TO ENVIRONMENTAL, HEALTH AND SAFETY LAWS, WHICH COULD INCREASE
OUR COSTS AND RESTRICT OUR FUTURE OPERATIONS.
Our operations are subject to a wide range of environmental, health and safety
laws, including laws relating to the use, disposal, clean up of, and human
exposure to, hazardous substances. In the United States, these laws often
require parties to fund remedial action regardless of fault. Although we believe
our reserves are adequate to cover our environmental liabilities, factors such
as the discovery of additional contaminants, the extent of remediation and
compliance expenses, and the imposition of additional cleanup obligations at
Superfund and other sites could cause our capital expenditures and other
expenses relating to remediation activities to exceed the amount reflected in
our environmental reserve and adversely affect our results of operations or cash
flows. Compliance with existing or future environmental, health and safety laws
could subject us to future liabilities, cause the suspension of production,
restrict our ability to expand facilities, require us to acquire costly
pollution control equipment or incur other
34
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
significant expenses or modify manufacturing processes.
RAPID CHANGES TO EXISTING REGULATIONS OR TECHNICAL STANDARDS OR THE
IMPLEMENTATION OF NEW REGULATIONS OR TECHNICAL STANDARDS UPON PRODUCTS AND
SERVICES NOT PREVIOUSLY REGULATED COULD BE DISRUPTIVE, TIME CONSUMING AND
COSTLY.
Many of the products and services we offer are developed in reliance upon
existing regulations and technical standards, our interpretation of unfinished
technical standards or the lack of such regulations and standards. Rapid changes
to existing regulations and technical standards or the implementation of new
regulations and technical standards upon products and services not previously
regulated could adversely affect development, demand, sale and warranty of our
products and services, thus increasing our costs and decreasing the demand for
our products and services.
WE CONDUCT A SIGNIFICANT AMOUNT OF OUR OPERATIONS OUTSIDE THE UNITED STATES,
WHICH SUBJECTS US TO SOCIAL, POLITICAL AND ECONOMIC RISKS OF DOING BUSINESS IN
FOREIGN COUNTRIES AND MAY CAUSE OUR PROFITABILITY TO DECLINE DUE TO INCREASED
COSTS.
We have significant operations in foreign countries, including manufacturing
facilities, sales personnel and customer support operations. For fiscal 2001, we
derived approximately 35% of our revenues from sales outside the United States.
We manufacture a significant portion of our products outside the United States.
We are also dependent on international suppliers for many of our parts. We
expect to concentrate sales and marketing, product development, services and
supply chain resources to meet the global needs of the world's largest service
providers and have initiated actions to follow the geographic footprint of our
large service provider customers around the world to the approximately 20 core
countries in which these customers do business. We will, therefore, continue to
be subject to the risks inherent in doing business in foreign countries. These
risks include: increases in tariffs and duties, price controls, restrictions on
foreign currencies and trade barriers imposed by foreign countries; exchange
controls and fluctuations in currency exchange rates; difficulties in staffing
and managing international operations; political or social unrest or economic
instability; the risk of nationalization of private enterprises by foreign
governments; and adverse tax consequences, including imposition of withholding
or other taxes on payments by subsidiaries.
Difficulties in foreign financial markets and economies, and of foreign
financial institutions, could also inhibit demand from our customers in the
affected countries. Any or all of these factors could have a material adverse
impact on our global business operations. Although we attempt to manage our
exposure to risks from fluctuations in foreign currency exchange rates, through
our regular operating and financing activities and, when deemed appropriate,
derivative financial instruments, our attempts may not be successful. A
significant change in the value of the United States dollar against the currency
of one or more countries where we sell products to local customers or make
purchases from local suppliers may materially adversely affect our operating
results.
35
Part II - Other Information
Item 1. Legal Proceedings.
As previously reported, Sparks, et al. v. AT&T and Lucent Technologies Inc. et
al., is a class action lawsuit filed in 1996 in Illinois state court under the
name of Crain v. Lucent Technologies. The complaint seeks damages on behalf of
present and former customers based on a claim that the AT&T Consumer Products
business (which became part of Lucent in 1996) and Lucent had defrauded and
misled customers who leased telephones, resulting in payments in excess of the
cost to purchase the telephones. Similar consumer class actions pending in
various state courts have been stayed pending the outcome of the Sparks case
and, in July 2001, the Illinois court certified a nationwide class of
plaintiffs. Lucent filed pretrial motions for, among other things,
decertification of the class and summary judgment in Lucent's favor. On July 29,
2002, the judge denied Lucent's motions, and set trial to begin on August 5,
2002.
After extensive negotiations subsequent to Lucent's July 23, 2002 earnings
release, a settlement proposal was submitted to the court on August 9, 2002, to
settle the litigation for up to $300 million in cash plus pre-paid calling cards
redeemable for minutes of long distance service. The settlement will be reviewed
by the court and must be approved before the settlement becomes final. Lucent
and AT&T deny they have defrauded or misled their customers, but have decided
to settle this matter to avoid the uncertainty of litigation and the diversion
of resources and personnel that the continuation of pursuing this matter would
require. The class claimants will apply for reimbursement from the settlement
fund, and will be required to demonstrate their entitlement through a claims
form to be provided to a claims administrator. Depending upon the number of
claims submitted and accepted, the actual cost of the settlement to the
defendants may be less than the stated amount, but it is not possible to
estimate the amount at this time.
Lucent is a party to various separation and distribution agreements, which
provide for contribution from formerly affiliated third parties for a portion of
any liability (including any settlement) in this case. However, Lucent would
remain responsible for a majority of any such liability or settlement. As a
result, Lucent recognized a $162 million charge recorded in other income
(expense), which is net of expected third party contributions.
In the purported shareholder class action lawsuit pending in U.S. District Court
of New Jersey, In re Lucent Technologies Inc. Securities Litigation, Lucent
filed a motion to dismiss the claims. In June 2002, the court denied Lucent's
motion. No trial date has been set for this case and discovery is ongoing. The
plaintiffs have indicated to the court that they will file a motion for class
certification shortly, and we have indicated that Lucent intends to oppose such
a motion. Lucent is unable to determine the potential impact of this case on our
consolidated financial statements. Lucent is defending this action vigorously.
In July 2001, a purported class action complaint was filed under ERISA alleging,
among other things, that Lucent and certain unnamed officers breached their
fiduciary duties with respect to Lucent's employee savings plans claiming that
the defendants were aware that Lucent stock was inappropriate for retirement
investment and continued to offer such stock as a plan investment option. The
complaint seeks damages, injunctive and equitable relief, interest and fees and
expenses associated with the litigation. In August 2001, a separate purported
class action complaint was filed under ERISA alleging, among other things, that
Lucent breached its fiduciary duties with respect to its employee benefit and
compensation plans by offering Lucent stock as an investment to employees
participating in the plans despite the fact that Lucent allegedly knew it was
experiencing significant business problems. The August action was dismissed
without prejudice on June 12, 2002. The July action is in the discovery stage
and Lucent is unable to determine the potential impact of the case on the
consolidated financial statements. Lucent is defending the action vigorously.
The case is pending in the U.S. District Court in New Jersey and is captioned
Reinhart et al. v. Lucent Technologies.
In June 2002, Lucent agreed to pay VTech a $50 million purchase price adjustment
to settle the claim between Lucent and its former subsidiary, Lucent
Technologies Consumer Products L.P., and VTech Holdings Limited and VTech
Electronics Netherlands B.V. The lawsuit arose from VTech's acquisition of wired
telephone assets from Lucent.
As previously reported, in March 2002, Lucent was named as a defendant in a case
captioned In re Winstar Communications Securities Litigation, pending in U.S.
District Court for the Southern District of New York. The case is a putative
class action on behalf of purchasers of common stock of Winstar Communications
("Winstar"), Inc., which filed for bankruptcy in April 2001, against several
former officers and directors of Winstar, Winstar's outside auditors, and
Lucent. In addition, in April 2002, a case captioned Preferred Life Insurance
Co. of New York et al. v. Lucent Technologies Inc. was filed in New Jersey
state court against Lucent. The plaintiffs in the New Jersey case are
institutional investors, many of which are affiliated with each other, that
purchased the common stock of Winstar. In both actions, the plaintiffs claim
that Lucent caused or contributed to money lost by the plaintiffs in
connection with their investments in Winstar stock. In the New York action, the
plaintiffs claim that Lucent violated federal securities laws in connection with
plaintiffs' purchases of Winstar stock. Lucent has moved to dismiss the claims
in the New York action during June 2002. In the New Jersey action, the
plaintiffs claim that Lucent committed common law fraud, negligent
misrepresentation, conspiracy to commit fraud and aiding and abetting fraud in
connection with plaintiffs' purchases of Winstar stock. Both cases are in the
early stages, and Lucent intends to defend the cases vigorously. Lucent is
unable to determine the potential impact of these cases on the consolidated
financial statements.
36
Part II - Other Information
As previously reported, Lucent is also a defendant in an adversary proceeding
filed in U.S. Bankruptcy Court in Delaware by Winstar and Winstar Wireless Inc.
in connection with the bankruptcy of Winstar and various related entities. The
complaint asserts claims for breach of contract and fraudulent inducement
against Lucent and seeks monetary damages and injunctive relief, as well as
costs and expenses associated with litigation. Lucent filed a motion to dismiss
certain of the claims asserted by plaintiffs. However, the plaintiffs have
indicated to the court that they intend to file an amended complaint. Lucent
intends to defend the case vigorously. Lucent is unable to determine the
potential impact of the case on the consolidated financial statements.
In May 2002, certain of Lucent's current and former officers and directors were
named as defendants, and Lucent was named as a nominal defendant, in a case
captioned Pallas v. Schacht et al., filed in U.S. District Court in New Jersey.
The action claims that the individual officer and director defendants violated
the federal securities laws in connection with the proxy statements disseminated
to Lucent shareholders following Lucent's fiscal years 1999, 2000 and 2001, by
allegedly failing to disclose that the Company's directors had breached
fiduciary duties and engaged in various forms of improper conduct. The action
also asserts derivative claims nominally on behalf of the Company against the
individual defendants for breach of fiduciary duties and corporate waste. In
July 2002, Lucent moved to dismiss the claims. Lucent intends to defend the case
vigorously.
In the Obtek, et al. v. Lucent Technologies Inc., et al. case pending in
Rockwall County Texas and pertaining to alleged violations of federal securities
laws, the Texas Securities Act and other claims, the court denied a motion to
dismiss the claims against the individual defendants and has set a trial date
for February 2003. Lucent is unable to determine the potential impact of this
case on the consolidated financial statements. Lucent is defending this action
vigorously.
The U.S. Attorney's Office in Newark, New Jersey, informed Lucent in early
August that, while Lucent is not the target of an investigation, their office is
conducting an investigation into matters that Lucent discovered and reported to
the SEC on November 21, 2000, and publicly disclosed in a press release that
day. Lucent understands that the U.S. Attorney's investigation primarily
concerns a software licensing agreement entered into between Lucent and Winstar
Communications, Inc. at the end of September of 2000. Lucent has been
cooperating fully with the SEC's investigation and will cooperate fully with the
U.S. Attorney's investigation as well.
On or about August 7, 2002, a lawsuit was filed against Lucent by PF.Net Supply
Corp. in the bankruptcy court for the U.S. District Court for the District of
New Jersey. The claims are based on an alleged breach of a contract between
PF.Net Supply Corp. and Lucent. PF.Net Supply Corp. seeks approximately $100
million in damages. Lucent denies liability and will defend this action
vigorously.
Item 5. Other Information.
In June 2002, the SEC issued an order requiring the principal executive officer
and the principal financial officer of certain public companies, including
Lucent, to file either (1) a certification that recent reports filed with the
SEC do not contain material misstatements or omissions or (2) a statement
explaining why the certification could not be made. The form of certification
that the SEC requested companies to file is attached to the SEC's order. On
August 13, 2002, Patricia Russo and Frank D'Amelio, the chief executive officer
and chief financial officer, respectively, of Lucent, each filed certifications
with the SEC in the form attached to the order and without qualification, which
included a statement that the contents of the certifications were reviewed with
Lucent's audit committee. The certifications covered Lucent's annual report for
fiscal 2001, Lucent's quarterly reports for the first, second, and third
quarters of fiscal 2002, the proxy material for Lucent's 2002 annual
shareowners' meeting, and all reports filed on Form 8-K since September 30, 2001
(excluding filings for Regulation FD purposes).
37
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
Exhibit number
(99)1 Certification of Patricia F. Russo pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(99)2 Certification of Frank A. D'Amelio pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K filed during the current quarter:
On June 17, 2002, we filed a Current Report on Form 8-K pursuant to
Item 5 (Other Events) to file restated consolidated financial
information giving retroactive effect to our new segment structure, at
September 30, 2001 and 2000 and for each of the years ended September
30, 2001 and 2000. In addition, we announced the adjustment to the
conversion prices of our preferred stock and the preferred securities
issued by our subsidiary trust, to reflect the Agere spin-off.
On June 13, 2002, we filed a Current Report on Form 8-K pursuant to
Item 5 (Other Events) to announce that we and the lenders to our credit
facility entered into the Third Amendment to our Five-Year Revolving
Credit Facility Agreement and the Second Amendment to Guarantee and
Collateral Agreement and filed a copy of this amendment. In addition,
we furnished pursuant to Item 9 (Regulation FD) a press release with
comments on our third quarter of fiscal 2002. On June 3, 2002, we filed
a Current Report on Form 8-K pursuant to Item 5 (Other Events) to
announce the completion of our spin-off of Agere.
On May 13, 2002, we filed a Current Report on Form 8-K pursuant to Item
5 (Other Events) to file the letter to our common shareowners, the
information statement and associated questions and answers document
regarding the distribution of Agere common stock.
On April 22, 2002, we filed a Current Report on Form 8-K pursuant to
Item 5 (Other Events) to announce that we met the financial conditions
under our credit facility to complete the spin-off of Agere. In
addition, we furnished pursuant to Item 9 a press release reporting the
results of our second fiscal quarter of 2002 and slides presented in a
webcast of our quarterly earnings conference call.
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Lucent Technologies Inc.
Registrant
Date August 13, 2002
/s/ John A. Kritzmacher
------------------------------------
John A. Kritzmacher
Senior Vice President and Controller
(Principal Accounting Officer)
39
Exhibit Index
Exhibit Number
(99)1 Certification of Patricia F. Russo pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(99)2 Certification of Frank A. D'Amelio pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.