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AS FILED WITH THE SEC ON February 11, 2003
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 December 31, 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 January 31, 2003, 3,911,148,944 common shares were outstanding.
2 Form 10-Q - Part I
INDEX
Part I - Financial Information:
Item 1. Financial Statements
Consolidated Statements of Operations for the Three Months
Ended December 31, 2002 and 2001...........................................................3
Consolidated Balance Sheets at
December 31, 2002 and September 30, 2002...................................................4
Consolidated Statements of Cash Flows for the Three Months
Ended December 31, 2002 and 2001...........................................................5
Notes to Consolidated Financial Statements...................................................6
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition..............................................16
Item 4. Controls and Procedures.....................................................................28
Part II - Other Information:
Item 1. Legal Proceedings...........................................................................29
Item 2. Changes in Securities and Use of Proceeds...................................................29
Item 6. Exhibits and Reports on Form 8-K............................................................29
3 Form 10-Q - Part I
PART I - 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 December 31,
------------------------------
2002 2001
-------------- ------------
Revenues:
Products ........................................................... $ 1,607 $ 2,811
Services ........................................................... 468 768
------- -------
Total revenues ............................................... 2,075 3,579
------- -------
Costs:
Products ........................................................... 1,218 2,510
Services ........................................................... 403 634
------- -------
Total costs .................................................. 1,621 3,144
------- -------
Gross margin .............................................................. 454 435
Operating expenses:
Selling, general and administrative .................................. 396 1,245
Research and development ............................................. 389 621
Business restructuring charges (reversals) and asset impairments, net (19) (79)
------- -------
Total operating expenses ......................................... 766 1,787
------- -------
Operating loss ............................................................ (312) (1,352)
Other income, net ......................................................... 22 540
Interest expense .......................................................... 94 97
------- -------
Loss before income taxes .................................................. (384) (909)
Benefit from income taxes ................................................. (120) (486)
------- -------
Net loss .................................................................. (264) (423)
Conversion cost - 8.00% redeemable convertible preferred stock ............ (100) -
Preferred stock dividends and accretion ................................... (25) (42)
------- -------
Loss applicable to common shareowners ..................................... $ (389) $ (465)
======= =======
Loss per common share--basic and diluted
Net loss applicable to common shareowners ............................ $ (0.11) $ (0.14)
Weighted average number of common shares
outstanding--basic and diluted ....................................... 3,581.2 3,416.3
See Notes to Consolidated Financial Statements.
4 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
December 31, September 30,
2002 2002
------------- --------------
ASSETS
Cash and cash equivalents ....................................................... $ 2,408 $ 2,894
Short-term investments .......................................................... 1,330 1,526
Receivables, less allowances of $321 and $325, respectively ..................... 1,466 1,647
Inventories ..................................................................... 1,093 1,363
Contracts in process, net of progress billings of $10,475 at December 31, 2002
and $10,314 at September 30, 2002 ............................................ 172 10
Other current assets ............................................................ 1,774 1,715
-------- --------
Total current assets ....................................................... 8,243 9,155
Property, plant and equipment, net .............................................. 2,036 1,977
Prepaid pension costs ........................................................... 4,184 4,355
Goodwill and other acquired intangibles, net .................................... 219 224
Other assets .................................................................... 1,753 2,080
-------- --------
Total assets ............................................................... $ 16,435 $ 17,791
======== ========
LIABILITIES
Accounts payable ................................................................ $ 1,114 $ 1,298
Payroll and benefit-related liabilities ......................................... 843 1,094
Debt maturing within one year ................................................... 193 120
Other current liabilities ....................................................... 3,397 3,814
-------- --------
Total current liabilities .................................................. 5,547 6,326
Postretirement and postemployment benefit liabilities ........................... 4,949 5,230
Pension liabilities ............................................................. 2,691 2,752
Long-term debt .................................................................. 3,234 3,236
Company-obligated mandatorily redeemable preferred securities of subsidiary trust 1,532 1,750
Other liabilities ............................................................... 1,526 1,551
-------- --------
Total liabilities .......................................................... 19,479 20,845
Commitments and contingencies
8.00% redeemable convertible preferred stock .................................... 1,298 1,680
SHAREOWNERS' DEFICIT
Preferred stock--par value $1.00 per share; authorized shares: 250,000,000;
none issued and outstanding .................................................. - -
Common stock--par value $.01 per share;
Authorized shares: 10,000,000,000; 3,714,625,955 issued and 3,713,350,863
outstanding shares at December 31, 2002 and 3,491,585,126 issued and
3,490,310,034 outstanding shares at September 30, 2002 ....................... 37 35
Additional paid-in capital ...................................................... 21,164 20,606
Accumulated deficit ............................................................. (22,289) (22,025)
Accumulated other comprehensive loss ............................................ (3,254) (3,350)
-------- --------
Total shareowners' deficit ................................................. (4,342) (4,734)
-------- --------
Total liabilities, redeemable convertible preferred stock and shareowners' .
deficit ................................................................. $ 16,435 $ 17,791
======== ========
See Notes to Consolidated Financial Statements.
5 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Three months ended
December 31,
----------------------
2002 2001
---- ----
Operating activities:
Net loss......................................................................... $ (264) $ (423)
Adjustments to reconcile net loss to net cash used in operating activities, net
of effects of dispositions of businesses:
Non-cash portion of business restructuring (reversals) charges.............. (31) 21
Depreciation and amortization............................................... 254 416
Provision for (recovery of) bad debt and customer financing................. (91) 451
Deferred income taxes....................................................... - (515)
Net pension and postretirement benefit credit............................... (134) (238)
Gains on sales of businesses................................................ - (583)
Other adjustments for non-cash items........................................ (71) 69
Changes in operating assets and liabilities:
Decrease in receivables..................................................... 179 1,181
Decrease in inventories and contracts in process............................ 116 697
Decrease in accounts payable................................................ (191) (553)
Changes in other operating assets and liabilities........................... (509) (931)
------- -------
Net cash used in operating activities from continuing operations................. (742) (408)
------- -------
Investing activities:
Capital expenditures........................................................ (155) (116)
Dispositions of businesses, net of cash and cash equivalents - 2,184
Sales and maturities of short-term investments.............................. 200 -
Other investing activities.................................................. 77 74
------- -------
Net cash provided by investing activities from continuing operations............. 122 2,142
------- -------
Financing activities:
Repayments of credit facilities............................................. - (1,000)
Net proceeds from (repayments of) other short-term borrowings............... 109 (57)
Other financing activities.................................................. (1) 21
------- -------
Net cash provided by (used in) financing activities from continuing operations... 108 (1,036)
Effect of exchange rate changes on cash and cash equivalents..................... 26 (1)
------- -------
Net cash (used in) provided by continuing operations............................. (486) 697
Net cash used in discontinued operations......................................... - (18)
------- -------
Net (decrease) increase in cash and cash equivalents............................. (486) 679
Cash and cash equivalents at beginning of year................................... 2,894 2,390
------- -------
Cash and cash equivalents at end of period....................................... $ 2,408 $ 3,069
======= =======
See Notes to Consolidated Financial Statements.
6 Form 10-Q - Part I
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 are considered necessary for a fair presentation of results of
operations, financial position and cash flows as of and for the periods
presented.
The unaudited consolidated financial statements are prepared in conformity with
generally accepted accounting principles. Management is required to make
estimates and assumptions that affect the amounts reported in the unaudited
consolidated financial statements and accompanying disclosures. Actual results
could differ from those estimates. Among other things, estimates and assumptions
are used in accounting for long-term contracts, allowances for bad debts and
customer financings, inventory obsolescence, restructuring reserves, product
warranty, amortization and impairment of intangibles, goodwill, and capitalized
software, depreciation and impairment of property, plant and equipment, employee
benefits, income taxes, and contingencies. 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 Annual Report on Form 10-K, filed on December 12, 2002, for the year
ended September 30, 2002.
Certain reclassifications were made to conform to the current period
presentation.
2. BUSINESS RESTRUCTURING CHARGES (REVERSALS) AND ASSET IMPAIRMENTS, NET
The current restructuring reserve continues to be evaluated as plans are being
executed. As a result, there may be additional charges or reversals. In
addition, since the restructuring program is an aggregation of many individual
plans currently being executed, actual costs have differed from estimated
amounts.
Revisions to
Sept. 30, Quarter ended prior year plans Dec. 31,
2002 Dec. 31, 2002 ---------------- Net charge/ 2002
reserve charge charge reversal (reversal) Deductions reserve
------- ------ ------ -------- --------- ---------- -------
Employee separations $ 367 $ 18 $ 2 $ (5) $ 15 (a) $(132) (a) $ 250
Contract settlements 150 17 5 (11) 11 (45) 116
Facility closings 483 - - (3) (3) (32) 448
Other 69 1 4 (4) 1 (10) 60
------ ------------------------------------------- ----- ------
Total restructuring costs $1,069 $ 36 $ 11 $ (23) $ 24 $(219) (b) $ 874
====== ------------------------------------------- ----- ======
Total asset write-downs $ 5 $ 22 $ (65) $ (38) (c)
-------------------------------------------
Total net charges (reversal) on
business restructuring $ 41 $ 33 $ (88) $ (14) (d)
===========================================
- ---------
(a) Includes non-cash charges of $4 for pension termination benefits to
certain U.S. employees expected to be funded through Lucent's pension
assets and pension curtailment charges of $3.
(b) Includes cash payments of $212 in addition to the non-cash charges
noted in (a).
(c) At December 31, 2002, the remaining restructuring reserve for
inventory was $91.
(d) Net inventory charges of $5 were included in costs.
The first quarter of fiscal 2003 charge of $41 included employee separation
charges and contract settlements associated with the discontinuance of the TMX
MultiService Switching and Spring Tide product lines in the Integrated Network
Solutions ("INS") segment. The revisions to prior year plans resulted in a net
credit of $55 and were primarily due to adjustments to the original plans for
facility closings, which increased property, plant and equipment by $44.
Including 200 in headcount reductions above and a reversal for approximately
1,100 employee separations due to higher than expected attrition rates, there
were 53,400 voluntary and involuntary employee separations associated with
employee separation charges recorded in fiscal 2001, fiscal 2002 and the first
quarter of fiscal 2003. As of
7 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
December 31, 2002, approximately 48,200 separations were completed. Most of the
remaining employee separations are expected to be completed by March 31, 2003.
The completed and future employee separations affect all business groups and
geographic regions. Approximately 70% of these separations were related to
management employees and were involuntary.
Contract settlement charges under the restructuring program were recognized for
settlements of purchase commitments with suppliers and contract renegotiations
or cancellations of contracts with customers, all of which resulted from the
discontinuance of various product lines. Revisions to prior year plans were
primarily due to settling certain purchase commitments and contracts with
customers for amounts lower than originally planned.
Facility closings charges were recognized under the restructuring program for
the expected remaining future cash outlays associated with trailing lease
liabilities, lease termination payments and expected restoration costs (net of
expected sublease income of $314) in connection with plans to reduce a
significant number of owned and leased facilities, totaling approximately 16.4
million square feet. As of December 31, 2002, owned and leased sites aggregating
12.6 million square feet have been exited and the remaining sites are expected
to be exited during fiscal 2003.
3. INVENTORIES
December 31, September 30,
2002 2002
------------------ ------------------
Completed goods $ 539 $ 711
Work in process 52 35
Raw materials 502 617
------ ------
Inventories $1,093 $1,363
====== ======
4. EXCHANGES OF CONVERTIBLE SECURITIES AND DEBT OBLIGATIONS
The following table summarizes the exchanges of preferred stock during the first
quarter of fiscal 2003 and the fourth quarter of fiscal 2002.
December 31, September 30, Total
2002 2002
---------------- ----------------- -------------
8% redeemable convertible preferred stock $392 $175 $567
Company-obligated 7.75% mandatorily redeemable
convertible preferred securities of subsidiary
trust 218 - 218
---- ---- ----
Total convertible securities exchanged $610 $175 $785
==== ==== ====
During the first quarter of fiscal 2003, the Company repurchased 392,274 shares
of its 8% redeemable convertible preferred stock and 217,500 of its
company-obligated 7.75% mandatorily redeemable convertible preferred securities
of subsidiary trust ("7.75% trust preferred securities") for 214,493,462 shares
of Lucent common stock. No gain or loss was recognized on the exchanges. The
exchanges resulted in a corresponding increase to common stock and additional
paid-in capital, net of applicable tax impacts related to the 7.75% trust
preferred securities. The fair value of the additional common shares issued to
the holders of each respective preferred security to prompt the exchange over
the shares obligated to be exchanged pursuant to the original conversion terms
amounted to $100 for the 8% redeemable convertible preferred stock, which was
included as a conversion cost in the net loss applicable to common shareowners,
and $31 for the 7.75% trust preferred securities, which was reflected in other
income, net.
8 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Since December 31, 2002 and through February 11, 2003, an additional 296,675
shares of 8% redeemable convertible preferred stock and 380,000 of 7.75% trust
preferred securities were repurchased for 261,068,241 shares of Lucent common
stock. The fair value of the additional common shares issued to the holders of
each respective preferred security to prompt the exchange over the shares
obligated to be exchanged pursuant to the original conversion terms amounted
to $139 for the 8% redeemable convertible preferred stock and $98 for the 7.75%
trust preferred securities and will be reflected in the second quarter of
fiscal 2003 results.
In addition, subsequent to December 31, 2002 and through February 11, 2003,
certain debt obligations with a carrying value of $52 were repurchased for
24,021,312 shares of Lucent common stock.
5. 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
December 31,
2002 2001
---- ----
Net loss $(264) $(423)
Other comprehensive loss:
Foreign currency translation adjustments 50 54
Reclassification adjustments to foreign currency translation for sale
of foreign entities - 20
Unrealized holding gains on investments 46 7
Reclassification adjustments for realized gains and impairment losses
on investments - (35)
----- -----
Comprehensive loss $(168) $(377)
===== =====
6. LOSS PER COMMON SHARE
Basic loss per common share is calculated by dividing the net loss applicable to
common shareowners by the weighted average number of common shares outstanding
during the period. Diluted loss per common share reflects all potential
issuances of common stock and is calculated by dividing net loss applicable to
common shareowners, adjusted for preferred stock dividends and accretion,
conversion costs related to the exchanges of the 8% redeemable convertible
preferred stock and the 7.75% trust preferred securities, and interest expense
for the 7.75% trust preferred securities. The diluted loss per share is the same
as basic, since any potentially dilutive securities would reduce the loss per
share.
Three months ended
December 31,
2002 2001
---- ----
(shares in millions)
8% redeemable convertible preferred stock 1,318 284
7.75% trust preferred securities 355 -
Stock options 1 12
----- ---
Total 1,674 296
===== ===
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 328 625
===== ===
The calculation of potential common shares related to the 8% redeemable
convertible preferred stock is based upon the quarterly average price of
Lucent's common stock and the weighted average preferred shares outstanding
during the periods due to the August 2004 redemption feature.
9 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
7. OPERATING SEGMENTS
Lucent designs and delivers networks for the world's largest communications
service providers. The INS segment sells to global wireline service providers,
including long distance carriers, traditional local telephone companies and
Internet service providers, and provides offerings comprised of a broad range of
core switching and access and optical networking products. The Mobility segment
sells to global wireless service providers and offers products to support the
needs of its customers for radio access and core networks. Lucent supports its
segments through its worldwide 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.
Operating income (loss) for reportable segments excludes the following:
o goodwill and other acquired intangibles amortization;
o business restructuring and asset impairments;
o acquisition/integration-related costs;
o revenues and expenses associated with intellectual property;
o the results of the optical fiber business;
o the results from billing and customer care software products,
messaging products and other smaller units;
o certain personnel costs and benefits, including most 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.
Indirect intersegment costs and expenses and the revenues and expenses from
licensing fees and royalties associated with intellectual property are no longer
included in the reportable segments. The prior period segment results have been
revised to conform to the current year's performance measure. The accounting
policies of the reportable segments are the same as those applied in the
unaudited consolidated financial statements.
10 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
The following tables present Lucent's revenues and operating income (loss) by
reportable operating segment and a reconciliation of the totals reported for
operating income (loss) of the segments to the consolidated operating loss:
Three months
ended December 31,
2002 2001
---- ----
Revenues
INS $ 1,015 $ 1,854
Mobility 1,008 1,460
------- -------
Total reportable segments 2,023 3,314
Optical fiber business - 114
Other 52 151
------- -------
Total revenues $ 2,075 $ 3,579
======= =======
Operating income (loss)
INS $ (133) $ (934)
Mobility 13 (152)
------- -------
Total reportable segments (120) (1,086)
Goodwill and other acquired intangibles amortization (5) (74)
Business restructuring and asset impairments, net 14 68
Optical fiber business - (68)
Unallocated personnel costs and benefits 286 384
Shared services such as general corporate functions (347) (439)
Other (140) (137)
------- -------
Total operating loss $ (312) $(1,352)
======= =======
Products and Services Revenues
The table below presents revenues for groups of similar products and
services:
Three months ended December 31,
2002 2001
---- ----
Switching and access $ 655 $ 865
Optical networking products 174 477
Wireless products 723 1,214
Services 468 768
Optical fiber business - 114
Other 55 141
------ ------
Total revenues $2,075 $3,579
====== ======
8. COMMITMENTS AND CONTINGENCIES
Lucent is subject to legal proceedings, lawsuits, and other claims, including
proceedings by government authorities. In addition, Lucent may be subject to
liabilities to some of its former affiliates under separation agreements with
them. Legal proceedings are subject to uncertainties, and the outcomes are
difficult to predict. Consequently, Lucent is unable to ascertain the ultimate
aggregate amount of monetary liability or financial impact with respect to these
matters at December 31, 2002. Lucent is subject to several purported class
action lawsuits and other lawsuits for alleged violations of federal securities
laws, ERISA and related claims described below, which could have a material
financial impact. Other than those matters, Lucent believes that the remainder
of the cases will not have a material financial impact after final disposition.
11 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Lucent and certain of its former officers and current and former members of its
Board of Directors are defendants in numerous purported shareholder class action
lawsuits for alleged violations of federal securities laws. These cases have
been consolidated into a single action pending in the United States District
Court for the District of New Jersey, captioned In re Lucent Technologies Inc.
Securities Litigation. The consolidated 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 had an adverse impact on its future earnings and prospects for
growth. The action seeks monetary damages, and costs and expenses associated
with the litigation.
Lucent has been served with derivative complaints filed by individual
shareowners in Delaware Chancery Court against certain current and former
members of its Board of Directors and a former officer. These complaints have
been consolidated in a single action. The consolidated complaint asserts that
certain current and former directors and an officer allegedly breached their
fiduciary duties to Lucent by acquiescing in or approving allegedly fraudulent
conduct and seek damages against the defendants and in favor of Lucent, as well
as costs and expenses associated with litigation. Lucent has also been served
with derivative actions in Delaware Chancery Court and United States District
Court for the District of New Jersey that have not been consolidated with the
other derivative cases. These non-consolidated actions allege that certain of
Lucent's current and former directors breached fiduciary duties to supervise
Lucent and seeks an accounting of the damages sustained as a result of these
alleged acts, as well as costs and expenses associated with litigation.
An additional derivative complaint was filed in September 2001 by an individual
shareholder in the Delaware Chancery Court against certain current and former
members of Lucent's Board of Directors and a former officer asserting claims of
corporate waste and breach of fiduciary duties arising out of the award of
performance-based compensation to certain of Lucent's directors and an officer
and seeks the return of all such performance-based compensation, compensation to
Lucent for resulting losses, the imposition of a constructive trust upon the
proceeds of any sale of Lucent shares by the defendants, as well as costs and
expenses associated with litigation.
In July 2001, a purported class action complaint was filed in United States
District Court for the District of New Jersey under ERISA alleging, among other
things, that Lucent and certain unnamed officers breached their fiduciary duties
with respect to Lucent's employee savings plans. The case claims that the
defendants were aware that Lucent's stock was inappropriate for retirement
investment and continued to offer Lucent stock as a plan investment option. The
complaint seeks damages, injunctive and equitable relief, interest and fees and
expenses associated with the litigation. A similar case was filed against Lucent
and certain unnamed officers involving similar claims for employee savings plans
for represented employees.
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 money to be lost by the
plaintiffs in connection with their investments in Winstar stock or contributed
to such loss. In the New York action, the plaintiffs claim that Lucent violated
federal securities laws in connection with plaintiffs' purchases of Winstar
stock. 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.
In November 2001, a purported class action complaint was filed in the United
States District Court for the District of New Jersey against Lucent and current
and former officers captioned Laufer v. Lucent Technologies Inc., et al. The
plaintiffs allege that Lucent and certain of its current and former officers
concealed adverse material information about Agere's financial condition prior
to Agere's IPO and about Lucent's vendor financing portfolio.
In October 2002, a purported class action lawsuit captioned Balaban v. Schacht,
et al., was filed on behalf of holders of Lucent's notes, convertible preferred
stock and trust preferred securities against Lucent, certain current and former
directors and two former officers. The complaint asserts claims for breach of
fiduciary duty by the
12 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
defendants during the period of April 1999 to September 2002 and seeks
compensatory damages and other damages and costs.
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 plaintiffs requested 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 were
stayed pending the outcome of the Sparks case, and in July 2001, the Illinois
court certified a nationwide class of plaintiffs.
The parties agreed in August 2002 to settle the litigation for up to $300 in
cash plus prepaid calling cards redeemable for minutes of long distance service.
The court approved the settlement in November 2002. 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 pursuing this matter would require. The class claimants were
required to apply for reimbursement from the settlement fund and demonstrate
their entitlement through a claims form to be provided to a claims
administrator. These claim forms were required to be postmarked by January 15,
2003. Lucent deposited approximately $200 in escrow accounts to cover a portion
of the settlement. Based upon preliminary information received from the claims
administrator as to the number of claims submitted, the final settlement amount
will be significantly less than the amount in the escrow account. Lucent is a
party to various separation and distribution agreements, which provide for
contribution from third parties formerly affiliated with Lucent for a portion of
any liability (including any settlement) in this case. However, Lucent is
responsible for a majority of any such liability or settlement. As a result of
the aforementioned preliminary information from the claims administrator and the
expected third-party contributions, Lucent reduced its related reserves for this
matter and recognized an $80 credit in other income, net in the first quarter of
fiscal 2003.
Lucent is 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 other claims against Lucent and seeks compensatory
damages, as well as costs and expenses associated with litigation. The complaint
also seeks recovery of a payment of approximately $190 to Lucent in December
2000.
Separation Agreements
Lucent is party to various agreements that were entered into in connection with
the separation of Lucent with former affiliates, including AT&T, Avaya, Agere
Systems and NCR Corporation. Pursuant to these agreements, Lucent and the former
affiliates have agreed to allocate certain liabilities related to each other's
business, and have agreed to share liabilities based upon certain allocations
and thresholds. For example, in the Sparks case discussed above, AT&T, Avaya and
NCR each assumed a portion of the liability for the settlement.
Other Commitments
Lucent has agreed to purchase 90% of its requirements for products it currently
purchases from Agere and 60% of its requirements for other products that Agere
can supply through September 30, 2006, provided Agere is competitive with other
potential suppliers as to price, delivery interval and technological merit.
Lucent has also agreed to proceed first with Agere on all joint product
development projects where Agere meets Lucent's criteria.
Lucent is generally not committed to unconditional purchase obligations, except
for a commitment that requires annual purchases of certain wireless components
ranging from $350 to $425 over the next two years. Lucent is in negotiations
with this supplier to completely restructure the arrangement. If this obligation
is not satisfied, Lucent will be required to pay 25% of the unfulfilled annual
commitment.
Lucent has exited most of its manufacturing operations and has increased its
use of contract manufacturers. Lucent is currently using a sole-source
supplier for a majority of the switching and wireless product lines. In
addition, Lucent is in the process of moving from a primarily sole-sourced
supplier for its optical product line to a
13 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
combination of multiple contract manufacturers, and continues to use a
combination of multiple contract manufacturers for their data networking and
other products. Lucent is generally not committed to unconditional purchase
obligations in these contract manufacturing relationships. However, Lucent is
exposed to short-term purchase commitments as they fall within the contract
manufacturers' lead-time of specific products or raw material components. As a
result, any sudden and significant changes in forecasted demand requirements
within the lead-time of those products or raw materials could adversely affect
Lucent's results of operations and cash flows.
Lucent currently outsources certain information technology services from a
supplier under a multi-year agreement which provides for minimum spending levels
of approximately $185 during fiscal 2003 and declines at various amounts to
approximately $40 during fiscal 2006. The agreement also provides for
termination charges of approximately $125 if the agreement is cancelled during
fiscal 2003.
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 environmental liabilities and
obligations are set forth in the footnotes to Lucent's consolidated financial
statements for the year ended September 30, 2002. It is often difficult to
estimate the future impact of environmental matters, including potential
liabilities. Environmental reserves are recorded 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 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 December 31, 2002, cannot be
reasonably estimated.
9. RECENT PRONOUNCEMENTS
Goodwill and Other Intangible Assets
Effective October 1, 2002, Lucent adopted Statement of Financial Accounting
Standards ("SFAS") 142. Prior to adoption, goodwill and identifiable intangible
assets were amortized on a straight-line basis over their estimated useful
lives. In connection with the adoption of SFAS 142, goodwill is no longer
amortized but tested for impairment upon adoption of SFAS 142 and annually
thereafter or more often if an event or circumstance indicates that an
impairment loss has been incurred, by comparing each reporting unit's fair value
to its carrying value. During the first quarter of fiscal 2003, the initial
goodwill impairment test was completed, which resulted in no transitional
impairment loss. Unless required earlier, as described above, the next goodwill
impairment test is expected to be completed during the fourth quarter of fiscal
2003. The carrying amount of goodwill for INS, Mobility and Other (primarily
associated with the messaging products business), was $189, $11 and $9,
respectively, as of December 31, 2002 and September 30, 2002.
The following table presents the net loss and the net loss per basic and diluted
share applicable to common shareowners for the three months ended December 31,
2001, adjusted to exclude goodwill amortization reflected in the period of $55,
net of tax, or $0.02 per share, which is no longer recorded under SFAS 142.
Net loss:
As reported $ (423)
Adjusted $ (368)
Basic and diluted loss per share:
As reported $(0.14)
Adjusted $(0.12)
14 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
At December 31, 2002, Lucent's identifiable intangible assets consisted of
existing technologies resulting from prior acquisitions. The gross carrying
amount and accumulated amortization of the acquired intangible assets at
December 31, 2002 was $144 and $134, respectively, after $5 of amortization
during the first quarter of fiscal 2003. The remaining net carrying amount is
expected to be fully amortized during fiscal 2003.
Asset Retirement Obligations
Effective October 1, 2002, Lucent adopted SFAS 143, which requires the
recognition of the future costs of retiring a tangible long-lived asset as a
liability at their present value when the retirement obligation arises and
accrete the liability to its future value and amortize the capitalized asset
retirement cost to expense over the life of the asset. The adoption of SFAS 143
did not have a material effect on the results of operations or financial
condition.
Impairment or Disposal of Long-Lived Assets
Effective October 1, 2002, Lucent adopted SFAS 144, which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
discontinued operations. SFAS 144 establishes a single accounting model between
SFAS 121 and APB 30 for long-lived assets to be disposed of. It establishes a
"primary-asset" approach to determine the cash flow estimation period for a
group of assets and liabilities, provides a definition for a "component" of an
entity and broadens the presentation of discontinued operations under APB 30 to
include a "component" of an entity rather than a segment of a business. It also
provides guidance on assets to be disposed of other than by sale. The adoption
of SFAS 144 did not have a material affect on the results of operations or
financial condition.
Costs Associated with Exit or Disposal Activities
In July 2002, the Financial Accounting Standards Board ("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. SFAS 146 is effective for restructuring
activities initiated after December 31, 2002 and requires recognition of a
liability for costs associated with an exit or disposal activity at fair value
when the liability is incurred, or for certain one-time employee termination
costs over a future service period. Previously, a liability for an exit cost was
recognized when a company committed to an exit plan. As a result, SFAS 146 may
affect both the timing and amounts of the recognition of future restructuring
costs.
Guarantees and Indemnification Agreements
In November 2002, the FASB issued FASB Interpretation ("FIN") 45, which expands
previously issued accounting guidance and disclosure requirements for certain
guarantees. FIN 45 requires recognition of an initial liability for the fair
value of an obligation assumed by issuing a guarantee and will be applied on a
prospective basis to all guarantees issued or modified after December 31, 2002.
A description of the Company's guarantees as of December 31, 2002 is provided
below. We are unable to reasonably estimate the maximum amount that could be
payable under certain of these arrangements because the exposures are not
capped.
Lucent guarantees the financing for certain product purchases by certain
customers. Requests for providing such guarantees are reviewed and approved by
senior management and regularly reviewed by them in assessing the
adequacy of reserves. At December 31, 2002, the total principal amount of
customer financing guarantees was $183. The remaining guarantee periods range
from 3 months to 7 years. In addition, $43 of commitments are available to
customers by third party lenders that have not been drawn and may expire. The
reserves for customer finance guarantee losses as of December 31, 2002 were
$119. Lucent is required to perform under these guarantees upon a customer's
default for non-payment to the creditor and typically retains a first-loss
position. Lucent will generally have the right to recover from the defaulting
party through subrogation, but usually only after the creditor has been paid in
full.
Lucent has divested certain businesses and assets through sales to third party
purchasers and spin-offs to its common shareowners. In connection with these
transactions, certain indemnities are provided to the buyers or other third
parties associated with the surviving entities. These guarantees include a
secondary liability for the assignments of
15 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
certain leases for real property and equipment and certain specific indemnities
for legal and environmental contingencies and vendor supply commitments. The
periods of indemnification vary, but are standard for transactions of this
nature, and some may be indefinite.
At December 31, 2002, Lucent remains secondarily liable for approximately $420
of lease obligations that were assigned to Avaya, Agere, and purchasers of other
businesses in the event of default by the assignee. The remaining terms of these
assigned leases and Lucent's corresponding guarantee range from 1 month to 16
years. The primary obligor under assigned leases may terminate or restructure
the lease obligation before its original maturity and thereby relieve Lucent of
its secondary liability. Lucent generally has the right to receive indemnity or
reimbursement from the assignees and has not reserved for losses on this form of
guarantee.
Lucent is a party to a tax sharing agreement to indemnify AT&T and is liable for
tax adjustments that are attributable to Lucent's lines of business as well as a
portion of certain other shared tax adjustments during the years prior to
separation from AT&T. Certain tax adjustments have been proposed or assessed
subject to this tax sharing agreement. Lucent does not believe the outcome of
these matters will have a material effect on the consolidated results of
operations, consolidated financial position or near-term liquidity.
Warranty reserves are established for costs that are expected to be incurred
after the sale and delivery of a product or service for deficiencies as required
under specific product or service warranty provisions. The warranty reserves are
determined based on the actual trend of historical charges incurred over the
prior twelve-month period excluding any significant or infrequent issues, which
are specifically identified and reserved for. The warranty liability is
established when it is probable that customers will make claims and when a
reasonable estimate of costs can be made.
Warranty reserve as of September 30, 2002 $440
Accruals for warranties issued during the period 45
Usage during the period (83)
----
Warranty reserve as of December 31, 2002 $402
====
In September 2000, Lucent and a third party created a non-consolidated Special
Purpose Trust ("Trust") for the purpose of allowing the company from time to
time to sell on a limited-recourse basis customer finance loans and receivables
("Loans") at any given point in time to the Trust. As a result of past credit
rating downgrades, Lucent is unable to sell additional Loans to the Trust. At
December 31, 2002, the Trust held approximately $350 in Loans relating to five
obligors, all of which are in default and in various stages of the resolution
process. Lucent's wholly-owned captive insurance company assumed the credit risk
of the Loans that are held in the Trust and reinsured a significant amount of
the exposure to an unaffiliated insurer. The self-insured loss reserve related
to these Loans (including accrued interest) was $371 and the corresponding
receivable due from the unaffiliated insurer was $298 at December 31, 2002.
Lucent expects that its captive insurance company will fund the $73 of remaining
obligations which were not reinsured by the end of the third quarter of fiscal
2003, at which time the unaffiliated insurer will ultimately be obligated to
make all remaining payments. In the event the unaffiliated insurer does not
honor these obligations, Lucent may be required under certain circumstances to
indemnify the Trust for amounts not funded by the unaffiliated insurer.
Variable Interest Entities
In January 2003, the FASB issued FIN 46, requiring the consolidation of certain
special purpose entities. Lucent has used special purpose entities for the sales
and securitizations of receivables and is currently assessing whether
consolidation of the Trust will be required beginning July 1, 2003.
16 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Results of Operations and Financial
Condition ("MD&A") contains 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" and 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. These risks and uncertainties
include: the failure of the telecommunications market to improve or improve at
the pace we anticipate; continued net losses may reduce or impair our legally
available surplus; our ability to realize the benefits we expect from our
strategic direction and restructuring program; our ability to secure additional
sources of funds on reasonable terms; our credit ratings; our ability to compete
effectively; our reliance on a limited number of key customers; our exposure to
the credit risk of our customers as a result of our vendor financing
arrangements and accounts receivable; our reliance on third parties to
manufacture most of our products; the cost and other risks inherent in our
long-term sales agreements; our product portfolio and ability to keep pace with
technological advances in our industry; the complexity of our products; our
ability to retain and recruit key personnel; existing and future litigation; our
ability to protect our intellectual property rights and the expenses we may
incur in defending such rights; changes in environmental health and safety law;
changes to existing regulations or technical standards; the social, political
and economic risks of our foreign operations; the impact if our common stock is
de-listed from the New York Stock Exchange; and the costs and risks associated
with our pension and postretirement benefit obligations. For a further list and
description of such risks and uncertainties, see our Annual Report on Form 10-K
for the year ended September 30, 2002. Except as otherwise required under
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 MD&A, whether as a result of new information,
future events, changes in assumptions or otherwise.
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.
The global telecommunications market continued to deteriorate during 2002. We
believe that large service providers, primarily in the wireline market, have
reduced their capital spending by more than 25% since the end of 2001. The U.S.
wireline service provider capital spending declined by about 40%. We expect
additional capital spending reductions during 2003. Reasons for this reduction
include the general 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 and may continue to be
adversely affected. The significant slowdown in capital spending has created
uncertainty as to the level of demand in our target 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
remains difficult.
During this prolonged market downturn, we are working closely with our customers
to position the full breadth of our products and services, significantly
reducing our cost structure and reducing our quarterly earnings per share
("EPS") breakeven revenue figure. 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. We are financially planning for our revenues to decline
by about 20% during fiscal 2003 as compared to fiscal 2002. However, our results
of operations are expected to improve by realizing higher gross margin rates and
lower operating expenses resulting from improved product mix, cost reductions
17 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
related to our restructuring actions, lower inventory-related charges, and lower
provisions for bad debts and customer financings.
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are based on the selection of accounting
policies and application of significant accounting estimates, which require
management to make significant estimates and assumptions. We believe that some
of the more critical judgments in the areas of accounting estimates and
assumptions that affect our financial condition and results of operations are
related to revenue recognition, receivables and customer financing, inventories,
income taxes, intangible assets, pension and post-retirement benefits, business
restructuring and legal contingencies. For a detailed discussion of our critical
accounting estimates please refer to our Annual Report on Form 10-K for the year
ended September 30, 2002. There were no material changes in the application of
our critical accounting estimates subsequent to that report. In addition, please
refer to note 9 to our unaudited consolidated financial statements for a
discussion of recent pronouncements, including the initial adoption of several
new accounting standards during the first quarter of fiscal 2003. We have
discussed the application of these critical accounting estimates with our Board
of Directors and Audit and Finance Committee.
The following update is related to our pension and postretirement benefits.
Excluding the impact of business restructuring actions, our net pension and
postretirement benefit credit is expected to be reduced from $972 million
during fiscal 2002 to approximately $600 million during fiscal 2003. The net
pension and postretirement credit reflected in the first quarter of fiscal 2003
was $134 million compared to $238 million in the comparable prior period.
Approximately two-thirds of these amounts are reflected in operating expenses
and the balance in costs. These changes are primarily a result of lower plan
assets, a reduction in the discount rate from 7.0% to 6.5%, a reduction in the
expected return on plan assets from 9.0% to 8.75% for pensions and from 9.0% to
7.93% for postretirement benefits and plan amendments related to certain
retiree benefits. During the first quarter of fiscal 2003 certain retiree death
benefits were eliminated which reduced future pension obligations by
approximately $450 million. We considered the available yields on high-quality
fixed-income investments with maturities corresponding to our benefit
obligations to develop our discount rate. We also considered the historical
long-term asset return experience, the expected investment portfolio mix of the
plans' assets and an estimate of long-term investment returns to develop our
expected return on plan assets. Our actual ten-year rates of return on plan
assets were 9.5%, 11.5% and 15.7% during the years ended September 30, 2002,
2001 and 2000, respectively. Our expected portfolio mix of plan assets considers
the duration of the plan liabilities and has been more heavily weighted towards
equity positions, including public and private equity investments and real
estate. The expected return on plan assets is determined using the expected rate
of return and a calculated value of assets referred to as the "market-related
value." The aggregate market-related value of pension and postretirement plan
assets was $41 billion at September 30, 2002, which exceeded the fair value of
plan assets by $10 billion. Differences between the assumed and actual returns
are reflected in the market-related value on a straight-line basis over a
five-year period. The amortization of these differences, including those
resulting from the actual losses incurred during fiscal 2002 and 2001, will
continue to reduce the market-related value through fiscal 2006. Gains and
losses resulting from changes in these assumptions and from differences between
assumptions and actual experience (except those associated with the
market-related value) are amortized over the remaining service lives to the
extent they exceed 10% of the higher of the market-related value or the
projected benefit obligation of each respective plan.
Holding all other assumptions constant, a one-half percent increase or decrease
in the discount rate would decrease or increase the annual fiscal 2003 net
pension and postretirement credit by approximately $50 million. Likewise, a
one-half percent increase or decrease in the expected return on plan assets
would increase or decrease the annual fiscal 2003 net pension and postretirement
credit by approximately $200 million. In addition, a $2.9 billion direct charge
to equity for minimum pension liabilities was recognized during the fourth
quarter of fiscal 2002. We expect to complete the next measurement of our
pension plan assets and obligations during the fourth quarter of fiscal 2003 at
which time it is likely that the minimum pension liabilities will be adjusted,
which will result in either an increase or decrease in shareowners' deficit
depending upon plan asset performance and the discount rate to be used in
measuring the obligation.
18 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
CONSOLIDATED RESULTS OF OPERATIONS - THREE MONTHS ENDED DECEMBER 31, 2002
VERSUS THREE MONTHS ENDED DECEMBER 31, 2001
Revenues
The following table presents our U.S. and non-U.S. revenues (dollars in
millions):
Three months ended
December 31,
---------------------
2002 2001
---- ----
U.S. revenues $1,292 $2,233
Non-U.S. revenues 783 1,346
------ ------
Total revenues $2,075 $3,579
====== =======
The significant reduction in capital spending by large service providers during
calendar 2002 was the primary reason for the 42% decline in revenues in the
first quarter of fiscal 2003 compared to the first quarter of fiscal 2002. To a
lesser extent, $114 million of the revenue decline resulted from the sale of the
optical fiber business ("OFS") in the first quarter of fiscal 2002. The impact
of product rationalizations and discontinuances under our restructuring program
has not had a significant effect on our overall trend of revenues. Our U.S. and
non-U.S. revenues each declined with the prior comparable period by 42%. Our
U.S. revenues represented 62% of our total revenues in both periods.
The decline in revenue from the comparable prior period occurred both in terms
of product revenues (43%) and service revenues (39%). The decrease in product
revenue occurred in all product lines including, switching and access products
(24%), optical networking products (64%) and wireless products (40%). The $300
million decline in service revenue was primarily due to lower engineering and
installation activity, primarily in support of INS customers. Total service
revenues supporting INS customers decreased by $271 million to $297 million,
primarily in the U.S.
Gross Margin
The following table presents our gross margin and the percentage to total
revenues (dollars in millions):
Three months ended
December 31,
---------------------
2002 2001
---- ----
Gross margin $454 $435
==== ====
Gross margin rate 21.9% 12.2%
The gross margin rate increased by approximately 10 percentage points in the
first quarter of fiscal 2003 as compared to the first quarter of fiscal 2002
despite significantly lower sales volumes. Inventory and other charges
negatively affected the gross margin rate in the first quarter of fiscal 2002 by
approximately six percentage points. The charges were primarily related to items
or events associated with customers experiencing financial difficulties and in
some cases declaring bankruptcy or becoming insolvent, higher provisions for
slow-moving and obsolete inventory and adjustments to certain long-term
projects. The remainder of the quarterly change was primarily related to
improved product mix and cost reductions, offset in part by lower sales volumes.
Restructuring charges did not have a material impact on the gross margin rates
in either of the periods presented.
Compared with the prior period, the gross margin attributable to services
declined by $69 million to $65 million due to the lower service revenues and a
3.5 percentage point decrease in the gross margin rate. The change in the gross
margin rate was due to the continuing decline in overall sales volume and
related labor utilization.
19 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Operating Expenses
The following table presents our operating expenses (dollars in millions):
Three months ended
December 31,
---------------------
2002 2001
---- ----
Selling, general and administrative ("SG&A") expenses,
excluding the following two items: $482 $ 720
Provision for (recovery of) bad debts and customer financings (91) 451
Amortization of goodwill and other acquired intangibles 5 74
---- ------
Total SG&A 396 1,245
Research and development ("R&D") 389 621
Business restructuring charges (reversals) and asset impairments, net (19) (79)
---- ------
Operating expenses $766 $1,787
==== ======
SG&A expenses
Excluding provisions for (recoveries of) bad debts and customer financings and
amortization of goodwill and other acquired intangibles, SG&A expenses decreased
by 33% in the first quarter of fiscal 2003 as compared with the first quarter of
fiscal 2002. The decrease was primarily a result of significant headcount
reductions under our restructuring program and other cost savings initiatives
that limited discretionary spending. Approximately 53% of the first quarter of
fiscal 2003 reduction was in the INS segment due to the greater degree of
product rationalization efforts in INS as well as the required cost reductions
due to the significant INS revenue decline.
Provision for (recovery of) bad debts and customer financings
The recoveries of bad debts and customer financings during the first quarter of
fiscal 2003 were primarily from the settlement of certain fully reserved notes
receivables. Approximately 77% of the total recoveries were related to Mobility
customers.
As a result of the decline in telecommunications market conditions in the first
quarter of fiscal 2002, certain customers experienced deterioration in their
creditworthiness, which resulted in higher provisions for bad debts and customer
financings. During the first quarter of fiscal 2002, approximately 60% of
provisions related to trade receivables with the balance related to customer
financings. Approximately 90% of the provisions were related to INS customers.
Amortization of goodwill and other acquired intangibles
During the first quarter of fiscal 2003, we adopted SFAS 142 (see Note 9 to the
unaudited consolidated financial statements). As a result, our remaining
goodwill of $209 million is no longer amortized, but is subject to an annual
impairment test. The amortization of identifiable intangible assets will
continue during the next two quarters at which point the assets will be fully
amortized.
R&D
The decrease in the first quarter of fiscal 2003 as compared with the first
quarter of fiscal 2002, was primarily due to headcount reductions and product
rationalizations under our restructuring program. Approximately 79% of the first
quarter of fiscal 2003 reduction was in the INS segment due to the greater
degree of product rationalizations in INS.
During the first quarter of fiscal 2003, 43% 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, multi-service switches that can handle both Internet
protocol services and multiple network traffic protocols and network operations
software solutions. The Mobility spending was primarily related to CDMA and UMTS
next-generation technologies.
20 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
During the first quarter of fiscal 2002, 56% of our R&D was attributable to our
INS segment, and most of the remaining amounts were attributable to our Mobility
segment.
Business restructuring charges (reversals) and asset impairments, net
During the first quarter of fiscal 2003, we recorded a net reversal of business
restructuring charges and asset impairments of $19 million, which consisted of
new charges of $38 million and net reversals of prior year plans of $57 million
(see Note 2 to the unaudited consolidated financial statements).
The current restructuring reserve continues to be evaluated as plans are being
executed. As a result, there may be additional charges or reversals. In
addition, since the restructuring program is an aggregation of many individual
plans currently being executed, actual costs have differed from estimated
amounts. The first quarter of fiscal 2003 charge included employee separation
charges and contract settlements associated with the discontinuance of the TMX
MultiService Switching and Spring Tide product lines in the INS segment. The
revisions to prior year plans were primarily due to adjustments to the original
plans for facility closings, which increased property, plant and equipment by
$44 million.
During the first quarter of fiscal 2002, we recorded a net reversal of business
restructuring charges and asset impairments of $79 million, which consisted of
charges for new plans of $45 million and reversals on fiscal 2001 plans of $124
million. The $124 million reserve reversal primarily related to revised
estimates of certain restructuring costs and employee separation costs due to
organizational changes and higher than expected attrition levels. The $45
million charge included restructuring costs related to approximately 500 new
employee separations of $23 million and capitalized software write-downs of $22
million in connection with product exits.
Other income, net
Other income, net for the first quarter of fiscal 2003 included the impact of an
$80 million reserve reduction for a legal settlement associated with our former
consumer products leasing business. The reserve reduction was due to lower than
anticipated claims experience. This was partly offset by $31 million of
conversion expense associated with the repurchase of 217,500 of our 7.75% trust
preferred securities with our common stock.
Other income, net for the first quarter of fiscal 2002 included $583 million in
gains on sales of businesses, of which $523 million related to the sale of OFS,
and interest income related to a tax settlement of $73 million.
Interest expense
Interest expense of $94 million for the first quarter of fiscal 2003 decreased
slightly compared to interest expense of $97 million in the first quarter of
fiscal 2002. Lower interest expense associated with lower short-term debt in the
current quarter was offset by interest expense of $33 million associated with
our 7.75% trust preferred securities.
Benefit from income taxes
The following table presents our benefit from income taxes and the related
effective tax benefit rates (dollars in millions):
Three months ended
December 31,
---------------------
2002 2001
---- ----
Benefit from income taxes $(120) $(486)
Effective tax benefit rate (31.3)% (53.5)%
The effective tax benefit rate for the three months ended December 31, 2002 was
less than the U.S. statutory rate due to maintaining a full valuation allowance
on our net deferred tax assets. The income tax benefit is attributed to the
utilization of a portion of the current period's operating losses as a result of
the tax impact of the repurchases of 7.75% trust preferred securities, including
certain transactions completed subsequent to December 31, 2002 ($105 million)
and the tax impact of the unrealized holding gains for certain investments ($30
million). Recognition of tax
21 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
benefits on future operating losses during the remainder of fiscal 2003 are
expected to be limited to the extent that the operating losses would offset
taxable income generated from similar equity transactions as described above.
The effective tax benefit rate for the three months ended December 31, 2001,
which included the recognition of tax benefits on our current operating losses,
was greater than the U.S. statutory rate primarily due to the tax impact from
the gain on the sale of OFS, which had a low effective tax rate due to
differences in the book and tax basis of the business sold, research and
development tax credits and a $60 million favorable one-time benefit relating to
a tax settlement, offset in part by non-tax deductible goodwill amortization and
valuation allowances on state net operating losses, which decreased the
effective tax benefit rate.
RESULTS OF OPERATIONS BY SEGMENT - THREE MONTHS ENDED DECEMBER 31, 2002 VERSUS
THREE MONTHS ENDED DECEMBER 31, 2001
INS
The following table presents certain financial information for INS (dollars in
millions):
Three months ended
December 31,
-----------------------
2002 2001
---- ----
U.S. revenues $ 548 $1,010
Non-U.S. revenues 467 844
------ ------
Total revenues $1,015 $1,854
====== ======
Operating loss $ (133) $ (934)
====== ======
Return on sales (13.1%) (50.4%)
====== ======
INS revenues declined 45% from the comparable prior period, as a result of
significant reductions in capital spending by service providers. The decline was
reflected in all geographic regions and product lines. Approximately, 55% of the
decline was in the United States, and about 45% was non-U.S., primarily in EMEA
(Europe, Middle East, and Africa) and China. The five largest INS customers were
approximately 40% of INS revenues for the first quarter of fiscal 2003 and
approximately 50% of INS revenues for the first quarter of fiscal 2002. Changes
in revenue levels from the five largest customers in the respective periods
represented about 50% of the INS revenue decline in the first quarter of fiscal
2003.
During the first quarter of fiscal 2003, the operating loss declined by $801
million to $133 million. The improved operating results were driven by a
substantial increase in the gross margin rate and a $746 million decrease in
operating expenses. The higher gross margin rate was primarily due to lower
inventory and other charges and cost reductions, offset in part by significantly
lower sales volumes. Despite the improvement in the gross margin rate in the
first quarter of fiscal 2003, the INS gross margin rate remains significantly
lower than the gross margin rate of Mobility. The operating expense decline
primarily resulted from lower provisions for bad debt and customer financing of
$437 million, including a $20 million impact from the settlement of certain
fully reserved notes as well as other operating expense reductions of $309
million due to headcount reductions under our restructuring program and less
discretionary spending.
22 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Mobility
The following table presents certain financial information for Mobility (dollars
in millions):
Three months ended
December 31,
-----------------------
2002 2001
---- ----
U.S. revenues $ 668 $1,045
Non-U.S. revenues 340 415
------ ------
Total revenues $1,008 $1,460
====== ======
Operating income (loss) $ 13 $ (152)
====== ======
Return on sales 1.3% (10.4%)
====== ======
Mobility revenues decreased by 31% from the comparable prior period. The
decrease in U.S. revenues resulted primarily from the significant reductions and
delays in capital spending by certain service providers. The decrease in
non-U.S. revenues for the first quarter of fiscal 2003 resulted from revenue
reductions in all international regions, with the exception of the Asia Pacific
region. Revenues from Mobility's five largest customers represented
approximately 70% of Mobility revenues in each period. Changes in revenue levels
from these customers represented about 60% of the Mobility revenue decline in
the first quarter of fiscal 2003. Two of these customers are pursuing
alternatives to our Time Division Multiple Access technology that we currently
sell to them. We do not have products for all of the alternative technologies.
If one or both of the customers select an alternative technology that we do not
provide, we could have an additional reduction in business from these customers.
During the first quarter of fiscal 2003, the operating loss improved by $165
million to an operating income of $13 million. Decreases in operating expenses
of $164 million drove the improvement. Although the gross margin rate increased
considerably in the first quarter of fiscal 2003, the gross margin rate
improvement was offset by lower sales volume. The increase in the gross margin
rate was primarily due to lower inventory and other charges and adjustments to
certain long-term contracts. The operating expense decline primarily resulted
from lower provisions for bad debt and customer financing of $132 million,
including a $60 million impact from the settlement of certain fully reserved
notes as well as $32 million of other operating expense reductions primarily due
to our restructuring program and less discretionary spending.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow for the three months ended December 31, 2002.
Operating activities
Net cash used in operating activities was $742 million during the first quarter
of fiscal 2003. This primarily resulted from the loss from continuing operations
of $337 million (adjusted for non-cash items) and changes in other operating
assets and liabilities of $509 million, offset in part by a reduction in working
capital requirements (accounts receivable, inventories and contracts in process
and accounts payable) of $104 million. The reduction in working capital
primarily resulted from the decrease in sales volume during the first quarter in
fiscal 2003 as compared with the fourth quarter of fiscal 2002. Generally,
working capital requirements will increase or decrease with sequential changes
in quarterly revenue levels. We are continuing to focus on reducing our working
capital requirements through more favorable billing terms, collection efforts
and streamlined supply chain operations. The changes in other operating assets
and liabilities include cash outlays under our restructuring program of $212
million and the payment of certain payroll related liabilities including fiscal
2002 bonuses.
Investing activities
The net cash provided by investing activities was $122 million for the first
quarter of fiscal 2003. This was primarily due to the maturities of short-term
investments of $200 million and the proceeds from the sale of certain other
investments of $68 million. Capital expenditures were $155 million, which
included $102 million for the repurchase of
23 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
certain real estate under synthetic lease agreements that were previously used
to fund certain real estate construction costs. We currently expect about $400
million of capital expenditures during fiscal 2003 and do not expect significant
proceeds from business or asset dispositions.
Financing activities
The net cash provided by financing activities was $108 million for the first
quarter of fiscal 2003. This was primarily due to proceeds of $94 million from
prepaid forward sales agreements for most of the Corning stock we owned. This
transaction has been reflected as a secured borrowing. As disclosed in more
detail in Note 4 to our unaudited consolidated financial statements, we
repurchased $610 million of our convertible preferred securities in exchange for
approximately 214 million shares of our common stock. Subsequent to December 31,
2002, we repurchased an additional $729 million of convertible securities and
certain other debt obligations for 285 million shares of our common stock. These
transactions, including those executed in fiscal 2002, have enabled us to reduce
future obligations at a discount, eliminate approximately $120 million of annual
interest and dividend requirements and improve our capital structure. We may
issue more of our common shares in similar transactions in the future.
Subsequent to December 31, 2002, we also issued 28 million shares of our common
stock to pay the semi-annual dividend requirement of $53 million on our 8%
redeemable convertible preferred stock.
Cash requirements
Our near term cash requirements are primarily to fund operations, including
spending on R&D, our restructuring program, capital expenditures and debt
service. We expect to use cash to fund our operations in fiscal 2003. Although
we believe we will realize additional cash savings upon completion of our
restructuring actions, including a full year impact of those actions completed
during fiscal 2002, these savings will be offset by less working capital
reductions and a reduction in the level of income tax refunds realized in fiscal
2002. We do not expect to have significant cash requirements related to our
pension and postretirement benefit plans during fiscal 2003. For more
information on these obligations, including their expected longer term effect on
liquidity, see the detailed risk factor included in our Form 10-K for the year
ended September 30, 2002.
Restructuring
Total cash requirements under the restructuring program since its inception are
expected to be approximately $2.6 billion, of which $1.7 billion was paid
through December 31, 2002 and $600 million is expected to be paid during the
next three quarters of fiscal 2003. Upon completion of the restructuring actions
during fiscal 2003, we expect to realize additional annual cash savings of
approximately $1.8 billion of which about one half has yet to be realized.
However, our restructuring program may not achieve all of the cost and expense
reductions and other benefits we anticipate and may not be completed on the
timetable contemplated.
If we do not complete our restructuring program and achieve our anticipated
expense reductions in the time frame we contemplate, our cash requirements to
fund our operations are likely to be higher than we currently anticipate. In
addition, because market demand continues to be uncertain and because we are
currently completing our restructuring program, it is difficult to estimate our
ongoing cash requirements. Our restructuring program may also have other
unanticipated adverse effects on our business.
24 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Customer financing commitments
The following table presents our customer financing commitments at December 31,
2002 and September 30, 2002 (dollars in millions):
December 31, 2002 September 30, 2002
----------------------------- --------------------------------------
Total Total
loans and loans and
guarantees Loans Guarantees guarantees Loans Guarantees
---------- ----- ---------- ---------- ----- ----------
Drawn commitments $683 $500 $183 $1,098 $ 909 $189
Available but not drawn 61 18 43 93 51 42
Not available -- -- -- 151 151 --
---- ---- ---- ------ ------ ----
Total commitments $744 $518 $226 $1,342 $1,111 $231
==== ==== ==== ====== ====== ====
Reserves $567 $ 951
==== ======
We may provide or commit to additional customer financing on a very limited
basis. We are focusing on the largest service providers who typically have less
demand for such financing. We currently have only a limited ability to offer
customer financing due to our capital structure, credit rating, level of
available credit and liquidity. We review requests for customer financing on a
case-by-case basis and may offer financing only after a careful review that
assesses the credit quality of the individual borrowers, their respective
business plans and market conditions. We also consider the likelihood of our
ability to sell or transfer the undrawn commitments and drawn borrowings to
unrelated third parties. We continue to monitor the drawn borrowings and undrawn
commitments by assessing, among other things, the customer's short-term and
long-term liquidity position, current operating performance versus plan,
execution challenges facing the company, changes in the competitive landscape,
and management experience and depth. We undertake certain mitigating actions,
including cancellation of commitments if corrective measures are not taken,
depending upon the extent of any deterioration of a customer's credit profile or
non-compliance with our loan conditions. Although these actions can limit the
extent of our losses, substantial exposure remains to the extent of drawn
amounts, which may not be recoverable. As a result of the settlement of certain
fully reserved notes and the expiration of several commitments, our customer
financing commitments were reduced to $744 million at December 31, 2002.
Debt service and preferred dividend requirements
Debt service primarily represents interest payments on our short- and long-term
debt and 7.75% trust preferred securities. Preferred dividend requirements
represent payments on our 8% redeemable convertible preferred stock. As
previously noted, we paid our semi-annual dividend requirement in February 2003
with our common stock. We expect that our interest payments on short- and
long-term debt and trust preferred securities will be approximately $300 million
throughout the remainder of fiscal 2003.
Future capital requirements
We believe our cash and cash equivalents of $2.4 billion and short-term
investments of $1.3 billion as of December 31, 2002 are currently sufficient to
fund our cash requirements during the next twelve months. However, we cannot
assure that our actual cash requirements will not be greater than we currently
expect. If our sources of liquidity are not available or if we cannot generate
sufficient 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. We cannot provide
assurance that these additional sources of funds will be available, or if
available, would have reasonable terms.
We are currently in negotiations with our banks concerning a new credit
facility. However we cannot provide assurance that one will be obtained.
Substantially all of our domestic U.S. assets are pledged as collateral as a
result of extending the Guarantee and Collateral Agreement with our banks
through March 14, 2003. This agreement provides security for financial
institutions in extending, among other things, credit facilities to non-U.S.
subsidiaries, letters of credit and foreign exchange hedging. Even if this
agreement is renewed or replaced with a similar agreement, we may be required to
use our cash to collateralize certain new or existing debt obligations or other
25 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
financial instruments, such as letters of credit. Any cash collateral
requirements would be expected to occur over time. There were approximately $680
million of standby letters of credit outstanding at December 31, 2002, of which
approximately $625 million was supported by the Guarantee and Collateral
Agreement. We have a mortgage for three of our primary facilities which requires
that we maintain minimum occupancy rates. We are currently in compliance with,
and expect to remain in compliance with this condition. However, if we failed to
maintain the minimum occupancy rates, our outstanding debt balance under this
mortgage ($295 million at December 31, 2002) could become due and payable.
Credit ratings
Our credit ratings as of February 11, 2003, are as follows:
Trust
Long-term Convertible preferred
debt preferred stock securities Last update
--------- --------------- ----------- -----------
Rating Agency
- -------------
Standard & Poor's B- (a) CCC- CCC- October 11, 2002
Moody's Caa1 (a) Ca Caa3 November 1, 2002
- ---------
(a) Ratings outlook is negative.
Our credit ratings are below investment grade. In addition, a credit downgrade
affects our ability to enter into and maintain certain contracts on favorable
terms and increases our cost of borrowing.
Special Purpose Entities
In September 2000, we and a third party created a non-consolidated Special
Purpose Trust ("Trust") for the purpose of allowing us to sell customer finance
loans and receivables ("Loans") to the Trust on a limited recourse basis. As a
result of past downgrades, we are unable to sell additional Loans to the Trust.
At December 31, 2002, the Trust held approximately $350 million in Loans
relating to five obligors, all of which are in default and in various stages of
resolution. Our wholly-owned captive insurance company assumed the credit risk
of the Loans that are held in the Trust and reinsured a significant amount of
the exposure to an unaffiliated insurer. The self-insured loss reserve related
to these Loans (including accrued interest) was $371 million and the
corresponding receivable due from the unaffiliated insurer was $298 million at
December 31, 2002. We expect that our captive insurance company will fund the
$73 million of remaining obligations which were not reinsured by the end of the
third quarter of fiscal 2003, at which time the unaffiliated insurer will
ultimately be obligated to make all remaining payments. In the event the
unaffiliated insurer does not honor these obligations we may be required under
certain circumstances to indemnify the Trust for amounts not funded by the
unaffiliated insurer. See Note 9 to the unaudited consolidated financial
statements.
RISK MANAGEMENT
We are exposed to market risk from changes in foreign currency exchange rates,
interest rates and equity prices. We manage our exposure to these market risks
through the use of derivative financial instruments coupled with other
strategies. Our risk management objective is to minimize the effects of
volatility on our cash flows by identifying the assets, liabilities or
forecasted transactions exposed to these risks and hedging them with either
forward or option contracts, swap derivatives or by embedding terms into certain
contracts that affect the ultimate amount of cash flows under the contract.
Since there is a high correlation between the hedging instruments and the
underlying exposures, the gains and losses on these exposures are generally
offset by reciprocal changes in the value of the hedging instruments when used.
We use derivative financial instruments as risk management tools and not for
trading or speculative purposes.
Foreign Currency Risk
As a multinational company, we conduct our business in a wide variety of
currencies and are therefore subject to market risk for changes in foreign
exchange rates. We use foreign exchange forward and option contracts to minimize
exposure to the risk to the eventual net cash inflows and outflows resulting
from foreign currency
26 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
denominated transactions with customers, suppliers and non-U.S. subsidiaries.
Our objective is to hedge all types of foreign currency risk to preserve our
economic cash flows, but we generally do not expect to designate these
derivative instruments as hedges under current accounting standards unless the
benefits of doing so are material. 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. To the extent that the
forecasted cash flow exposures are overstated or understated or if there is a
shift in the timing of the anticipated cash flows during periods of currency
volatility, we may experience unanticipated currency gains or losses. 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 from the prior year.
Interest Rate Risk
The fair values of our fixed-rate long-term debt, interest rate swaps, 7.75%
trust preferred securities, and short-term investments are sensitive to changes
in interest rates. Our portfolio of customer finance notes receivable is
predominantly comprised of variable-rate notes at LIBOR plus a stated percentage
which subjects us to variability in cash flows and earnings due to the effect of
changes in LIBOR. Prior to May 2002, our debt obligations primarily consisted of
fixed-rate debt instruments while our interest rate sensitive assets were
primarily variable-rate instruments. In the latter half of fiscal 2002, we began
to mitigate this interest rate sensitivity by adding short-term fixed-rate
assets to our investment portfolio and simultaneously entering into interest
rate swaps on a portion of our debt obligations to make them variable-rate debt
instruments. Under these swaps, we receive a fixed interest rate of 7.25% and
pay an average floating rate of LIBOR (1.4% at December 31, 2002) plus 2.91% on
the $500 million of notional amounts of the swaps. The objective of maintaining
the mix of fixed and floating-rate debt and investments is to mitigate the
variability of cash inflows and outflows resulting from interest rate
fluctuations, as well as reduce the overall cost of borrowing. We do not enter
into derivative transactions on our cash equivalents since their relatively
short maturities do not create significant risk. We do not foresee any
significant changes in our risk management strategy or in our exposure to
interest rate fluctuations.
Equity Price Risk
Our investment portfolio includes equity investments in publicly held companies
that are classified as available-for-sale and other strategic equity holdings in
privately held companies. These securities are exposed to price fluctuations and
are generally concentrated in the high-technology and telecommunications
industries. At December 31, 2002, the carrying value of our available-for-sale
securities and privately held securities were $25 million and $108 million,
respectively. The process of determining the fair values of our privately held
equity investments inherently requires subjective judgments. These valuation
assumptions and judgments include consideration of the investee's earnings and
cash flow position, cash flow projections and rate of cash consumption, recent
rounds of equity infusions by us and other investors, strength of the investee's
management and valuation data provided by the investee that may be compared with
peers. Due to a sustained weakness in the economic environment in both public
and private equity markets, we have and may continue to write down the carrying
value of certain equity investments and incur impairment charges when the
declines in fair value are other-than-temporary. Impairment charges of $41
million were recognized during the first quarter of fiscal 2003.
We generally do not hedge our equity price risk due to hedging restrictions
imposed by the issuers, illiquid capital markets or inability to hedge
non-marketable equity securities in privately held companies. An adverse
movement in the equity prices of our holdings in privately held companies can
not be easily quantified as our ability to realize returns on investments
depends on the investees' ability to derive sales from continuing operations or
raise additional capital through liquidity events such as initial public
offerings, mergers or private sales. During the first quarter of fiscal 2003, we
entered into prepaid forward sales agreements for most of the Corning stock we
owned, under which we received $94 million and locked in $66 million of
unrealized appreciation.
OTHER INFORMATION
On November 21, 2000, we announced that we had identified an issue impacting
revenue in the fourth fiscal quarter of 2000. We informed the SEC and initiated
a review by our outside counsel and independent accountants. In late December
2000, we announced the results of the review, which resulted in certain
adjustments to our fourth fiscal quarter of 2000 results from those previously
announced in our October 2000 earnings release. We are cooperating fully with
the SEC's investigation of these matters.
27 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
On February 7, 2003 certain contracts with the Communications Workers of America
and the International Brotherhood of Electrical Workers were ratified extending
their expiration to October 31, 2004.
28 Form 10-Q - Part I
Item 4. Controls and Procedures
Within the 90-day period prior to the filing of this report, an evaluation was
carried out under the supervision and with the participation of our management,
including the Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"), of the effectiveness of our disclosure controls and procedures. Based
on that evaluation, the CEO and CFO have concluded that our disclosure controls
and procedures are effective to provide reasonable assurance that information
required to be disclosed by us in reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. We periodically review the design and effectiveness of our internal
controls worldwide, including compliance with various laws and regulations
that apply to our operations both inside and outside the United States. We make
modifications to improve the design and effectiveness of our internal
control structure, and may take other corrective action, if our reviews
identify deficiencies or weaknesses in our controls. Subsequent to the date
of our management's evaluation, there were no significant changes in our
internal controls or in other factors that could significantly affect these
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
29 Form 10-Q - Part II
Part II - Other Information
Item 1. Legal Proceedings.
Lucent settled several cases since it filed its Annual Report on Form 10-K for
the year ended September 30, 2002, including the Obtek, et al. v. Lucent
Technologies Inc., et al case, the Aversano v. Lucent Technologies Inc. case and
several commercial disputes and other matters. The payments made to settle all
of these various matters and related disputes did not have a material effect on
the results of operations and financial condition.
In the Sparks consumer class action case, the process for filing claims in this
settlement required that the claims be postmarked not later that January 15,
2003. Based upon preliminary information received from the claims administrator,
the final claims amount will be significantly less than the amount held in the
escrow accounts.
A new case, captioned Larry Dane v. Lucent Technologies, was filed in U.S.
District Court for the District of New Jersey against Lucent in January 2003.
This is a purported class action case alleging that the Company and various
unnamed officers breached their fiduciary duties under ERISA with respect to the
represented employees savings plans. The case claims that the defendants were
aware that Lucent stock was not an appropriate retirement investment and
continued to offer Lucent stock as a plan investment. This case is similar to
the Reinhart case which is described in more detail in our Annual Report on Form
10-K for the year ended September 30, 2002.
Additional information about legal proceedings is set forth in Note 8 to the
consolidated financial statements included in this report.
Item 2. Changes in Securities and Use of Proceeds.
(c) Sale of Unregistered Securities.
During the first quarter of fiscal 2003, Lucent issued a total of 214,493,462
shares of its common stock that were not registered under the Securities Act of
1933 in reliance on an exemption pursuant to Section 3(a)(9) of that Act. These
shares of common stock were issued in several separately and privately
negotiated transactions occurring on various dates throughout the quarter in
exchange for 392,274 shares of our 8% redeemable convertible preferred stock
with a liquidation value of $392,274,000 and 217,500 of our 7.75% trust
preferred securities with a total liquidation value of $217,500,000. No
underwriters were used for these transactions.
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 October 23, 2002 we filed a Current Report on Form 8-K pursuant to Item 5
(Other Events) to announce that we entered into a letter agreement amending
the Guarantee and Collateral Agreement and filed a copy of this letter
agreement pursuant to Item 7 (Financial Statements and Exhibits). In
addition, we furnished pursuant to Item 9 (Regulation FD) a press release
reporting the results of our fourth quarter of fiscal 2002 and slides
presented in a webcast of our quarterly earnings conference call.
On October 18, 2002, we filed a Current Report on Form 8-K pursuant to Item
5 to announce that Lucent's board of directors authorized the company to
seek shareowner approval for a reverse stock split and filed a copy of a
press release announcing this pursuant to Item 7.
30 Form 10-Q - Part II
Part II - Other Information
On October 11, 2002, we filed a Current Report on Form 8-K pursuant to Item
5 to announce the cancellation of our $1.5 billion credit facility and our
$500 million accounts receivable securitization vehicle. In addition, we
furnished pursuant to Item 9 a press release with comments on this
cancellation and on our fourth quarter of fiscal 2002 results.
31 Form 10-Q - Part II
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 February 11, 2003
/s/ John A. Kritzmacher
-----------------------
John A. Kritzmacher
Senior Vice President and Controller
(Principal Accounting Officer)
32 Form 10-Q - Part II
CHIEF EXECUTIVE OFFICER CERTIFICATION
I, Patricia F. Russo, President and Chief Executive Officer of Lucent
Technologies Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lucent Technologies
Inc. (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 11, 2003
/s/ Patricia F. Russo
- ------------------------
President and Chief Executive Officer
(Principal Executive Officer)
33 Form 10-Q - Part II
CHIEF FINANCIAL OFFICER CERTIFICATION
I, Frank A. D'Amelio, Executive Vice President and Chief Financial Officer of
Lucent Technologies Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lucent Technologies
Inc. (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 11, 2003
/s/ Frank A. D'Amelio
- ----------------------------
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
34 Form 10-Q - Part II
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