AS FILED WITH THE SEC ON AUGUST 13, 2001
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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, 2001
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, 2001, 3,412,889,948 common shares were outstanding.
2
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,
2001 2000 2001 2000
---- ---- ---- ----
Revenues................................. $5,819 $7,412 $ 16,088 $21,732
Costs.................................... 5,005 4,278 14,093 12,445
------- ------ -------- -------
Gross margin............................. 814 3,134 1,995 9,287
Operating Expenses:
Selling, general and administrative...... 2,046 1,304 6,049 3,855
Research and development................. 793 801 2,775 2,396
Purchased in-process research and
development........................... - 428 - 428
Business restructuring charges and
related asset impairments............. 541 - 2,715 -
------- ------ -------- -------
Total operating expenses................. 3,380 2,533 11,539 6,679
------- ------ -------- -------
Operating income (loss).................. (2,566) 601 (9,544) 2,608
Other income (expense)- net ............. (179) 103 (296) 340
Interest expense......................... 115 77 395 237
------- ------ -------- -------
Income (loss) from continuing operations
before provision (benefit) for income
taxes................................. (2,860) 627 (10,235) 2,711
Provision (benefit) for income taxes..... (973) 341 (3,394) 984
------- ------ -------- -------
Income (loss) from continuing operations. (1,887) 286 (6,841) 1,727
Loss from discontinued operations (net of
taxes)................................ (1,360) (587) (1,673) (24)
------- ------ -------- -------
Income (loss) before extraordinary item
and cumulative effect of accounting
change................................ (3,247) (301) (8,514) 1,703
Extraordinary gain (net of taxes)........ - - 1,154 -
Cumulative effect of accounting change
(net of taxes)........................ - - 30 -
------- ------ -------- -------
Net income (loss)........................ $(3,247) $(301) $ (7,330) $1,703
======= ====== ======== =======
Earnings (loss) per common share - basic:
Income (loss) from continuing
operations............................. $(0.55) $ 0.09 $(2.01) $0.54
Net income (loss)........................ $(0.95) $(0.09) $(2.16) $0.53
Earnings (loss) per common share - diluted:
Income (loss) from continuing
operations............................. $(0.55) $ 0.09 $(2.01) $0.52
Net income (loss)........................ $(0.95) $(0.09) $(2.16) $0.52
Weighted average number of common
shares outstanding - basic ............. 3,405.2 3,242.3 3,396.9 3,193.3
Weighted average number of common
shares outstanding - diluted ........... 3,405.2 3,331.2 3,396.9 3,297.6
See Notes to Unaudited Consolidated Financial Statements.
3
Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
June 30, September 30,
2001 2000
---- ----
ASSETS
Cash and cash equivalents .............................. $ 2,285 $ 1,467
Receivables, less allowance of $583 at June 30, 2001 and
$479 at September 30, 2000 ............................ 4,618 8,782
Inventories............................................. 5,059 5,100
Contracts in process, net of contract billings of $7,013
at June 30, 2001 and $6,744 at September 30, 2000..... 1,245 1,881
Deferred income taxes - net ............................ 1,993 1,101
Other current assets ................................... 1,765 1,575
Net current assets of discontinued operations .......... - 634
------- -------
Total current assets ................................... 16,965 20,540
Property, plant and equipment, net of accumulated
depreciation of $4,835 at June 30, 2001 and
$4,464 at September 30, 2000.......................... 5,055 5,046
Prepaid pension costs .................................. 6,420 6,238
Goodwill and other acquired intangibles, net of
accumulated amortization of $1,589 at June 30, 2001
and $852 at September 30, 2000........................ 4,880 6,463
Other assets ........................................... 3,662 3,593
Net long-term assets of discontinued operations ........ 2,857 5,632
------- -------
Total assets ........................................... $39,839 $47,512
======= =======
LIABILITIES
Accounts payable ....................................... $ 1,896 $ 2,583
Payroll and benefit-related liabilities ................ 979 1,010
Debt maturing within one year .......................... 3,215 3,468
Other current liabilities .............................. 4,002 3,099
Net current liabilities of discontinued operations...... 462 -
------- -------
Total current liabilities............................... 10,554 10,160
Postretirement and postemployment benefit liabilities... 5,239 5,395
Long-term debt ......................................... 2,995 3,030
Deferred income taxes - net ............................ - 1,203
Other liabilities ...................................... 1,226 1,552
------- -------
Total liabilities ...................................... 20,014 21,340
Commitments and contingencies
SHAREOWNERS' EQUITY
Preferred stock-par value $1.00 per share
Authorized shares: 250,000,000;
issued and outstanding shares: none................... - -
Common stock-par value $.01 per share
Authorized shares: 10,000,000,000; 3,410,772,734
issued and 3,410,125,365 outstanding shares at
June 30, 2001 and 3,384,332,104 issued and
outstanding shares at September 30, 2000.............. 34 34
Additional paid-in capital ............................. 21,658 20,390
Guaranteed ESOP obligation ............................. - (16)
Retained earnings (accumulated deficit)................. (1,401) 6,129
Accumulated other comprehensive income (loss)........... (466) (365)
------- -------
Total shareowners' equity .............................. 19,825 26,172
------- -------
Total liabilities and shareowners' equity .............. $39,839 $47,512
======= =======
See Notes to Unaudited Consolidated Financial Statements.
4
Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Nine Months Ended June 30,
2001 2000
---- ----
Operating Activities:
Net income (loss)........................................ $ (7,330) $ 1,703
Less: Loss from discontinued operations.................. (1,673) (24)
Extraordinary gain................................. 1,154 -
Cumulative effect of accounting change............. 30 -
------- -------
Income (loss) from continuing operations................. (6,841) 1,727
Adjustments to reconcile income (loss) from continuing
operations to net cash used in operating activities:
Non-cash portion of business restructuring charges
and related asset impairments....................... 2,636 -
Depreciation and amortization.......................... 1,955 1,073
Provision for uncollectibles and customer financings... 1,950 210
Tax benefit from employee stock options ............... 13 1,026
Deferred income taxes ................................. (2,281) 69
Purchased in-process research and development.......... - 428
Pension credit ........................................ (1,097) (739)
Other adjustments for non-cash items .................. 318 (571)
Changes in operating assets and liabilities:
Decrease (increase) in receivables..................... 3,790 (1,963)
Increase in inventories and contracts in process....... (334) (1,260)
Decrease in accounts payable........................... (673) (325)
Changes in other operating assets and liabilities...... (2,371) (399)
------- -------
Net cash used in operating activities from continuing
operations............................................. (2,935) (724)
------- -------
Investing Activities:
Capital expenditures .................................... (1,102) (1,266)
Purchases of investments ................................ (92) (523)
Sales or maturity of investments ........................ 38 853
Dispositions of businesses .............................. 2,494 250
Other investing activities .............................. 11 (56)
------- -------
Net cash provided by (used in) investing activities from
continuing operations.................................. 1,349 (742)
------- -------
Financing Activities:
Net borrowings under credit facilities................... 4,800 -
Net payments on commercial paper......................... (2,065) (109)
Payment of credit facility fees.......................... (100) -
Proceeds from issuances of long-term debt................ - 61
Repayments of long-term debt ............................ - (390)
Proceeds from issuance of common stock .................. 213 1,165
Dividends paid .......................................... (204) (190)
Other financing activities............................... (6) -
------- -------
Net cash provided by financing activities
from continuing operations ............................ 2,638 537
Effect of exchange rate changes on cash and
cash equivalents ...................................... (25) (38)
------- -------
Net cash provided by (used in) continuing operations..... 1,027 (967)
Net cash used in discontinued operations................. (209) (9)
------- -------
Net increase (decrease) in cash and cash equivalents..... 818 (976)
Cash and cash equivalents at beginning of year........... 1,467 1,686
------- -------
Cash and cash equivalents at end of period .............. $ 2,285 $ 710
======= =======
See Notes to Unaudited Consolidated Financial Statements.
5
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
by Lucent Technologies Inc. ("Lucent" or the "Company") pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC") and, in the
opinion of the Company, include all adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of results of operations, financial
position and cash flows as of and for the periods presented.
The preparation of financial statements and related disclosures in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and revenues and expenses during the period reported.
Actual results could differ from those estimates. Estimates are used in
accounting for, among other things, long-term contracts, allowances for
uncollectible receivables and customer financings, inventory obsolescence,
product warranty, depreciation, employee benefits, taxes and contingencies.
Estimates and assumptions are reviewed periodically and the effects of revisions
are reflected in the consolidated financial statements in the period that they
are determined to be necessary.
The Company believes that the disclosures made are adequate to keep the
information presented from being misleading. The results for the three and nine
months ended June 30, 2001 are not necessarily indicative of financial results
for the full year. These consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
for the year ended September 30, 2000, included in Form 8-K filed on July 31,
2001.
Certain reclassifications have been made to conform to the current period
presentation.
2. BUSINESS RESTRUCTURING CHARGES AND RELATED ASSET IMPAIRMENTS
In connection with Lucent's ongoing restructuring program to exit certain
non-strategic product lines and to streamline its cost structure in various
businesses and corporate operations, Lucent recorded pre-tax charges to earnings
of $3,394 for the nine months ended June 30, 2001. The charges include inventory
write-downs of $679 for the nine months ended June 30, 2001, which are recorded
as a component of Costs in the Consolidated Statement of Operations.
The following table displays the activity and balances of the restructuring
reserve account:
Initial Net Additions
Type of Cost Charge Three months ---------Deductions-------
Three months ended June 30,
ended March 31, June 30, 2001 Cash Non-cash 2001
2001 Charges charges Reserve
Restructuring costs:
Contract settlements $ 350 $ 61 (a) $118 $ - $293
Employee separations 389 436 (a) 83 560 182
Facility closings 60 - 4 - 56
Other 11 11 4 - 18
------ ---- ---- ------ ----
Total Restructuring Costs
810 508 209 560 549
------ ---- ---- ------ ----
Asset write-downs:
Goodwill and other acquired
intangibles 835 11 - 846 -
Inventory 536 143 - 679 -
Capitalized software 179 10 - 189 -
Property, plant &
Equipment, net 94 9 - 103 -
Other 256 3 - 259 -
------ ---- ---- ------ ----
Total asset write-downs
1,900 176 - 2,076 -
------ ---- ---- ------ ----
Total $2,710 $684 $209 $2,636 $549
====== ==== ==== ====== ====
--------
(a) Includes $99 of reversals of charges recorded in the three months ended
March 31, 2001 consisting of lower contract settlements of $13 and an $86
reversal of employee separation charges resulting from revisions to prior
cost assumptions.
6
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
Employee Separations
Lucent recorded charges associated with voluntary and involuntary employee
separations totaling approximately 10,500 employees for the nine months ended
June 30, 2001, of which 4,900 employees were reflected in the third fiscal
quarter of 2001. Of the total employee separation charge, payments of $282, of
which $198 was charged in the third fiscal quarter of 2001, for termination
benefits to certain US employees are expected to be funded through the Company's
surplus pension assets. Employee separations impact all business groups and
geographic regions of the Company. Approximately 60% of the employees were
management and approximately 70% of the employee separations were related to
involuntary terminations. As of June 30, 2001, approximately 8,500 employee
separations have been completed. Lucent anticipates that employee separations
reflected in the charges for the nine months ended June 30, 2001 will be
substantially completed during the fourth fiscal quarter of 2001. As of June 30,
2001, the total headcount reductions were 10,500, including 2,000 from
attrition.
In the third fiscal quarter of 2001 Lucent recorded a non-cash charge of $278
for pension and postretirement benefit curtailment charges as a result of the
employee separations, including the 8,500 separations discussed below. The
Company recognized curtailment charges since a significant number of expected
years of future service of present plan participants will be eliminated.
On June 6, 2001 Lucent announced a voluntary early-retirement offer that
included a special pension plan enhancement. The offer was available to
qualified U.S. paid management employees. On July 10, 2001, approximately 8,500
eligible employees accepted the early-retirement offer. In the fourth fiscal
quarter, Lucent expects to record a non-cash charge of approximately $1,200 for
pension and postretirement termination charges in connection with this early
retirement offer.
Asset write-downs
Asset write-downs primarily reflect the write-down of certain long-lived assets
and inventory that became impaired as a result of management's decision to
discontinue certain product lines and product development efforts. Impairment
losses were primarily based upon the write-down of goodwill and other acquired
intangibles to their fair value, which was estimated by discounting the expected
future cash flows. As a result, for the nine months ended June 30, 2001, an
impairment charge of $846 for goodwill and other acquired intangibles was
recorded and largely relates to the write-off of $567 of goodwill relating to
the rationalization of the metro optical networking product portfolio. The
remainder of the asset write-downs primarily consists of inventory, property,
plant and equipment and capitalized software associated with the Company's
product rationalizations included in the restructuring program. These actions
primarily affect the Products segment.
The Company expects to substantially complete the current phase of its
restructuring program by December 31, 2001, however Lucent is developing a
proposed phase II to its restructuring program (see MANAGEMENT'S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION - PROPOSED PHASE II TO
OUR RESTRUCTURING PROGRAM).
7
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
3. AGERE INITIAL PUBLIC OFFERING AND DISCONTINUED OPERATIONS
On December 29, 2000, Lucent completed the sale of its power systems business
(see Note 4). On April 2, 2001, Agere Systems Inc. ("Agere"), Lucent's
microelectronics business, completed an initial public offering ("IPO") of 600
shares of Class A common stock, resulting in net proceeds of $3,440. As a result
of the IPO and the planned spin-off of Agere described below, Lucent recorded an
increase to shareowner's equity of $922 in the third fiscal quarter of 2001. In
addition, on April 2, 2001, Morgan Stanley exercised its overallotment option to
purchase an additional 90 shares of Agere Class A common stock from Lucent.
Morgan Stanley exchanged $519 of Lucent commercial paper for the Agere common
shares. This transaction resulted in a gain of $141, which has partially reduced
the estimated loss on disposal of Agere. Lucent intends to spin off Agere
through a tax-free distribution to its shareholders, although the distribution
is expected to be delayed for up to six months from the previously anticipated
distribution date of September 30, 2001 (see Note 7). The Company has
historically reported the microelectronics and power systems businesses as part
of a single significant segment. Accordingly, Lucent's consolidated financial
statements for all periods presented have been reclassified to reflect Agere and
the power systems business as a discontinued business segment in accordance with
Accounting Principles Board Opinion No. 30. During the current fiscal quarter,
Lucent recorded a charge of $1,360 reflecting a revised estimate of the
Company's loss on disposal of Agere. This charge includes Lucent's 57.8% share
of Agere's estimated future losses through the expected spin date of March 31,
2002, which includes separation and business restructuring and related one-time
charges, including inventory writedowns and other asset impairments.
On September 30, 2000, Lucent completed the spin-off of Avaya, Lucent's former
enterprise networks business in a tax-free distribution to its shareholders.
This segment has also been treated as a discontinued business segment.
Summarized financial information for the discontinued operations is as follows:
Three Months Ended Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
---- ---- ---- ----
Revenues:
Agere and power systems.... $ 814 $1,301 $ 3,303 $3,401
Avaya ..................... - 1,869 - 5,610
------- ------ ------- ------
Total revenues................ $ 814 $3,170 $ 3,303 $9,011
======= ====== ======= ======
Income(loss)from discontinued
operations (net of taxes):
Agere and power
systems(a)............. $ - $ (300) $ (151) $ 5
Avaya(b)................. - 45 - 303
Loss on disposal of Agere
(net of taxes)(a)......
(1,360) - (1,522) -
Loss on disposal of Avaya
(net of taxes)(b)......
- (332) - (332)
------- ------ ------- ------
Total loss from discontinued
operations (net of taxes).. $(1,360) $ (587) $(1,673) $ (24)
======= ====== ======= ======
8
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
June 30, September 30,
2001 2000
---- ----
Agere and power systems:
Current assets.................... $4,199 $1,583
Current liabilities............... 4,661 (c) 949
------ ------
Net current assets (liabilities)
of discontinued operations..... $ (462) $ 634
====== ======
Long-term assets.................. $5,721 $6,050
Long-term liabilities............. 2,864 (d) 418
------ ------
Net long-term assets of
discontinued operations........ $2,857 $5,632
====== ======
-------
(a) Agere and power systems income (loss) from discontinued operations was net
of an income tax benefit of $107 for the nine months ended June 30, 2001,
and net of applicable income tax provisions of $131 and $313 for the three
and nine months ended June 30, 2000, respectively. The loss on disposal of
Agere, net of tax provision of $133 and $39 for the three and nine months
ended June 30, 2001, respectively, is composed of Lucent's share of the
estimated future net losses and separation costs of the microelectronics
business through the planned spin date, partially offset by a gain of $141
associated with Lucent's debt exchange on April 2, 2001 as noted above.
(b) Avaya's income from discontinued operations was net of applicable income
tax provisions of $24 and $160 for the three and nine months ended June 30,
2000, respectively. The loss on disposal of Avaya, net of a tax benefit of
$28 for the three and nine months ended June 30, 2000, is composed of the
costs directly associated with the spin-off, partially offset by the
estimated future net earnings of the enterprise networks business through
the spin date of September 30, 2000. The costs reflect those components of
the enterprise networks business reorganization plan, including an
estimated business restructuring charge along with estimated transaction
costs for the spin-off.
(c) Includes $2,500 of short-term debt assumed by Agere (see Note 7) and $1,035
of reserves associated with Lucent's share of Agere's estimated future
losses through March 31, 2002.
(d) Includes $2,488 of minority interest in the net assets of Agere.
4. EXTRAORDINARY GAIN
On December 29, 2000, Lucent completed the sale of its power systems business to
Tyco International Ltd. for $2,500 in cash. In connection with the sale, Lucent
recorded an extraordinary gain of $1,154 (net of tax of $762), subject to
potential purchase price adjustments to be resolved by the end of fiscal year
2001. Lucent does not expect such adjustments, if any, to be significant to its
consolidated results of operations.
5. ACCOUNTING CHANGE - DERIVATIVE FINANCIAL INSTRUMENTS
Effective October 1, 2000, Lucent adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"), and its corresponding amendments under SFAS No. 138.
SFAS 133 requires Lucent to measure all derivatives, including certain
derivatives embedded in other contracts, at fair value and to recognize them in
the Consolidated Balance Sheet as an asset or liability, depending on Lucent's
rights or obligations under the applicable derivative contract. For derivatives
designated as fair value hedges, the changes in the fair value of both the
derivative instrument and the hedged item are recorded in other income
(expense). For derivatives designated as cash flow hedges, the effective
portions of changes in fair value of the derivative are reported in other
comprehensive income ("OCI") and are subsequently reclassified into earnings
when the hedged item affects other income (expense). Changes in fair value of
derivative instruments not designated as hedging instruments and ineffective
portions of hedges are recognized in other income (expense) in the period
incurred. The adoption of SFAS 133 as of October 1, 2000, resulted in a
cumulative after-tax reduction in net loss of $30 (net of tax of $17) and an $11
credit to OCI recorded in the quarter ended December 31, 2000. The reduction in
net loss is primarily attributable to derivatives not designated as hedging
instruments, including foreign currency embedded derivatives, equity warrants
and other derivatives. For the nine months ended June 30, 2001, the change in
fair market value of derivative instruments was recorded in other income
(expense) and was not material.
9
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
Foreign Currency Risk
---------------------
Lucent conducts its business on a multinational basis in a wide variety of
foreign currencies. Lucent's foreign currency risk management policy is to hedge
100% of all recorded foreign currency receivables and payables and firmly
committed transactions and 50% of the first six months of a 12-month anticipated
exposure forecast, with the hedging of the remainder of the forecast to be
evaluated on an ongoing basis. This applies to all transactions with value
greater than or equal to the lesser of $5 or 10% of the relevant subsidiary's
12-month trailing net revenues. This policy provides risk management flexibility
in cases where hedging cost may be excessive relative to the actual risk and
when there is greater cash flow uncertainty. To manage this risk, Lucent enters
into various foreign exchange forward and option contracts to manage its
exposure to changes in those foreign exchange rates. Alternatively, Lucent may
hedge foreign exchange risk in certain sales and purchase contracts by embedding
terms in the contracts that affect the ultimate amount of cash flows under the
contract. Principal currencies hedged as of June 30, 2001, expressed in millions
of U.S dollars are as follows:
Forward and Option Contracts Embedded Foreign Currency
---------------------------- Derivative Instruments
Fair Value -----------------------------------
Notional Asset Notional Fair Value Asset
Currency Amount (Liability) Amount (Liability)
-------- ------ ----------- ------ -----------
Euros................ $ 597 $ 8 $ 63 $ 2
Brazilian reals...... 167 (9) 39 4
Danish kroner........ 222 (3) - -
Australian dollars... 160 7 - -
British pounds....... 102 (1) - -
Japanese yen......... 47 (11) - -
Lucent has designated certain freestanding foreign currency derivatives as
hedging instruments under SFAS 133 against its intercompany and external
foreign-currency-denominated loans. These exposures make up a large proportion
of the notional value of Lucent's total foreign currency risk and are well
defined as to amounts and timing of repayments. The derivatives hedging these
exposures are designated as cash flow hedging instruments for anticipated cash
flows not to exceed twelve months. Lucent will continue to hedge all other types
of foreign currency risk to preserve the economic cash flows of the Company in
accordance with corporate risk management policies but generally does not expect
to designate related derivative instruments as hedges for cost/benefit reasons.
Accordingly, the changes in fair value of these undesignated freestanding
foreign currency derivative instruments are recorded in other income (expense)
in the period of change and have not been material to Lucent due to the short
maturities of these instruments.
Lucent's foreign currency embedded derivatives consist of sales and purchase
contracts with cash flows indexed to changes in or denominated in a currency
that neither party to the contract uses as their functional currency. Changes in
the fair value of these embedded derivatives are recorded in other income
(expense) in the current period.
Interest Rate Risk
-------------------
Lucent uses a combination of financial instruments, including medium-term and
short-term financings, variable-rate debt instruments and to a lesser extent,
interest rate swaps to manage its interest rate mix of the total debt portfolio
and related overall cost of borrowing. To manage this mix in a cost-effective
manner, Lucent, from time to time, may enter into interest rate swap agreements,
in which it agrees to exchange various combinations of fixed and/or variable
interest rates based on agreed upon notional amounts. The objective of
maintaining this mix of fixed and floating rate debt allows Lucent to manage its
overall value of cash flows attributable to its debt instruments. There were no
interest rate swaps in effect at June 30, 2001.
Other Derivatives
------------------
From time to time, Lucent may obtain warrants to purchase equity securities in
other companies to complement its investment portfolio. Warrants that provide
for net share settlement are considered to be derivative instruments and are
generally not eligible to be designated as hedging instruments as there is no
corresponding underlying exposure.
10
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
6. SECURITIZATION FACILITY
On June 28, 2001, Lucent established a $750 revolving accounts receivable
securitization facility expiring in June 2003. Under the terms of the facility,
Lucent sold $435 of undivided interest collateralized by $1,507 of trade
accounts receivable, in exchange for cash proceeds of $435 and a subordinated
retained interest in the remaining outstanding receivables of $1,072. The $1,072
of retained interests is included in Receivables in the Consolidated Balance
Sheet. In order to maintain the facility level at June 30, 2001, Lucent must
continue to generate eligible accounts receivable sufficient to support such
level under the terms of the facility. The Company's ability to obtain further
proceeds through the facility will depend on a combination of factors, including
its credit ratings and increasing the level of its eligible accounts receivable.
7. DEBT
June 30, 2001 September 30, 2000
------------- ------------------
Debt Maturing Within One Year:
Commercial paper................ $ - $2,475
Current portion of long-term
debt.......................... 750 750
Revolving credit facility....... 2,300 -
Secured borrowings and other.... 165 243
------ ------
3,215 3,468
Long-term debt...................... 2,995 3,030
------ ------
Total debt....................... $6,210 $6,498
====== ======
On February 22, 2001, Lucent completed arrangements for $6,500 of Credit
Facilities with financial institutions. These Credit Facilities consist of a
replacement for the 364-day $2,000 Credit Facility that expired on February 22,
2001 and a new 364-day $2,500 assumable Credit Facility for Agere (the
"Assumable Credit Facility"). In addition to these two Credit Facilities, Lucent
amended an existing $2,000 Credit Facility expiring in February 2003. Under the
364-day $2,000 Credit Facility, any loans outstanding at maturity may be
extended, at Lucent's option, to February 26, 2003. Prior to March 31, 2001,
Lucent borrowed $2,500 under the Assumable Credit Facility, which was assumed by
Agere on April 2, 2001, the closing of their IPO.
The Credit Facilities are secured by substantially all of Lucent's assets (the
"Collateral"), including the pledge of the Agere stock owned by Lucent.
Certain other existing financings and obligations are, and certain future
financings and obligations could be, similarly secured during the time
the Collateral arrangements for the Credit Facilities are in effect. The
Credit Facilities contain affirmative and negative covenants, including
financial covenants requiring the maintenance of specified consolidated minimum
net worth and minimum earnings before interest, taxes, depreciation and
amortization (EBITDA). In addition, maintaining a minimum current asset ratio
requirement is a condition for releasing the pledge of the Agere stock and will
terminate upon the distribution. The Agere stock can be released and the
distribution can occur at Lucent`s request if there is no event of default under
Lucent's Credit Facilities (including compliance with the net worth, EBITDA, and
current asset ratio covenants) and Lucent has received $2,500 of proceeds from
certain non-operating sources. Lucent has recently entered into discussions with
the lenders under its credit facilities to obtain the amendments necessary to
allow the Company to adopt and implement proposed phase II of its restructuring
program which, if approved by the banks, is expected to change certain covenants
and conditions for the distribution (see MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION - LIQUIDITY AND CAPITAL
RESOURCES).
On July 16, 2001, Lucent repaid at maturity $750 principal amount on its 6.90%
notes, which was included in debt maturing within one year at June 30, 2001. On
July 2, 2001, Lucent incurred approximately $300 of additional long-term debt as
part of a real estate debt financing.
11
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
8. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) are reflected net of tax, except
for foreign currency translation adjustments which are not currently adjusted
for income taxes since they relate to indefinite investments in non-United
States subsidiaries and are as follows:
Three Months Ended Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
---- ---- ---- ----
Net income (loss)................... $(3,247) $(301) $(7,330) $1,703
Other comprehensive income (loss):
Foreign currency translation
adjustments....................... (69) (37) (117) (96)
Reclassification adjustment to
foreign currency translation for
sale of foreign entities (net of
tax of $2)...................... - - (3) -
Unrealized holding gains (losses) on
certain investments............... 87 (14) (34) 156
Reclassification adjustments for
realized gains and impairment
losses on certain investments(net
of tax provision (benefit) of $2,
($8), $30 and ($118),
respectively)..................... 3 (11) 46 (182)
Cumulative effect of accounting
change (SFAS 133)................. - - 11 -
Net derivative losses on cash flow
hedges............................ (5) - (4) -
------- ----- ------- ------
Comprehensive income (loss)......... $(3,231) $(363) $(7,431) $1,581
======= ===== ======= ======
9. INVENTORIES
June 30, 2001 September 30, 2000
------------- ------------------
Completed goods................... $2,526 $2,810
Work in process................... 773 863
Raw materials..................... 1,760 1,427
----------------- --------------------
Total inventories.............. $5,059 $5,100
================= ====================
10. EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings (loss) per share is calculated by dividing net income
(loss) by the sum of the weighted average number of common shares outstanding
plus all additional common shares that would have been outstanding if
potentially dilutive securities had been issued. As a result of the net loss
from continuing operations reported for the three and nine months ended June 30,
2001, approximately 13.8 and 35.6, respectively, of potential common shares have
been excluded from the calculation of diluted earnings (loss) per share because
their effect would reduce the loss per share.
In addition, options where the exercise price was greater than the average
market price of the common shares of 611.6 and 455.1 for the three and nine
month periods ended June 30, 2001, respectively, and 58.1 and 22.7 for the three
and nine month periods ended June 30, 2000, respectively, were excluded from the
computation of diluted earnings (loss) per share.
12
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
The following table sets forth the components of basic and diluted earnings
(loss) per share:
Three Months Ended Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
---- ---- ---- ----
Earnings (loss) per common share - basic:
Income (loss) from continuing
operations............................. $ (0.55) $ 0.09 $ (2.01) $ 0.54
Income (loss) from discontinued
operations............................ (0.40) (0.18) (0.50) (0.01)
Extraordinary gain....................... - - 0.34 -
Cumulative effect of accounting change... - - 0.01 -
------- ------- ------- -----
Net income (loss)........................ $ (0.95) $ (0.09) $ (2.16) $ 0.53
======= ======= ======= =====
Earnings (loss) per common share-diluted:
Income (loss) from continuing
operations............................. $ (0.55) $ 0.09 $ (2.01) $ 0.52
Income (loss) from discontinued
operations............................ (0.40) (0.18) (0.50) (0.00)
Extraordinary gain....................... - - 0.34 -
Cumulative effect of accounting change... - - 0.01 -
------- ------- -------- -------
Net income (loss)........................ $ (0.95) $ (0.09) $ (2.16) $ 0.52
======= ======= ======== =======
Dividends declared per common share........ $ 0.02 $ 0.02 $ 0.06 $ 0.06
======= ======= ======== =======
Number of Shares
Common shares - basic...................... 3,405.2 3,242.3 3,396.9 3,193.3
Effect of dilutive securities:
Stock options........................... - 83.7 - 99.1
Other .................................. - 5.2 - 5.2
------- ------- -------- -------
Common shares - diluted.................... 3,405.2 3,331.2 3,396.9 3,297.6
======= ======= ======== =======
11. OPERATING SEGMENTS
Lucent operates in the global telecommunications networking industry and
designs, develops, manufactures and services communication systems, software and
related products. Lucent's operations include two reportable segments: Products
and Services. The two reportable segments are managed separately. The Products
segment provides public networking systems and software to telecommunications
service providers and public network operators around the world and optical
fiber for applications in the communications and computing industries. The
Services segment includes the full life cycle of planning and design, consulting
and integration support services as well as network engineering, provisioning,
installation and warranty support. During July 2001, Lucent announced that it is
realigning its business to be organized into two customer focused segments: an
Integrated Network Solutions unit, targeting wireline customers, and a Mobility
Solutions unit, targeting wireless customers, which may result in a change in
its reportable segments.
Lucent has reclassified the results of operations related to Agere, its power
systems business and Avaya as discontinued operations (see Note 3). Agere and
the power systems business were previously disclosed within a separate operating
segment, Microelectronics and Communications Technologies. In addition, Avaya
was also previously disclosed as a separate operating segment, Enterprise
Networks.
13
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
Performance measurement and resource allocation for the reportable operating
segments are based on many factors. The primary financial measure is
contribution margin, which includes the revenues, costs and expenses directly
controlled by the reportable segment. In addition, contribution margin includes
allocations of the provision for uncollectibles and customer financings, which
are typically managed on a common basis. Contribution margin for reportable
segments excludes certain personnel costs including those related to pension and
post-retirement and certain other costs related to shared services such as
general corporate functions and regional sales and marketing which are managed
on a common basis in order to realize economies of scale and efficient use of
resources. Contribution margin for reportable segments also excludes
acquisition-related costs such as goodwill and other acquired intangibles
amortization, purchased in-process research and development and other costs from
business acquisitions and, in fiscal 2001, business restructuring charges and
related asset impairments. The accounting policies of the reportable segments
are essentially the same as those applied in the consolidated financial
statements to the extent that the related items are included within contribution
margin. Intersegment sales that occur are based on current market prices and are
not material. All intersegment profit is eliminated in consolidation.
The following tables present Lucent's revenues and contribution margin by
reportable operating segment:
Three Months Nine Months
Ended June 30, Ended June 30,
2001 2000 2001 2000
---- ---- ---- ----
External Revenues
Products......................................... $ 4,613 $ 6,102 $12,665 $17,695
Services......................................... 1,137 1,286 3,163 3,523
-------- ------- ------- -------
Total reportable segments..................... 5,750 7,388 15,828 21,218
Other (a)........................................ 69 24 260 514
-------- ------- ------- -------
Total External Revenues....................... $ 5,819 $ 7,412 $16,088 $21,732
======== ======= ======= =======
Contribution Margin
Products......................................... $ (960) $ 1,506 $(2,818) $ 4,379
Services......................................... (119) 146 (452) 457
-------- ------- ------- --------
Total reportable segments .................... (1,079) 1,652 (3,270) 4,836
Business restructuring charges and related asset
impairments................................. (684) - (3,394) -
Acquisition/integration-related costs ........... - (428) - (490)
Goodwill and other acquired intangibles
amortization ............................... (233) (51) (743) (139)
Regional sales and marketing expenses ........... (460) (588) (1,623) (1,773)
Other (a)........................................ (110) 16 (514) 174
-------- ------ -------- --------
Operating income (loss)....................... $ (2,566) $ 601 $(9,544) $ 2,608
======== ====== ======== ========
---------
(a) Other primarily includes the results from the Company's remaining consumer
products business in fiscal 2000, other smaller units, eliminations of
internal business, and unallocated costs of shared services. The remaining
consumer products business was sold in the second fiscal quarter of 2000.
14
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
12. COMMITMENTS AND CONTINGENCIES
In the normal course of business, Lucent is subject to proceedings, lawsuits and
other claims, including proceedings under laws and government regulations
related to environmental and other matters. Such matters are subject to many
uncertainties, and outcomes are not predictable with assurance. Consequently,
the ultimate aggregate amount of monetary liability or financial impact with
respect to these matters at June 30, 2001 cannot be ascertained. While these
matters could affect the operating results of any one quarter when resolved in
future periods and while there can be no assurance with respect thereto,
management believes that after final disposition, any monetary liability or
financial impact to Lucent, from matters other than those described in the next
paragraph, beyond that provided for at June 30, 2001 would not be material to
the annual consolidated financial statements.
Lucent and certain of its former officers are defendants in several purported
shareholder class action lawsuits for alleged violations of federal securities
laws, which have been consolidated in a single action. Specifically, the
complaints allege, among other things, that beginning in late October 1999,
Lucent and certain of its officers misrepresented Lucent's financial condition
and failed to disclose material facts that would have an adverse impact on
Lucent's future earnings and prospects for growth. These actions seek
compensatory and other damages, and costs and expenses associated with the
litigation. These actions are in the early stages and the Company is unable to
determine their potential impact on the consolidated financial statements.
Lucent intends to defend these actions vigorously. Also, Lucent has been served
with several derivative complaints filed by individual Lucent shareholders
against the current members of Lucent's Board of Directors, two former directors
and a former officer. All but one of these actions have been consolidated in a
single action. These actions make claims for breach of fiduciary duties
allegedly owed to the Company, and seek damages against the defendants and in
favor of Lucent, as well as costs and expenses associated with litigation for
the individual plaintiffs. These derivative actions are in the early stages and
the Company is unable to determine their potential impact on the consolidated
financial statements. Lucent intends to defend this action vigorously. In July,
2001, a purported class action complaint was filed under ERISA alleging, among
other things, that Lucent and certain unnamed officers breached their fiduciary
duties with respect to employee savings plans claiming that they knew Lucent
stock was inappropriate for retirement investment and continued to offer such
stock as a plan investment option. The complaint seeks monetary relief,
injunctive and equitable relief, interest and fees and expenses associated with
litigation. This action is in the early stages and the Company is unable to
determine its potential impact on the consolidated financial statements. The
Company intends to defend this action vigorously.
A complaint has been filed by Winstar Communications, Inc. and Winstar Wireless,
Inc. against Lucent in connection with the Chapter 11 bankruptcy petition filed
by Winstar Communications, Inc. and various related entities. The complaint
asserts claims for breach of contract and fraudulent inducement against the
Company and seeks damages in excess of $10 billion and injunctive relief, as
well as costs and expenses associated with litigation. Lucent believes this
action is without merit.
In connection with the formation of Lucent from certain units of AT&T Corp. and
the associated assets and liabilities of those units and AT&T's distribution of
its remaining interest in Lucent to its shareowners, Lucent, AT&T and NCR
Corporation executed and delivered the Separation and Distribution Agreement
(the "Separation and Distribution Agreement"), dated as of February 1, 1996, as
amended and restated, and certain related agreements. The Separation and
Distribution Agreement, among other things, provides that Lucent will indemnify
AT&T and NCR for all liabilities relating to Lucent's business and operations
and for all contingent liabilities relating to Lucent's business and operations
or otherwise assigned to Lucent. In addition to contingent liabilities relating
to the present or former business of Lucent, any contingent liabilities relating
to AT&T's discontinued computer operations (other than those of NCR) were
assigned to Lucent. The Separation and Distribution Agreement provides for the
sharing of contingent liabilities not allocated to one of the parties, in the
following proportions: AT&T: 75%, Lucent: 22%, and NCR: 3%. The Separation and
Distribution Agreement also provides that each party will share specified
portions of contingent liabilities related to the business of any of the other
parties that exceed specified levels.
15
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
In connection with the spin-off of Avaya, Lucent and Avaya executed and
delivered a Contribution and Distribution Agreement which provides for
indemnification by each company with respect to contingent liabilities primarily
relating to their respective businesses or otherwise assigned to each, subject
to certain sharing provisions. In the event the aggregate value of all amounts
paid by each company, in respect of any single contingent liability or any set
or group of related contingent liabilities, is in excess of $50, each company
will share portions in excess of the threshold amount based on agreed-upon
percentages. The Contribution and Distribution Agreement also provides for the
sharing of certain contingent liabilities, specifically: (1) any contingent
liabilities that are not primarily contingent liabilities of Lucent or
contingent liabilities associated with the businesses attributed to Avaya; (2)
certain specifically identified liabilities, including liabilities relating to
terminated, divested or discontinued businesses or operations; and (3) shared
contingent liabilities within the meaning of the Separation and Distribution
Agreement with AT&T Corp.
Environmental Matters
Lucent's current and historical operations are subject to a wide range of
environmental protection laws. In the United States, these laws often require
parties to fund remedial action regardless of fault. Lucent has remedial and
investigatory activities under way at numerous current and former facilities. In
addition, Lucent was named a successor to AT&T as a potentially responsible
party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or
comparable state statutes. Under the Separation and Distribution Agreement,
Lucent is responsible for all liabilities primarily resulting from or relating
to the operation of Lucent's business as conducted at any time prior to or after
the Separation including related businesses discontinued or disposed of prior to
the Separation, and Lucent's assets including, without limitation, those
associated with these sites. In addition, under such Separation and Distribution
Agreement, Lucent is required to pay a portion of contingent liabilities paid
out in excess of certain amounts by AT&T and NCR, including environmental
liabilities.
It is often difficult to estimate the future impact of environmental matters,
including potential liabilities. Lucent records an environmental reserve when it
is probable that a liability has been incurred and the amount of the liability
is reasonably estimable. This practice is followed whether the claims are
asserted or unasserted. Management expects that the amounts reserved will be
paid out over the periods of remediation for the applicable sites, which
typically range from five to 30 years. Reserves for estimated losses from
environmental remediation are, depending on the site, based primarily on
internal or third-party environmental studies and estimates as to the number,
participation level and financial viability of any other PRPs, the extent of the
contamination and the nature of required remedial actions. Accruals are adjusted
as further information develops or circumstances change. The amounts provided
for in Lucent's consolidated financial statements for environmental reserves are
the gross undiscounted amounts of such reserves, without deductions for
insurance or third-party indemnity claims. In those cases where insurance
carriers or third-party indemnitors have agreed to pay any amounts and
management believes that collectibility of such amounts is probable, the amounts
are reflected as receivables in the financial statements. Although Lucent
believes that its reserves are adequate, there can be no assurance that the
amount of capital expenditures and other expenses which will be required
relating to remedial actions and compliance with applicable environmental laws
will not exceed the amounts reflected in Lucent's reserves or will not have a
material adverse effect on Lucent's financial condition, results of operations
or cash flows. Any possible loss or range of possible loss that may be incurred
in excess of that provided for at June 30, 2001 cannot be estimated.
13. RECENT PRONOUNCEMENTS
In December 1999, the SEC issued Staff Accounting Bulletin 101, "Revenue
Recognition in Financial Statements" ("SAB 101"). SAB 101 provides guidance on
the recognition, presentation and disclosure of revenues in financial statements
and requires adoption no later than the fourth quarter of fiscal 2001. Lucent
will adopt SAB 101 in the fourth fiscal quarter of 2001 retroactively to the
beginning of fiscal 2001. Management is currently evaluating the potential
effect of the implementation of SAB 101 on Lucent's financial condition and
results of operations. SAB 101 does not impact revenue recognition for software
and long-term contracts. The implementation of SAB 101 could result in a
one-time charge to earnings as a cumulative effect of accounting change. In
addition, the adoption may result in revisions of previously issued quarterly
results issued in fiscal 2001.
16
Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" ("SFAS 141"), and No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). Under these new standards, all acquisitions
subsequent to June 30, 2001 must be accounted for under the purchase method of
accounting, and purchased goodwill is no longer amortized over its useful life.
Rather, goodwill will be subject to a periodic impairment test based upon its
fair value. SFAS 142 is effective for Lucent in fiscal year 2003, although
earlier adoption is permitted. Lucent is currently evaluating the potential
effect of the implementation of these two standards on its financial condition
and results of operations as well as the timing of its adoption.
14. SUBSEQUENT EVENT
On August 6, 2001, the Company sold 1,885 shares of 8.00% redeemable convertible
preferred stock having an initial liquidation preference of $1,000 per share,
subject to accretion, in a private placement, resulting in net proceeds of
$1,833. The convertible preferred stock has an annual dividend rate of eight
percent, payable semi-annually in cash or Lucent common stock at the Company's
option. From and after the earlier of the Agere spin-off or May 6, 2002, at the
holder's option, each share of convertible preferred stock is convertible into
the Company's common stock at an initial conversion price of $7.48, subject to
adjustment under certain circumstances, including the Agere spin-off. At the
Company's option, at any time, the Company can require all
holders to exchange their shares of convertible preferred stock for convertible
subordinated debentures having terms substantially similar to the preferred
stock. The convertible preferred stock is redeemable, at the option of the
Company after August 15, 2006 and at the option of the holders on August 2 of
2004, 2007, 2010 and 2016. The Company also has the option to redeem the
convertible preferred stock for cash or its common stock at a five percent
discount from the then current market price or a combination of cash and shares
of its common stock. The Company is obligated to redeem all outstanding
preferred shares on August 1, 2031.
17
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
OVERVIEW
Lucent Technologies designs and delivers networks for the world's largest
communications service providers. Backed by Bell Labs research and development,
we rely on our capabilities in mobility, optical and data 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.
During the current fiscal year, various initiatives were undertaken by us to
reorganize and become more focused and better positioned to capitalize on market
opportunities. This reorganization included:
o On July 24, 2001, we announced that we are developing a phase II to our
restructuring program (see PROPOSED PHASE II OF OUR RESTRUCTURING PROGRAM).
o On July 24, 2001, we announced that we entered into agreements to sell our
optical fiber business (see Sale of optical fiber business).
o On July 24, 2001, we announced that we entered into an agreement to sell to
Celestica Inc. our Oklahoma and Ohio manufacturing operations (see Sale of
manufacturing operations).
o On April 2, 2001, Agere (our microelectronics business) completed an IPO of
600 million shares of Class A common stock. We continue to move forward
with our intention to spin off Agere through a tax-free distribution to our
shareholders (see Agere Spin-off update).
o On February 22, 2001, we completed arrangements for $6.5 billion of Credit
Facilities with financial institutions (see Credit facilities).
o On January 24, 2001, we announced our restructuring program. In connection
with the program, we recorded pre-tax charges of $3.4 billion in the nine
months ended June 30, 2001 (see RESTRUCTURING CHARGE AND RELATED ASSET
IMPAIRMENTS).
o On December 29, 2000 we completed the sale of our power systems business to
Tyco International Ltd, for $2.5 billion in cash.
o On September 30, 2000 we completed the spin-off of Avaya Inc., formerly our
enterprise networks business.
Our consolidated financial statements for all periods presented reflect Agere
and the power systems business and Avaya as discontinued operations (see Note 3
of the consolidated financial statements).
18
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
FINANCIAL HIGHLIGHTS
We reported a net loss of $3.2 billion, or $0.95 loss per basic and diluted
share for the quarter ended June 30, 2001, as compared with a net loss in the
prior year quarter of $301 million, or $0.09 loss per diluted share. The current
quarter net loss was impacted by a pretax charge for business restructuring and
related asset impairments of $684 million ($0.14 per basic and diluted share)
and a pre-tax charge of approximately $700 million ($0.13 per basic and diluted
share) for provisions for reserves associated with two vendor finance projects,
including One.Tel Ltd. (see Customer financing). In addition, the current
quarter included a net loss from discontinued operations of $1.4 billion ($0.40
per basic and diluted share; see Note 3 to the accompanying consolidated
financial statements). The prior year included $428 million ($0.13 per diluted
share) of non-tax impacting purchased in-process research and development
("IPRD") related to the acquisition of Chromatis Networks and a net loss from
discontinued operations of $587 million ($0.18 per diluted share).
For the nine months ended June 30, 2001, we reported a net loss of $7.3 billion,
or $2.16 loss per basic and diluted share compared with net income of $1.7
billion, or $0.52 per diluted share in the same period last year. The net loss
for the nine-month period ended June 30, 2001 includes a pre-tax charge for
business restructuring and related asset impairments of $3.4 billion ($0.72 per
basic and diluted share), a pre-tax charge of approximately $700 million ($0.13
per basic and diluted share) for provisions for reserves associated with two
vendor finance projects, including One.Tel, a pre-tax charge of $845 million
($0.15 per basic and diluted share) for an additional loss provision to fully
reserve for amounts due from Winstar Communications, Inc., which announced that
it is seeking protection under the U.S. Bankruptcy Code, and the write-down of
certain equity investments. In addition, we recorded an extraordinary gain of
$1.2 billion ($0.34 per basic and diluted share) related to the sale of the
power systems business, a gain from a cumulative effect of accounting change of
$30 million ($0.01 per basic and diluted share) related to the adoption of
Statement of Financial Accounting Standard No. 133 and a net loss from
discontinued operations of $1.7 billion ($0.50 per basic and diluted share). Net
income for the comparable prior year period includes a net loss from
discontinued operations of $24 million ($0.00 per diluted share), a pre-tax gain
on the sale of an equity investment of $189 million and a pre-tax charge of $61
million to operating expenses primarily associated with the mergers with
International Network Services, Excel Switching Corp. and Xedia Corporation
(combined $0.02 per diluted share).
STRATEGIC DIRECTION
We are moving from a multidivisional company to one that is focused on large
service providers. As part of this strategy, we are realigning our business to
be organized into two customer focused units: an Integrated Network Solutions
unit, targeting wireline customers, and a Mobility Solutions unit, targeting
wireless customers. As part of this realignment, we expect to orient our product
lines, research and development efforts, sales and marketing, and supply chain
and services to meet the needs of the large service providers worldwide.
While market demand continues to be uncertain, we believe the large service
provider market segment offers the most stable and attractive opportunity for
us. We believe we have strong relationships with many of the large service
providers in the United States and are building strong relationships with large
service providers outside the United States. We also have substantial experience
in building and supporting the complex networks that large service providers use
to meet the needs of their customers.
The successful implementation of our proposed phase II to our restructuring
efforts is essential in order to implement our new strategy in the manner and on
the timeline we intend, and is subject to obtaining the consent of the banks to
amend our credit facilities (see PROPOSED PHASE II OF OUR RESTRUCTURING PROGRAM
and Proposed amendments to our credit facilities).
As a result of the realignment and sharpening of our business focus and scope of
operations, and in particular as a result of the expected sale of our optical
fiber business, we expect that our total revenues will decline in the short term
as compared to fiscal 2001 levels. We believe, however, that this sharper focus
and our related restructuring efforts will enable us to return to profitability
and maximize return to stockholders. Because the implementation of our new
strategy is in the early stages and proposed phase II of our restructuring
program is being developed and is subject to conditions and risks, we cannot
predict with certainty the impact on our future earnings and revenues.
19
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RESTRUCTURING CHARGES AND RELATED ASSET IMPAIRMENTS
In connection with our ongoing restructuring program to exit certain
non-strategic product lines within the data networking, wireless, optical
networking and switching solutions groups and to streamline our cost structure
in various businesses and corporate operations, we recorded a pre-tax charge to
earnings of $3.4 billion for the nine months ended June 30, 2001, of which $.7
billion was incurred in the third fiscal quarter of 2001. The charges include
restructuring costs of $1.3 billion for the nine months ended June 30, 2001, of
which $.5 billion was incurred in the third fiscal quarter of 2001 and asset
write-downs of $2.1 billion for the nine months ended June 30, 2001, of which
$.2 billion was incurred in the third fiscal quarter of 2001. Asset write-downs
include inventory write-downs of $.7 billion for the nine months ended June 31,
2001, of which $.1 billion was incurred in the third fiscal quarter of 2001,
which are recorded as a component of Costs in the Consolidated Statement of
Operations.
The restructuring costs include employee separation costs of $825 million for
the nine months ended June 30, 2001, of which $436 million was incurred in the
third fiscal quarter of 2001, contract settlements of $411 million for the nine
months ended June 30, 2001, of which $61 million was incurred in the third
fiscal quarter of 2001, facility closings of $60 million for the nine months
ended June 30, 2001 and other of $22 million for the nine months ended June 30,
2001, of which $11 million was incurred in the third fiscal quarter of 2001.
During the past two quarters, we have reduced our headcount by approximately
10,500 through 8,500 of completed employee separations related to our
restructuring program as described below and 2,000 through attrition. This
reduction exceeded our original target of 10,000.
We recorded charges associated with voluntary and involuntary employee
separations totaling approximately 10,500 employees for the nine months ended
June 30, 2001. Of the total employee separation charge, payments of $282
million, of which $198 million was charged in the third fiscal quarter of 2001,
for termination benefits to certain U.S. employees are expected to be funded
through our surplus pension assets. Employee separations impact all of our
business groups and geographic regions. Approximately 60% of the employees were
management and approximately 70% of the employee separations were related to
involuntary terminations. We anticipate that the remaining 2,000 employee
separations reflected in the charges for the nine months ended June 30, 2001
will be substantially completed during the fourth fiscal quarter of 2001. The
employee separation costs include an $86 million reversal, recorded in the third
fiscal quarter of 2001, resulting from revisions to prior cost assumptions.
We recorded a non-cash charge of $278 million for pension and postretirement
benefit curtailment charges in the third fiscal quarter of 2001 as a result of
the employee separations, including the additional voluntary early-retirement
separations discussed below. We recognized curtailment charges since a
significant number of expected years of future service of present plan
participants will be eliminated.
On June 6, 2001, we announced a voluntary early-retirement offer that included a
special pension plan enhancement. The offer was available to qualified U.S.
management employees. On July 10, 2001, approximately 8,500 eligible employees
accepted the early-retirement offer. In the fourth fiscal quarter we expect to
record a non-cash charge of approximately $1.2 billion for pension and
postretirement termination charges in connection with this early retirement
offer.
Asset write-downs primarily reflect the write-down of certain long-lived assets
and inventory that became impaired as a result of our decision to discontinue
certain product lines and product development efforts. Impairment losses were
primarily based upon the write-down of goodwill and other acquired intangibles
to their fair value, which was estimated by discounting expected future cash
flows. As a result, for the nine months ended June 30, 2001, an impairment
charge of $846 million for goodwill and other acquired intangibles was recorded
and largely relates to the write-down of $567 million of goodwill relating to
the rationalization of the metro optical networking product portfolio. The
remainder of the asset write-downs primarily consists of inventory, property,
plant and equipment and capitalized software associated with our product
rationalizations included in the restructuring program. These actions primarily
affect the Products segment.
20
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
We do not expect significant cash savings from the restructuring program in the
current fiscal year. The restructuring program, including the voluntary
early-retirement offer, is expected to yield cash savings of approximately $2.0
billion annually, beginning in fiscal year 2002. These anticipated savings are
primarily from reduced headcount and more than two-thirds are expected to be
realized in operating expenses.
We expect to substantially complete the current restructuring program by
December 31, 2001.
PROPOSED PHASE II OF OUR RESTRUCTURING PROGRAM
On July 24, 2001, we announced that, to implement our new strategic direction in
the manner and on the timeline we intend, we are developing a proposed phase II
to our restructuring program. We believe this phase II, if implemented, would
significantly enhance our ability to achieve the goals associated with our new
strategic direction as a streamlined company focused on large service providers.
As proposed, phase II includes plans to:
o reduce annual operating expenses by an additional $2.0 billion;
o generate an additional $1.0 billion in working capital improvements;
o reduce our capital spending rate by an additional $750 million; and
o further reduce our work force by another 15,000 to 20,000 employees
worldwide.
If implemented in the manner and on the timeline we intend, we expect to realize
the full benefits of phase II of our restructuring program by the end of fiscal
year 2002. In addition, we expect phase II, if implemented, to result in an
additional charge during our fourth fiscal quarter relating to headcount
reductions, product rationalizations and associated asset write-offs of
approximately $7 billion to $9 billion, of which an estimated $2 billion would
result in cash outlays during fiscal 2002. As described below, implementation of
phase II of our restructuring program is subject to a number of important
conditions, principally agreement by the lenders under our credit facilities to
a proposed amendment thereunder. Accordingly, the timing, scope and components
of the proposed program (and the size of the related charge) cannot be currently
determined.
Our proposed restructuring program is subject to significant risks and
uncertainties. Because the covenants in our credit agreements do not permit us
to incur the charge that we expect to record in connection with phase II of our
program, we will need to amend our credit facilities by obtaining the consent of
the lenders holding a majority of the commitments under each of our credit
facilities prior to adopting and implementing phase II in its current form. We
have recently initiated the process of seeking the necessary amendments to our
credit facilities. If we are unable to obtain the necessary approval for the
amendments from the lenders under our credit facilities, we would not implement
phase II of our restructuring program as currently contemplated and we would be
required to substantially revise or delay those plans. Our inability to
implement phase II on the schedule we intend or at all would limit our ability
to pursue our new strategic direction to the fullest extent and significantly
impede our ability to achieve the expected benefits. If we are delayed in or
prevented from implementing phase II of our restructuring program, we would not
be able to take a number of the actions that we are currently considering,
including reducing our number of product lines and our headcount, on our
proposed timeline. As a result, we would not be able to improve our operating
performance at the pace that we believe we could otherwise achieve. In such a
circumstance, we would have difficulty complying with the financial
21
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
covenants in our credit facilities in the first fiscal quarter of 2002 or, if
our results of operations are worse than we expect, in the fourth fiscal quarter
of 2001.
Our estimated expense reductions, working capital improvements and headcount
reductions associated with phase II are preliminary. Our ability to achieve
these goals as well as the remaining goals related to the restructuring program
announced in January 2001, will depend on a number of conditions, some of which
are outside of our control. Even if we complete our existing and proposed
restructuring program, we cannot assure you that we will achieve all of the
expense reductions we anticipate or on the timetable contemplated. Because this
restructuring program involves realigning our business units and sales forces,
it may be disruptive to our customer relationships. Decreases in spending by
these large service providers, if greater than we expect, would likely also have
an adverse effect on revenues. Our existing and proposed phase II restructuring
program may also have other unanticipated adverse effects on our business.
RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED JUNE 30, 2001 VERSUS THREE
AND NINE MONTHS ENDED JUNE 30, 2000
REVENUES
The following table presents our revenues by U.S. and non-U.S. and the
approximate percentage of total revenues (in millions):
Three Months Ended June 30, Nine Months Ended June 30,
---------------------------- --------------------------
2001 2000 decrease 2001 2000 decrease
---- ---- -------- ---- ---- --------
U.S. $ 3,759 $ 5,441 (30.9%) $ 10,601 $ 15,104 (29.8%)
Non - U.S. 2,060 1,971 4.5% 5,487 6,628 (17.2%)
------- ------- ------ -------- -------- -------
Total Revenues $ 5,819 $ 7,412 (21.5%) $ 16,088 $ 21,732 (26.0%)
======= ======= ====== ======== ======== =======
As a percentage of As a percentage of
------------------------- ------------------------
total revenues total revenues
-------------- --------------
U.S. 64.6% 73.4% 65.9% 69.5%
Non - U.S. 35.4% 26.6% 34.1% 30.5%
----- ----- ----- -----
Total Revenues 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
The decrease in U.S. revenues for the three and nine months ended June 30, 2001
compared to comparable prior year periods was primarily due to the continued
softening in and less emphasis in the competitive local exchange carrier market,
a slowdown in capital spending by established service providers, which resulted
in lower sales of hardware and software products, and continued focus on a more
selective vendor financing program. The increase in non-U.S. revenues for the
three months ended June 30, 2001 compared to comparable prior year period was
primarily driven by increased optical networking product sales in the
Europe/Middle East/Africa region. The decrease in non - U.S. revenues for the
nine months ended June 30, 2001 compared to the comparable prior year period was
primarily due to the wind down of a project with Saudi Telecommunications
Company (STC) in Saudi Arabia. As a result of the overall market conditions in
the current fiscal year, revenues for fiscal year 2001 are expected to be
significantly lower than fiscal 2000.
22
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
REVENUES BY SEGMENT
The following table presents our revenues by segment and by U.S. and non-U.S.,
and the approximate percentage of total revenues for the three and nine months
ended June 30, 2001 and 2000 (in millions):
Three Months Ended June 30, Nine Months Ended June 30,
---------------------------- ---------------------------
% increase
2001 2000 (decrease) 2001 2000 % decrease
---- ---- ---------- ---- ---- ----------
U.S.:
Products $ 2,831 $ 4,538 (37.6%) $ 8,116 $ 12,270 (33.9%)
Services 849 885 (4.1%) 2,218 2,304 (3.7%)
Non - U.S.:
Products 1,782 1,564 13.9% 4,549 5,425 (16.1%)
Services 288 401 (28.2%) 945 1,219 (22.5%)
Total:
Products $ 4,613 $ 6,102 (24.4%) $ 12,665 $ 17,695 (28.4%)
Services 1,137 1,286 (11.6%) 3,163 3,523 (10.2%)
As a percentage of total As a percentage of
------------------------- ------------------------
total revenues total revenues
-------------- --------------
Products 79.3% 82.3% 78.7% 81.4%
Services 19.5% 17.4% 19.7% 16.2%
Decreases in Products' revenue, compared to the comparable prior year period,
resulted from decreases across most product lines, except optical fiber (for
both the three and nine months ended June 30, 2001) and optical solutions (for
the three month period ended June 30, 2001), and were primarily attributable to
the factors noted in REVENUES. The nine-month decrease was also impacted by a
substantial reduction of revenues from AT&T in the U.S., partially offset by
improved revenues from other large service providers, and the wind down of a
project with STC as noted above.
Revenues from Services decreased due to the factors noted above. A significant
portion of Services revenues is generated from revenues from Products;
therefore, declines in Products affects Services revenue.
GROSS MARGIN
As a percentage of revenue, gross margin decreased to 14.0% from 42.3% in the
prior year quarter and to 12.4% from 42.7% in the prior nine-month period.
Excluding the impacts of the inventory write-downs associated with the business
restructuring charges, gross margin for the three and nine month periods would
have been 16.4% and 16.6%, respectively. Gross margin continues to be impacted
by lower sales volumes across most product lines resulting in less absorption of
fixed costs, decreased high-margin software revenue, the impact of several
lower-margin international contracts and provisions for obsolete inventory and
contract settlements.
23
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 and the percentage change
(in millions, excluding business restructuring and related asset impairment
charges):
Three Months Ended June 30, Nine Months Ended June 30,
--------------------------------- -----------------------------------
2001 2000 %increase 2001 2000 %increase
---- ---- --------- ---- ---- ---------
Selling, general and administrative
("SG&A") expenses, excluding the
following two items $ 936 1,156 (19.0%) $3,356 $3,506 (4.3%)
Provision for uncollectibles and
customer financings 877 97 NM 1,950 210 NM
Amortization of goodwill and other
acquired intangibles 233 51 NM 743 139 NM
------ ------ ------ ------
Total SG&A 2,046 1,304 56.9% 6,049 3,855 56.9%
Research and development 793 801 (1.0%) 2,775 2,396 15.8%
In-process research and development - 428 NM - 428 NM
------ ------ ------ ------
Operating expenses $2,839 $2,533 12.1% $8,824 $6,679 32.1%
====== ====== ====== ======
---------
NM Not meaningful
The implementation of our restructuring program and other savings initiatives
resulted in reduced selling, general and administrative expenses, excluding the
amortization of goodwill and other acquired intangibles and provision for
uncollectibles and customer financings, for the three and nine months ended June
30, 2001.
Increase in the provision for uncollectibles and customer financings for the
three months ended June 30, 2001 was largely the result of the provisions for
reserves associated with two vendor finance projects, including One.Tel,
recorded in the current fiscal quarter. The increase in the provision for
uncollectibles and customer financings for the nine months ended June 30, 2001
was largely the result of the items impacting the third fiscal quarter and a
$700 million provision recorded in the second fiscal quarter for amounts due
from Winstar.
The increases in the amortization of goodwill and acquired intangibles are
primarily from the acquisitions of Chromatis Networks, Inc. in June 2000 and
Spring Tide Networks in September 2000.
The increases in research and development ("R&D") expenses for the nine months
ended June 30, 2001 are primarily due to acquisitions made late in fiscal year
2000 and new product development, particularly in Internet infrastructure and
next-generation wireless products. R&D expenses decreased for the three months
ended June 30, 2001 as compared to the comparable prior year period, and as
compared to the 2001 second fiscal quarter as a result of our headcount
reductions and product rationalizations associated with our restructuring
initiatives.
The IPRD reflected in the three and nine months ended June 30, 2000 resulted
from the Chromatis acquisition.
OTHER INCOME (EXPENSE) - NET
Other income (expense)- net, was an expense of $179 million for the current
fiscal third quarter compared to income of $103 million in the prior year
quarter. Other expense in the current fiscal quarter primarily consists of
charges of approximately $72 million related to write-downs of certain equity
investments, a charge of approximately $42 million related to the write-off of
an embedded derivative asset due to the credit risk and uncollectibility
associated with One.Tel and other miscellaneous write-offs, partially offset by
interest income. Other income in the comparable prior year quarter consisted
largely of $156 million net gains of from the sales of investments.
For the nine months ended June 30, 2001, other income (expense)- net was an
expense of $296 million compared to income of $340 million in the year-ago
period. Other expense for the nine months ended June 30, 2001 primarily
consisted of $277 of write-downs of equity investments and the write-off
associated with One.Tel noted above, partially offset by interest income. The
prior year nine-month period other income primarily consisted of net gains on
the sales and settlements of financial instruments of $383 million, including a
$189 million gain from the sale of an equity investment, and interest income.
24
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
INTEREST EXPENSE
Interest expense for the quarter increased $38 million to $115 million and for
the nine months increased $158 million to $395 million as compared with the
similar periods of the prior year. The increases in interest expense are due to
higher average short-term debt levels coupled with an increase in weighted
average interest rates as compared to the same prior year periods.
PROVISION (BENEFIT) FOR INCOME TAXES
The following table presents our provision (benefit) for income taxes and the
related effective tax rates (in millions):
Three Months Ended Nine Months Ended
June 30, June 30,
-------- -------
2001 2000 2001 2000
---- ---- ---- ----
Provision (benefit) for income
taxes $(973) $341 $(3,394) $984
Effective tax rate 34.0% 54.4% 33.2% 36.3%
The current three and nine month period effective tax rates are lower than the
U.S. statutory rate primarily from the impact of non-tax deductible goodwill
amortization and certain non-tax deductible business restructuring charges and
related asset impairments on the pre-tax loss, both of which decrease the
effective tax benefit rate, offset in part by research and development tax
credits, which increase the effective tax benefit rate on the pre-tax loss.
The prior year three month period effective tax rate is greater than the U.S.
statutory rate primarily due to IPRD charges and the amortization of non-tax
deductible goodwill, partially offset by research and development tax credits
and the tax impact of non-U.S. activity. The prior year nine month period
effective tax rate is lower than the U.S. statutory rate primarily due to
research and development tax credits and the tax impact of non-U.S. activity,
partially offset by IPRD charges and the amortization of non-tax deductible
goodwill.
As a result of our loss from operations, we have recorded a tax benefit and
related tax assets of $2.8 billion as of June 30, 2001. While we have taxable
income for U.S. federal purposes in the applicable carryback periods to apply
against a portion of the current period loss, realizability of the recorded tax
assets is dependent primarily on future taxable income. We believe that
sufficient future taxable income will be generated in order to utilize the
future deductible amounts arising during fiscal 2001 and that these tax assets
are realizable, although there can be no assurance that this will be the case.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow for the nine months ended June 30, 2001 and June 30, 2000
Net Cash Used in Operating Activities
Net cash used in operating activities was $2.9 billion for the nine months ended
June 30, 2001 and was primarily due to the loss from continuing operations
(adjusted for non-cash items) of $3.3 billion, an increase in inventories and
contracts in process of $0.3 billion and changes in other operating assets and
liabilities of $2.4 billion due to customer financing requirements and non-cash
tax benefits resulting from the current year loss. These increases were
partially offset by a decrease in receivables of $3.8 billion. Receivable
improvement is largely due to improved collections in fiscal 2001. As a result,
average days outstanding improved 31 days from the end of fiscal 2000 to 83 days
at June 30, 2001.
Net cash used in operating activities of $724 million for the nine months ended
June 30, 2000 was primarily due to increases in receivables and inventories and
contracts in process of $2.0 and $1.3 billion, respectively, decrease in
accounts payable of $325 million and changes in other operating assets and
liabilities of $399 million, offset by income from continuing operations
(adjusted for non-cash items) of $2.2 billion and tax benefits from stock
options of $1.0 billion.
25
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Net Cash Provided by Investing Activities
Net cash provided by investing activities was $1.3 billion for the nine months
ended June 30, 2001 and primarily consisted of the $2.5 billion cash proceeds
received from the sale of the power systems business offset in part by capital
expenditures of $1.1 billion.
Net cash used in investing activities was $742 million for the nine months ended
June 30, 2000 and primarily consisted of $1.3 billion of capital expenditures
and $523 million in purchases of investments offset by proceeds from the sales
of investments of $853 million.
Net Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities for the nine months ended June 30,
2001 of $2.6 billion was primarily due to $4.8 billion of net borrowings under
the credit facilities ($2.5 billion of the debt was subsequently assumed by
Agere - see Note 7 of the consolidated financial statements), of which
approximately $2.0 billion was used for net commercial paper repayments.
Net cash provided by financing activities for the nine months ended June 30,
2000 of $537 million was primarily from the proceeds from issuances of common
stock related to the exercise of stock options offset by net repayments of
long-term debt and commercial paper.
Liquidity
Our cash requirements through the end of fiscal 2002 are primarily to fund:
o operations, including spending on research and development;
o debt service;
o cash restructuring costs;
o capital expenditures; and
o capital requirements in connection with our customer financing
commitments.
Although we have recently implemented a more selective customer financing
program, we have existing, and expect to continue to enter into, financing
arrangements for our customers that involve significant capital requirements. In
addition, our capital needs associated with customer financing may increase if
deterioration in the credit quality of the customers to which we have extended
financing limits our ability to sell the notes representing existing customer
financing or transfer future funding commitments on acceptable terms to
financial institutions and investors.
If we do not complete our existing and proposed phase II restructuring program
and achieve our anticipated expense reductions in the time frame we contemplate,
our cash requirements to fund our operations are likely to be significantly
higher than we currently anticipate. In addition, because market demand
continues to be uncertain, and we are in the early stages of both developing
phase II of our restructuring program and implementing our new business
strategy, it is difficult to estimate our ongoing cash requirements.
We had net liquidity of approximately $4.0 billion on June 30, 2001, comprised
of cash and cash equivalents of $2.3 billion and availability under our credit
facilities of $1.7 billion. This excludes approximately $300 million in net
proceeds from a real estate debt financing that closed on July 2, 2001, the
repayment on July 16, 2001, of $750 million principal amount of our 6.90%
notes that matured and net proceeds of approximately $1.8 million from our
redeemable convertible preferred stock offering.
We currently have a 364-day $2.0 billion credit facility that expires on
February 21, 2002, and a $2.0 billion credit facility that expires on February
26, 2003. We have the option to extend the maturity of our 364-day credit
facility to February 26, 2003. These credit facilities are secured by
substantially all of our assets, including a pledge of the shares of common
stock of Agere that we own. Certain other existing financings and obligations
are, and certain future financings and obligations could be, similarly secured
during the time the collateral arrangements for the credit facilities are
in effect. As of June 30, 2001 and August 13, 2001, we had $2.3
billion and $1.0 billion, respectively, outstanding under these credit
facilities. Repayments of our credit facilities were primarily from the net
proceeds from our redeemable convertible preferred stock offering.
On June 28, 2001, we established a $750 million revolving accounts receivable
securitization facility. At the time we established the facility, we obtained
proceeds of $435 million from our initial sale of receivables into the facility,
collateralized by $1.5 billion in accounts receivable. In order to maintain the
facility at the June 30, 2001 level, we must continue to generate eligible
accounts receivable sufficient to support such level under the terms of the
26
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
facility. Our ability to obtain further proceeds through the facility will
depend on a combination of factors, including our credit ratings and increasing
the level of our eligible accounts receivable. In addition to approximately $1.8
billion in net proceeds that we received on August 6, 2001 from the redeemable
convertible preferred stock offering, we expect to raise an aggregate of
approximately $550 to $650 million of additional funds during the fourth fiscal
quarter from the closing of the transaction involving our Oklahoma and Ohio
manufacturing operations as part of our outsourcing plan for contract
manufacturing. Furthermore, prior to the end of our first fiscal quarter of
2002, we expect to obtain approximately $2.75 billion from the sale of our
optical fiber business. On July 24, 2001, we announced that we have eliminated
the dividend on our common stock, which will improve our cash flow by $68
million each quarter.
If our proposed phase II restructuring program is successfully implemented and
our anticipated expense reductions are achieved in the time frame we currently
anticipate, we expect to fund our currently expected cash requirements for
fiscal year 2002 through a combination of the following sources:
o our expected cash and cash equivalents as of September 30, 2001, which
we expect will include the net proceeds of the transaction involving our
Oklahoma and Ohio manufacturing operations;
o our expected available credit under our credit facilities;
o proceeds from the expected sale of our optical fiber business; and
o cash flows from operations, subject to the successful implementation of
our business strategy.
We believe our planned sources of liquidity are currently sufficient to meet our
requirements through the end of fiscal year 2002. We cannot assure you, however,
that these sources of liquidity will be available when needed or that our actual
cash requirements will not be greater than we currently expect. For example, the
closing of the expected sale of our optical fiber business is subject to a
number of conditions, including various regulatory approvals, and delay in
obtaining or failure to obtain these approvals, or delay in the closing of the
sale for any reason, could have a significant negative impact on our liquidity.
In addition, if phase II of our restructuring program is revised or delayed, our
cash requirements are likely to be significantly higher than we currently
anticipate, and we also may not remain in compliance with the financial
covenants in our credit facilities. In such instances we may have to repay
outstanding indebtedness and may not be able to borrow under our existing credit
facilities and it could limit the availability of alternative financing sources.
See "Credit facilities" for a description of the other consequences of a default
under our credit facilities. As described under "Credit facilities", the receipt
by us of proceeds from specified asset sales in excess of a specified threshold
will result in a reduction in the amount of available borrowings under our
credit facilities. If our sources of liquidity are not available to us or are
not sufficient to satisfy our cash requirements, or we are delayed in, or unable
to, successfully implement the remaining aspects of our existing restructuring
program or proposed phase II program, or generate positive cash flow from
operations, we will need to obtain additional sources of funds through operating
improvements, additional asset sales and financing from third parties or a
combination thereof. We cannot assure you that these additional sources of funds
would be available on reasonable terms or at all.
Our credit ratings as of August 13, 2001 are as follows:
Rating for our Rating for our
long-term debt commercial paper Last update
--------------------- ----------------------- -----------------------
Rating Agency
-------------
Standard & Poor's BB- (a) C July 31, 2001
Moody's (b) Ba3 Not Prime August 1, 2001
Fitch BB- B August 2, 2001
---------
(a) The rating for our senior unsecured long-term debt remains on CreditWatch
with negative implications.
(b) Our Moody's long-term ratings are under review for possible further
downgrade.
27
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The Standard & Poor's, Moody's and Fitch ratings are below investment grade. We
expect both the recent, and any future, lowering of the ratings of our debt to
result in higher financing costs and reduced access to the capital markets. As a
result of the reductions of our credit ratings earlier in fiscal 2001,
commercial paper and some other types of borrowings became unavailable to us and
the costs of our financings increased. We cannot assure you that our credit
ratings will not be reduced in the future by Standard & Poor's, Moody's or
Fitch.
Credit facilities
We currently have a 364-day $2 billion credit facility that expires on February
21, 2002, and a $2 billion credit facility that expires on February 26, 2003.
These credit facilities are collateralized by substantially all of our assets,
including a pledge of the shares of common stock of Agere that we own. As of
June 30, 2001 we had $ 2.3 billion outstanding under these credit facilities,
which borrowings since March 31, 2001, were used to fund our operations and pay
down commercial paper. We had no commercial paper outstanding as of June 30,
2001. Our ability to access our credit facilities is subject to our compliance
with the terms and conditions of the credit facilities, including financial
covenants. These financial covenants require us to have minimum earnings before
interest taxes, depreciation and amortization (EBITDA) and minimum net worth
measured at the end of each fiscal quarter. The EBITDA covenant requires us to
achieve positive EBITDA for the six months ended December 31, 2001, with
sequential improvement thereafter tested over rolling periods of nine to twelve
months. As of June 30, 2001, we were in compliance with these covenants.
Under the terms of our credit facilities, if we undertake certain debt reduction
transactions or generate additional funds from specified non-operating sources
(which would include the proceeds from our redeemable convertible preferred
stock offering and the proceeds from the sale of our optical fiber business and
other specified types of transactions, but would not include the proceeds from
the transaction involving our Oklahoma and Ohio manufacturing operations, the
accounts receivable securitization, or other specified types of transactions) in
excess of $2.5 billion, first, the total lending commitments under our 364-day
$2 billion credit facility would be reduced by the entire amount by which such
funds exceed $2.5 billion and, second, if and once commitments under the 364-day
$2 billion credit facility have been terminated, the total lending commitments
under our $2 billion credit facility that expires on February 26, 2003 would be
reduced by 50% of the amount of such funds not otherwise used to reduce the
364-day credit facility until the amount of lending commitments under that
facility is reduced to $1.5 billion. Any outstanding borrowing under our credit
facilities that exceed the reduced lending commitments must be repaid at that
time. As of August 13, 2001, we have generated $2.35 billion toward the $2.5
billion threshold.
Proposed amendments to our credit facilities
We have recently entered into discussions with the lenders under our credit
facilities to obtain the amendments necessary to allow us to adopt and implement
phase II of our restructuring program. We have reached agreement with the two
agent banks for our credit facilities on the terms of the amendments. The two
agent banks currently hold less than 25% in principal amount of the commitments
under each of our credit facilities. The amendments will not become effective
unless and until we obtain the consent of the lenders holding a majority of the
commitments under each of our credit facilities.
The proposed amendments to our credit facilities, if approved as proposed, will
include, among other things, (1) changes to our EBITDA covenant and minimum net
worth covenant in order to permit us to implement our new business strategy
including phase II of our restructuring program, (2) changes that will impose
revised and additional conditions that we must satisfy in order to spin off
Agere, (3) changes to the mandatory prepayment provisions of the credit
facilities that will require us in some circumstances to apply all or an
increased percentage of certain financing and asset sale proceeds to reduce
our credit facilities, (4) changes to impose conditions upon our ability to
resume payment of cash dividends with respect to shares of our common stock
and (5) changes to impose conditions on our ability to sell or otherwise
dispose of Agere and other material assets. The changes applicable to our
right to consummate the spin-off of Agere are anticipated to include (in
addition to other conditions) conditions requiring us to achieve positive
EBITDA in the fiscal quarter immediately preceding the spin-off and to raise a
significant amount of additional liquidity from specified sources, a
substantial portion of which requirement would be satisfied if we were to
consummate the expected sale of our optical fiber business and the expected
sale of our Oklahoma and Ohio
28
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
manufacturing operations. In addition, as part of the proposed amendment we are
seeking consent to pay cash dividends on the preferred stock.
Sale of optical fiber business
On July 24, 2001, we announced that we have entered into an agreement to sell
our optical fiber business, including two joint ventures in China, to The
Furukawa Electric Co., Ltd. and Corning Incorporated for an aggregate purchase
price of $2.75 billion. We will receive $2.525 billion from Furukawa for the
major portion of the business. Corning will pay $225 million in cash for our two
Chinese joint ventures -- Lucent Technologies Shanghai Fiber Optic Co. Ltd. and
Lucent Technologies Beijing Fiber Optic Cable Co., Ltd. In addition, Furukawa
and CommScope have agreed to enter into one or more joint ventures that will be
formed to operate the optical fiber business. Up to $250 million of Furukawa's
payment to us may be in CommScope securities. The closing is subject to U.S. and
foreign governmental approvals and other customary closing conditions. We expect
this transaction to close by the end of the first fiscal quarter of 2002.
Sale of manufacturing operations
On July 24, 2001, we announced that we entered into an agreement to sell to
Celestica Inc. our Oklahoma and Ohio manufacturing operations, other than our
Oklahoma manufacturing facility, which we will lease to them. The purchase
price, which we expect to be approximately $550 million to $650 million in cash,
will be determined based on the value of the assets, primarily inventory,
transferred at the completion of the transaction. At closing, we will enter into
a five-year supply agreement valued at up to $10 billion with Celestica to be
the primary manufacturer for our switching, access and wireless networking
systems products. The execution of the supply agreement is a condition to the
closing of the transaction. We expect to close this transaction by the end of
the fourth fiscal quarter of 2001. The workforce related to these two operations
is expected to be reduced and/or transferred to Celestica over time, resulting
in a non-cash charge of approximately $350 million, a portion of which we expect
to record in the next two fiscal quarters and the remainder of which we expect
to record prior to the end of fiscal year 2002.
Agere Spin Off Update
On April 2, 2001, Agere completed an initial public offering of 600 million
shares of Class A common stock, resulting in net proceeds of $3.4 billion. As a
result of the IPO, we recorded an increase to shareowner's equity of $922
million in the current fiscal quarter of 2001. In addition, on April 2, 2001,
Morgan Stanley exercised its overallotment option to purchase an additional 90
million shares of Agere Class A common stock from us. Morgan Stanley exchanged
$519 million of our commercial paper for the Agere common shares. This
transaction resulted in a gain of $141 million, which has partially reduced the
estimated loss on disposal of Agere.
We remain committed to completing the process of separating Agere from our
company, and we intend to move forward with our distribution of the shares of
Agere stock that we then own in a tax-free spin off to our stockholders.
Although we have entered into an agreement with Agere (subject to the
satisfaction or waiver of a variety of conditions) that obligates us to complete
the distribution on or before September 30, 2001, our credit facilities, the
relevant terms of which are described below, do not currently permit us to
complete the distribution. We are in discussion with our lenders to amend the
covenants under our credit facilities. The terms of such an amendment are
expected to delay our ability to effect the Agere spin off for up to six months
from the previously anticipated distribution date of September 30, 2001 (see
Proposed amendments to our credit facilities).
Our agreement with Agere provided that, if the Agere distribution is not
completed on or before September 30, 2001, we will complete the Agere spin off
as promptly as practicable following our satisfaction or waiver of all
conditions of such agreement. However, we do have the right to terminate our
obligation to complete the distribution if, as of September 30, 2001, the
distribution is not permitted under the terms of our indebtedness or would
result in the acceleration of any payment under our indebtedness. As a result,
although we intend to complete the Agere distribution as soon as practicable, we
cannot assure you that the conditions to our obligation to complete the
distribution will be satisfied by a particular date or that our indebtedness
will permit the distribution by a particular date or
29
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
at all. Under our agreement with Agere, we may terminate our obligation to
complete the distribution if, after consultation with Agere senior management,
our board of directors determines, in its sole discretion, that the distribution
is not in the best interests of us or our stockholders.
We may explore an alternative path for achieving full independence of Agere from
our company through a secondary public offering of the Agere shares held by us
if our board of directors determines that a change in the spin off plan is in
the best interests of us or our stockholders.
Proceeds Requirement
The current terms of our credit facilities will not allow the distribution
unless, at the time of the distribution, we have generated $2.5 billion of
additional funds or reduction in debt from specified non-operating sources
(which would include the proceeds from the redeemable convertible preferred
stock offering and the proceeds from the transaction involving our optical fiber
business and other specified types of transactions, but would not include the
proceeds from the transaction involving our Oklahoma and Ohio manufacturing
operations, the accounts receivable securitization or other specified types of
transactions). As of August 13, 2001, we have generated $519 million of debt
reduction in a debt for equity exchange in which we exchanged shares of Class A
common stock of Agere held by us for approximately $519 million of our
indebtedness held by Morgan Stanley and $1.8 billion of net proceeds received
from the redeemable convertible preferred stock offering. The proceeds from the
expected sale of our optical fiber business will constitute additional funds
that satisfy the requirement of our credit facilities. The closing of the sale
of our optical fiber business is subject to various conditions, uncertainties
and risks and we cannot assure you that any such sale will be completed on a
timely basis or at all (see Proposed amendments to our credit facilities). We
cannot assure you that any amendments approved by the banks will not impose
additional or different conditions on our ability to consummate the Agere spin
off from those in the proposed amendments as described above.
Compliance with Financial Covenants and Release of Pledge Requirements
Our credit facilities also will not allow the spin off unless no event of
default exists under our credit facilities, which means that we must, amoung
other requirements, be in compliance with specified financial covenants. The
financial covenants require us to have minimum net worth and minimum earnings
before interest, taxes, depreciation and amortization. In addition, our pledge
of Agere's common stock must be released in order for us to consummate the
distribution. Our pledge will not be released unless we have, as of the end of
the quarter preceding the release, a minimum ratio of current assets to the
amount committed under the credit facilities plus specified secured debt and
other obligations which share in the collateral securing the credit facilities,
which ratio must be maintained from the date of any such release until
distribution. We cannot assure you that we will be in compliance with these
financial covenants or satisfy the minimum ratio test currently required to
release our pledge of the Agere shares in order to complete the distribution on
a timely basis or at all. As part of obtaining the consent to the proposed
amendment from our lenders under our credit facilities necessary to adopt and
implement phase II of our restructuring program, it is likely that the covenants
described above and other terms of the credit facilities relevant to the spin
off will change.
Tax Condition to Spin Off
We have received a private letter ruling from the Internal Revenue Service
holding that the distribution of our shares of Agere common stock to our
stockholders in the spin off and to holders of our debt in the debt for equity
exchange will be tax free to us and our stockholders. The effectiveness of the
ruling is conditioned on completion of the spin off by September 30, 2001,
unless that date is extended by the Internal Revenue Service in a supplemental
ruling. As discussed above, we expect the amended terms of our credit facilities
to impose conditions that would delay the spin off beyond that date. In
addition, the private letter ruling does not take into account certain
additional issues under the tax rules for spinoffs arising from the issuance of
preferred stock. Specifically, these issues arise under section 355(e) of the
Internal Revenue Code, which limits the amount of stock that can be issued in
connection with a spin off.
We have applied for supplemental rulings from the Internal Revenue Service
authorizing an extension of the date for the spin off and favorably resolving
the additional issues arising
30
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
from the issuance of preferred stock. We are hopeful that we can obtain these
rulings from the Internal Revenue Service. If we cannot do so, we may attempt to
obtain opinions of counsel to the same effect. However, an opinion of counsel is
not binding on the Internal Revenue Service, and, in the absence of rulings by
the Internal Revenue Service, the Internal Revenue Service could assert that the
spin off or the debt for equity exchange was taxable to us.
In the absence of a ruling from the Internal Revenue Service or an opinion of
counsel that we determine to rely on, we would be more likely to explore an
alternative path for achieving full independence of Agere from our company.
Customer financing
The following table presents our customer financing commitments at June 30, 2001
(in billions):
At June 30, 2001
----------------
Total Loans and
Guarantees Loans Guarantees
Drawn commitments $2.9 $2.3 $0.6
Available but not drawn 1.6 1.6 -
Not available 1.0 0.7 0.3
---- ---- ----
Total $5.5 $4.6 $0.9
==== ==== ====
Some of our customers worldwide are requiring their suppliers to arrange or
provide long-term financing for them as a condition of obtaining or bidding on
infrastructure projects. These projects may require financing in amounts ranging
from modest sums to more than a billion dollars. We use a disciplined credit
evaluation and business review process that takes into account the credit
quality of individual borrowers and their related business plans as well as
market conditions. We consider requests for financing on a case-by-case basis
and offer financing only after careful review. As market conditions permit, our
intention is to sell or transfer these long-term financing arrangements, which
may include both commitments and drawn-down borrowings, to financial
institutions and other investors. This enables us to reduce the amount of our
commitments and free up additional financing capacity. As part of the revenue
recognition process, we determine whether the notes receivable under these
contracts are reasonably assured of collection based on various factors, among
which is our ability to sell these notes.
We have a credit process that monitors the drawn and undrawn commitments and
guarantees of debt to our customers. Customers are reviewed on a quarterly or
annual basis depending upon their risk profile. As part of our review, we assess
the customers' short-term and long-term liquidity position, current operating
performance versus plan, execution challenges facing the company, changes in
competitive landscape, industry and macro economic conditions, and changes to
management and sponsors. Depending upon the extent of any deterioration of a
customer's credit profile or non-compliance with our legal documentation, we
undertake actions that could include canceling the commitment, forcing the
borrower to take corrective measures, and increasing resources. These actions
are designed to mitigate unexpected events that could have an impact on our
future results of operations and cash flows, however, there can be no assurance
that this will be the case. Adverse industry conditions, such as the continued
softening in the competitive local exchange carrier market, have negatively
affected the creditworthiness of several customers that participate in our
customer financing program. For the nine months ended June 30, 2001, we recorded
provisions for uncollectibles and customer financing of $1,950 million. For
example, in late May 2001, the board of directors of One.Tel, an Australian
telecommunications company and one of our customers, declared One.Tel insolvent.
One.Tel announced on June 5, 2001, that it will be liquidated and its assets
sold shortly. We have built a mobile fiberoptic network for One.Tel, portions of
which are near completion. As a result, in our third fiscal quarter of 2001, we
took significant reserves associated with two vendor finance projects, including
One.Tel, of approximately $700 million. Also, in the second fiscal quarter of
2001, we recorded a provision of approximately $700 million associated with
uncollectible receivables and customer financing, primarily due to Winstar.
31
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The overall vendor financing exposure, coupled with a continued decline in
telecommunications market conditions, negatively impacted results of operations
in the current fiscal quarter and has caused revenue, results of operations and
cash flows in the current fiscal year 2001 to be lower than fiscal year 2000. We
may be required to record additional reserves related to customer financing in
the future. We will continue to provide or commit to financing where appropriate
for our business. Our ability to arrange or provide financing for our customers
will depend on a number of factors, including our capital structure, credit
rating and level of available credit, and continued ability to sell or transfer
commitments and drawn-down borrowings on acceptable terms.
RISK MANAGEMENT
We are exposed to market risk from changes in foreign currency exchange rates,
interest rates and equity prices that could impact our results of operations and
financial condition. We manage our exposure to these market risks through our
regular operating and financing activities and, when deemed appropriate, hedge
these risks through the use of derivative financial instruments. We use the term
hedge to mean a strategy designed to manage risks of volatility in prices or
rate movements on certain assets, liabilities or anticipated transactions by
creating a relationship in which the gains or losses on derivative instruments
are expected to counter-balance the losses or gains on the assets, liabilities
or anticipated transactions exposed to such market risks. We use derivative
financial instruments as risk management tools and not for trading or
speculative purposes. In addition, derivative financial instruments are entered
into with a diversified group of major financial institutions in order to manage
our exposure to nonperformance on such instruments.
We use derivative financial instruments, including foreign exchange forward
contracts and to a lesser extent option contracts and interest rate swap
agreements to manage changes in foreign exchange rates and interest rates that
may affect the eventual cash flows in foreign currencies or underlying financial
instruments. We believe that our hedge activities achieve hedge effectiveness by
creating a relationship whereby the gains and losses on our derivative
instruments counterbalance the changes in value of the designated assets,
liabilities and forecasted transactions being hedged.
Effective October 1, 2000, we adopted SFAS 133 - "Accounting for Derivative
Instruments and Hedging Activities" and its corresponding amendments under SFAS
No. 138. The adoption of SFAS 133 resulted in a cumulative after-tax reduction
in net loss of $30 million (net of tax of $17 million) and an $11 million credit
to other comprehensive income (OCI) in the first quarter of fiscal year 2001.
The reduction in net loss is primarily attributable to derivatives not
designated as hedging instruments, including foreign currency embedded
derivatives, equity warrants and other derivatives (see Note 5 of the
accompanying Consolidated Financial Statements).
We have not changed our policy regarding how exposures are managed since the
year ended September 30, 2000. We continuously monitor all of our foreign
currency exposures. We cannot predict whether we will incur foreign exchange
losses in the future; however, if significant foreign exchange losses are
experienced, they could have a material adverse effect on the our results of
operations, financial condition and cash flows.
We use a combination of financial instruments, including medium-term and
short-term financings, variable-rate debt instruments and to a lesser extent,
interest rate swaps to manage our interest rate mix of the total debt portfolio
and related overall cost of borrowing. To manage this mix in a cost-effective
manner, from time to time, we may enter into interest rate swap agreements in
which we agree to exchange various combinations of fixed and/or variable
interest rates based on agreed-upon notional amounts. We had no material
interest rate swap agreements in effect at June 30, 2001 or September 30, 2000.
Our investment portfolio consists of equity investments accounted for under the
cost and equity methods as well as equity investments in publicly held companies
that are classified as available-for-sale. These available-for-sale securities
are exposed to price fluctuations and are generally concentrated in the
high-technology communications and semi-conductor industries, many of which are
small capitalization stocks. Due to the recent economic downturn in the
technology sector, we recorded net write-downs of approximately $277 million on
equity investments during the current fiscal year. Given current market
conditions, we may incur additional charges on our investment portfolio in the
future. We generally do not hedge our equity price risk; however, on occasion,
may use equity derivative financial instruments that are subject to equity price
risks to complement our investment strategies. As of June 30, 2001, we had no
outstanding hedge instruments for our equity price risk.
32
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
OTHER INFORMATION
On November 21, 2000, we announced that we had identified an issue impacting
revenue in the fourth fiscal quarter of 2000. We informed the SEC and initiated
a review by our outside counsel and outside auditors. In late December, we
announced the results of the review, which resulted in certain adjustments to
fourth fiscal quarter results. We also informed the SEC and are cooperating
fully with the SEC's investigation of these matters.
See Note 13 of the consolidated financial statements for Recent Pronouncements.
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Results of Operations and Financial
Condition and other sections of this report contain forward-looking statements
that are based on current expectations, estimates, forecasts and projections
about the industries in which we operate, our beliefs, and assumptions made by
us. 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," "intends," "plans," "believes," "seeks," "estimates,"
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions ("Future
Factors") that are difficult to predict. Therefore, actual outcomes and results
may differ materially from what is expressed or forecast in such forward-looking
statements. Except as required under the federal securities laws and the rules
and regulations of Securities and Exchange Commission, we do not have any
intention or obligation to update publicly any forward-looking statements after
the distribution of this Form 10-Q, whether as a result of new information,
future events or otherwise.
Future Factors include increasing price, products and services competition by
U.S. and non-U.S. competitors, including new entrants; rapid technological
developments and changes and the Company's ability to continue to introduce and
dependence upon the development of competitive new products and services on a
timely, cost-effective basis; the mix of products and services; the availability
of manufacturing capacity, components and materials; the ability to recruit and
retain talent; control of costs and expenses; credit concerns in the emerging
service provider market and the potential for deterioration of the credit
quality of customers for which we have provided financing; customer demand for
our products and services; completion on the anticipated timetable of the
expected distribution of our remaining shares of Agere; timely completion of the
sale of certain of our manufacturing facilities and assets and our optical fiber
business, and continued availability of quality products and components at
reasonable prices after the sales; the timely implementation of our
restructuring program and financial plan, including the amendment of our bank
credit facilities on satisfactory terms and on a timely basis to allow us to
accomplish phase II of its restructuring program in a timely way; our ability to
implement successfully our new strategic direction focused on offering fewer
products to large service providers, including our ability to focus our business
on the mix of products and services necessary to take advantage of the most
desirable opportunities in our industry and to implement our product
rationalizations and other aspects of our new strategic direction in a manner
that does not disrupt customers' business; U.S. and non-U.S. governmental and
public policy changes that may affect the level of new investments and purchases
made by customers; changes in environmental and other U.S. and non-U.S.
governmental regulations; protection and validity of patent and other
intellectual property rights; reliance on large customers and significant
suppliers; technological, implementation and cost/financial risks in the use of
large, multiyear contracts; our credit ratings and ability to provide customer
financing when appropriate; compliance with the covenants and restrictions of
our bank credit facilities; the outcome of pending and future litigation and
governmental proceedings and continued availability of financing, financial
instruments and financial resources in the amounts, at the times and on the
terms required to support the Company's future business. These are
representative of the Future Factors that could affect the outcome of the
forward-looking statements. In addition, such statements could be affected by
general industry and market conditions and growth rates, general U.S. and
non-U.S. economic conditions, including the global economic slowdown and
interest rate and currency exchange rate fluctuations and other Future Factors.
For a further description of Future Factors that could cause actual results to
differ materially from such forward-looking statements, see the discussion in
Lucent's Annual Report on Form 10-K, as amended on Form 10-K/A filed on June 13,
2001, for the year ended September 30, 2000 - Item 1. section VIII. OUTLOOK and
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition - Forward-Looking Statements, as restated on Form 8-K filed
July 31, 2001. In addition, see the prospectus and reports filed by Agere with
the SEC for a further list and description of risks and uncertainties related to
Agere.
33
Form 10-Q - Part I
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
European Monetary Union--Euro
Several member countries of the European Union have established fixed conversion
rates between their existing sovereign currencies and the Euro and have adopted
the Euro as their new single legal currency. The legacy currencies will remain
legal tender in the participating countries for a transition period until
January 1, 2002. During the transition period, cashless payments can be made in
the Euro. Between January 1, 2002 and March 1, 2002, the participating countries
will introduce Euro notes and coins and withdraw all legacy currencies so that
they will no longer be available.
We have in place a joint European-United States team representing affected
functions within the Company. This team is evaluating our Euro-related issues
affecting our pricing/marketing strategy, conversion of information technology
systems and existing contracts.
The Euro conversion may affect cross-border competition by creating cross-border
price transparency. We will continue to evaluate issues involving introduction
of the Euro as further accounting, tax and governmental legal and regulatory
guidance becomes available. Based on current information and our current
assessment, we do not expect that the Euro conversion will have a material
adverse effect on our business or financial condition.
34
Form 10-Q - Part II
Part II - Other Information
Item 1. Legal Proceedings
Lucent has been served with several derivative complaints in Chancery Court in
the State of Delaware. The actions were filed by individual Lucent shareholders
against the current members of Lucent's Board of Directors, two former directors
and a former officer. The actions, all but one of which have been consolidated
in a single action in Chancery Court in Delaware, make claims for breach of the
fiduciary duty of good faith and other fiduciary duties allegedly owed to the
Company. The actions seek damages against the defendants and in favor of Lucent,
as well as costs and expenses associated with litigation for the individual
plaintiffs. These actions are in the early stages and the Company is unable to
determine their potential impact on the consolidated financial statements.
Lucent and the individual defendants intend to defend these actions vigorously.
Several purported shareholder class actions have been filed against the Company
and certain of its current and former officers for alleged violations of federal
securities laws in addition to the purported shareholder class actions described
in Lucent's Annual Report on Form 10-K/A for the year ended September 30, 2000.
The claims and relief sought in these actions are similar to the claims and
relief sought in the purported class actions previously described in the Annual
Report and all of these related actions have been consolidated in a single
action in U.S. District Court in New Jersey. This consolidated action, which
seeks damages on behalf of purchasers of Lucent stock from October 26, 1999, to
December 21, 2000, is in the early stages and Lucent is unable to determine its
potential impact on the consolidated financial statements. Lucent has moved to
dismiss the consolidated complaint and intends to defend this action vigorously.
On July 25, 2001, plaintiffs filed a purported class action complaint in US
District Court, District of New Jersey, pursuant to ERISA alleging that Lucent
breached its fiduciary duties with respect to Lucent's sponsored Long Term
Savings Plan for Management Employees and Retirement Savings and Profit Plan.
Plaintiffs allege that Lucent and its executive officers were made aware of
numerous business problems that made Lucent's stock inappropriate for retirement
investment and breached its fiduciary duty by continuing to offer Lucent stock
as a plan investment option. Plaintiffs also allege that during calendar 2000
Lucent introduced new plan provisions designed to protect the plans' fiduciaries
from liability to the plans' participants and beneficiaries. The complaint seeks
monetary relief, injunctive and equitable relief, interest and fees and expenses
associated with litigation. This action is in the early stages and Lucent is
unable to determine its potential impact on the consolidated financial
statements. Lucent intends to defend this action vigorously.
A complaint has been filed by Winstar Communications, Inc. and Winstar Wireless,
Inc. against Lucent in connection with the Chapter 11 bankruptcy petition filed
by Winstar Communications, Inc. and various related entities in U.S. Bankruptcy
Court in Delaware. The complaint asserts claims for breach of contract and
fraudulent inducement against the Company and seeks damages in excess of $10
billion and injunctive relief, as well as costs and expenses associated with
litigation. Lucent believes this action to be without merit.
Item 2. Changes in Securities and Use of Proceeds
On August 6, 2001, the Company sold 1,885,000 shares of 8.00% redeemable
convertible preferred stock having an initial liquidation preference of $1,000
per share, subject to accretion, in a private placement to the following initial
purchasers: Salomon Smith Barney Inc., Morgan Stanley & Co. Incorporated, Bear,
Stearns & Co. Inc., J.P.Morgan Securities Inc., Merrill Lynch, Pierce, Fenner &
Smith Incorporated, and SG Cowen Securities Corporation. The shares of
convertible preferred stock were offered and sold only to qualified
institutional buyers in the U.S. in reliance on the exemption from registration
provided by Rule 144A and outside the U.S. to non-U.S. persons in reliance upon
Regulation S under the Securities Act of 1933. The aggregate offering price for
the convertible preferred shares was $1,885 million, and aggregate discounts and
commissions were $52 million.
The convertible preferred stock has an annual dividend rate of eight percent,
payable semi-annually in cash or Lucent common stock at the Company's option.
Dividends may be paid only out of funds legally available for payment. The terms
of the Company's existing credit facilities currently prohibit the payment of
cash dividends on the preferred stock. The Company is obligated to file a
registration statement under the Securities Act to cover the possible resale of
the convertible preferred stock, the common stock to be issued upon conversion
of the convertible preferred stock and the sale of any common stock paid as
dividends.
From and after the earlier of the Agere spin-off or May 6, 2002, at the holder's
option, each share of convertible preferred stock is convertible the Company's
common stock at an initial conversion price of $7.48, subject to adjustment
under certain circumstances, including the Agere spin-off.
35
Form 10-Q - Part II
Part II - Other Information
At the Company's option, at any time, the Company can require
all holders to exchange their shares of convertible preferred stock for
convertible subordinated debentures having terms substantially similar to the
preferred stock. The convertible preferred stock is redeemable, at the option of
the Company after August 15, 2006 and at the option of the holders on August 2
of 2004, 2007, 2010 and 2016. The Company also has the option to redeem the
convertible preferred stock for cash or its common stock at a five percent
discount from the then current market price or a combination of cash and shares
of its common stock. The Company is obligated to redeem all outstanding
preferred shares on August 1, 2031. The Company may pay the redemption price
only out of funds legally available for such payment and if it pays the
redemption price in shares of its common stock, such shares must be eligible for
resale in the public market by non-affiliates of the Company, absent a
registration statement.
The Company intends to use the net proceeds from the sale of the convertible
preferred stock for working capital, capital expenditures, debt service and
other general corporate purposes.
Item 6. Exhibits and Report on Form 8-K.
(a) Exhibits:
Exhibit Number
(3) Certificate of Designations of 8.00% Redeemable Convertible
Preferred Stock setting forth the powers, preferences and
rights, and the qualifications, limitations and restrictions
thereof, filed with the Certificate of Incorporation.
(99.1) Richard A. McGinn Settlement Agreement, Dated as of June 6, 2001
(99.2) Deborah C. Hopkins Separation Agreement, Dated as of May 4, 2001
(b) Report on Form 8-K:
The following report on Form 8-K was filed during the current quarter:
Current Report on Form 8-K dated and filed April 24, 2001, filed
pursuant to Item 9 (Regulation FD Disclosures) to furnish the
Company's Investor Relations HighLights bulletin.
36
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, 2001
/s/ Mark R. White
--------------------------------
Mark R. White
Senior Vice President and Controller
(Principal Accounting Officer)
37
Form 10-Q - Part II
Exhibit Index
Exhibit Number
(3) Certificate of Designations of 8.00% Redeemable Convertible
Preferred Stock setting forth the powers, preferences and
rights, and the qualifications, limitations and restrictions
thereof, filed with the Certificate of Incorporation.
(99.1) Richard A. McGinn Settlement Agreement, Dated as of June 6, 2001
(99.2) Deborah C. Hopkins Separation Agreement, Dated as of May 4, 2001