Source: Seeking Alpha
Alcatel-Lucent SA (NYSE:ALU)
Q2 2014 Results Earnings Conference Call
July 31, 2014; 07:00 a.m. ET
Michel Combes – Chief Executive Officer
Jean Raby – Chief Financial Officer
Ehud Gelblum – Citigroup
Gareth Jenkins – UBS
Achal Sultania – Credit Suisse
Alexander Peterc – Exane BNP Paribas
Sandeep Deshpande – JPMorgan
Francois Meunier – Morgan Stanley
Stuart Jeffrey – Nomura
Welcome to the Alcatel Lucent press and analyst conference. We leave the floor to Michel Combes.
Michel Combes – Chief Executive Officer
Okay. Good morning and good afternoon to everyone. Thank you for joining us on the call to discuss Alcatel Lucent’s Q2 and H1, 2014 results. As usual, I will start by presenting an overview of our results and our activity before handing over to Jean Raby for a detailed financial review.
Let me start with some introductory remarks on the key developments we observed during Q2 and the first half of the year. First, from a near term market standpoint, we saw operators intensifying their focus on wireless access, pushed by LTE deployments. We perceived this on a broad base, although with somewhat more vigor in North America and in China.
This movement has clearly favored our access segment, notably our wireless access business, which recorded both year-on-year and quarter-on-quarter growth in the neighborhood of 30% in Q2. Such an increase was fueled by coverage and capacity projects.
More specifically in LTE and Small Cells, the two areas where we decided to place our bets, our revenues more than doubled over the first half, while almost tripling in Q2 alone. Meanwhile, demand for high broadband access also led our fixed business to enjoy a solid quarter in revenues and in profitability.
On the other hand, revenue performance in core networking was a bit more mixed. IP routing was down 7% on a very high conversion basis, which I had flagged on various occasions. I will repeat what I say every quarter, namely that one should not over read a single quarter performance, given the viability we may and have already experienced.
To put things into context, Q2, 2014 stands among the top three quarters in routing revenue history. Performance in IT transport and platforms, with revenues also down year-over-year was to a large extent a function of continued transition of the business mix from Legacy to new generation of products and technologies and which by the way end up in an improvement of the profitability of this segment.
The key item I want to stress is profitability. While business mix was skewed towards access in Q2, profitability continued to improve significantly and this is really what I have focused on. This is essentially the result of our relentless focus on costs. At the end of Q2 we have achieved close to 60% of our fixed cost saving targets and our operating income was multiplied by three to EUR136 million.
It is also important to mention that while there may be some temporary movements in operators spending, underlying market fundamentals remain intact. It is our belief that the current spin towards wireless can only be temporary and cannot go without investments in backhaul and core, as the same long term dynamics remains in play, namely the data traffic tsunami if I may call it that way.
To be absolutely 100% clear, I reiterate our EUR7 billion target for core network revenue in 2015 and operating margin of 12.5%, compared to an operating margin for the segment in H1 2014 of 8% and an operating margin for the very same segment in H1 2013 of 4.3%. So we have a sequence which drives us without any issue to the 12.5% that I have mentioned.
Moving to the next slide, this is the fourth quarter since we announced The Shift Plan and this is now the fourth consecutive quarter of constant delivery, which I guess is very critical for an enterprise which is in a recovery story.
First, revenues excluding Managed Services grew 5% in Q2 year-on-year. Second, profitability continued to improve meaningfully, notably gross margin which recorded a gain of 140 basis points to 32.6%, which allows us to post a 32.4% margin on H1 compared to 29.8% margin on H1 last year, and adjusted operating profit which totaled to EUR136 million as I have already mentioned, giving a margin of 4.1%. In total, over the first half, the operating profit increased by an amount exceeding EUR300 million compared to last year.
Third, cost savings of EUR94 million were achieved in Q2, bringing the cumulative amounts since 2013 to a total of EUR572 million. We have now covered close to 60% of the way for our 2015 plan and continue to feel confident that we will hit our savings goal.
This translated into substantial progress in segment operating cash flow. We have a positive segment operating cash flow of close to EUR100 million generated in Q2, up from a negative EUR41 million last year and representing 71% of operating income.
Regarding the Access segment, the outflow of EUR9 million in Q2 was reduced by a more than EUR100 million compared to last year, demonstrating that we are on the right path towards reaching to cash generation as we are committed to do.
Finally, net cash outflow continued to contract, reflecting the operating profit improvement and also valuable compensation, paid in 2014 on the account of 2013. For the record, there has been zero payments in 2012.
Moving to the next slide, I will now provide an overview of our repositioning on IP, cloud and ultra broadband access. Starting with the commercial successes gained across our business line.
IP routing: In addition to our sustained strength in Edge, we continued to progress in core routers, registering four more wins in Q2, including with a major European service provider, bringing the total to eight wins over the first half.
Terrestrial optics: Traction with our 1830 platform continued with more than 480 customers at the end of the first half and already more than 15,000 ports shipped in 100G. Over the first half our 1830 platform represented 43% of optical revenue, compared to 33% last year.
The cloud and virtualization spaces, our SDN solution with Nuage added three commercial wins in Q2, bringing the total to eight at the end of June and momentum continued as well on the NAV front, with more than 55 proof of concepts and trials, including first deployments of virtual RAN software at Mobiliy.
Moving to ultra broadband access, we recorded several important wins in LTE overlay and now manage 55 contracts. Meanwhile small sales momentum remains strong with a total of 71 customers at the end of June.
Fixed Access had a very good first half and continued to add new customers in both copper with VDSL2 vectoring and fiber. So as you can see, commercial traction in the first half was solid, broadly based and aligned with the refocus of our product portfolio.
I would now like to talk about our footprint and our progress with customers. Two things here to gauge our developments. First, the extension of customer reach within our traditional addressable area, meaning the service providers.
Let me highlight a few of our recent wins, including AT&A adding us to their user defined network cloud supplier program, known previously as their Domain 2.0 supplier program, hence extending our long standing relationship with AT&T to the next generation network.
Several wins in virtualization and SDN with notably but also Telefonica, China Mobile, NTT DoCoMo and as I said earlier on, Mobiliy in Saudi Arabia. Good traction in IP core. We have Chorus in New Zealand, Elisa and several others that are not public, including a very major one in Europe. We were recently selected by Vodafone in small cells and added several LTE wins.
Second important building block of our strategy, is diversification outside the service provider space, by addressing new customers, including cable operators and large stake enterprise, including web scale players, as well as adjacent segments.
There it is a complete new territory that we have started to explore. It does take time to make sure to be relevant and have the right product, define the right go-to-market, have wins and start to get traction. In that respect, we are putting the appropriate means and resources to be successful and we already have registered some positive return.
In particular, we recorded first wins in the cable segments for both IP routing, but also Fixed Access and started to extend into the web-scale space. In addition for Nuage, we are able to address the data center area and completely a new set of customers, including but not limited to financial institutions.
Moving now to innovation. We are intensifying our activity as illustrated by these charts that sums up key announcements made throughout the first half of the year. I will give color on just some of them.
As part of the Shift Plan we developed several partnerships as you already know. Our partnership with Qualcomm was announced in September last year and according to plan; we shipped our first small cells in the first half of this year. So it’s not about only announcing, but it’s also about coming in the market in due course, which is very promising.
We announced a partnership with Intel for the virtualization and more recently with Thales in the domain of Cyber Security. We also made two small investments; one, the EBlink started to compliment the distribution architecture of the small cells and one in counter attack around network security.
Looking at our move to the cloud and to the virtualization, you may remember that we had announced a suite of virtualized functions; some already deployed at customers like the virtualized run to Mobiliy. As to our new OSS portfolio, it will also enable us to harness the benefits of cloud technologies with a totally new approach to automating our customers operations.
For Bell Labs, as I said a year ago, we want to have a new engagement model, be closer to our portfolio lifecycle and to innovate its speed and scale. To that purpose, we have recently opened two new Bell Labs locations; one is Tel Aviv, in Israel in the cloud theme and one in Cambridge in the U.K., where we leverage our expertise in video, inherited from the former acquisition of Velocix. Another opening is contemplating in Mountain View in the coming months.
We received a number of prices and awards during the first half. This reflects high quality of our R&D teams and it further encourages to continue focusing on innovation by expanding the role of Bell Labs.
Turning now to the second pillar of shift, restructuring. Let me take you a step back and look at the turnaround in wireless, which is I guess quite illustrative of what we are achieving within the company.
As you know, with the announcement of the Shift Plan last year, we decided to make the best of focusing on 4G and small cells, while at the same time dramatically reshuffle the cost structure, in order to bring the activity back on the path of profitability. Halfway through the Shift Plan I can report very good progress of the turnaround.
First, the best on 4G LTE overlay and small cells resonates well with customers as demonstrated by our commercial traction in North America, China, but also in EMEA and by revenue momentum recorded over the last four quarters.
Second, and this is the absolute priority. Profitability has been in constant improvement over the last quarters on the back of continued cost reduction. SG&A expenses were cut by 12% in the first half; reorganization of R&D spending and notably the increased focus on 4G and small cells.
Over the first half these two technologies represented more than 70% of R&D investments, compared to 60% last year. In addition as you know, we entered into an agreement with HCL to outsource R&D on 2G, 3G.
In total, the message I want to convey today is the message of confidence regarding the execution of the wireless turnaround. We are definitely on the right path to bring the business back into profitable territory by the end of 2015, once all the measures that I have just mentioned will be fully implemented; the last one being when we’ll get the full benefit of the outsourcing of the 2G, 3G that we have just announced.
Now turning to patents, which is also an important piece of the strategy. The planned reimbursement of the secured loan in August is a decisive milestone in Alcatel-Lucent’s turnaround story. By allowing us to regain the full ownership of our patents, it signals to a certain extent the closing of the balance sheet normalization sequence.
We firmly believe that there is a lot of value within our patent portfolio as some of our peers have demonstrated. However, as you know, we inherited from a complex situation and had to restart the business from zero last year. We have delivered on our first commitments, but recognize that ramping up the licensing activity is a lengthy process, requiring notably the right go-to-market approach. We will take the time necessary to extract the base value from our patent portfolio.
In order to achieve this goal, I have the pleasure to announce today, that we will shortly be joined by Laura Quatela. Laura will lead our monetization strategy, bringing a proven track record in IP management, notably in her role as senior executive of Kodak, where she successfully managed the intellectual property of the group, and leveraging on the resources from the IP firm she co-founded. I will personally oversee this role in order to make sure that we deliver as we should in this space.