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AS FILED WITH THE SEC ON AUGUST 13, 2003
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________to _____________
Commission file number 001-11639
LUCENT TECHNOLOGIES INC.
A Delaware I.R.S. Employer
Corporation No. 22-3408857
600 Mountain Avenue, Murray Hill, New Jersey 07974
Telephone Number: 908-582-8500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
At July 31, 2003, 4,160,571,938 common shares were outstanding.
2 Form 10-Q - Part I
INDEX
Part I - Financial Information:
Item 1. Financial Statements
Consolidated Statements of Operations for the Three and Nine Months
Ended June 30, 2003 and 2002.............................................................3
Consolidated Balance Sheets at
June 30, 2003 and September 30, 2002.....................................................4
Consolidated Statement of Changes in Shareowners' Deficit for the Nine Months
Ended June 30, 2003......................................................................5
Consolidated Statements of Cash Flows for the Nine Months
Ended June 30, 2003 and 2002.............................................................6
Notes to Consolidated Financial Statements.................................................7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition............................................22
Item 4. Controls and Procedures...................................................................36
Part II - Other Information:
Item 1. Legal Proceedings.........................................................................37
Item 2. Changes in Securities and Use of Proceeds.................................................37
Item 5. Other Information.........................................................................38
Item 6. Exhibits and Reports on Form 8-K..........................................................38
3 Form 10-Q - Part I
PART 1 - Financial Information
Item 1. Financial Statements
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
----------- -------------- ----------- -------------
Revenues:
Products $ 1,526 $2,304 $ 5,099 $7,883
Services 439 645 1,344 2,161
----------- -------------- ----------- -------------
Total revenues 1,965 2,949 6,443 10,044
----------- -------------- ----------- -------------
Costs:
Products 1,041 1,738 3,523 6,376
Services 351 560 1,131 1,780
----------- -------------- ----------- -------------
Total costs 1,392 2,298 4,654 8,156
----------- -------------- ----------- -------------
Gross margin 573 651 1,789 1,888
Operating expenses:
Selling, general and administrative 412 871 1,299 2,992
Research and development 382 480 1,153 1,625
Goodwill impairment 35 811 35 811
Business restructuring charges (reversals) and asset
impairments, net 13 791 (137) 653
----------- -------------- ----------- -------------
Total operating expenses 842 2,953 2,350 6,081
----------- -------------- ----------- -------------
Operating loss (269) (2,302) (561) (4,193)
Other income (expense), net 31 (261) (436) 242
Interest expense 85 107 258 284
----------- -------------- ----------- -------------
Loss from continuing operations before income taxes (323) (2,670) (1,255) (4,235)
Provision for (benefit from) income taxes (69) 5,329 (386) 4,782
----------- -------------- ----------- -------------
Loss from continuing operations (254) (7,999) (869) (9,017)
(Loss) income from discontinued operations, net - (27) - 73
----------- -------------- ----------- -------------
Net loss (254) (8,026) (869) (8,944)
Conversion cost - 8.00% redeemable convertible preferred stock (20) - (286) -
Preferred stock dividends and accretion (21) (42) (82) (124)
----------- -------------- ----------- -------------
Net loss applicable to common shareowners $ (295) $(8,068) $(1,237) $(9,068)
=========== ============== =========== =============
Loss per common share - basic and diluted
Loss from continuing operations $(0.07) $(2.34) $ (0.32) $(2.67)
(Loss) income from discontinued operations - $(0.01) - $ 0.02
Net loss applicable to common shareowners $(0.07) $(2.35) $ (0.32) $(2.65)
Weighted average number of common shares
outstanding - basic and diluted 4,120.6 3,428.5 3,882.3 3,422.5
See Notes to Consolidated Financial Statements.
4 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
June 30, September 30,
2003 2002
----------------- --------------
ASSETS
Cash and cash equivalents $ 4,339 $2,894
Short-term investments 589 1,526
Receivables, less allowance of $272 and $325, respectively 1,620 1,647
Inventories 806 1,363
Contracts in process, net of progress billings of $10,551 and $10,314,
respectively 70 10
Other current assets 1,181 1,715
----------------- --------------
Total current assets 8,605 9,155
Property, plant and equipment, net 1,705 1,977
Prepaid pension costs 4,483 4,355
Goodwill and other acquired intangibles, net 189 224
Other assets 1,954 2,080
----------------- --------------
Total assets $ 16,936 $17,791
================= ==============
LIABILITIES
Accounts payable $ 1,221 $1,298
Payroll and benefit-related liabilities 776 1,094
Debt maturing within one year 616 120
Other current liabilities 2,866 3,814
----------------- --------------
Total current liabilities 5,479 6,326
Postretirement and postemployment benefit liabilities 4,935 5,230
Pension liabilities 2,357 2,752
Long-term debt 4,687 3,236
Company-obligated mandatorily redeemable preferred securities of subsidiary
trust 1,152 1,750
Other liabilities 1,351 1,551
----------------- --------------
Total liabilities 19,961 20,845
Commitments and contingencies
8.00% redeemable convertible preferred stock 933 1,680
SHAREOWNERS' DEFICIT
Preferred stock - par value $1.00 per share;
Authorized shares: 250.0; issued and outstanding shares: none - -
Common stock - par value $.01 per share;
Authorized shares: 10,000.0; 4,143.8 issued and 4,142.5 outstanding shares
at June 30, 2003 and 3,491.6 issued and 3,490.3 outstanding shares at
September 30, 2002 41 35
Additional paid-in capital 22,096 20,606
Accumulated deficit (22,894) (22,025)
Accumulated other comprehensive loss (3,201) (3,350)
----------------- --------------
Total shareowners' deficit (3,958) (4,734)
----------------- --------------
Total liabilities, redeemable convertible preferred stock and
shareowners' deficit $ 16,936 $ 17,791
================= ==============
See Notes to Consolidated Financial Statements.
5 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREOWNERS' DEFICIT
(Dollars in Millions)
(Unaudited)
Accumulated
Additional other Total
Common paid-in Accumulated comprehensive shareowners'
stock capital deficit loss deficit
----------- ---------------------------------------- -------------
Balance at September 30, 2002 $35 $20,606 $(22,025) $(3,350) $(4,734)
----------- ---------------------------------------- -------------
Net loss (869)
Foreign currency translation adjustment 108
Unrealized holding gains on certain investments 41
Issuance of common stock in connection with the
exchange for convertible securities and certain other
debt obligations (see Note 6) 6 1,430
Conversion costs in connection with the exchange of
7.75% trust preferred securities 129
Tax benefit in connection with the exchange of 7.75%
trust preferred securities (135)
Issuance of common stock in connection with payment
of preferred stock dividend 53
Issuance of common stock in connection with
contribution to Lucent Technologies Inc. Represented
Employees Post-Retirement Health Benefits Trust 75
Other issuance of common stock 32
Preferred stock dividends and accretion (82)
Other (12)
----------- ---------------------------------------- ----------------
Balance at June 30, 2003 $ 41 $ 22,096 $ (22,894) $ (3,201) $ (3,958)
=========== ======================================== ================
See Notes to Consolidated Financial Statements.
6 Form 10-Q - Part I
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Nine months ended
June 30,
2003 2002
----------- ---------
Operating Activities
Net loss $ (869) $(8,944)
Less: income from discontinued operations - 73
----------- ---------
Loss from continuing operations (869) (9,017)
Adjustments to reconcile loss from continuing operations to net cash (used in)
provided by operating activities, net of effects of dispositions of
businesses:
Non-cash portion of business restructuring (reversals) charges (179) 434
Impairment of goodwill 35 811
Depreciation and amortization 782 1,189
(Recovery of) provision for bad debt and customer financings (99) 829
Deferred income taxes - 5,285
Net pension and postretirement benefit credit (488) (719)
Gain on sales of businesses (47) (583)
Other adjustments for non-cash items 132 313
Changes in operating assets and liabilities:
Decrease in receivables 18 2,008
Decrease in inventories and contracts in process 513 1,870
Decrease in accounts payable (104) (592)
Changes in other operating assets and liabilities (787) (1,782)
----------- ---------
Net cash (used in) provided by operating activities from continuing
operations (1,093) 46
----------- ---------
Investing Activities
Capital expenditures (226) (312)
(Acquisitions) dispositions of businesses, net of cash (18) 2,543
Maturities (purchases) of short-term investments 941 (865)
Other investing activities 155 108
----------- ---------
Net cash provided by investing activities from continuing operations 852 1,474
----------- ---------
Financing Activities
Issuance of convertible senior debt 1,631 -
Issuance of company-obligated mandatorily redeemable preferred
securities of subsidiary trust - 1,750
Repayments of credit facilities - (1,000)
Net proceeds from (repayments of) other short-term borrowings 49 (45)
Payment of preferred dividends - (73)
Other financing activities (48) (3)
----------- ---------
Net cash provided by financing activities from continuing operations 1,632 629
Effect of exchange rate changes on cash and cash equivalents 54 28
----------- ---------
Net cash provided by continuing operations 1,445 2,177
Net cash used in discontinued operations - (11)
----------- ---------
Net increase in cash and cash equivalents 1,445 2,166
Cash and cash equivalents at beginning of year 2,894 2,390
----------- ---------
Cash and cash equivalents at end of period $ 4,339 $ 4,556
=========== =========
Tax refunds, net $143 $783
----------- ---------
Interest paid $220 $217
----------- ---------
See Notes to Consolidated Financial Statements.
7 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
1. BASIS OF PRESENTATION
Lucent Technologies Inc.'s ("Lucent" or the "Company") unaudited consolidated
financial statements reflect all adjustments (consisting of normal recurring
accruals) that are considered necessary for a fair presentation of results of
operations, financial position and cash flows as of and for the periods
presented.
The unaudited consolidated financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America.
Management is required to make estimates and assumptions that affect the amounts
reported in the unaudited consolidated financial statements and accompanying
disclosures. Actual results could differ from those estimates. Among other
things, estimates and assumptions are used in accounting for long-term
contracts, allowances for bad debts and customer financings, inventory
obsolescence, restructuring reserves, product warranty, amortization and
impairment of intangibles, goodwill and capitalized software, depreciation and
impairment of property, plant and equipment, employee benefits, income taxes,
and contingencies. Estimates and assumptions are periodically reviewed and the
effects of any material revisions are reflected in the consolidated financial
statements in the period that they are determined to be necessary.
The results for the periods presented are not necessarily indicative of the
results for the full year and should be read in conjunction with the audited
consolidated financial statements for the year ended September 30, 2002 included
in Form 8-K, filed on February 21, 2003.
Certain reclassifications were made to conform to the current period
presentation.
2. STOCK-BASED COMPENSATION
Lucent has stock-based compensation plans under which directors, officers and
other employees receive stock options and other equity-based awards. The plans
provide for the grant of stock options, stock appreciation rights, performance
awards, restricted stock awards and other stock unit awards.
Lucent follows the disclosure requirements of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"). As permitted under SFAS 123, Lucent follows Accounting Principles Board
Opinion No. 25 for its stock-based compensation plans and does not recognize
expense for stock option grants if the exercise price is at least equal to the
market value of the common stock at the date of grant. Stock-based compensation
expense reflected in the as reported net loss includes expense for restricted
stock unit awards and the amortization of certain acquisition-related deferred
compensation expense.
The fair value of stock options used to compute pro forma net loss and pro forma
loss per share disclosures is estimated using the Black-Scholes option-pricing
model, which was developed for use in estimating the fair value of traded
options that have no vesting restrictions and are fully transferable. In
addition, this model requires the input of subjective assumptions, including the
expected price volatility of the underlying stock. Projected data related to the
expected volatility and expected life of stock options is based upon historical
and other information. Changes in these subjective assumptions can materially
affect the fair value estimate, and therefore the existing valuation models do
not provide a precise measure of the fair value of the Company's employee stock
options.
As required under SFAS 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," the following table summarizes the pro forma effect
of stock-based compensation on net loss and loss per share if the fair value
expense recognition provisions of SFAS 123 had been adopted. No tax benefits
were attributed to the stock-based employee compensation expense during the
three and nine months ended June 30, 2003 due to providing a full valuation
allowance on net deferred tax assets. The pro forma net loss for the three and
nine months ended June 30, 2002 includes the impact of an increase in valuation
allowances for net deferred tax assets of approximately $6.6 billion and the
reversal of tax benefits previously recognized in the first and second quarters
of fiscal 2002.
8 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Three months ended June 30, Nine months ended June 30,
2003 2002 2003 2002
------------- ------------ -------------- -----------
Net loss, as reported $ (254) $ (8,026) $ (869) $ (8,944)
Add: Stock-based employee compensation expense included in
as reported net loss, including tax expense of $24 and
$13 during the three and nine months ended June
30, 2002, respectively 3 26 13 42
Deduct: Total stock-based employee compensation expense
determined under the fair value based method, including
tax expense of $1,692 and $1,408, during the three
and nine months ended June 30, 2002, respectively (50) (1,900) (235) (2,387)
-------- --------- --------- ---------
Pro forma net loss $(301) $(9,900) $(1,091) $(11,289)
======== ========= ========= =========
Loss per share applicable to common shareowners:
Basic and diluted - as reported $(0.07) $(2.35) $(0.32) $(2.65)
Basic and diluted - pro forma $(0.08) $(2.90) $(0.38) $(3.33)
3. BUSINESS RESTRUCTURING CHARGES, REVERSALS AND ASSET IMPAIRMENTS
Nine months Revisions to
Sept. 30, ended prior year plans June 30,
2002 June 30, 2003 ----------------- Net charge/ 2003
reserve charge charge reversal (reversal) Deductions reserve
------- ------ ------ ------- ---------- ---------- -------
Employee separations $ 367 $ 18 $106 $(182) $(58) $(205) $104
Contract settlements 150 17 21 (51) (13) (83) 54
Facility closings 483 - 49 (37) 12 (100) 395
Other 69 1 5 (9) (3) (46) 20
------ ----------------------------------------- ------- ------
Total restructuring costs $1,069 $ 36 $181 $(279) $(62) $(434) $ 573
====== ========================================= ======= ======
Total asset write-downs $ 5 $ 43 $(128) $(80)
Total business ---- ---- ------ -----
restructuring charges
(reversals) and asset
impairments, net $ 41 $224 $(407) $(142)(a)
==== ==== ====== ======
- ---------
(a) Net inventory reversals of $5 were included in costs.
A net reversal of business restructuring charges and asset impairments of $142
was recognized during the nine months ended June 30, 2003. The net reversal
included a charge for new plans of $41 and a net credit or reversal resulting
from revisions to prior year plans of $183, consisting of reversals of $407 and
charges of $224. These amounts are not included in the operating income (loss)
for reportable segments.
The new plans (initiated during the first fiscal quarter of 2003) primarily
related to employee separation charges and contract settlements associated with
the discontinuance of the TMX Multi-Service Switching and Spring Tide product
lines in the Integrated Network Solutions ("INS") segment.
The revisions to prior year plans included:
o net employee separations reversals of $76 primarily related to actual
termination benefits and curtailment costs being lower than the estimated
amounts. These variances were due to certain differences in assumed
demographic experience including the age, service lives and salaries of the
separated employees;
o net contract settlement reversals of $30 related to the settlement of
certain contractual obligations and purchase commitments for amounts lower
than originally estimated;
o net facility closing charges of $12 primarily due to lower revised
estimates for expected sublease rental income on certain properties, offset
by reversals resulting from negotiated settlements for lower amounts than
originally planned on certain properties; and
o net reversals to prior asset write-downs of $85, which included a $75
reversal of property, plant and equipment primarily resulting from
adjustments to original plans for certain owned facility closings.
9 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Deductions to the business restructuring reserves of $434 included:
Cash payments $(534)
Reversals of pension termination benefits to certain U.S. employees previously expected to be funded
through Lucent's pension assets 51
Postretirement termination charges (6)
Reversals of net pension, postemployment and postretirement benefit curtailments 82
Reversals due to the expiration of certain contingencies related to prior business dispositions 3
Foreign currency translation adjustments related to the liquidation of certain foreign legal entities (30)
-----------
Total deductions $(434)
===========
There were approximately 53,600 voluntary and involuntary employee separations
associated with employee separation charges recorded in fiscal 2001, fiscal 2002
and the first nine months of fiscal 2003. As of June 30, 2003, approximately
52,400 employee separations were completed. The majority of the remaining 1,200
employee separations are expected to be completed by the end of fiscal 2003. The
completed and future employee separations affect all business groups and
geographic regions. Management represented approximately 70% of the total
employee separations. In addition, involuntary separations represented
approximately 70% of the total employee separations.
Facility closing charges were recognized under the restructuring program for the
expected remaining future cash outlays associated with trailing lease
liabilities, lease termination payments and expected restoration costs in
connection with plans to reduce a significant number of owned and leased
facilities, totaling approximately 16.1 million square feet. As of June 30,
2003, owned and leased sites aggregating 15.0 million square feet have been
exited and the majority of the remaining sites are expected to be exited by the
end of fiscal 2003. The remaining liabilities of $395 are expected to be paid
over the remaining lease terms ranging from several months to 13 years and are
reflected net of expected sublease income of $250.
Restructuring reserves continue to be evaluated as plans are being executed. As
a result, there may be additional changes in estimates. In addition, since the
restructuring program is an aggregation of many individual plans currently being
executed, actual costs have differed from estimated amounts.
4. INVENTORIES
June 30, 2003 September 30, 2002
----------------- --------------------
Raw materials $ 193 $ 617
Work in process 58 35
Completed goods 555 711
----------------- -------------------
Inventories, net of reserves of $1,106 at June 30, 2003 and
$1,490 at September 30, 2002 $ 806 $ 1,363
================= ===================
5. ISSUANCE OF CONVERTIBLE DEBT
During the third quarter of fiscal 2003, Lucent sold 2.75% Series A Convertible
Senior Debentures and 2.75% Series B Convertible Senior Debentures for an
aggregate amount of $1,631 or $1,585 after deducting the underwriters discount
and related fees and expenses. The debentures were issued at a price of $1,000
per debenture and were issued under the Company's universal shelf registration.
The debentures rank equal in priority with all of the existing and future
unsecured and unsubordinated indebtedness and senior in right of payment to all
of the existing and future subordinated indebtedness. The terms governing the
debentures limit the Company's ability to create liens, secure certain
indebtedness and merge with or sell substantially all of the Company's assets to
another entity.
The debentures are convertible into shares of common stock only if (1) the
average sale price of the Company's common stock is at least equal to 120% of
the applicable conversion price, (2) the average trading price of the debentures
is less than 97% of the product of the sale price of the common stock and the
conversion rate, (3) if the debentures have been called for redemption by the
Company or (4) upon the occurrence of certain specified corporate actions.
10 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
At the option of the Company, the debentures are redeemable after certain dates
("optional redemption periods") at 100% of the principal amount plus any accrued
and unpaid interest for cash. In addition, at the option of the Company, the
debentures are redeemable earlier ("provisional redemption periods") if the
average sale price of the common stock exceeds 130% of the applicable conversion
price. Under these circumstances, the redemption price would also include a make
whole payment equal to the present value of all remaining scheduled interest
payments through the beginning of the optional redemption periods.
At the option of the holder, the debentures are redeemable on certain dates at
100% of the principal amount plus any accrued and unpaid interest. In these
circumstances, the Company may pay the purchase price with cash, common stock
(with the common stock to be valued at a 5% discount from the then current
market price) or a combination of both.
Specific terms and information for each series of the debentures are as follows:
Series A Series B
-------- --------
Amount $ 750 $ 881
Conversion ratio of common shares per bond 299.4012 320.5128
Initial conversion price $ 3.34 $ 3.12
Redemption periods at the option of the Company:
Provisional redemption periods June 20, 2008 thru June 19, 2010 June 20, 2009 thru June 19, 2013
Optional redemption periods After June 19, 2010 After June 19, 2013
Redemption dates at the option of the holder June 15, 2010, 2015 and 2020 June 15, 2013 and 2019
Maturity dates June 15, 2023 June 15, 2025
6. RETIREMENTS OF CONVERTIBLE PREFERRED SECURITIES AND DEBT OBLIGATIONS
The following table summarizes the convertible preferred securities and certain
debt obligations which have been retired through exchanges with Lucent common
stock during fiscal 2002 and the nine months ended June 30, 2003.
Year ended Nine months ended
September 30, June 30,
(shares in millions) 2002 2003 Total
------------------- -------------------- -------------
8% redeemable convertible preferred stock $ 175 $ 767 $ 942
7.75% trust preferred securities - 598 598
------------------- -------------------- -------------
Total convertible securities retired $ 175 $1,365 $1,540
=================== ==================== =============
Debt obligations $ - $ 87 $ 87
=================== ==================== =============
Total shares of Lucent common stock exchanged 58 563 621
=================== ==================== =============
Conversion costs have been recognized in amounts equal to the fair value of the
additional common shares issued to the holders of each respective preferred
security to prompt the exchange over the number of shares of common stock
obligated to be issued pursuant to the original conversion terms of the
respective security.
o The charges for the 8% redeemable convertible preferred stock amounted to
$20 and $286 during the three and nine months ended June 30, 2003,
respectively, and were reflected in the net loss applicable to common
shareowners.
o The charge for the 7.75% trust preferred securities amounted to $129 during
the nine months ended June 30, 2003 and was included in other income
(expense), net.
o Additionally, the gains associated with the exchange of the debt
obligations for Lucent common stock amounted to $6 and $17 during the three
and nine months ended June 30, 2003, respectively, and were included in
other income (expense), net.
Since June 30, 2003 and through August 13, 2003, an additional $68 of 8%
redeemable convertible preferred stock and certain debt obligations with a
carrying value of $167 were retired for $222 of cash. These transactions
resulted in additional other income of $14 and redemption cost of $1 that will
be reflected in the results of the fourth quarter of fiscal 2003.
11 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
7. COMPREHENSIVE LOSS
The components of comprehensive loss are reflected net of tax, except for
foreign currency translation adjustments. Foreign currency translation
adjustments are generally not adjusted for income taxes as they relate to
indefinite investments in certain non-U.S. subsidiaries.
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
-------------- ------------- ------------ ------------
Net loss $(254) $(8,026) $(869) $(8,944)
Other comprehensive loss:
Foreign currency translation adjustments 50 71 108 111
Reclassification adjustments to foreign currency
translation for sale of foreign entities - (6) - (6)
Unrealized holding gains (losses) on investments (1) (1) 42 (20)
Reclassification adjustments for realized gains and
impairment losses on investments (1) 19 (1) -
Unrealized losses and reclassification adjustments
on derivative instruments - - - (10)
------------ ----------- ---------- -----------
Comprehensive loss $(206) $(7,943) $(720) $(8,869)
============ =========== ========== ===========
8. LOSS PER COMMON SHARE
Basic loss per common share is calculated by dividing the net loss applicable to
common shareowners by the weighted average number of common shares outstanding
during the period. Diluted loss per common share is calculated by dividing net
loss applicable to common shareowners, adjusted to exclude preferred dividends
and accretion, conversion costs and interest expense related to the potentially
dilutive securities, by the weighted average number of common shares outstanding
during the period, plus any additional common shares that would have been
outstanding if potentially dilutive common shares had been issued during the
period. Due to the net loss incurred in each of the periods presented, the
diluted loss per share is the same as basic, because any potentially dilutive
securities would reduce the loss per share. The following table summarizes the
potentially dilutive securities:
Three months ended Nine months ended
June 30, June 30,
(in millions) 2003 2002 2003 2002
-------- --------- -------- ---------
8% redeemable convertible preferred stock 504 592 770 428
7.75% trust preferred securities 238 362 285 136
2.75% convertible senior debt 271 - 91 -
Stock options 24 3 11 8
-------- --------- -------- ---------
Total 1,037 957 1,157 572
======== ========= ======== =========
Stock options excluded from the calculation of
diluted loss per share because
the exercise price was greater than the
average market price of the common shares 255 372 315 533
======== ========= ======== =========
The calculation of potential common shares related to the 8% redeemable
convertible preferred stock and the 2.75% convertible senior debt is based upon
the three and nine month average price of Lucent's common stock and the weighted
average number of the respective securities outstanding during the periods
presented due to their redemption feature which allows the Company to settle
certain redemption requests through the issuance of Lucent's common stock.
12 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
9. OPERATING SEGMENTS
Lucent designs and delivers networks for the world's largest communications
service providers. The INS segment sells to global wireline service providers,
including long distance carriers, traditional local telephone companies and
Internet service providers, and provides offerings comprised of a broad range of
software, equipment and services related to voice networking (which primarily
consists of switching products, which we sometimes refer to as convergence
solutions, and voice messaging products), data and network management (which
primarily consists of access and related data networking equipment and operating
support software) and optical networking. The Mobility segment sells to global
wireless service providers and offers products to support the needs of its
customers for radio access and core networks. Lucent supports its segments
through its worldwide services organization. Performance measurement and
resource allocation for the reportable segments are based on many factors. The
primary financial measure is operating income (loss), which includes the
revenues, costs and expenses directly controlled by each reportable segment.
Operating income (loss) for reportable segments excludes the following:
o goodwill impairment and other acquired intangibles amortization;
o business restructuring and asset impairments;
o acquisition/integration-related costs;
o revenues and expenses associated with intellectual property;
o the results of the optical fiber business;
o the results from billing and customer care software products and other
smaller business units;
o certain personnel costs and benefits, including most of those related
to pension and postretirement benefits and differences between the
actual and standard allocated benefit rates;
o certain other costs related to shared services, such as general
corporate functions, which are managed on a common basis in order to
realize economies of scale and efficient use of resources; and
o certain other general and miscellaneous costs and expenses not
directly used in assessing the performance of the operating segments.
The segment results for the prior period have been revised to conform to the
current year's performance measure, which now includes the operating results of
the Messaging product unit. The reportable segments may change in the future if
changes in the Company's management model occur. The accounting policies of the
reportable segments are the same as those applied in the unaudited consolidated
financial statements.
13 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Three months Nine months
ended June 30, ended June 30,
2003 2002 2003 2002
--------- ------------ ----------- ------------
Revenues
INS $ 1,059 $ 1,353 $ 3,123 $ 5,009
Mobility 826 1,505 3,145 4,596
--------- ----------- ----------- ------------
Total reportable segments 1,885 2,858 6,268 9,605
Optical fiber business - - - 114
Other 80 91 175 325
--------- ----------- ----------- ------------
Total revenues $ 1,965 $ 2,949 $ 6,443 $ 10,044
========= =========== =========== ============
Operating income (loss)
INS $ (47) $ (619) $ (257) $ (2,028)
Mobility (56) 200 181 252
--------- ----------- ----------- ------------
Total reportable segments (103) (419) (76) (1,776)
Goodwill and other acquired intangibles amortization (5) (75) (15) (218)
Goodwill impairments (35) (811) (35) (811)
Business restructuring (charges) reversals and asset impairments, net (14) (834) 142 (706)
Optical fiber business - - - (68)
Unallocated personnel costs and benefits 290 371 875 1,194
Shared services such as general corporate functions (338) (393) (1,070) (1,238)
Other (64) (141) (382) (570)
--------- ----------- ----------- ------------
Total operating loss $ (269) $ (2,302) $ (561) $ (4,193)
========= =========== =========== ============
Products and Services Revenues
The table below presents revenues for groups of similar products and
services:
Three months Nine months
ended June 30, ended June 30,
2003 2002 2003 2002
--------------- -------------- -------------- -----------
Wireless $ 624 $ 1,197 $ 2,446 $ 3,763
Voice networking 411 480 1,201 1,673
Data and network management 246 274 771 928
Optical networking 165 267 491 1,090
Services 439 645 1,344 2,161
Optical fiber - - - 114
Other 80 86 190 315
--------------- -------------- -------------- -----------
Total revenues $ 1,965 $ 2,949 $ 6,443 $ 10,044
=============== ============== ============== ===========
Revenues from one customer accounted for approximately 19% to 23% of total
revenues in all interim periods presented. In addition, revenues from another
customer accounted for 10% and 12% of total revenues during the three months
ended June 30, 2003 and 2002, respectively.
10. COMMITMENTS AND CONTINGENCIES
Lucent is subject to legal proceedings, lawsuits, and other claims, including
proceedings by government authorities. In addition, Lucent may be subject to
liabilities to some of its former affiliates under separation agreements with
them. Legal proceedings are subject to uncertainties, and the outcomes are
difficult to predict. Consequently, Lucent is unable to ascertain the ultimate
aggregate amounts of monetary liability or financial impact with respect to
these matters as of June 30, 2003.
14 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Securities and Related Cases
On March 27, 2003, Lucent announced that it had reached an agreement to settle
the assorted securities, ERISA and derivative class action lawsuits and other
lawsuits against Lucent and certain of its current and former directors,
officers and employees. The settlement requires court approval from various
courts before it becomes final. Lucent did not admit any wrongdoing as part of
the settlement.
The agreement is a global settlement of what were 53 separate lawsuits,
including the consolidated shareowner class action lawsuit in the U.S. District
Court in Newark, N.J., and related ERISA, bondholder, derivative, and other
state securities cases. These cases include all the cases described under the
caption "Securities and Related Cases" in Item 3, Part 1 of Lucent's Annual
Report on Form 10-K for the year ended September 30, 2002, as updated by
Lucent's quarterly report on Form 10-Q for the period ended March 31, 2003.
These cases include: In re Lucent Technologies Inc. Securities Litigation; In re
Winstar Communications Securities Litigation; Preferred Life Insurance Co. of
New York et al. v. Lucent Technologies Inc.; Laufer v. Lucent Technologies Inc.,
et al; and Balaban v. Schacht, et al., as well a new case filed during the
second quarter of fiscal 2003, Freund v. Schacht, et al.
Under the settlement agreement, Lucent will pay $315 in common stock, cash or a
combination of both, at Lucent's option. Lucent will also issue warrants to
purchase 200 million shares of Lucent common stock, at an exercise price of
$2.75 per share with an expiration date three years from the date of issuance.
As of June 30, 2003, the value of these warrants, using the Black-Scholes
option-pricing model, was approximately $128. Lucent will pay up to $5 in cash
for the cost of settlement administration.
Lucent expects the settlement approval and claims administration process to last
up to 18 months and does not expect to distribute any proceeds until sometime in
fiscal 2004 or fiscal 2005. Lucent has agreed to deposit into escrow $100 in
cash or securities, or combination of both, of the settlement amount upon the
approval of the settlement by the U.S District Court for the District of New
Jersey in the consolidated case In re Lucent Technologies Inc., Securities
Litigation, the U.S. District Court for the Southern District of New York in In
Re Winstar Communications Securities Litigation and any other required
lower-court approvals. In addition to the cash, stock and warrants that Lucent
will contribute, certain of Lucent's insurance carriers have agreed to pay their
available policy limits of $148 in cash into the total settlement fund. Lucent's
former affiliate, Avaya Inc., is contractually responsible for a portion of the
settlement under its agreements with Lucent. Avaya's contribution to the
settlement is still being determined and, when received by Lucent, will be added
to the total settlement fund described above.
A $415 charge related to the settlement was recognized during the second quarter
of fiscal 2003. An additional $33 charge was recognized during the third quarter
of fiscal 2003 to reflect changes in the fair value of the warrants. Lucent will
seek partial recovery of the settlement amount from its fiduciary insurance
carriers under certain insurance policies that provide coverage up to $70. The
charge may be revised in future quarters if Lucent is able to recover a portion
of the settlement from its fiduciary insurance carriers, as well as to reflect
additional changes in the fair value of the warrants before they are issued.
The definitive documents for settlement are in the process of being prepared and
approved by the parties, and are expected to contain a provision giving Lucent
the right to terminate the settlement if class members who purchased more than
3% of the total shares purchased by all class members during the class period of
any alleged class elect to opt out of the settlement and pursue their claims
directly against Lucent. Any lawsuits that may be brought by parties opting out
of the settlement will need to be defended regardless of whether Lucent elects
to consummate the settlement.
Lucent and certain current and former officers and directors of Lucent are
defendants in an action in the U.S. District Court of New Jersey, Staro Asset
Management, LLC v. Lucent Technologies Inc. et al., alleging violations of the
federal securities laws. The case, which was filed in March 2003, was originally
part of the global settlement referred to above but plaintiff indicated its
desire not to settle and to pursue its claim separately against the defendants.
Lucent has moved to dismiss the complaint.
15 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
SEC Investigation
In November and December 2000, Lucent identified certain revenue recognition
issues that it publicly disclosed and brought to the SEC's attention. On
February 27, 2003, Lucent announced that it had reached an agreement in
principle with the staff of the SEC, which would resolve their investigation of
Lucent. The agreement is subject to final approval by the SEC. Under this
agreement, without admitting or denying any wrongdoing, Lucent would consent to
a settlement enjoining Lucent from future violations of the anti-fraud,
reporting, books and records and internal control provisions of the federal
securities laws. Under the agreement in principle, Lucent would pay no fines or
penalties and would not be required to restate any of its financial statements.
Other Matters
Sparks, et al. v. AT&T and Lucent Technologies Inc. et al., is a class action
lawsuit filed in 1996 in Illinois state court under the name of Crain v. Lucent
Technologies. The plaintiffs requested damages on behalf of present and former
customers based on a claim that the AT&T Consumer Products business (which
became part of Lucent in 1996) and Lucent had defrauded and misled customers who
leased telephones, resulting in payments in excess of the cost to purchase the
telephones. Similar consumer class actions pending in various state courts were
stayed pending the outcome of the Sparks case, and in July 2001, the Illinois
court certified a nationwide class of plaintiffs.
The parties agreed, with court approval in August 2002, to settle the
litigation, and the settlement process is nearly completed. Lucent recognized a
$162 charge in the third fiscal quarter of 2002 and subsequently reversed $80 of
the reserve in the first fiscal quarter of 2003 since the final settlement
amount was significantly less than the original estimate due to the number of
claimants that applied for reimbursement.
Lucent is a defendant in an adversary proceeding filed in U.S. Bankruptcy Court
in Delaware by Winstar and Winstar Wireless, Inc. in connection with the
bankruptcy of Winstar and various related entities. The complaint asserts claims
for breach of contract and other claims against Lucent and seeks compensatory
damages, as well as costs and expenses associated with litigation. The complaint
also seeks recovery of a payment of approximately $190 to Lucent in December
2000.
A description of a special purpose trust previously used to sell customer
finance loans on a limited recourse basis is included in Note 11 under
"Guarantees and Indemnification Agreements". As more fully described therein,
Lucent and an unaffiliated insurer are in dispute regarding credit insurance
coverage.
There are approximately $500 of gross receivables (primarily retention
receivables included in other assets) from long-term projects at June 30, 2003
that have been winding down in Saudi Arabia. Management is in the process of
resolving various contractual claims and counter claims with the customer in
order to collect the retention receivables. There were minimal project revenues
realized during fiscal 2003 and collections on the related receivables slowed
considerably during the past two quarters due to various reasons, including the
political situation in the region. Management believes that the resolution of
these project close out issues will not have an adverse effect on the results of
operations.
On August 8, 2003, National Group for Communications and Computers Ltd. ("NGC")
filed an action in the United States District Court for the Southern District of
New York against Lucent Technologies Inc., Lucent Technologies International
Inc. and an unaffiliated company, alleging violations of the Racketeer
Influenced Corrupt Organizations ("RICO") Act. These allegations relate to
certain activities in Saudi Arabia in connection with certain telecommunications
contracts between Lucent, the Kingdom of Saudi Arabia and other entities. The
complaint seeks damages in excess of $63, which could be trebled pursuant to the
provisions of RICO. The allegations in this complaint appear to arise out of
certain contractual disputes between NGC and Lucent, which are the subject of a
separate case that NGC previously filed against Lucent in United States District
Court for the District of New Jersey. Lucent will defend these actions
vigorously.
Separation Agreements
Lucent is party to various agreements that were entered into in connection with
the separation of Lucent with former affiliates, including AT&T, Avaya, Agere
Systems and NCR Corporation. Pursuant to these agreements, Lucent and the former
affiliates have agreed to allocate certain liabilities related to each other's
business, and have agreed to share liabilities based upon certain allocations
and thresholds. For example, in the Sparks case discussed above, AT&T, Avaya
16 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
and NCR each assumed a portion of the liability for the settlement. Lucent is
not aware of any material liabilities to its former affiliates as a result of
these agreements that are not otherwise reflected in the consolidated financial
statements. Nevertheless, it is possible that potential liabilities for which
the former affiliates bear primary responsibility may lead to contributions by
Lucent.
Avaya is defending three separate purported class action lawsuits, one pending
in state court in West Virginia, one in federal court in the Southern District
of New York and another in federal court in the Southern District of California.
All three actions are based upon claims that Lucent, as predecessor to Avaya's
business, sold products that were not Year 2000 compliant, meaning that the
products were designed and developed without considering the possible impact of
the change in the calendar from December 31, 1999 to January 1, 2000. The
complaints seek, among other remedies, compensatory damages, punitive damages
and counsel fees in amounts that have not yet been specified. Under the
separation agreement with Avaya, Lucent is responsible for 50% of the
liabilities and costs related to these cases that exceed $50. Avaya has informed
us that it currently cannot determine whether the outcome of these actions will
be material or will trigger a Company obligation under the separation agreement.
Other Commitments
Lucent has agreed to purchase 90% of its requirements for products it currently
purchases from Agere and 60% of its requirements for other products that Agere
can supply through September 30, 2006, provided Agere is competitive with other
potential suppliers as to price, delivery interval and technological merit.
Lucent has also agreed to proceed first with Agere on all joint product
development projects where Agere meets Lucent's criteria.
Lucent is generally not committed to unconditional purchase obligations, except
for a commitment that requires annual purchases of certain wireless components
ranging from approximately $225 to $350 over the next three years. Generally,
differences between the actual annual purchases and the committed levels can be
applied to future years through fiscal 2006, at which time Lucent would be
required to pay 25% of the unfulfilled aggregate commitment.
Lucent has exited most of its manufacturing operations and has increased its use
of contract manufacturers. A sole-source supplier is currently used for a
majority of the switching and wireless product lines and a combination of
multiple contract manufacturers for the majority of the other product lines.
Lucent is generally not committed to unconditional purchase obligations in these
contract manufacturing relationships. However, there is exposure to short-term
purchase commitments as they fall within the contract manufacturers' lead-time
of specific products or raw material components. As a result, any sudden and
significant changes in forecasted demand requirements within the lead-time of
those products or raw materials could adversely affect Lucent's results of
operations and cash flows.
Lucent currently outsources certain information technology services from a
supplier under a multi-year agreement which provides for minimum spending levels
of approximately $185 during fiscal 2003 and declines at various amounts to
approximately $40 during fiscal 2006. The agreement also provides for
termination charges of approximately $125 if the agreement is cancelled during
fiscal 2003 and lower termination charges if cancelled thereafter.
Environmental Matters
Current and historical operations are subject to a wide range of environmental
laws. In the United States, these laws often require parties to fund remedial
action regardless of fault. Lucent has remedial and investigatory activities
under way at numerous current and former facilities. Additional information and
background on environmental liabilities and obligations are set forth in the
footnotes to Lucent's consolidated financial statements for the year ended
September 30, 2002.
Environmental reserves of $116 have been provided for remedial and related costs
for which Lucent is or is probably liable and that can be reasonably estimated
as of June 30, 2003. These reserves are not discounted to present value. In
addition, receivables of $46 due from insurance carriers and other third-party
indemnitors have been recognized as of June 30, 2003. Lucent recognizes these
receivables only if the carriers or other indemnitors have agreed to pay the
claims and management believes collection of the receivables is probable. These
environmental matters have not had a significant impact on the results of
operations or changes in financial condition during the nine months ended June
30, 2003 and 2002.
17 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Reserves for estimated losses from environmental remediation are, depending on
the site, based upon analyses of many interrelated factors, including:
o the extent and degree of contamination and the nature of existing required
remedial actions;
o the timing and various types of environmental expenditures such as
investigatory, remedial, capital and operations and maintenance costs;
o applicable legal requirements defining remedial goals and methods;
o progress and stage of existing remedial programs in achieving remedial
goals;
o innovations in remedial technology and expected trends in environmental
costs and legal requirements;
o the number, participation level and financial viability of other
potentially responsible parties;
o the timing and likelihood of potential recoveries or contributions from
other third parties;
o historical experience; and
o the degree of certainty and reliability with respect to all the factors
considered.
It is often difficult to estimate the future impact of environmental matters,
including potential liabilities, due to the above factors and the lengthy time
periods to resolve these environmental matters (which may take up to thirty
years or longer). Although Lucent believes that its reserves are currently
adequate, there can be no assurance that the amount of capital expenditures and
other expenses that will be required relating to remedial actions and compliance
with applicable environmental laws will not exceed the amounts reflected in
reserves or will not have a material adverse effect on Lucent's financial
condition, results of operations or cash flows. Any possible loss or range of
possible loss that may be incurred in excess of amounts provided for as of June
30, 2003, cannot be reasonably estimated.
11. RECENT PRONOUNCEMENTS
Goodwill and Other Intangible Assets
Effective October 1, 2002, SFAS 142 was adopted. Prior to adoption, goodwill and
identifiable intangible assets were amortized on a straight-line basis over
their estimated useful lives. In connection with the adoption of SFAS 142,
goodwill is no longer amortized but tested for impairment upon adoption of SFAS
142 and annually thereafter or more often if an event or circumstance indicates
that an impairment loss has been incurred, by comparing each reporting unit's
fair value to its carrying value. During the first quarter of fiscal 2003, the
initial goodwill impairment test was completed, which resulted in no
transitional impairment loss. In the third quarter of fiscal 2003, an impairment
charge of $35 was recognized, as described below. The next impairment test for
all goodwill is expected to be completed during the fourth quarter of fiscal
2003.
The following table displays a rollforward of the carrying amount of goodwill
from September 30, 2002 to June 30, 2003 by reportable segment:
Acquisition/
September 30, contingency Impairment / June 30,
2002 Reclasses payments amortization Other 2003
-----------------------------------------------------------------------------------------
INS $189 $ 9 $ 5 $ (35) $ 2 $ 170
Mobility 11 - 5 - 16
Other 9 (9) - - -
-----------------------------------------------------------------------------------------
Total goodwill 209 - 10 (35) 2 186
Other intangible assets 15 - 3 (15) - 3
-----------------------------------------------------------------------------------------
Total goodwill and other
Intangible assets $ 224 $ - $ 13 $ (50) $ 2 $ 189
=========================================================================================
On February 3, 2003, the remaining 10% minority interest in AG Communications
Systems Corporation ("AGCS") was purchased for $23, which resulted in an
additional $3 of goodwill and $3 of intangible assets. The amounts allocated to
intangible assets relate to existing technology that will be amortized over its
useful life of three years. In addition, the resolution of certain contingent
consideration related to a prior acquisition resulted in a $7 increase in
goodwill.
18 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Recent business decisions to partner with other suppliers to use their products
in Lucent's sales offerings prompted an assessment of the recoverability of
certain goodwill associated with the multi-service switching reporting unit
within INS during the third quarter of fiscal 2003. The reporting unit's fair
value was determined using projected cash flows over a seven year period
discounted at 15% after considering terminal value and related cash flows
associated with service revenues. The excess of the reporting unit's goodwill
carrying value over its implied fair value was recognized as an impairment
charge in the third quarter of fiscal 2003 in the amount of $35.
The following table presents the net loss and the net loss per basic and diluted
share applicable to common shareowners for the three and nine months ended June
30, 2002, adjusted to exclude goodwill amortization of $55, net of tax, or $0.01
per share, and $156, net of tax, or $0.05 per share, respectively.
Three months ended Nine months ended
June 30, 2002 June 30, 2002
---------------------- ----------------------
Net loss:
As reported $ (8,026) $ (8,944)
Adjusted $ (7,971) $ (8,788)
Basic and diluted loss per share:
As reported $ (2.35) $ (2.65)
Adjusted $ (2.34) $ (2.60)
As of June 30, 2003, identifiable intangible assets consisted of existing
technologies resulting from prior acquisitions. The gross carrying amount and
accumulated amortization of the acquired intangible assets as of June 30, 2003
was $8 and $5, respectively, and as of September 30, 2002 was $144 and $129,
respectively. Amortization of approximately $15 was recognized during the nine
months ended June 30, 2003 and amortization is estimated to be $1 in each of the
next three fiscal years.
Costs Associated with Exit or Disposal Activities
Effective January 1, 2003, SFAS 146 was adopted, which addresses significant
issues regarding the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including restructuring
activities. SFAS 146 requires recognition of a liability for costs associated
with an exit or disposal activity at fair value when the liability is incurred,
or for certain one-time employee termination costs over a future service period.
Previously, a liability for an exit cost was recognized when a company committed
to an exit plan. As a result, SFAS 146 may affect both the timing and amounts of
the recognition of costs associated with future restructuring actions.
Guarantees and Indemnification Agreements
Effective January 1, 2003, the recognition provisions of FASB Interpretation No.
45 ("FIN 45") were adopted, which expands previously issued accounting guidance
for certain guarantees. FIN 45 requires recognition of an initial liability for
the fair value of an obligation assumed by issuing a guarantee and will be
applied on a prospective basis to all guarantees issued or modified after
December 31, 2002. Guarantees issued or modified during the three months ended
June 30, 2003 did not have a material effect on the consolidated financial
statements. A description of the Company's guarantees as of June 30, 2003 is
provided below. The Company is unable to reasonably estimate the maximum amount
that could be payable under certain of these arrangements because the exposures
are not capped, and also due to the conditional nature of the Company's
obligations and the unique facts and circumstances involved in each particular
agreement. Historically, payments made under these agreements did not have a
material effect on the Company's business, financial condition or results of
operations other than certain guarantee payments made in connection with the
customer financing arrangements discussed below.
Lucent guarantees the financing of certain product purchases by certain
customers. Requests for providing such guarantees are reviewed and approved by
senior management and regularly reviewed by them in assessing the adequacy of
reserves. The principal amount of drawn customer financing guarantees and
related reserves was $157 and $116, respectively, as of June 30, 2003. The
remaining guarantee periods range from three months to seven years. In addition,
$42 of commitments are available to customers from third party lenders that may
expire undrawn. Lucent is required to perform under these guarantees upon a
customer's default for non-payment to the creditor and typically retains a
first-loss position. Lucent will
19 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
generally have the right to recover from the defaulting party through
subrogation, but usually only after the creditor has been paid in full.
Lucent has divested certain businesses and assets through sales to third party
purchasers and spin-offs to its common shareowners. In connection with these
transactions, certain direct or indirect indemnifications are provided to the
buyers or other third parties doing business with the divested entities. These
indemnifications include secondary liability for certain leases of real property
and equipment assigned to the divested entity and certain specific
indemnifications for certain legal and environmental contingencies and vendor
supply commitments. The time duration of such indemnifications vary, but are
standard for transactions of this nature, and some may be indefinite.
Lucent remains secondarily liable for approximately $315 of lease obligations as
of June 30, 2003 that were assigned to Avaya, Agere, and purchasers of other
businesses in the event of default by the assignee. The remaining terms of these
assigned leases and Lucent's corresponding guarantee range from one month to 16
years. The primary obligor under assigned leases may terminate or restructure
the lease obligation before its original maturity and, thereby, relieve Lucent
of its secondary liability. Lucent generally has the right to receive indemnity
or reimbursement from the assignees and has not reserved for losses on this form
of guarantee.
Lucent is a party to a tax sharing agreement to indemnify AT&T and is liable for
tax adjustments that are attributable to its lines of business as well as a
portion of certain other shared tax adjustments during the years prior to
separation from AT&T. Certain tax adjustments have been proposed or assessed
subject to this tax sharing agreement. The outcome of these matters is not
expected to have a material effect on the consolidated results of operations,
consolidated financial position or near-term liquidity. Lucent has similar
agreements with Avaya and Agere, but does not expect to have any material
liabilities under these agreements.
Lucent licenses to its customers software and rights to use intellectual
property that might provide the licensees with an indemnification against any
liability arising from third-party claims of patent, copyright or trademark
infringement. Lucent cannot determine the maximum amount of losses that it could
incur under this type of indemnification because it often may not have enough
information about the nature and scope of an infringement claim until it has
been submitted to the Company.
Lucent indemnifies its directors and certain of its current and former officers
for third party claims alleging certain breaches of their fiduciary duties as
directors or officers. Certain costs incurred for providing such indemnification
may be recovered under various insurance policies.
Warranty reserves are established for costs that are expected to be incurred
after the sale and delivery of a product or service for deficiencies under
specific product or service warranty provisions. The warranty reserves are
determined as a percentage of revenues based on the actual trend of historical
charges incurred over various periods, excluding any significant or infrequent
issues that are specifically identified and reserved. The warranty liability is
established when it is probable that customers will make claims and when a
reasonable estimate of costs can be made. During fiscal 2003, warranties
associated with certain optical fiber products associated with the optical fiber
business sold in fiscal 2002 expired, resulting in a reduction in reserves. The
following table summarizes the activity related to warranty reserves for the
current nine-month period.
Nine months ended
June 30, 2003
-----------------------
Warranty reserve as of October 1, 2002 $ 440
Accruals for warranties 98
Payments (176)
Optical Fiber business adjustment (15)
-----
Warranty reserve as of June 30, 2003 $ 347
=====
20 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
In September 2000, Lucent and a third party created a non-consolidated Special
Purpose Trust (the "Trust") to which Lucent sold on a limited-recourse basis
customer finance loans and receivables. The Trust held loans relating to five
obligors, all of which were in default. The Trust has a credit insurance policy
from an unaffiliated insurance company insuring the Trust against losses on
these loans. Through reinsurance treaties, Lucent's wholly-owned captive
insurance company assumed the risk under this policy for the loans and reinsured
a significant amount of the exposure with an unaffiliated insurer. Lucent
ultimately expects that its captive insurance company will fund $50 of remaining
first loss obligations and that the unaffiliated insurance company will fund
$298 of its reinsurance obligation (which has been reflected as a receivable in
other assets at June 30, 2003).
In April 2003, written notice was received from the unaffiliated insurer denying
claims and coverage of certain loans in the Trust with an aggregate principal
balance of approximately $175. The insurer has subsequently denied coverage on
the remaining loans in the Trust. The insurer alleged, among other claims, that
the loans were not eligible to be sold to the Trust due to their credit quality
at the time of sale. The insurer stated that it would cease paying claims on
these loans and requested that it be reimbursed for all claims previously paid
and that Lucent repurchase the loans. The amount previously paid to the Trust
under the insurance policy was funded by Lucent's captive insurance company.
Lucent disputes the assertions by the insurer and is pursuing binding
arbitration to resolve the matter.
If the insurer prevails on its denial of coverage, Lucent will be required to
indemnify the Trust and the Trust's lenders and investors for the amount of
coverage denied and the funds returned to the insurer, as well as be required to
recognize a charge for the amount of the denied coverage. In addition, Lucent
has agreed to advance funds to the Trust to cover their principal and interest
payments and fees as they become due until resolution of the dispute with the
insurer. Absent favorable resolution of the dispute, the funding requirements
are approximately $40 during the remainder of fiscal 2003, $90 in fiscal 2004
and $216 thereafter.
Variable Interest Entities ("VIEs")
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46 ("FIN 46"), requiring the consolidation of certain
variable interest entities. In general, a variable interest entity is a
corporation, partnership, trust or other legal structure used for business
purposes that either does not have equity investors with voting rights or lacks
sufficient financial resources to support its activities. Prior to the issuance
of FIN 46, VIE's were more commonly referred to as special-purpose entities or
off-balance sheet arrangements. A company must consolidate the VIE if it is
determined to be the VIE's primary beneficiary that stands to share in the
majority of the VIE's expected losses or expected residual returns.
In the ordinary course of business, Lucent occasionally engages in relationships
with VIE's and holds variable interests in other entities. Lucent is the primary
beneficiary of the Trust described above and has consolidated the Trust during
the third quarter of fiscal 2003, which resulted in additional debt and minority
interest of approximately $300 and a corresponding reduction to a previously
established self-insured loss reserve related to the customer finance loans held
by the Trust which are in default. The Trust is expected to be dissolved upon
resolution of the defaulted assets matter as described above.
Revenue Arrangements with Multiple Deliverables
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus
regarding EITF Issue 00-21. The consensus addresses not only when and how an
arrangement involving multiple deliverables should be divided into separate
elements of accounting but also how the arrangement's consideration should be
allocated among separate units. The pronouncement is effective for revenue
arrangements entered into on or after July 1, 2003 and is not expected to
materially affect the consolidated financial statements.
Derivative Instruments and Hedging Activities
In May 2003, the FASB issued SFAS 149 that amends SFAS 133 on the accounting and
reporting of derivative instruments and hedging activities to incorporate
certain conclusions reached by the FASB's Derivatives Implementation Group and
to provide further clarification on the definition of a derivative. SFAS 149 is
effective for derivative contracts entered into or modified after June 30, 2003
and is not expected to materially affect the consolidated financial statements.
21 Form 10-Q - Part I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
Financial Instruments with Characteristics of both Liabilities and Equity
In May 2003, the FASB issued SFAS 150, which establishes rules for the
accounting for certain financial instruments with characteristics of
liabilities, equity or both. These types of financial instruments have been
reported as liabilities, as part of equity, or in the mezzanine section in the
balance sheet and include mandatorily redeemable instruments, certain
instruments with an obligation to repurchase an issuer's own equity shares and
instruments with obligations for an issuer to settle in a variable number of its
own equity shares.
Due to its conversion feature, Lucent's 8% redeemable convertible preferred
stock is a conditional redeemable obligation and is outside the scope of SFAS
150 and shall continue to be classified in the mezzanine section of the
consolidated balance sheet. The FASB intends to provide further accounting
guidance on conditional redeemable instruments at a later date. SFAS 150 was
adopted on July 1, 2003 and is not expected to materially affect the
consolidated financial statements.
22 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Results of Operations and Financial
Condition ("MD&A") contains forward-looking statements that are based on current
expectations, estimates, forecasts and projections about us, our future
performance, the industries in which we operate, our beliefs and our
management's assumptions. In addition, other written or oral statements that
constitute forward-looking statements may be made by or on behalf of us. Words
such as "expects," "anticipates," "targets," "goals," "projects," "intends,"
"plans," "believes," "seeks," "estimates" and variations of such words and
similar expressions are intended to identify such forward-looking statements.
These statements are not guarantees of future performance and involve certain
risks, uncertainties and assumptions that are difficult to predict. Therefore,
actual outcomes and results may differ materially from what is expressed or
forecast in such forward-looking statements. These risks and uncertainties
include: the failure of the telecommunications market to improve or improve at
the pace we anticipate; continued net losses may reduce or impair our legally
available surplus; our ability to realize the benefits we expect from our
strategic direction and restructuring program; our ability to secure additional
sources of funds on reasonable terms; our credit ratings; our ability to compete
effectively; our reliance on a limited number of key customers; our exposure to
the credit risk of our customers as a result of our vendor financing
arrangements and accounts receivable; our reliance on third parties to
manufacture most of our products; the cost and other risks inherent in our
long-term sales agreements or long-term projects; our product portfolio and
ability to keep pace with technological advances in our industry; the complexity
of our products; our ability to retain and recruit key personnel; existing and
future litigation; our ability to protect our intellectual property rights and
the expenses we may incur in defending such rights; changes in environmental
health and safety law; changes to existing regulations or technical standards;
the social, political and economic risks of our foreign operations; and the
costs and risks associated with our pension and postretirement benefit
obligations. For a further list and description of such risks and uncertainties,
see our Annual Report on Form 10-K for the year ended September 30, 2002. Except
as otherwise required under federal securities laws and the rules and
regulations of the SEC, we do not have any intention or obligation to update
publicly any forward-looking statements after the distribution of this MD&A,
whether as a result of new information, future events, changes in assumptions or
otherwise.
OVERVIEW
We design and deliver networks for the world's largest communications service
providers. Backed by Bell Labs research and development, we rely on our
strengths in mobility, optical, data and voice networking technologies, as well
as software and services, to develop next-generation networks. Our systems,
services and software are designed to help customers quickly deploy and better
manage their networks and create new, revenue-generating services that help
businesses and consumers.
The global telecommunications market declined during 2002 as service providers
reduced spending to preserve capital and improve cash flow and has continued to
decline during 2003. Reasons for the reductions include the general economic
slowdown, network overcapacity, customer bankruptcies, network build-out delays
and limited availability of capital. As a result, our sales and results of
operations have been and may continue to be adversely affected. The significant
slowdown in capital spending has created uncertainty as to the level and timing
of demand in our target markets. The level of demand can change quickly and can
vary over short periods of time, including from month to month. As a result of
the uncertainty in our markets, accurately forecasting near- and long-term
results, earnings and cash flow remains difficult. In addition, since a limited
number of customers account for a significant amount of revenue, our results are
subject to volatility from changes in spending by one or more of our significant
customers.
During this prolonged market downturn, we are working closely with our customers
to position the full breadth of our products and services, significantly
reducing our cost structure and reducing our quarterly earnings per share
("EPS") breakeven revenue figure. If the telecommunications market continues to
decline, or does not improve or improves at a slower pace than we anticipate,
our revenues and profitability will continue to be adversely affected and
additional restructuring actions may be undertaken to further reduce costs,
which may result in additional charges. Our revenues declined by 36% during the
nine months ended June 30, 2003, which exceeded our annual planning assumptions.
However, as expected, our results of operations for the first nine months of
fiscal 2003 have improved by realizing higher gross margin rates and lower
operating expenses resulting from lower restructuring charges and asset
impairments, cost reductions as a result of our restructuring actions, favorable
product mix, lower inventory-related and other charges, and lower provisions for
bad debts and customer financings.
23 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are based on the selection of accounting
policies and application of significant accounting estimates, which require
management to make significant estimates and assumptions. We believe that some
of the more critical judgments in the areas of accounting estimates and
assumptions that affect our financial condition and results of operations are
related to revenue recognition, receivables and customer financing, inventories,
income taxes, intangible assets, pension and post-retirement benefits, business
restructuring and legal contingencies. For a detailed discussion of our critical
accounting estimates please refer to our Annual Report on Form 10-K for the year
ended September 30, 2002. There were no material changes in the application of
our critical accounting estimates subsequent to that report. In addition, please
refer to Note 11 to our unaudited consolidated financial statements for a
discussion of recent pronouncements. We have discussed the application of these
critical accounting estimates with our Board of Directors and Audit and Finance
Committee.
Some of the critical judgments used in accounting estimates that have
significantly impacted our interim fiscal 2003 results are discussed throughout
this report on Form 10-Q. These judgments include our expectations on:
o the future cash flows that were used in determining the realizability
of certain assets;
o the timing and amount of potential proceeds related to the sale of
certain facilities;
o the legal settlement of our securities and related cases, including
the estimated fair value of the warrants expected to be issued in
connection therewith;
o the favorable resolution of certain income tax audit matters and
refundable federal income taxes;
o the favorable resolution of a dispute with an insurer regarding the
coverage of certain customer finance loans held in the Trust; and
o the favorable resolution of contract closeout procedures related to a
long-term project in Saudi Arabia.
The following update is related to our pension and postretirement benefits.
Excluding the impact of business restructuring actions, our net pension and
postretirement benefit credit is expected to be reduced from $972 million during
fiscal 2002 to approximately $700 million during fiscal 2003. The net pension
and postretirement credit reflected in the nine months ended June 30, 2003 was
$488 million compared to $719 million in the comparable prior period.
Approximately two-thirds of these amounts are reflected in operating expenses
and the balance in costs. The reduction in the net pension and postretirement
credit is primarily a result of lower plan assets, a reduction in the discount
rate from 7.0% to 6.5%, a reduction in the expected return on plan assets from
9.0% to 8.75% for pensions and from 9.0% to 7.93% for postretirement benefits
during fiscal 2003 and plan amendments related to certain retiree benefits.
During the first quarter of fiscal 2003 certain retiree death benefits were
eliminated, which reduced future pension obligations by approximately $450
million.
We considered the available yields on high-quality fixed-income investments with
maturities corresponding to our benefit obligations to develop our discount
rate. We also considered the historical long-term asset return experience, the
expected investment portfolio mix of the plans' assets and an estimate of
long-term investment returns to develop our expected return on plan assets. Our
expected portfolio mix of plan assets considers the duration of the plan
liabilities and has been more heavily weighted towards equity positions,
including public and private equity investments and real estate, rather than
fixed-income securities. The expected return on plan assets is determined using
the expected rate of return and a calculated value of assets referred to as the
"market-related value." The aggregate market-related value of pension and
postretirement plan assets was $41 billion at September 30, 2002, which exceeded
the fair value of plan assets by $10 billion. Differences between the assumed
and actual returns are reflected in the market-related value on a straight-line
basis over a five-year period. The amortization of these differences, including
those resulting from the actual losses incurred during fiscal 2002 and 2001,
will continue to reduce the market-related value through fiscal 2006. Gains and
losses resulting from changes in these assumptions and from differences between
assumptions and actual experience (except those differences not yet recognized
in the market-related value) are amortized over the remaining service lives to
the extent they exceed 10% of the higher of the market-related value or the
projected benefit obligation of each respective plan.
Holding all other assumptions constant, a one-half percent increase or decrease
in the discount rate would decrease or increase the annual fiscal 2003 net
pension and postretirement credit by approximately $50 million. Likewise, a
one-half percent increase or decrease in the expected return on plan assets
would increase or decrease the annual fiscal 2003 net pension and postretirement
credit by approximately $200 million.
24 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The estimated accumulated benefit obligation related to the U.S. management
employees pension plan and several other smaller pension plans, exceeded the
fair value of the plan assets at September 30, 2002. This was due primarily to
negative returns on the pension funds as a result of the overall decline in the
equity markets and a decline in the discount rate used to estimate the pension
liability as a result of declining interest rates in the U.S. As a result, we
recognized a $2.9 billion direct charge to equity for minimum pension
liabilities during the fourth quarter of fiscal 2002. We will complete the next
measurement of our pension plan assets and obligations during the fourth quarter
of fiscal 2003, at which time it is likely that the minimum pension liabilities
will be adjusted. Any adjustment will result in either an increase or decrease
in shareowners' deficit depending upon plan asset performance and the discount
rate to be used in measuring the obligation. It is difficult to predict these
factors due to highly volatile market conditions. Assuming that the plan asset
values are not significantly different at September 30, 2003 from June 30, 2003,
and no change in the 6.5% discount rate, an additional direct charge to equity
for minimum pension liabilities of approximately $300 million would be required.
In addition, a one-half percent decrease or increase in the discount rate would
further increase or decrease the minimum pension liabilities by approximately
$800 million.
CONSOLIDATED RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED JUNE 30, 2003
VERSUS THREE AND NINE MONTHS ENDED JUNE 30, 2002
Revenues
As discussed in the Overview of this MD&A, the significant reduction in capital
spending by large service providers was the primary reason for the 33% and 36%
decline in revenues in the three and nine months ended June 30, 2003 as compared
with the three and nine months ended June 30, 2002. Beginning with the third
quarter of fiscal 2001, our quarterly revenues have declined sequentially,
except for the three months ended March 31, 2003. The sequential decline in the
current quarter was primarily related to spending reductions in wireless
products in the U.S. and an unexpected network acceptance delay from a non-U.S.
customer. The impact of product rationalizations and discontinuances under our
restructuring program has not had a significant effect on our overall reduction
of revenues. Our revenues by segment are summarized in the following table
(dollars in millions). Refer to the segment discussion later in this MD&A for
additional information on changes in segment revenues.
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
------------- ------------- -------------- ------------
INS $ 1,059 54% $ 1,353 46% $ 3,123 48% $ 5,009 50%
Mobility 826 42% 1,505 51% 3,145 49% 4,596 46%
Other 80 4% 91 3% 175 3% 439 4%
------------- ------------- -------------- ------------
Total revenues $ 1,965 100% $ 2,949 100% $ 6,443 100% $ 10,044 100%
============= ============= ============== ============
The following table presents regional revenues (dollars in millions):
Three months ended June 30, Nine months ended June 30,
2003 2002 2003 2002
---------------- ------------- ------------- ------------
U.S. $ 1,202 $ 2,049 $ 3,914 $ 6,761
Other Americas (Canada, Central & Latin America) 98 166 314 567
EMEA (Europe, Middle East & Africa) 295 377 867 1,360
APAC (Asia Pacific & China) 370 357 1,348 1,356
---------------- ------------- ------------- ------------
Total revenues $ 1,965 $ 2,949 $ 6,443 $10,044
================ ============= ============= ============
Our U.S. and Other Americas revenues declined from the comparable three and nine
month periods within a range of 41% to 45%. The revenue declines in both periods
were primarily the result of customer spending reductions, primarily with large
service providers in the U.S. EMEA revenues declined by 22% and 36% as compared
with the prior three and nine month periods primarily due to continued lower
spending for optical products as customers are dealing with overcapacity issues
and, to a lesser extent, lower revenues in the Middle East region, largely due
to the unstable political environment. Revenues for the APAC region have been
relatively constant as compared with the prior periods due to new CDMA Wireless
network build-outs in India and ongoing build-outs in China. The proportion of
our U.S. revenues to total revenues declined to 61% from 67% for the nine months
ended June 30, 2003 as compared to the prior period.
25 Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The decline in revenue during the three months ended June 30, 2003 from the
comparable prior period occurred both in terms of product revenues (34%) and
service revenues (32%). The decrease in product revenue occurred in all product
lines including wireless (48%), voice networking (14%), data and network
management (10%) and optical networking (38%). Wireless product revenue declines
are attributable to reductions in TDMA infrastructure spending as two of our
customers have selected alternatives to this technology which we do not provide;
delayed UMTS deployments; and the timing of customer spending patterns. Optical
networking product declines were more severe than other wireline products due to
network overcapacity and delays in customer spending on next generation
products. The $206 million decline in service revenues was primarily due to
lower engineering and installation activity, primarily in support of INS
customers. Total service revenues supporting INS customers decreased by $130
million, or 30%, to $298 million, primarily within the U.S.
The decline in revenue during the nine months ended June 30, 2003 from the
comparable prior period occurred both in terms of product revenues (35%) and
service revenues (38%). The decrease in product revenue occurred in all product
lines including wireless (35%), voice networking (28%), data and network
management (17%) and optical networking (55%). The declines in certain product
revenues during the nine-month period were due to the reasons noted in the
three-month explanation above. The $817 million decline in service revenue was
primarily due to lower engineering and installation activity, primarily in
support of INS customers. Total service revenues supporting INS customers
decreased by $612 million, or 41%, to $876 million, primarily within the U.S.
Gross Margin
The following table presents our gross margin and the percentage to total
revenues (dollars in millions):
Three months ended Nine months ended
June 30, June 30,
2003 2002 2003 2002
--------------- ----------- ------------- --------------
Gross margin $ 573 $651 $ 1,789 $ 1,888
Gross margin rate 29.2% 22.1% 27.8% 18.8%
Despite significantly lower sales volume, the gross margin rate increased by
approximately seven and nine percentage points during the three and nine months
ended June 30, 2003, respectively, from the comparable prior periods. Inventory
and other charges unfavorably affected the gross margin rate in the current
fiscal 2003 periods by approximately four percentage points and in the prior
fiscal 2002 periods b