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AS FILED WITH THE SEC ON AUGUST 13, 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 June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________to _____________
Commission file number 001-11639
LUCENT TECHNOLOGIES INC.
A Delaware I.R.S. Employer
Corporation No. 22-3408857
600 Mountain Avenue, Murray Hill, New Jersey 07974
Telephone Number: 908-582-8500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
At July 31, 2003, 4,160,571,938 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 and Nine Months
Ended June 30, 2003 and 2002.............................................................3
Consolidated Balance Sheets at
June 30, 2003 and September 30, 2002.....................................................4
Consolidated Statement of Changes in Shareowners' Deficit for the Nine Months
Ended June 30, 2003......................................................................5
Consolidated Statements of Cash Flows for the Nine Months
Ended June 30, 2003 and 2002.............................................................6
Notes to Consolidated Financial Statements.................................................7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition............................................22
Item 4. Controls and Procedures...................................................................36
Part II - Other Information:
Item 1. Legal Proceedings.........................................................................37
Item 2. Changes in Securities and Use of Proceeds.................................................37
Item 5. Other Information.........................................................................38
Item 6. Exhibits and Reports on Form 8-K..........................................................38
3 Form 10-Q - Part I
PART 1 - Financial Information
Item 1. Financial Statements
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
----------- -------------- ----------- -------------
Revenues:
Products $ 1,526 $2,304 $ 5,099 $7,883
Services 439 645 1,344 2,161
----------- -------------- ----------- -------------
Total revenues 1,965 2,949 6,443 10,044
----------- -------------- ----------- -------------
Costs:
Products 1,041 1,738 3,523 6,376
Services 351 560 1,131 1,780
----------- -------------- ----------- -------------
Total costs 1,392 2,298 4,654 8,156
----------- -------------- ----------- -------------
Gross margin 573 651 1,789 1,888
Operating expenses:
Selling, general and administrative 412 871 1,299 2,992
Research and development 382 480 1,153 1,625
Goodwill impairment 35 811 35 811
Business restructuring charges (reversals) and asset
impairments, net 13 791 (137) 653
----------- -------------- ----------- -------------
Total operating expenses 842 2,953 2,350 6,081
----------- -------------- ----------- -------------
Operating loss (269) (2,302) (561) (4,193)
Other income (expense), net 31 (261) (436) 242
Interest expense 85 107 258 284
----------- -------------- ----------- -------------
Loss from continuing operations before income taxes (323) (2,670) (1,255) (4,235)
Provision for (benefit from) income taxes (69) 5,329 (386) 4,782
----------- -------------- ----------- -------------
Loss from continuing operations (254) (7,999) (869) (9,017)
(Loss) income from discontinued operations, net - (27) - 73
----------- -------------- ----------- -------------
Net loss (254) (8,026) (869) (8,944)
Conversion cost - 8.00% redeemable convertible preferred stock (20) - (286) -
Preferred stock dividends and accretion (21) (42) (82) (124)
----------- -------------- ----------- -------------
Net loss applicable to common shareowners $ (295) $(8,068) $(1,237) $(9,068)
=========== ============== =========== =============
Loss per common share - basic and diluted
Loss from continuing operations $(0.07) $(2.34) $ (0.32) $(2.67)
(Loss) income from discontinued operations - $(0.01) - $ 0.02
Net loss applicable to common shareowners $(0.07) $(2.35) $ (0.32) $(2.65)
Weighted average number of common shares
outstanding - basic and diluted 4,120.6 3,428.5 3,882.3 3,422.5
See Notes to Consolidated Financial Statements.
4 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
June 30, September 30,
2003 2002
----------------- --------------
ASSETS
Cash and cash equivalents $ 4,339 $2,894
Short-term investments 589 1,526
Receivables, less allowance of $272 and $325, respectively 1,620 1,647
Inventories 806 1,363
Contracts in process, net of progress billings of $10,551 and $10,314,
respectively 70 10
Other current assets 1,181 1,715
----------------- --------------
Total current assets 8,605 9,155
Property, plant and equipment, net 1,705 1,977
Prepaid pension costs 4,483 4,355
Goodwill and other acquired intangibles, net 189 224
Other assets 1,954 2,080
----------------- --------------
Total assets $ 16,936 $17,791
================= ==============
LIABILITIES
Accounts payable $ 1,221 $1,298
Payroll and benefit-related liabilities 776 1,094
Debt maturing within one year 616 120
Other current liabilities 2,866 3,814
----------------- --------------
Total current liabilities 5,479 6,326
Postretirement and postemployment benefit liabilities 4,935 5,230
Pension liabilities 2,357 2,752
Long-term debt 4,687 3,236
Company-obligated mandatorily redeemable preferred securities of subsidiary
trust 1,152 1,750
Other liabilities 1,351 1,551
----------------- --------------
Total liabilities 19,961 20,845
Commitments and contingencies
8.00% redeemable convertible preferred stock 933 1,680
SHAREOWNERS' DEFICIT
Preferred stock - par value $1.00 per share;
Authorized shares: 250.0; issued and outstanding shares: none - -
Common stock - par value $.01 per share;
Authorized shares: 10,000.0; 4,143.8 issued and 4,142.5 outstanding shares
at June 30, 2003 and 3,491.6 issued and 3,490.3 outstanding shares at
September 30, 2002 41 35
Additional paid-in capital 22,096 20,606
Accumulated deficit (22,894) (22,025)
Accumulated other comprehensive loss (3,201) (3,350)
----------------- --------------
Total shareowners' deficit (3,958) (4,734)
----------------- --------------
Total liabilities, redeemable convertible preferred stock and
shareowners' deficit $ 16,936 $ 17,791
================= ==============
See Notes to Consolidated Financial Statements.
5 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREOWNERS' DEFICIT
(Dollars in Millions)
(Unaudited)
Accumulated
Additional other Total
Common paid-in Accumulated comprehensive shareowners'
stock capital deficit loss deficit
----------- ---------------------------------------- -------------
Balance at September 30, 2002 $35 $20,606 $(22,025) $(3,350) $(4,734)
----------- ---------------------------------------- -------------
Net loss (869)
Foreign currency translation adjustment 108
Unrealized holding gains on certain investments 41
Issuance of common stock in connection with the
exchange for convertible securities and certain other
debt obligations (see Note 6) 6 1,430
Conversion costs in connection with the exchange of
7.75% trust preferred securities 129
Tax benefit in connection with the exchange of 7.75%
trust preferred securities (135)
Issuance of common stock in connection with payment
of preferred stock dividend 53
Issuance of common stock in connection with
contribution to Lucent Technologies Inc. Represented
Employees Post-Retirement Health Benefits Trust 75
Other issuance of common stock 32
Preferred stock dividends and accretion (82)
Other (12)
----------- ---------------------------------------- ----------------
Balance at June 30, 2003 $ 41 $ 22,096 $ (22,894) $ (3,201) $ (3,958)
=========== ======================================== ================
See Notes to Consolidated Financial Statements.
6 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Nine months ended
June 30,
2003 2002
----------- ---------
Operating Activities
Net loss $ (869) $(8,944)
Less: income from discontinued operations - 73
----------- ---------
Loss from continuing operations (869) (9,017)
Adjustments to reconcile loss from continuing operations to net cash (used in)
provided by operating activities, net of effects of dispositions of
businesses:
Non-cash portion of business restructuring (reversals) charges (179) 434
Impairment of goodwill 35 811
Depreciation and amortization 782 1,189
(Recovery of) provision for bad debt and customer financings (99) 829
Deferred income taxes - 5,285
Net pension and postretirement benefit credit (488) (719)
Gain on sales of businesses (47) (583)
Other adjustments for non-cash items 132 313
Changes in operating assets and liabilities:
Decrease in receivables 18 2,008
Decrease in inventories and contracts in process 513 1,870
Decrease in accounts payable (104) (592)
Changes in other operating assets and liabilities (787) (1,782)
----------- ---------
Net cash (used in) provided by operating activities from continuing
operations (1,093) 46
----------- ---------
Investing Activities
Capital expenditures (226) (312)
(Acquisitions) dispositions of businesses, net of cash (18) 2,543
Maturities (purchases) of short-term investments 941 (865)
Other investing activities 155 108
----------- ---------
Net cash provided by investing activities from continuing operations 852 1,474
----------- ---------
Financing Activities
Issuance of convertible senior debt 1,631 -
Issuance of company-obligated mandatorily redeemable preferred
securities of subsidiary trust - 1,750
Repayments of credit facilities - (1,000)
Net proceeds from (repayments of) other short-term borrowings 49 (45)
Payment of preferred dividends - (73)
Other financing activities (48) (3)
----------- ---------
Net cash provided by financing activities from continuing operations 1,632 629
Effect of exchange rate changes on cash and cash equivalents 54 28
----------- ---------
Net cash provided by continuing operations 1,445 2,177
Net cash used in discontinued operations - (11)
----------- ---------
Net increase in cash and cash equivalents 1,445 2,166
Cash and cash equivalents at beginning of year 2,894 2,390
----------- ---------
Cash and cash equivalents at end of period $ 4,339 $ 4,556
=========== =========
Tax refunds, net $143 $783
----------- ---------
Interest paid $220 $217
----------- ---------
See Notes to Consolidated Financial Statements.
7 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
accounting principles generally accepted in the United States of America.
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 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 for the year ended September 30, 2002 included
in Form 8-K, filed on February 21, 2003.
Certain reclassifications were made to conform to the current period
presentation.
2. STOCK-BASED COMPENSATION
Lucent has stock-based compensation plans under which directors, officers and
other employees receive stock options and other equity-based awards. The plans
provide for the grant of stock options, stock appreciation rights, performance
awards, restricted stock awards and other stock unit awards.
Lucent follows the disclosure requirements of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"). As permitted under SFAS 123, Lucent follows Accounting Principles Board
Opinion No. 25 for its stock-based compensation plans and does not recognize
expense for stock option grants if the exercise price is at least equal to the
market value of the common stock at the date of grant. Stock-based compensation
expense reflected in the as reported net loss includes expense for restricted
stock unit awards and the amortization of certain acquisition-related deferred
compensation expense.
The fair value of stock options used to compute pro forma net loss and pro forma
loss per share disclosures is estimated using the Black-Scholes option-pricing
model, which was developed for use in estimating the fair value of traded
options that have no vesting restrictions and are fully transferable. In
addition, this model requires the input of subjective assumptions, including the
expected price volatility of the underlying stock. Projected data related to the
expected volatility and expected life of stock options is based upon historical
and other information. Changes in these subjective assumptions can materially
affect the fair value estimate, and therefore the existing valuation models do
not provide a precise measure of the fair value of the Company's employee stock
options.
As required under SFAS 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," the following table summarizes the pro forma effect
of stock-based compensation on net loss and loss per share if the fair value
expense recognition provisions of SFAS 123 had been adopted. No tax benefits
were attributed to the stock-based employee compensation expense during the
three and nine months ended June 30, 2003 due to providing a full valuation
allowance on net deferred tax assets. The pro forma net loss for the three and
nine months ended June 30, 2002 includes the impact of an increase in valuation
allowances for net deferred tax assets of approximately $6.6 billion and the
reversal of tax benefits previously recognized in the first and second quarters
of fiscal 2002.
8 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Three months ended June 30, Nine months ended June 30,
2003 2002 2003 2002
------------- ------------ -------------- -----------
Net loss, as reported $ (254) $ (8,026) $ (869) $ (8,944)
Add: Stock-based employee compensation expense included in
as reported net loss, including tax expense of $24 and
$13 during the three and nine months ended June
30, 2002, respectively 3 26 13 42
Deduct: Total stock-based employee compensation expense
determined under the fair value based method, including
tax expense of $1,692 and $1,408, during the three
and nine months ended June 30, 2002, respectively (50) (1,900) (235) (2,387)
-------- --------- --------- ---------
Pro forma net loss $(301) $(9,900) $(1,091) $(11,289)
======== ========= ========= =========
Loss per share applicable to common shareowners:
Basic and diluted - as reported $(0.07) $(2.35) $(0.32) $(2.65)
Basic and diluted - pro forma $(0.08) $(2.90) $(0.38) $(3.33)
3. BUSINESS RESTRUCTURING CHARGES, REVERSALS AND ASSET IMPAIRMENTS
Nine months Revisions to
Sept. 30, ended prior year plans June 30,
2002 June 30, 2003 ----------------- Net charge/ 2003
reserve charge charge reversal (reversal) Deductions reserve
------- ------ ------ ------- ---------- ---------- -------
Employee separations $ 367 $ 18 $106 $(182) $(58) $(205) $104
Contract settlements 150 17 21 (51) (13) (83) 54
Facility closings 483 - 49 (37) 12 (100) 395
Other 69 1 5 (9) (3) (46) 20
------ ----------------------------------------- ------- ------
Total restructuring costs $1,069 $ 36 $181 $(279) $(62) $(434) $ 573
====== ========================================= ======= ======
Total asset write-downs $ 5 $ 43 $(128) $(80)
Total business ---- ---- ------ -----
restructuring charges
(reversals) and asset
impairments, net $ 41 $224 $(407) $(142)(a)
==== ==== ====== ======
- ---------
(a) Net inventory reversals of $5 were included in costs.
A net reversal of business restructuring charges and asset impairments of $142
was recognized during the nine months ended June 30, 2003. The net reversal
included a charge for new plans of $41 and a net credit or reversal resulting
from revisions to prior year plans of $183, consisting of reversals of $407 and
charges of $224. These amounts are not included in the operating income (loss)
for reportable segments.
The new plans (initiated during the first fiscal quarter of 2003) primarily
related to employee separation charges and contract settlements associated with
the discontinuance of the TMX Multi-Service Switching and Spring Tide product
lines in the Integrated Network Solutions ("INS") segment.
The revisions to prior year plans included:
o net employee separations reversals of $76 primarily related to actual
termination benefits and curtailment costs being lower than the estimated
amounts. These variances were due to certain differences in assumed
demographic experience including the age, service lives and salaries of the
separated employees;
o net contract settlement reversals of $30 related to the settlement of
certain contractual obligations and purchase commitments for amounts lower
than originally estimated;
o net facility closing charges of $12 primarily due to lower revised
estimates for expected sublease rental income on certain properties, offset
by reversals resulting from negotiated settlements for lower amounts than
originally planned on certain properties; and
o net reversals to prior asset write-downs of $85, which included a $75
reversal of property, plant and equipment primarily resulting from
adjustments to original plans for certain owned facility closings.
9 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Deductions to the business restructuring reserves of $434 included:
Cash payments $(534)
Reversals of pension termination benefits to certain U.S. employees previously expected to be funded
through Lucent's pension assets 51
Postretirement termination charges (6)
Reversals of net pension, postemployment and postretirement benefit curtailments 82
Reversals due to the expiration of certain contingencies related to prior business dispositions 3
Foreign currency translation adjustments related to the liquidation of certain foreign legal entities (30)
-----------
Total deductions $(434)
===========
There were approximately 53,600 voluntary and involuntary employee separations
associated with employee separation charges recorded in fiscal 2001, fiscal 2002
and the first nine months of fiscal 2003. As of June 30, 2003, approximately
52,400 employee separations were completed. The majority of the remaining 1,200
employee separations are expected to be completed by the end of fiscal 2003. The
completed and future employee separations affect all business groups and
geographic regions. Management represented approximately 70% of the total
employee separations. In addition, involuntary separations represented
approximately 70% of the total employee separations.
Facility closing 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 in
connection with plans to reduce a significant number of owned and leased
facilities, totaling approximately 16.1 million square feet. As of June 30,
2003, owned and leased sites aggregating 15.0 million square feet have been
exited and the majority of the remaining sites are expected to be exited by the
end of fiscal 2003. The remaining liabilities of $395 are expected to be paid
over the remaining lease terms ranging from several months to 13 years and are
reflected net of expected sublease income of $250.
Restructuring reserves continue to be evaluated as plans are being executed. As
a result, there may be additional changes in estimates. In addition, since the
restructuring program is an aggregation of many individual plans currently being
executed, actual costs have differed from estimated amounts.
4. INVENTORIES
June 30, 2003 September 30, 2002
----------------- --------------------
Raw materials $ 193 $ 617
Work in process 58 35
Completed goods 555 711
----------------- -------------------
Inventories, net of reserves of $1,106 at June 30, 2003 and
$1,490 at September 30, 2002 $ 806 $ 1,363
================= ===================
5. ISSUANCE OF CONVERTIBLE DEBT
During the third quarter of fiscal 2003, Lucent sold 2.75% Series A Convertible
Senior Debentures and 2.75% Series B Convertible Senior Debentures for an
aggregate amount of $1,631 or $1,585 after deducting the underwriters discount
and related fees and expenses. The debentures were issued at a price of $1,000
per debenture and were issued under the Company's universal shelf registration.
The debentures rank equal in priority with all of the existing and future
unsecured and unsubordinated indebtedness and senior in right of payment to all
of the existing and future subordinated indebtedness. The terms governing the
debentures limit the Company's ability to create liens, secure certain
indebtedness and merge with or sell substantially all of the Company's assets to
another entity.
The debentures are convertible into shares of common stock only if (1) the
average sale price of the Company's common stock is at least equal to 120% of
the applicable conversion price, (2) the average trading price of the debentures
is less than 97% of the product of the sale price of the common stock and the
conversion rate, (3) if the debentures have been called for redemption by the
Company or (4) upon the occurrence of certain specified corporate actions.
10 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
At the option of the Company, the debentures are redeemable after certain dates
("optional redemption periods") at 100% of the principal amount plus any accrued
and unpaid interest for cash. In addition, at the option of the Company, the
debentures are redeemable earlier ("provisional redemption periods") if the
average sale price of the common stock exceeds 130% of the applicable conversion
price. Under these circumstances, the redemption price would also include a make
whole payment equal to the present value of all remaining scheduled interest
payments through the beginning of the optional redemption periods.
At the option of the holder, the debentures are redeemable on certain dates at
100% of the principal amount plus any accrued and unpaid interest. In these
circumstances, the Company may pay the purchase price with cash, common stock
(with the common stock to be valued at a 5% discount from the then current
market price) or a combination of both.
Specific terms and information for each series of the debentures are as follows:
Series A Series B
-------- --------
Amount $ 750 $ 881
Conversion ratio of common shares per bond 299.4012 320.5128
Initial conversion price $ 3.34 $ 3.12
Redemption periods at the option of the Company:
Provisional redemption periods June 20, 2008 thru June 19, 2010 June 20, 2009 thru June 19, 2013
Optional redemption periods After June 19, 2010 After June 19, 2013
Redemption dates at the option of the holder June 15, 2010, 2015 and 2020 June 15, 2013 and 2019
Maturity dates June 15, 2023 June 15, 2025
6. RETIREMENTS OF CONVERTIBLE PREFERRED SECURITIES AND DEBT OBLIGATIONS
The following table summarizes the convertible preferred securities and certain
debt obligations which have been retired through exchanges with Lucent common
stock during fiscal 2002 and the nine months ended June 30, 2003.
Year ended Nine months ended
September 30, June 30,
(shares in millions) 2002 2003 Total
------------------- -------------------- -------------
8% redeemable convertible preferred stock $ 175 $ 767 $ 942
7.75% trust preferred securities - 598 598
------------------- -------------------- -------------
Total convertible securities retired $ 175 $1,365 $1,540
=================== ==================== =============
Debt obligations $ - $ 87 $ 87
=================== ==================== =============
Total shares of Lucent common stock exchanged 58 563 621
=================== ==================== =============
Conversion costs have been recognized in amounts equal to the fair value of the
additional common shares issued to the holders of each respective preferred
security to prompt the exchange over the number of shares of common stock
obligated to be issued pursuant to the original conversion terms of the
respective security.
o The charges for the 8% redeemable convertible preferred stock amounted to
$20 and $286 during the three and nine months ended June 30, 2003,
respectively, and were reflected in the net loss applicable to common
shareowners.
o The charge for the 7.75% trust preferred securities amounted to $129 during
the nine months ended June 30, 2003 and was included in other income
(expense), net.
o Additionally, the gains associated with the exchange of the debt
obligations for Lucent common stock amounted to $6 and $17 during the three
and nine months ended June 30, 2003, respectively, and were included in
other income (expense), net.
Since June 30, 2003 and through August 13, 2003, an additional $68 of 8%
redeemable convertible preferred stock and certain debt obligations with a
carrying value of $167 were retired for $222 of cash. These transactions
resulted in additional other income of $14 and redemption cost of $1 that will
be reflected in the results of the fourth quarter of fiscal 2003.
11 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
7. COMPREHENSIVE LOSS
The components of comprehensive loss are reflected net of tax, except for
foreign currency translation adjustments. Foreign currency translation
adjustments are generally not adjusted for income taxes as they relate to
indefinite investments in certain non-U.S. subsidiaries.
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
-------------- ------------- ------------ ------------
Net loss $(254) $(8,026) $(869) $(8,944)
Other comprehensive loss:
Foreign currency translation adjustments 50 71 108 111
Reclassification adjustments to foreign currency
translation for sale of foreign entities - (6) - (6)
Unrealized holding gains (losses) on investments (1) (1) 42 (20)
Reclassification adjustments for realized gains and
impairment losses on investments (1) 19 (1) -
Unrealized losses and reclassification adjustments
on derivative instruments - - - (10)
------------ ----------- ---------- -----------
Comprehensive loss $(206) $(7,943) $(720) $(8,869)
============ =========== ========== ===========
8. 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 is calculated by dividing net
loss applicable to common shareowners, adjusted to exclude preferred dividends
and accretion, conversion costs and interest expense related to the potentially
dilutive securities, by the weighted average number of common shares outstanding
during the period, plus any additional common shares that would have been
outstanding if potentially dilutive common shares had been issued during the
period. Due to the net loss incurred in each of the periods presented, the
diluted loss per share is the same as basic, because any potentially dilutive
securities would reduce the loss per share. The following table summarizes the
potentially dilutive securities:
Three months ended Nine months ended
June 30, June 30,
(in millions) 2003 2002 2003 2002
-------- --------- -------- ---------
8% redeemable convertible preferred stock 504 592 770 428
7.75% trust preferred securities 238 362 285 136
2.75% convertible senior debt 271 - 91 -
Stock options 24 3 11 8
-------- --------- -------- ---------
Total 1,037 957 1,157 572
======== ========= ======== =========
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 255 372 315 533
======== ========= ======== =========
The calculation of potential common shares related to the 8% redeemable
convertible preferred stock and the 2.75% convertible senior debt is based upon
the three and nine month average price of Lucent's common stock and the weighted
average number of the respective securities outstanding during the periods
presented due to their redemption feature which allows the Company to settle
certain redemption requests through the issuance of Lucent's common stock.
12 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
9. 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
software, equipment and services related to voice networking (which primarily
consists of switching products, which we sometimes refer to as convergence
solutions, and voice messaging products), data and network management (which
primarily consists of access and related data networking equipment and operating
support software) and optical networking. 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 impairment 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 and other
smaller business 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.
The segment results for the prior period have been revised to conform to the
current year's performance measure, which now includes the operating results of
the Messaging product unit. The reportable segments may change in the future if
changes in the Company's management model occur. The accounting policies of the
reportable segments are the same as those applied in the unaudited consolidated
financial statements.
13 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Three months Nine months
ended June 30, ended June 30,
2003 2002 2003 2002
--------- ------------ ----------- ------------
Revenues
INS $ 1,059 $ 1,353 $ 3,123 $ 5,009
Mobility 826 1,505 3,145 4,596
--------- ----------- ----------- ------------
Total reportable segments 1,885 2,858 6,268 9,605
Optical fiber business - - - 114
Other 80 91 175 325
--------- ----------- ----------- ------------
Total revenues $ 1,965 $ 2,949 $ 6,443 $ 10,044
========= =========== =========== ============
Operating income (loss)
INS $ (47) $ (619) $ (257) $ (2,028)
Mobility (56) 200 181 252
--------- ----------- ----------- ------------
Total reportable segments (103) (419) (76) (1,776)
Goodwill and other acquired intangibles amortization (5) (75) (15) (218)
Goodwill impairments (35) (811) (35) (811)
Business restructuring (charges) reversals and asset impairments, net (14) (834) 142 (706)
Optical fiber business - - - (68)
Unallocated personnel costs and benefits 290 371 875 1,194
Shared services such as general corporate functions (338) (393) (1,070) (1,238)
Other (64) (141) (382) (570)
--------- ----------- ----------- ------------
Total operating loss $ (269) $ (2,302) $ (561) $ (4,193)
========= =========== =========== ============
Products and Services Revenues
The table below presents revenues for groups of similar products and
services:
Three months Nine months
ended June 30, ended June 30,
2003 2002 2003 2002
--------------- -------------- -------------- -----------
Wireless $ 624 $ 1,197 $ 2,446 $ 3,763
Voice networking 411 480 1,201 1,673
Data and network management 246 274 771 928
Optical networking 165 267 491 1,090
Services 439 645 1,344 2,161
Optical fiber - - - 114
Other 80 86 190 315
--------------- -------------- -------------- -----------
Total revenues $ 1,965 $ 2,949 $ 6,443 $ 10,044
=============== ============== ============== ===========
Revenues from one customer accounted for approximately 19% to 23% of total
revenues in all interim periods presented. In addition, revenues from another
customer accounted for 10% and 12% of total revenues during the three months
ended June 30, 2003 and 2002, respectively.
10. 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 amounts of monetary liability or financial impact with respect to
these matters as of June 30, 2003.
14 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Securities and Related Cases
On March 27, 2003, Lucent announced that it had reached an agreement to settle
the assorted securities, ERISA and derivative class action lawsuits and other
lawsuits against Lucent and certain of its current and former directors,
officers and employees. The settlement requires court approval from various
courts before it becomes final. Lucent did not admit any wrongdoing as part of
the settlement.
The agreement is a global settlement of what were 53 separate lawsuits,
including the consolidated shareowner class action lawsuit in the U.S. District
Court in Newark, N.J., and related ERISA, bondholder, derivative, and other
state securities cases. These cases include all the cases described under the
caption "Securities and Related Cases" in Item 3, Part 1 of Lucent's Annual
Report on Form 10-K for the year ended September 30, 2002, as updated by
Lucent's quarterly report on Form 10-Q for the period ended March 31, 2003.
These cases include: In re Lucent Technologies Inc. Securities Litigation; In re
Winstar Communications Securities Litigation; Preferred Life Insurance Co. of
New York et al. v. Lucent Technologies Inc.; Laufer v. Lucent Technologies Inc.,
et al; and Balaban v. Schacht, et al., as well a new case filed during the
second quarter of fiscal 2003, Freund v. Schacht, et al.
Under the settlement agreement, Lucent will pay $315 in common stock, cash or a
combination of both, at Lucent's option. Lucent will also issue warrants to
purchase 200 million shares of Lucent common stock, at an exercise price of
$2.75 per share with an expiration date three years from the date of issuance.
As of June 30, 2003, the value of these warrants, using the Black-Scholes
option-pricing model, was approximately $128. Lucent will pay up to $5 in cash
for the cost of settlement administration.
Lucent expects the settlement approval and claims administration process to last
up to 18 months and does not expect to distribute any proceeds until sometime in
fiscal 2004 or fiscal 2005. Lucent has agreed to deposit into escrow $100 in
cash or securities, or combination of both, of the settlement amount upon the
approval of the settlement by the U.S District Court for the District of New
Jersey in the consolidated case In re Lucent Technologies Inc., Securities
Litigation, the U.S. District Court for the Southern District of New York in In
Re Winstar Communications Securities Litigation and any other required
lower-court approvals. In addition to the cash, stock and warrants that Lucent
will contribute, certain of Lucent's insurance carriers have agreed to pay their
available policy limits of $148 in cash into the total settlement fund. Lucent's
former affiliate, Avaya Inc., is contractually responsible for a portion of the
settlement under its agreements with Lucent. Avaya's contribution to the
settlement is still being determined and, when received by Lucent, will be added
to the total settlement fund described above.
A $415 charge related to the settlement was recognized during the second quarter
of fiscal 2003. An additional $33 charge was recognized during the third quarter
of fiscal 2003 to reflect changes in the fair value of the warrants. Lucent will
seek partial recovery of the settlement amount from its fiduciary insurance
carriers under certain insurance policies that provide coverage up to $70. The
charge may be revised in future quarters if Lucent is able to recover a portion
of the settlement from its fiduciary insurance carriers, as well as to reflect
additional changes in the fair value of the warrants before they are issued.
The definitive documents for settlement are in the process of being prepared and
approved by the parties, and are expected to contain a provision giving Lucent
the right to terminate the settlement if class members who purchased more than
3% of the total shares purchased by all class members during the class period of
any alleged class elect to opt out of the settlement and pursue their claims
directly against Lucent. Any lawsuits that may be brought by parties opting out
of the settlement will need to be defended regardless of whether Lucent elects
to consummate the settlement.
Lucent and certain current and former officers and directors of Lucent are
defendants in an action in the U.S. District Court of New Jersey, Staro Asset
Management, LLC v. Lucent Technologies Inc. et al., alleging violations of the
federal securities laws. The case, which was filed in March 2003, was originally
part of the global settlement referred to above but plaintiff indicated its
desire not to settle and to pursue its claim separately against the defendants.
Lucent has moved to dismiss the complaint.
15 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
SEC Investigation
In November and December 2000, Lucent identified certain revenue recognition
issues that it publicly disclosed and brought to the SEC's attention. On
February 27, 2003, Lucent announced that it had reached an agreement in
principle with the staff of the SEC, which would resolve their investigation of
Lucent. The agreement is subject to final approval by the SEC. Under this
agreement, without admitting or denying any wrongdoing, Lucent would consent to
a settlement enjoining Lucent from future violations of the anti-fraud,
reporting, books and records and internal control provisions of the federal
securities laws. Under the agreement in principle, Lucent would pay no fines or
penalties and would not be required to restate any of its financial statements.
Other Matters
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, with court approval in August 2002, to settle the
litigation, and the settlement process is nearly completed. Lucent recognized a
$162 charge in the third fiscal quarter of 2002 and subsequently reversed $80 of
the reserve in the first fiscal quarter of 2003 since the final settlement
amount was significantly less than the original estimate due to the number of
claimants that applied for reimbursement.
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.
A description of a special purpose trust previously used to sell customer
finance loans on a limited recourse basis is included in Note 11 under
"Guarantees and Indemnification Agreements". As more fully described therein,
Lucent and an unaffiliated insurer are in dispute regarding credit insurance
coverage.
There are approximately $500 of gross receivables (primarily retention
receivables included in other assets) from long-term projects at June 30, 2003
that have been winding down in Saudi Arabia. Management is in the process of
resolving various contractual claims and counter claims with the customer in
order to collect the retention receivables. There were minimal project revenues
realized during fiscal 2003 and collections on the related receivables slowed
considerably during the past two quarters due to various reasons, including the
political situation in the region. Management believes that the resolution of
these project close out issues will not have an adverse effect on the results of
operations.
On August 8, 2003, National Group for Communications and Computers Ltd. ("NGC")
filed an action in the United States District Court for the Southern District of
New York against Lucent Technologies Inc., Lucent Technologies International
Inc. and an unaffiliated company, alleging violations of the Racketeer
Influenced Corrupt Organizations ("RICO") Act. These allegations relate to
certain activities in Saudi Arabia in connection with certain telecommunications
contracts between Lucent, the Kingdom of Saudi Arabia and other entities. The
complaint seeks damages in excess of $63, which could be trebled pursuant to the
provisions of RICO. The allegations in this complaint appear to arise out of
certain contractual disputes between NGC and Lucent, which are the subject of a
separate case that NGC previously filed against Lucent in United States District
Court for the District of New Jersey. Lucent will defend these actions
vigorously.
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
16 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
and NCR each assumed a portion of the liability for the settlement. Lucent is
not aware of any material liabilities to its former affiliates as a result of
these agreements that are not otherwise reflected in the consolidated financial
statements. Nevertheless, it is possible that potential liabilities for which
the former affiliates bear primary responsibility may lead to contributions by
Lucent.
Avaya is defending three separate purported class action lawsuits, one pending
in state court in West Virginia, one in federal court in the Southern District
of New York and another in federal court in the Southern District of California.
All three actions are based upon claims that Lucent, as predecessor to Avaya's
business, sold products that were not Year 2000 compliant, meaning that the
products were designed and developed without considering the possible impact of
the change in the calendar from December 31, 1999 to January 1, 2000. The
complaints seek, among other remedies, compensatory damages, punitive damages
and counsel fees in amounts that have not yet been specified. Under the
separation agreement with Avaya, Lucent is responsible for 50% of the
liabilities and costs related to these cases that exceed $50. Avaya has informed
us that it currently cannot determine whether the outcome of these actions will
be material or will trigger a Company obligation under the separation agreement.
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 approximately $225 to $350 over the next three years. Generally,
differences between the actual annual purchases and the committed levels can be
applied to future years through fiscal 2006, at which time Lucent would be
required to pay 25% of the unfulfilled aggregate commitment.
Lucent has exited most of its manufacturing operations and has increased its use
of contract manufacturers. A sole-source supplier is currently used for a
majority of the switching and wireless product lines and a combination of
multiple contract manufacturers for the majority of the other product lines.
Lucent is generally not committed to unconditional purchase obligations in these
contract manufacturing relationships. However, there is exposure 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 and lower termination charges if cancelled thereafter.
Environmental Matters
Current and historical operations are subject to a wide range of environmental
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.
Environmental reserves of $116 have been provided for remedial and related costs
for which Lucent is or is probably liable and that can be reasonably estimated
as of June 30, 2003. These reserves are not discounted to present value. In
addition, receivables of $46 due from insurance carriers and other third-party
indemnitors have been recognized as of June 30, 2003. Lucent recognizes these
receivables only if the carriers or other indemnitors have agreed to pay the
claims and management believes collection of the receivables is probable. These
environmental matters have not had a significant impact on the results of
operations or changes in financial condition during the nine months ended June
30, 2003 and 2002.
17 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Reserves for estimated losses from environmental remediation are, depending on
the site, based upon analyses of many interrelated factors, including:
o the extent and degree of contamination and the nature of existing required
remedial actions;
o the timing and various types of environmental expenditures such as
investigatory, remedial, capital and operations and maintenance costs;
o applicable legal requirements defining remedial goals and methods;
o progress and stage of existing remedial programs in achieving remedial
goals;
o innovations in remedial technology and expected trends in environmental
costs and legal requirements;
o the number, participation level and financial viability of other
potentially responsible parties;
o the timing and likelihood of potential recoveries or contributions from
other third parties;
o historical experience; and
o the degree of certainty and reliability with respect to all the factors
considered.
It is often difficult to estimate the future impact of environmental matters,
including potential liabilities, due to the above factors and the lengthy time
periods to resolve these environmental matters (which may take up to thirty
years or longer). Although Lucent believes that its reserves are currently
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 amounts provided for as of June
30, 2003, cannot be reasonably estimated.
11. RECENT PRONOUNCEMENTS
Goodwill and Other Intangible Assets
Effective October 1, 2002, SFAS 142 was adopted. 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. In the third quarter of fiscal 2003, an impairment
charge of $35 was recognized, as described below. The next impairment test for
all goodwill is expected to be completed during the fourth quarter of fiscal
2003.
The following table displays a rollforward of the carrying amount of goodwill
from September 30, 2002 to June 30, 2003 by reportable segment:
Acquisition/
September 30, contingency Impairment / June 30,
2002 Reclasses payments amortization Other 2003
-----------------------------------------------------------------------------------------
INS $189 $ 9 $ 5 $ (35) $ 2 $ 170
Mobility 11 - 5 - 16
Other 9 (9) - - -
-----------------------------------------------------------------------------------------
Total goodwill 209 - 10 (35) 2 186
Other intangible assets 15 - 3 (15) - 3
-----------------------------------------------------------------------------------------
Total goodwill and other
Intangible assets $ 224 $ - $ 13 $ (50) $ 2 $ 189
=========================================================================================
On February 3, 2003, the remaining 10% minority interest in AG Communications
Systems Corporation ("AGCS") was purchased for $23, which resulted in an
additional $3 of goodwill and $3 of intangible assets. The amounts allocated to
intangible assets relate to existing technology that will be amortized over its
useful life of three years. In addition, the resolution of certain contingent
consideration related to a prior acquisition resulted in a $7 increase in
goodwill.
18 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Recent business decisions to partner with other suppliers to use their products
in Lucent's sales offerings prompted an assessment of the recoverability of
certain goodwill associated with the multi-service switching reporting unit
within INS during the third quarter of fiscal 2003. The reporting unit's fair
value was determined using projected cash flows over a seven year period
discounted at 15% after considering terminal value and related cash flows
associated with service revenues. The excess of the reporting unit's goodwill
carrying value over its implied fair value was recognized as an impairment
charge in the third quarter of fiscal 2003 in the amount of $35.
The following table presents the net loss and the net loss per basic and diluted
share applicable to common shareowners for the three and nine months ended June
30, 2002, adjusted to exclude goodwill amortization of $55, net of tax, or $0.01
per share, and $156, net of tax, or $0.05 per share, respectively.
Three months ended Nine months ended
June 30, 2002 June 30, 2002
---------------------- ----------------------
Net loss:
As reported $ (8,026) $ (8,944)
Adjusted $ (7,971) $ (8,788)
Basic and diluted loss per share:
As reported $ (2.35) $ (2.65)
Adjusted $ (2.34) $ (2.60)
As of June 30, 2003, identifiable intangible assets consisted of existing
technologies resulting from prior acquisitions. The gross carrying amount and
accumulated amortization of the acquired intangible assets as of June 30, 2003
was $8 and $5, respectively, and as of September 30, 2002 was $144 and $129,
respectively. Amortization of approximately $15 was recognized during the nine
months ended June 30, 2003 and amortization is estimated to be $1 in each of the
next three fiscal years.
Costs Associated with Exit or Disposal Activities
Effective January 1, 2003, SFAS 146 was adopted, 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 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 costs associated with future restructuring actions.
Guarantees and Indemnification Agreements
Effective January 1, 2003, the recognition provisions of FASB Interpretation No.
45 ("FIN 45") were adopted, which expands previously issued accounting guidance
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. Guarantees issued or modified during the three months ended
June 30, 2003 did not have a material effect on the consolidated financial
statements. A description of the Company's guarantees as of June 30, 2003 is
provided below. The Company is unable to reasonably estimate the maximum amount
that could be payable under certain of these arrangements because the exposures
are not capped, and also due to the conditional nature of the Company's
obligations and the unique facts and circumstances involved in each particular
agreement. Historically, payments made under these agreements did not have a
material effect on the Company's business, financial condition or results of
operations other than certain guarantee payments made in connection with the
customer financing arrangements discussed below.
Lucent guarantees the financing of 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. The principal amount of drawn customer financing guarantees and
related reserves was $157 and $116, respectively, as of June 30, 2003. The
remaining guarantee periods range from three months to seven years. In addition,
$42 of commitments are available to customers from third party lenders that may
expire undrawn. 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
19 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
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 direct or indirect indemnifications are provided to the
buyers or other third parties doing business with the divested entities. These
indemnifications include secondary liability for certain leases of real property
and equipment assigned to the divested entity and certain specific
indemnifications for certain legal and environmental contingencies and vendor
supply commitments. The time duration of such indemnifications vary, but are
standard for transactions of this nature, and some may be indefinite.
Lucent remains secondarily liable for approximately $315 of lease obligations as
of June 30, 2003 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 one 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 its 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. The outcome of these matters is not
expected to have a material effect on the consolidated results of operations,
consolidated financial position or near-term liquidity. Lucent has similar
agreements with Avaya and Agere, but does not expect to have any material
liabilities under these agreements.
Lucent licenses to its customers software and rights to use intellectual
property that might provide the licensees with an indemnification against any
liability arising from third-party claims of patent, copyright or trademark
infringement. Lucent cannot determine the maximum amount of losses that it could
incur under this type of indemnification because it often may not have enough
information about the nature and scope of an infringement claim until it has
been submitted to the Company.
Lucent indemnifies its directors and certain of its current and former officers
for third party claims alleging certain breaches of their fiduciary duties as
directors or officers. Certain costs incurred for providing such indemnification
may be recovered under various insurance policies.
Warranty reserves are established for costs that are expected to be incurred
after the sale and delivery of a product or service for deficiencies under
specific product or service warranty provisions. The warranty reserves are
determined as a percentage of revenues based on the actual trend of historical
charges incurred over various periods, excluding any significant or infrequent
issues that are specifically identified and reserved. The warranty liability is
established when it is probable that customers will make claims and when a
reasonable estimate of costs can be made. During fiscal 2003, warranties
associated with certain optical fiber products associated with the optical fiber
business sold in fiscal 2002 expired, resulting in a reduction in reserves. The
following table summarizes the activity related to warranty reserves for the
current nine-month period.
Nine months ended
June 30, 2003
-----------------------
Warranty reserve as of October 1, 2002 $ 440
Accruals for warranties 98
Payments (176)
Optical Fiber business adjustment (15)
-----
Warranty reserve as of June 30, 2003 $ 347
=====
20 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
In September 2000, Lucent and a third party created a non-consolidated Special
Purpose Trust (the "Trust") to which Lucent sold on a limited-recourse basis
customer finance loans and receivables. The Trust held loans relating to five
obligors, all of which were in default. The Trust has a credit insurance policy
from an unaffiliated insurance company insuring the Trust against losses on
these loans. Through reinsurance treaties, Lucent's wholly-owned captive
insurance company assumed the risk under this policy for the loans and reinsured
a significant amount of the exposure with an unaffiliated insurer. Lucent
ultimately expects that its captive insurance company will fund $50 of remaining
first loss obligations and that the unaffiliated insurance company will fund
$298 of its reinsurance obligation (which has been reflected as a receivable in
other assets at June 30, 2003).
In April 2003, written notice was received from the unaffiliated insurer denying
claims and coverage of certain loans in the Trust with an aggregate principal
balance of approximately $175. The insurer has subsequently denied coverage on
the remaining loans in the Trust. The insurer alleged, among other claims, that
the loans were not eligible to be sold to the Trust due to their credit quality
at the time of sale. The insurer stated that it would cease paying claims on
these loans and requested that it be reimbursed for all claims previously paid
and that Lucent repurchase the loans. The amount previously paid to the Trust
under the insurance policy was funded by Lucent's captive insurance company.
Lucent disputes the assertions by the insurer and is pursuing binding
arbitration to resolve the matter.
If the insurer prevails on its denial of coverage, Lucent will be required to
indemnify the Trust and the Trust's lenders and investors for the amount of
coverage denied and the funds returned to the insurer, as well as be required to
recognize a charge for the amount of the denied coverage. In addition, Lucent
has agreed to advance funds to the Trust to cover their principal and interest
payments and fees as they become due until resolution of the dispute with the
insurer. Absent favorable resolution of the dispute, the funding requirements
are approximately $40 during the remainder of fiscal 2003, $90 in fiscal 2004
and $216 thereafter.
Variable Interest Entities ("VIEs")
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46 ("FIN 46"), requiring the consolidation of certain
variable interest entities. In general, a variable interest entity is a
corporation, partnership, trust or other legal structure used for business
purposes that either does not have equity investors with voting rights or lacks
sufficient financial resources to support its activities. Prior to the issuance
of FIN 46, VIE's were more commonly referred to as special-purpose entities or
off-balance sheet arrangements. A company must consolidate the VIE if it is
determined to be the VIE's primary beneficiary that stands to share in the
majority of the VIE's expected losses or expected residual returns.
In the ordinary course of business, Lucent occasionally engages in relationships
with VIE's and holds variable interests in other entities. Lucent is the primary
beneficiary of the Trust described above and has consolidated the Trust during
the third quarter of fiscal 2003, which resulted in additional debt and minority
interest of approximately $300 and a corresponding reduction to a previously
established self-insured loss reserve related to the customer finance loans held
by the Trust which are in default. The Trust is expected to be dissolved upon
resolution of the defaulted assets matter as described above.
Revenue Arrangements with Multiple Deliverables
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus
regarding EITF Issue 00-21. The consensus addresses not only when and how an
arrangement involving multiple deliverables should be divided into separate
elements of accounting but also how the arrangement's consideration should be
allocated among separate units. The pronouncement is effective for revenue
arrangements entered into on or after July 1, 2003 and is not expected to
materially affect the consolidated financial statements.
Derivative Instruments and Hedging Activities
In May 2003, the FASB issued SFAS 149 that amends SFAS 133 on the accounting and
reporting of derivative instruments and hedging activities to incorporate
certain conclusions reached by the FASB's Derivatives Implementation Group and
to provide further clarification on the definition of a derivative. SFAS 149 is
effective for derivative contracts entered into or modified after June 30, 2003
and is not expected to materially affect the consolidated financial statements.
21 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Financial Instruments with Characteristics of both Liabilities and Equity
In May 2003, the FASB issued SFAS 150, which establishes rules for the
accounting for certain financial instruments with characteristics of
liabilities, equity or both. These types of financial instruments have been
reported as liabilities, as part of equity, or in the mezzanine section in the
balance sheet and include mandatorily redeemable instruments, certain
instruments with an obligation to repurchase an issuer's own equity shares and
instruments with obligations for an issuer to settle in a variable number of its
own equity shares.
Due to its conversion feature, Lucent's 8% redeemable convertible preferred
stock is a conditional redeemable obligation and is outside the scope of SFAS
150 and shall continue to be classified in the mezzanine section of the
consolidated balance sheet. The FASB intends to provide further accounting
guidance on conditional redeemable instruments at a later date. SFAS 150 was
adopted on July 1, 2003 and is not expected to materially affect the
consolidated financial statements.
22 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 or long-term projects; 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; 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 declined during 2002 as service providers
reduced spending to preserve capital and improve cash flow and has continued to
decline during 2003. Reasons for the reductions include the general economic
slowdown, network overcapacity, customer bankruptcies, network build-out delays
and limited availability of capital. 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 and timing
of demand in our target markets. 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 in our markets, accurately forecasting near- and long-term
results, earnings and cash flow remains difficult. In addition, since a limited
number of customers account for a significant amount of revenue, our results are
subject to volatility from changes in spending by one or more of our significant
customers.
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 the telecommunications market continues to
decline, or does not improve or improves at a slower pace than we anticipate,
our revenues and profitability will continue to be adversely affected and
additional restructuring actions may be undertaken to further reduce costs,
which may result in additional charges. Our revenues declined by 36% during the
nine months ended June 30, 2003, which exceeded our annual planning assumptions.
However, as expected, our results of operations for the first nine months of
fiscal 2003 have improved by realizing higher gross margin rates and lower
operating expenses resulting from lower restructuring charges and asset
impairments, cost reductions as a result of our restructuring actions, favorable
product mix, lower inventory-related and other charges, and lower provisions for
bad debts and customer financings.
23 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
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 11 to our unaudited consolidated financial statements for a
discussion of recent pronouncements. We have discussed the application of these
critical accounting estimates with our Board of Directors and Audit and Finance
Committee.
Some of the critical judgments used in accounting estimates that have
significantly impacted our interim fiscal 2003 results are discussed throughout
this report on Form 10-Q. These judgments include our expectations on:
o the future cash flows that were used in determining the realizability
of certain assets;
o the timing and amount of potential proceeds related to the sale of
certain facilities;
o the legal settlement of our securities and related cases, including
the estimated fair value of the warrants expected to be issued in
connection therewith;
o the favorable resolution of certain income tax audit matters and
refundable federal income taxes;
o the favorable resolution of a dispute with an insurer regarding the
coverage of certain customer finance loans held in the Trust; and
o the favorable resolution of contract closeout procedures related to a
long-term project in Saudi Arabia.
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 $700 million during fiscal 2003. The net pension
and postretirement credit reflected in the nine months ended June 30, 2003 was
$488 million compared to $719 million in the comparable prior period.
Approximately two-thirds of these amounts are reflected in operating expenses
and the balance in costs. The reduction in the net pension and postretirement
credit is 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
during fiscal 2003 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
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, rather than
fixed-income securities. 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 differences not yet recognized
in 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.
24 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The estimated accumulated benefit obligation related to the U.S. management
employees pension plan and several other smaller pension plans, exceeded the
fair value of the plan assets at September 30, 2002. This was due primarily to
negative returns on the pension funds as a result of the overall decline in the
equity markets and a decline in the discount rate used to estimate the pension
liability as a result of declining interest rates in the U.S. As a result, we
recognized a $2.9 billion direct charge to equity for minimum pension
liabilities during the fourth quarter of fiscal 2002. We will 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. Any adjustment 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. It is difficult to predict these
factors due to highly volatile market conditions. Assuming that the plan asset
values are not significantly different at September 30, 2003 from June 30, 2003,
and no change in the 6.5% discount rate, an additional direct charge to equity
for minimum pension liabilities of approximately $300 million would be required.
In addition, a one-half percent decrease or increase in the discount rate would
further increase or decrease the minimum pension liabilities by approximately
$800 million.
CONSOLIDATED RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED JUNE 30, 2003
VERSUS THREE AND NINE MONTHS ENDED JUNE 30, 2002
Revenues
As discussed in the Overview of this MD&A, the significant reduction in capital
spending by large service providers was the primary reason for the 33% and 36%
decline in revenues in the three and nine months ended June 30, 2003 as compared
with the three and nine months ended June 30, 2002. Beginning with the third
quarter of fiscal 2001, our quarterly revenues have declined sequentially,
except for the three months ended March 31, 2003. The sequential decline in the
current quarter was primarily related to spending reductions in wireless
products in the U.S. and an unexpected network acceptance delay from a non-U.S.
customer. The impact of product rationalizations and discontinuances under our
restructuring program has not had a significant effect on our overall reduction
of revenues. Our revenues by segment are summarized in the following table
(dollars in millions). Refer to the segment discussion later in this MD&A for
additional information on changes in segment revenues.
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
------------- ------------- -------------- ------------
INS $ 1,059 54% $ 1,353 46% $ 3,123 48% $ 5,009 50%
Mobility 826 42% 1,505 51% 3,145 49% 4,596 46%
Other 80 4% 91 3% 175 3% 439 4%
------------- ------------- -------------- ------------
Total revenues $ 1,965 100% $ 2,949 100% $ 6,443 100% $ 10,044 100%
============= ============= ============== ============
The following table presents regional revenues (dollars in millions):
Three months ended June 30, Nine months ended June 30,
2003 2002 2003 2002
---------------- ------------- ------------- ------------
U.S. $ 1,202 $ 2,049 $ 3,914 $ 6,761
Other Americas (Canada, Central & Latin America) 98 166 314 567
EMEA (Europe, Middle East & Africa) 295 377 867 1,360
APAC (Asia Pacific & China) 370 357 1,348 1,356
---------------- ------------- ------------- ------------
Total revenues $ 1,965 $ 2,949 $ 6,443 $10,044
================ ============= ============= ============
Our U.S. and Other Americas revenues declined from the comparable three and nine
month periods within a range of 41% to 45%. The revenue declines in both periods
were primarily the result of customer spending reductions, primarily with large
service providers in the U.S. EMEA revenues declined by 22% and 36% as compared
with the prior three and nine month periods primarily due to continued lower
spending for optical products as customers are dealing with overcapacity issues
and, to a lesser extent, lower revenues in the Middle East region, largely due
to the unstable political environment. Revenues for the APAC region have been
relatively constant as compared with the prior periods due to new CDMA Wireless
network build-outs in India and ongoing build-outs in China. The proportion of
our U.S. revenues to total revenues declined to 61% from 67% for the nine months
ended June 30, 2003 as compared to the prior period.
25 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The decline in revenue during the three months ended June 30, 2003 from the
comparable prior period occurred both in terms of product revenues (34%) and
service revenues (32%). The decrease in product revenue occurred in all product
lines including wireless (48%), voice networking (14%), data and network
management (10%) and optical networking (38%). Wireless product revenue declines
are attributable to reductions in TDMA infrastructure spending as two of our
customers have selected alternatives to this technology which we do not provide;
delayed UMTS deployments; and the timing of customer spending patterns. Optical
networking product declines were more severe than other wireline products due to
network overcapacity and delays in customer spending on next generation
products. The $206 million decline in service revenues was primarily due to
lower engineering and installation activity, primarily in support of INS
customers. Total service revenues supporting INS customers decreased by $130
million, or 30%, to $298 million, primarily within the U.S.
The decline in revenue during the nine months ended June 30, 2003 from the
comparable prior period occurred both in terms of product revenues (35%) and
service revenues (38%). The decrease in product revenue occurred in all product
lines including wireless (35%), voice networking (28%), data and network
management (17%) and optical networking (55%). The declines in certain product
revenues during the nine-month period were due to the reasons noted in the
three-month explanation above. The $817 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 $612 million, or 41%, to $876 million, primarily within the U.S.
Gross Margin
The following table presents our gross margin and the percentage to total
revenues (dollars in millions):
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
--------------- ----------- ------------- --------------
Gross margin $ 573 $651 $ 1,789 $ 1,888
Gross margin rate 29.2% 22.1% 27.8% 18.8%
Despite significantly lower sales volume, the gross margin rate increased by
approximately seven and nine percentage points during the three and nine months
ended June 30, 2003, respectively, from the comparable prior periods. Inventory
and other charges unfavorably affected the gross margin rate in the current
fiscal 2003 periods by approximately four percentage points and in the prior
fiscal 2002 periods by approximately eight percentage points. The higher charges
in the prior periods were primarily related to larger provisions for slow-moving
and obsolete inventory, items or events associated with customers experiencing
financial difficulties and, in some cases, declaring bankruptcy or becoming
insolvent, and adjustments to certain long-term projects. The remaining
improvement was primarily driven by our continued focus on cost reductions in
the three and nine month periods, and to a lesser extent, the effect of patent
licensing revenue. The improvement in the gross margin rate was higher during
the nine months ended June 30, 2003 due to the higher proportion of Mobility
sales (which has a higher gross margin than INS) to total sales compared with
the respective prior periods.
Compared with the prior three-month period, the gross margin attributable to
services increased by $3 million to $88 million despite the significantly lower
sales volume due to a seven-percentage point increase in the gross margin rate
to 20%. The change in the gross margin rate was primarily due to a larger
portion of services revenue being derived from maintenance services which
historically has higher gross margins than engineering and installation revenues
and inventory related charges in the prior period, which were slightly offset by
the continuing decline in sales volume and related lower labor utilization.
Compared with the prior nine-month period, the gross margin attributable to
services declined by $168 million to $213 million due to the lower service
revenues and a two-percentage point decrease in the gross margin rate to 16%.
The change in the gross margin rate was due to the continuing decline in total
sales volume and related lower labor utilization, partially offset by a larger
portion of services revenue being derived from maintenance services and lower
inventory related charges.
26 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 Nine months ended
June 30, June 30,
2003 2002 2003 2002
------------ ---------- ----------- -----------
Selling, general and administrative ("SG&A")
expenses, excluding the following two items: $ 439 $ 610 $ 1,383 $ 1,944
Provision for (recovery of) bad debts and
customer financings (32) 186 (99) 829
Amortization of goodwill and other acquired
intangibles 5 75 15 219
------------ ---------- ----------- -----------
Total SG&A 412 871 1,299 2,992
R&D 382 480 1,153 1,625
Goodwill impairment 35 811 35 811
Business restructuring charges (reversals) and
asset impairments, net 13 791 (137) 653
------------ ---------- ----------- -----------
Operating expenses $ 842 $ 2,953 $ 2,350 $ 6,081
============ ========== =========== ===========
SG&A expenses
Excluding provisions for (recovery of) bad debts and customer financings and
amortization of goodwill and other acquired intangibles, SG&A expenses decreased
by 28% and 29% in the three and nine months ended June 30, 2003, as compared
with the same interim periods of fiscal 2002. The decreases were primarily a
result of significant headcount reductions under our restructuring program and
other cost savings initiatives that limited discretionary spending. The
decreases in SG&A expenses were offset in part by accelerated depreciation and
other related charges of $14 million and $107 million in the respective current
interim periods as a result of shortening the estimated useful lives of several
properties that have been or are in the process of being sold. Approximately 60%
of the reduction for the nine months ended June 30, 2003 was in the INS segment
due to the greater degree of product rationalization and cost reduction efforts
in INS as a result of the significant revenue decline in this segment. The
remaining decreases were attributed to reductions in general corporate
functions. The restructuring program is essentially complete and therefore is
not expected to further reduce SG&A expenses.
Provision for (recovery of) bad debts and customer financings
We had net recoveries of bad debt and customer financing of approximately $99
million during the nine months ended June 30, 2003. These recoveries were
primarily due to the favorable settlement of certain fully reserved notes
receivable and accounts receivable and significantly lower bad debt and customer
financing exposure. The significant provisions reflected in the fiscal 2002
periods were due to the deterioration in the creditworthiness of certain
customers as a result of the decline in the telecommunications market.
Amortization of goodwill and other acquired intangibles
During the first quarter of fiscal 2003, we adopted SFAS 142. As a result, our
remaining goodwill of $186 million is no longer amortized but tested for
impairment annually 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.
R&D
The decrease in R&D expenses for the three and nine months ended June 30, 2003
as compared with the fiscal 2002 interim periods was primarily due to headcount
reductions and product rationalizations under our restructuring program. The
restructuring program is essentially complete and therefore is not expected to
further reduce R&D expenses. Substantially all of the reduction for the three
and nine months ended June 30, 2003 was in the INS segment due to the greater
degree of product rationalizations in INS.
27 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
R&D attributed to the Mobility segment was approximately 60% and 40% of total
R&D during the nine months ended June 30, 2003 and 2002, respectively. Mobility
spending was primarily related to CDMA and UMTS next-generation technologies.
INS spending was primarily related to next generation technologies and
additional feature and function enhancements on existing optical networking,
multi-service switching, network operating systems and circuit and packet
switching products.
Goodwill impairment
Recent business decisions to partner with other suppliers to use their products
in our sales offerings prompted an assessment of the recoverability of certain
goodwill associated with the multi-service switching reporting unit within INS
during the third quarter of fiscal 2003. The excess of the reporting unit's
goodwill carrying value over its implied fair value was recognized as an
impairment charge in the third quarter of fiscal 2003 in the amount of $35
million. See Note 11 to the unaudited consolidated financial statements for
further information including the expected timing of future impairment tests.
The continued and sharper decline in the telecommunications market prompted an
assessment of all key assumptions underlying goodwill valuation judgments
(including those related to short- and long-term growth rates) during the third
quarter of fiscal 2002. It was determined that the carrying value of goodwill
previously recorded in connection with the September 2000 acquisition of Spring
Tide was less than the forecasted undiscounted cash flows. As a result, a
goodwill impairment charge of $811 million was recognized based on the
difference between the estimated fair value and corresponding carrying value.
Fair values were determined on the basis of discounted cash flows.
Business restructuring charges (reversals) and asset impairments, net
Three months ended Nine months ended
(dollars in millions) June 30, June 30,
2003 2002 2003 2002
------------ ------------- ------------ ------------
Employee separations $ 51 $ 358 $(58) $ 294
Contract settlements (8) 46 (13) (38)
Facility closings - 159 12 217
Other (4) 6 (3) 14
------------ ------------- ------------ ------------
Total restructuring costs 39 569 (62) 487
Total asset write-downs (25) 195 (80) 259
Net gains (losses) on sales - 70 - (40)
------------ ------------- ------------ ------------
Total net charge/(reversal) $14 $ 834 $(142) $ 706
============ ============= ============ ============
Reflected in operating expenses $ 13 $ 791 $ (137) $ 653
Reflected in costs $ 1 $ 43 $ (5) $ 53
During the second quarter of fiscal 2001, we committed to and began implementing
a restructuring program to realign our resources to focus on the large service
provider market. We assessed our product portfolio and associated R&D, and then
streamlined the rest of our operations to support those reassessments. We
eliminated some marginally profitable or non-strategic product lines, merged
certain technology platforms, consolidated development activities, eliminated
management positions and many duplications in marketing functions and programs,
centralized our sales support functions and sold or leased certain of our
manufacturing facilities and made greater use of contract manufacturers. We sold
or disposed of the assets related to the eliminated product lines, closed
facilities and reduced the workforces in many of the countries that we operated
in at the end of fiscal 2000. As a result we incurred net business restructuring
charges and asset impairments in fiscal 2001 and 2002 of $11.4 billion and $2.3
billion (including the Spring Tide goodwill impairment), respectively.
Since the inception of the restructuring program, including the impacts of
attrition and other headcount reductions in the ordinary course of business, we
have reduced our headcount by approximately 69,500 employees to 36,500 employees
as of June 30, 2003. In addition, the restructuring plans included facility
closing charges to reduce a significant number of owned and leased facilities,
totaling approximately 16.1 million square feet. As of June 30, 2003, owned and
leased sites aggregating 15.0 million square feet have been exited and the
majority of the remaining sites are targeted for closing by the end of fiscal
2003.
28 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
We are currently in the process of completing the restructuring actions
initiated during fiscal 2001 and 2002 and the first quarter of 2003 and continue
to evaluate the remaining restructuring reserves as the plans are executed. As a
result, there may be additional charges or reversals. In addition, since the
company-wide restructuring program is an aggregation of many individual plans
requiring judgements and estimates, actual costs have differed from estimated
amounts.
Employee separation charges recorded in the current fiscal quarter primarily
related to higher than previously expected severance costs for certain non-U.S.
plans. These differences were due to certain demographic changes including the
age, service lives and salaries of the employees separated. The net reversals
recorded in the current nine-month fiscal period primarily related to the
true-up of termination benefits, expected to be funded with pension plan assets,
and curtailments due to actual costs being lower than the estimated amounts for
certain U.S. plans. These reversals were partially offset by the current quarter
severance charges. In addition, a reversal to property, plant and equipment
primarily resulted from adjustments to the original plans for certain facility
closings in the three and nine month periods.
The net charges recorded in the prior fiscal periods primarily related to
additional headcount reductions; revisions to facility closings as a result of
changes in estimates as to the amount and timing of expected sublease rental
income due to changes in the commercial real estate market; net asset write
downs primarily related to property, plant and equipment, capitalized software
and inventory associated with additional product exits and the disposition of a
manufacturing facility. The net gains (losses) on sales were related to business
dispositions, including the enterprise professional services business in the
third quarter of fiscal 2002 and the billing and customer care business in the
second quarter of fiscal 2002.
Other income (expense), net and interest expense
Three months ended Nine months ended
(dollars in millions) June 30, June 30,
2003 2002 2003 2002
------------ ---------- ----------- ---------
Legal settlements $ (33) $ (212) $ (368) $ (212)
Net debt conversion expense & gain on bond extinguishment 6 - (112) -
Net gain on sales of businesses 18 - 47 583
Other-than-temporary write-downs of investments (10) (62) (71) (103)
Miscellaneous 50 13 68 (26)
------------ ---------- ----------- ---------
Total other income (expense), net $ 31 $ (261) $(436) $ 242
============ ========== =========== =========
Interest expense $ 85 $ 107 $ 258 $ 284
============ ========== =========== =========
Other income (expense), net during the nine months ended June 30, 2003 included
a $448 million charge for the settlement of all purported class action lawsuits
and other lawsuits against us and certain of our current and former directors
and officers for alleged violation of federal securities laws, ERISA and related
claims. This included a $33 million charge recognized during the third quarter
of fiscal 2003 for an increase in the fair market value of warrants expected to
be issued in connection with the settlement. Partially offsetting the $448
million charge was an $80 million reserve reduction, which was reflected during
the first quarter of fiscal 2003, for a legal settlement associated with our
former consumer products leasing business due to lower than anticipated claims
experience. The initial consumer products leasing business legal settlement
reserve was $162 million and was recognized during the three and nine months
ended June 30, 2002. Also, a $50 million legal settlement related to a purchase
price adjustment associated with the acquisition of the consumer products wired
telephone assets by VTech was reflected in the three and nine months ended June
30, 2002. See Note 10 to the unaudited consolidated financial statements for
further information on legal settlements.
The current fiscal year periods reflect conversion expense associated with the
exchange of a portion of our 7.75% trust preferred securities and gains
associated with the exchange of certain other debt obligations for shares of our
common stock. See Note 6 to the unaudited consolidated financial statements for
further information on these exchanges.
The write-downs of equity investments in the current and prior year fiscal
periods were due to the sustained weakness in the public and private equity
markets. Refer to the Risk Management section for a discussion on Equity Price
Risk.
29 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The nine months ended June 30, 2002 included $583 million in gains on sales of
businesses, of which $523 million related to the sale of our optical fiber
business. Certain contingencies related to this sale were favorably resolved
during the nine months ended June 30, 2003, which resulted in an additional $34
million gain.
Interest expense for the three and nine months ended June 30, 2003 decreased $22
million and $26 million, respectively, as compared to the prior year periods,
primarily due to the higher average balances of the trust preferred securities
during fiscal 2002 and interest on certain revolving credit facilities that were
terminated.
Provision for (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 June 30, Nine months ended June 30,
2003 2002 2003 2002
-------------- -------------- --------------- -------------
Provision for (benefit from) income taxes $ (69) $ 5,329 $ (386) $ 4,782
Effective tax benefit rate (21.4%) N/M (30.8%) N/M
The tax benefit for the three and nine months ended June 30, 2003 reflected a
full valuation allowance on our net deferred tax assets, current tax expense
primarily related to certain non-U.S. operations as well as several discrete
items. These discrete items included $76 million and $211 million of refundable
federal income taxes related to taxes paid in prior years which were recognized
during the three and nine months ended June 30, 2003, respectively. These
discrete items also included a $3 million and a $77 million benefit resulting
from the expected favorable resolution of certain tax audit matters which were
recognized in the three and nine months ended June 30, 2003. The income tax
benefit was also attributed to the utilization of a portion of the current
periods' operating losses as a result of certain equity transactions. These
transactions included a $2 million and a $135 million tax impact of the
exchanges of the 7.75% trust preferred securities for shares of our common stock
which were recognized during the three and nine months ended June 30, 2003,
respectively, as well as the tax impact of the unrealized holding gains for
certain investments in the amount of $30 million, which was recognized in the
first quarter of fiscal 2003.
Recognition of tax benefits on future operating losses during the fourth quarter
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. It is also reasonably possible that the income tax benefit will
be adjusted during the fourth quarter of fiscal 2003 as a result of potential
changes in the minimum pension liability that would be reflected in other
comprehensive income. See "Application of Critical Accounting Estimates" for
additional information. We are currently unable to estimate the effects or
determine if the effect would be favorable or unfavorable. However, if the
minimum pension liability increases, the related tax impact will reduce the
fiscal 2003 tax benefits resulting from equity transactions. Likewise, if the
minimum pension liability decreases, the related tax impact could increase the
fiscal 2003 tax benefits depending on the level of pretax losses.
The provision for income taxes during the three and nine months ended June 30,
2002 was primarily due to providing for a full valuation allowance on our net
deferred tax assets during the third quarter of fiscal 2002 and reversing the
tax benefits which were previously recognized in the first and second quarters
of fiscal 2002. During the third quarter of fiscal 2002, several significant
developments were considered in determining the need for a full valuation
allowance, including the continuing severe market decline, uncertainty and lack
of visibility in the telecommunications market as a whole, a significant
decrease in sequential quarterly revenue levels, a decrease in sequential
earnings after several quarters of sequential improvement and the necessity for
further restructuring and cost reduction actions to attain profitability. Prior
to this assessment, we believed it was more likely than not that the net
deferred tax assets of $5.2 billion at both September 30, 2001 and March 31,
2002 would be realized principally based upon forecasted taxable income,
generally within the twenty-year research and development credit and net
operating loss carryforward periods, giving consideration to substantial
benefits realized to date through our restructuring actions.
30 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
RESULTS OF OPERATIONS BY SEGMENT - THREE AND NINE MONTHS ENDED JUNE 30, 2003
VERSUS THREE AND NINE MONTHS ENDED JUNE 30, 2002
INS
The following table presents revenues by U.S. and non-U.S. and operating loss
(dollars in millions):
Three months ended June 30, Nine months ended June 30,
% %
2003 2002 change 2003 2002 Change
----------- ----------- ----------- ------------- ----------- -----------
U.S. $ 537 $ 747 (28%) $ 1,659 $ 2,752 (40%)
Non-U.S. 522 606 (14%) 1,464 2,257 (35%)
----------- ----------- ------------- -----------
Total revenues $ 1,059 $ 1,353 (22%) $ 3,123 $ 5,009 (38%)
=========== =========== ============= ===========
Operating loss $ (47) $ (619) 92% $ (257) $ (2,028) 87%
=========== =========== ============= ===========
Return on sales (4%) (46%) 42 pts (8%) (40%) 32 pts
=========== =========== ============= ===========
INS revenues decreased by 22% and 38% during the three and nine-month periods
ended June 30, 2003 compared to the prior interim periods. The declines
primarily resulted from continued reductions and delays in capital spending by
large service providers. The revenue declines were reflected in all product
lines and geographic regions except APAC, which was relatively constant in the
three-month comparative periods. The percentage declines in revenues generated
in each region were lower in the current quarter compared with the percentage
declines in the first and second quarters of fiscal 2003 as customer spending
reductions have leveled off somewhat from those reductions that occurred earlier
in fiscal 2003. The five largest INS customers represented about 42% of its
revenues during the nine months ended June 30, 2003 and about 48% of its revenue
decline from the comparable prior period.
During the current quarter, the operating loss declined by $572 million to $47
million as compared with the prior fiscal year period. The reduction in the
operating loss primarily resulted from a $371 million decrease in operating
expenses and a $201 million increase in gross margin. The increase in gross
margin was due to a significant increase in the gross margin rate, despite lower
sales volume. The higher gross margin rate was primarily due to continued cost
reductions and lower inventory and other charges, offset in part by lower sales.
Although the gross margin rate improved significantly, it remained lower than
the Mobility gross margin rate. The operating expense decline primarily resulted
from operating expense reductions of $259 million due to headcount reductions
and product rationalizations under our restructuring program as well as lower
provisions for bad debt and customer financing of $112 million.
During the nine month period ended June 30, 2003, the operating loss decreased
as compared with the prior fiscal year interim period by approximately $1.8
billion to $257 million. The reduction in the operating loss primarily resulted
from decreases in operating expenses of approximately $1.5 billion and a $286
million increase in gross margin. The increase in gross margin was due to a
significant increase in the gross margin rate, despite lower sales volume. The
reasons for the increase in the gross margin rate were similar to those
described above. The operating expense decline resulted from a combination of
lower provisions for bad debt and customer financing of $671 million and
operating expense reductions of $814 million due to headcount reductions and
product rationalizations under our restructuring program.
31 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Mobility
The following table presents revenues by U.S. and non-U.S. and operating
(loss) income (dollars in millions):
Three months ended June 30, Nine months ended June 30,
% %
2003 2002 change 2003 2002 change
----------- ---------- -------------- ---------- ----------- ---------
U.S. $ 585 $ 1,230 (52%) $ 2,079 $ 3,660 (43%)
Non-U.S. 241 275 (12%) 1,066 936 14%
----------- ---------- ---------- -----------
Total revenues $ 826 $ 1,505 (45%) $ 3,145 $ 4,596 (32%)
=========== ========== ========== ===========
Operating (loss) income $(56) $ 200 (128%) $ 181 $ 252 (28%)
=========== ========== ========== ===========
Return on sales (7%) 13% (20 pts) 6% 5% 1 pt
=========== ========== ========== ===========
Mobility revenues decreased by 45% and 32% during the three and nine-month
periods ended June 30, 2003 compared to the prior interim periods. The declines
resulted from reductions in capital spending, primarily in the U.S., as large
service providers are preserving capital resources. In addition, changes in
revenue trends were significantly impacted by delays in obtaining certain
network acceptance criteria on a large network deployment in the APAC region.
The declines in the U.S. revenues were also attributed to two large service
providers that have selected alternatives to our TDMA technologies that we
currently sell to them. The decline in revenues attributed to these two
customers represented approximately 50% of our total U.S. revenue declines
during the nine months ended June 30, 2003. Although changes in revenue due to
sudden changes in customer spending patterns and obtaining acceptance criteria
on large network buildouts have affected historical trends and may affect future
trends, they were especially significant in the current quarter. The Non-U.S.
revenues increased by 14% during the nine months ended June 30, 2003 primarily
as a result of two large CDMA network build-outs in China and India. The five
largest Mobility customers represented approximately 72% of its revenues during
the nine months ended June 30, 2003, and about 92% of its revenue decline from
the comparable prior period. Future revenue trends are likely to remain volatile
as a result of this concentration with a limited number of customers.
The operating income for the three months ended June 30, 2003 decreased by $256
million to a $56 million loss as compared to the three months ended June 30,
2002. Decreases in operating expenses of $73 million were offset by a $329
million decrease in gross margin. The decrease in gross margin was due to a
moderate decrease in the gross margin rate and was primarily due to lower sales
volume and product mix, especially in the U.S., partially offset by lower
inventory and other charges. The operating expense decline primarily resulted
from lower provisions for bad debt and customer financing of $83 million. This
was partially offset by a $10 million increase in other operating expenses.
During the nine month period ended June 30, 2003, operating income decreased as
compared with the prior fiscal year interim period by $71 million to $181
million. Decreases in operating expenses of $328 million were offset by a $399
million decrease in gross margin. Although the gross margin rate increased
slightly in the current period, this improvement was offset by lower sales
volume. The reason for the increase in the gross margin rate was primarily due
to lower inventory and other charges. The operating expense decline primarily
resulted from lower provisions for bad debt and customer financing of $275
million, including a $60 million impact from the favorable settlement of certain
fully reserved notes in the first quarter of fiscal 2003. The remaining $53
million of operating expense reductions were primarily due to our restructuring
program and less discretionary spending. In addition, UMTS software development
costs of approximately $75 million were capitalized during the nine months ended
June 30, 2002. These related costs have been expensed as incurred during the
fiscal 2003 periods due to the uncertain UMTS market.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents increased $1.4 billion during the nine months
ended June 30, 2003. This increase was due to the $1.6 billion of cash provided
from the issuance of convertible senior debt and $941 million of cash provided
by maturities of short-term investments partially offset by $1.1 billion used in
operating activities.
32 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Operating activities
Net cash used in operating activities was $1.1 billion for the nine months ended
June 30, 2003. This primarily resulted from a loss from continuing operations of
$733 million (adjusted for non-cash items) and changes in other operating assets
and liabilities of $787 million, partially offset by a reduction in working
capital requirements (accounts receivable, inventories and contracts in process,
and accounts payable) of $427 million. The reduction in working capital was due
to the decrease in sales volume during the current quarter compared to the
fourth quarter of fiscal 2002. Generally, working capital requirements will
increase or decrease with similar changes in quarterly revenue levels. Our
working capital requirements have also been reduced 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 $534 million and capitalized software of $231 million.
Our restructuring program's cash requirements are approximately $2.7 billion, of
which approximately $2.1 billion has been paid through June 30, 2003. The
expected cash requirement for the remainder of fiscal 2003 is approximately $135
million and the remaining balance is expected to be paid over several years.
Most of the remaining cash requirement beyond fiscal 2003 is for lease
obligations, which are net of expected sublease rental income of approximately
$250 million. If we do not receive this expected income, our cash requirements
under the restructuring program could increase. The completion of our
restructuring actions during fiscal 2003 is expected to generate annual cash
savings of approximately $1.8 billion, of which most has been realized at June
30, 2003.
Investing activities
The net cash provided by investing activities was $852 million for the nine
months ended June 30, 2003. This was primarily due to the maturities of
short-term investments of $941 million and the proceeds from the sale of certain
other investments of $78 million. Capital expenditures were $226 million, which
included $102 million for the repurchase of certain real estate under synthetic
lease agreements in the first quarter of fiscal 2003 that were previously used
to fund certain real estate construction costs. On February 3, 2003 we purchased
our remaining 10% minority interest in AGCS for $23 million. We currently do not
expect any significant proceeds from business or asset dispositions.
Financing activities
The net cash provided by financing activities was $1.6 billion for the nine
months ended June 30, 2003. This was primarily due to the issuance of 2.75%
Series A and Series B Convertible Senior Debentures in the third quarter of
fiscal 2003 for an aggregate amount of $1.6 billion. The offering was made under
the shelf registration statement. We expect to use the net proceeds toward the
repayment or possible repurchase of certain short- and medium-term obligations
over time, as well as for general corporate purposes. In addition, this offering
has provided us with the flexibility to reduce the overall cost of financing to
the extent that the proceeds are used to repay existing debt obligations. Refer
to Note 5 of the unaudited consolidated financial statements for specific terms
regarding this transaction.
We are currently authorized by our board of directors to issue shares of our
common stock in exchange for convertible securities and certain other debt
obligations. As disclosed in more detail in Note 6 to our unaudited consolidated
financial statements, we retired approximately $1.6 billion of our convertible
securities and certain other debt obligations in exchange for approximately 621
million shares of our common stock through June 30, 2003 in several separate and
privately negotiated transactions. These transactions were completed in order to
reduce future obligations at a discount, reduce our annual interest and dividend
requirements and improve our capital structure. These transactions, including
those executed in fiscal 2002, have eliminated approximately $125 million of
annual interest and dividend requirements and have reduced these annual
requirements to approximately $400 million. We may issue more of our common
shares in similar transactions in the future that would result in additional
dilution to our common shareowners.
Also included in the results for the nine months ended June 30, 2003 are the
proceeds of $113 million from prepaid forward sales agreements for our
investment in Corning common stock. These transactions have been reflected as
secured borrowings. In addition, we paid the August 1, 2003 semi-annual dividend
requirement of $38 million on our 8% redeemable convertible preferred stock with
18 million shares of common stock and $6 million of cash.
33 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Future Capital Requirements
Our near term cash requirements are primarily to fund our operations and
restructuring program, capital expenditures, interest and preferred stock
dividends and other obligations discussed below. We expect to continue to use
cash to meet these requirements throughout the remainder of fiscal 2003 and
2004. We believe our cash and cash equivalents of $4.3 billion and short-term
investments of $589 million as of June 30, 2003 are currently sufficient to fund
our cash requirements during the next twelve months. However, we cannot provide
assurance 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.
On May 28, 2003, we entered into two new senior secured credit agreements with
various banks which provide for the issuance of up to $270 million of new
letters of credit and the renewal of up to approximately $350 million of
existing letters of credit until December 31, 2004. Outstanding letters of
credit that were subject to this commitment approximated $300 million as of June
30, 2003. The agreements are subject to certain cash collateral requirements
that may increase if we fail to maintain specified levels of consolidated
minimum operating income (adjusted for certain defined items) or maintain a
minimum amount of unrestricted cash and short-term investments.
On May 28, 2003, we also amended our Guarantee and Collateral Agreement and the
Collateral Sharing Agreement. Under these agreements, specified U.S.
subsidiaries of the Company have guaranteed certain obligations of the Company
and these subsidiaries have pledged substantially all of their assets as
collateral. These agreements provide security for certain of our obligations for
letters of credit, specified hedging arrangements, guarantees to lenders for
vendor financing, lines of credit, an agreement relating to our special purpose
trust, and cash management and other bank operating arrangements. The amount of
these obligations was $357 million as of June 30, 2003.
We have a mortgage for three of our primary facilities totaling $279 million as
of June 30, 2003. We prepaid approximately $240 million of this obligation in
August 2003. In addition, we retired some of our debt obligations and
convertible securities for $222 million of cash subsequent to June 30, 2003. We
may use cash for similar transactions in the future as market conditions permit.
We have agreed to indemnify the Special Purpose Trust ("Trust") and the Trust
lenders and investors for certain defaulted principal and interest payments
related to customer finance loans held by the Trust that are subject to a
dispute with an unaffiliated insurer regarding credit insurance. These funding
requirements are approximately $40 million during the remainder of fiscal 2003,
$90 million in fiscal 2004 and $216 million thereafter. See Note 11 to our
unaudited consolidated financial statements for additional information on the
Trust and the dispute regarding insurance coverage.
Our 8% redeemable convertible preferred stock is redeemable at the option of the
holders on various dates, the earliest of which is August 2, 2004. Provided
certain criteria are met, we have the option to satisfy this put with cash,
shares of our common stock or a combination of both. The liquidation value of
these securities is $875 million as of August 13, 2003.
We do not expect to make contributions to our U.S. pension plans in fiscal 2003
or fiscal 2004. Our current expected funding requirements for post-retirement
healthcare benefits are minimal, if any, in fiscal 2003 and are approximately
$300 million to $350 million in fiscal 2004. For more information on these
obligations, including their expected longer-term effect on liquidity, see the
detailed risk factors included in our Form 10-K for the year ended September 30,
2002. In addition, legislative and regulatory changes are being considered that
could alter the manner in which liabilities are determined for the purpose of
calculating required pension contributions under ERISA. Depending on the outcome
of the proposals, our longer-term funding requirement for our pension plans
could be significantly impacted. At this time it is impossible to predict the
outcome and therefore the impact on us.
As discussed in more detail in Note 10 to our unaudited consolidated financial
statements we may fund up to $315 million of our shareowner litigation
settlement with cash, shares of our common stock or a combination of both.
34 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Customer finance commitments
The following table presents our customer financing commitments as of June 30,
2003 and September 30, 2002 (in millions):
June 30, 2003 September 30, 2002
------------------------------------------ ------------------------------------------
Total Total loans
loans and and
guarantees Loans Guarantees guarantees Loans Guarantees
------------ ---------- ------------ -------------
Drawn commitments $ 573 $ 416 $ 157 $ 1,098 $909 $ 189
Available but not drawn 58 16 42 93 51 42
Not available 1 1 - 151 151 -
------------ ---------- ------------ ------------- -------- -------------
Total commitments $ 632 $ 433 $ 199 $ 1,342 $1,111 $ 231
============ ========== ============ ============= ======== =============
Reserve $ 505 $ 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. Our customer financing commitments were
reduced to $632 million as of June 30, 2003, as a result of the settlement of
certain fully reserved notes and the expiration of several commitments.
Credit ratings
Our credit ratings as of August 13, 2003 are as follows:
Trust
Long-term Convertible preferred
debt preferred stock securities Last update
-------------- ---------------- --------------- ---------------------
Rating Agency
- -------------
Standard & Poor's (a) B- CCC- CCC- July 15, 2003
Moody's (b) Caa1 Ca Caa3 November 1, 2002
- ---------
(a) Rating unchanged since October 11, 2002, however, put on Credit Watch with
a negative outlook.
(b) 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.
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
35 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
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 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 note receivables are
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 (1.1% as of June 30, 2003) 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. As of June 30, 2003, the carrying value of our available-for-sale
securities and privately held securities was $3 million and $91 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 written down 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
$71 million were recognized during the nine months ended June 30, 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.
36 Form 10-Q - Part I
Item 4. Controls and Procedures
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 as of
the end of the period covered by this report, 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 timely
reported as provided in the Securities and Exchange Commission rules and forms.
We periodically review the design and effectiveness of our internal controls
over financial reporting 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. We did note some
deficiencies in internal controls for a foreign operation in prior years. These
deficiencies were not significant and did not materially impact our financial
results, and we have taken action which management believes will enhance our
controls in this operation. No changes occurred during the quarter ended June
30, 2003 in our internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
37 Form 10-Q - Part II
Item 1. Legal Proceedings.
Information about legal proceedings is set forth in Note 10 to the consolidated
financial statements included in this report.
Item 2. Changes in Securities and Use of Proceeds.
(c) Sales of Unregistered Securities.
During the three months ended June 30, 2003, Lucent issued a total of 38,152,175
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 30,000 shares of our 8% redeemable convertible preferred stock with
a liquidation value of $30,000,000; $16,907,007 principal amount of our 7.25%
Notes due July 15, 2006; and $17,891,255 principal amount of our 5.5% Notes due
November 15, 2008. No underwriters were used for these transactions.
38 Form 10-Q - Part II
Item 5. Other Information.
In April 2003, we received notice from the NYSE that our common stock was in
compliance with the NYSE listing standards. If our common stock price declines
below $1.00, we could again be in jeopardy of having our common stock delisted.
If our common stock declines below the NYSE minimum trading price of $1.00, we
could effect a reverse stock split to help us meet the NYSE minimum stock price
requirement. We may elect to effect the reverse stock split even if our common
stock price does not fall below $1.00. However, at this time, no decision has
been made whether or not to effect a reverse stock split.
In April 2003, Edward E. Hagenlocker was elected to our Board of Directors and
appointed to the Corporate Governance and Compensation Committee of the Board.
In July 2003, Karl J. Krapek and Richard C. Levin were elected to our Board of
Directors and appointed to the Audit and Finance Committee of the Board. At that
time, Robert Denham was elected chairman of the Audit and Finance Committee. Mr.
Krapek's term will expire in 2004, Mr. Levin's term will expire in 2005 and Mr.
Hagenlocker's term will expire in 2006.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
See Exhibit Index on page 40 for a description of the documents that are filed
as Exhibits to this report on Form 10-Q or incorporated by reference herein. Any
document incorporated by reference is identified by a parenthetical referencing
the SEC filing which included the document.
(b) Reports on Form 8-K filed during the current quarter:
On June 25, 2003, we filed a Current Report on Form 8-K pursuant to
Item 7 (Financial Statements and Exhibits), to file the Indenture and
First Supplemental Indenture between Lucent Technologies Inc. and The
Bank of New York.
On June 5, 2003, we filed a Current Report on Form 8-K pursuant to Item
5 (Other Events), disclosing Paul Allaire's resignation from the Board
of Directors and Robert Denham's appointment as the chair of the Audit
and Finance Committee.
On May 30, 2003, we filed a Current Report on Form 8-K pursuant to Item
7 (Financial Statements and Exhibits) and Item 9 (Regulation FD
Disclosure), disclosing the completion of a $1.525 billion convertible
debenture offering.
On May 28, 2003, we filed a Current Report on Form 8-K pursuant to Item
5 (Other Events) and Item 7 (Financial Statements and Exhibits), filing
and disclosing the $245 million Letter of Credit and $350 million
External Sharing Debt Agreement and certain other agreements with
JPMorgan Chase Bank and others.
On April 23, 2003, we filed a Current Report on Form 8-K pursuant to
Item 9 (Regulation FD Disclosure) to furnish a press release reporting
results of our second quarter of fiscal 2003.
On April 11, 2003, we filed a Current Report on Form 8-K pursuant to
Item 5 (Other Events) and Item 7 (Financial Statements and Exhibits)
filing and disclosing the Equity Distribution Agreement with UBS
Warburg LLC to sell up to 100 million shares of common stock.
39 Form 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Lucent Technologies Inc.
Registrant
Date: August 13, 2003
/s/ John A. Kritzmacher
--------------------------------
John A. Kritzmacher
Senior Vice President and Controller
(Principal Accounting Officer)
40 Form 10-Q
Exhibit Index
Exhibit
Number Description
- ------- -----------
4.1 Indenture, dated as of June 4, 2003, between Lucent Technologies Inc.
and The Bank of New York, as trustee (Exhibit 4.1 to Current Report on
Form 8-K filed June 25, 2003).
4.2 First Supplemental Indenture, dated as of June 4, 2003, between Lucent
Technologies Inc. and The Bank of New York, as trustee (Exhibit 4.2 to
Current Report on Form 8-K filed June 25, 2003).
10.1 Letter of Credit Issuance and Reimbursement Agreement, dated as of May
28, 2003, among Lucent Technologies Inc., several banks and other
parties thereto and JPMorgan Chase Bank, as administrative agent
(Exhibit 99.1 to Current Report on Form 8-K filed May 28, 2003).
10.2 External Sharing Debt Agreement, dated as of May 28, 2003, among Lucent
Technologies Inc., several banks and other parties thereto and JPMorgan
Chase Bank, as administrative agent (Exhibit 99.2 to Current Report on
Form 8-K filed May 28, 2003).
10.3 Amended and Restated Guarantee and Collateral Agreement, dated as of
May 28, 2003, made by Lucent Technologies Inc. and certain of its
subsidiaries in favor of JPMorgan Chase Bank, as collateral agent
(Exhibit 99.3 to Current Report on Form 8-K filed May 28, 2003).
10.4 Amended and Restated Collateral Sharing Agreement, dated as of May 28,
2003, made by Lucent Technologies Inc. and certain of its subsidiaries
in favor of JPMorgan Chase Bank, as collateral agent (Exhibit 99.4 to
Current Report on Form 8-K filed May 28, 2003).
10.5 First Amendment, dated as of June 6, 2003, to (i) Letter of Credit
Issuance and Reimbursement Agreement, dated as of May 28, 2003, among
Lucent Technologies Inc., several banks and other parties thereto and
JPMorgan Chase Bank, as administrative agent, (ii) External Sharing
Debt Agreement, dated as of May 28, 2003, among Lucent Technologies
Inc., several banks and other parties thereto and JPMorgan Chase Bank,
as administrative agent, (iii) Amended and Restated Guarantee and
Collateral Agreement, dated as of May 28, 2003, made by Lucent
Technologies Inc. and certain of its subsidiaries in favor of JPMorgan
Chase Bank, as collateral agent, and (iv) Amended and Restated
Collateral Sharing Agreement, dated as of May 28, 2003, made by Lucent
Technologies Inc. and certain of its subsidiaries in favor of JPMorgan
Chase Bank, as collateral agent (Exhibit 99.1 to Current Report on Form
8-K filed July 15, 2003).
10.6 Second Amendment, dated as of July 7, 2003, to (i) Letter of Credit
Issuance and Reimbursement Agreement, dated as of May 28, 2003, among
Lucent Technologies Inc., several banks and other parties thereto and
JPMorgan Chase Bank, as administrative agent, and (ii) External Sharing
Debt Agreement, dated as of May 28, 2003, among Lucent Technologies
Inc., several banks and other parties thereto and JPMorgan Chase Bank,
as administrative agent (Exhibit 99.2 to Current Report on Form 8-K
filed July 15, 2003).
31.1 Certification of Patricia F. Russo required by Rule 13a-14(a)
(17 C.F.R. 240.13a-14(a)).
31.2 Certification of Frank A. D'Amelio required by Rule 13a-14(a)
(17 C.F.R. 240.13a-14(a)).
32 Certification of Patricia F. Russo and 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.