Alcatel-Lucent (ALU) CEO Michel Combes on Q2 2014 Results – Earnings Call Transcript

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.

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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.

Turning now to Submarine Cable. Let me tell you right away, it is a strategic decision that we are announcing today. This is not an alternative plan. There is obviously plenty of interest for that business, but we believe it is part and parcel of the group, and we want to grow this activity and to get the benefit of the value creation of this activity.

As you know, ASN is an integrated leader in the telecommunication submarine cables. Integrated means that we design and manufacture the cables, and we also have the marine capabilities to lay and maintain them. In that business our ASN subsidiary is providing to our customers parts of its repeated submarine cables up to 12,000 kilometers; unrepeated submarine cables for regional connections; system upgrades, notably to 100G activating capacity over existing cable systems; and marine maintenance services.

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For telecom customers, the demand is driven by capacity and connectivity needs. After the lows of 2013, this telecom activity is recovering and we signed several important wins in the last month, such as Sea-Me-We 5 or EASSy along the African coast.

We intend to reinforce that leadership that ASN has built over the years, as we are clearly the leader on a worldwide basis, and to support its expansion to seize new market opportunities, notably in the oil and gas domain, where we have already recorded early wins like the one recently announced with NextGen, to connect oil and gas production facilities in Northwest of Australia, meaning through communication services, of course to connect those platforms and we foresee market opportunity of the same size as in telecommunication cable, in the oil and gas domain.

Majors in the oil and gas industry now expect to have broadband access for their offshore platforms. Besides we started helping those majors in their subsea engineering operations when wet systems are used. In this context, we are looking at potential investment opportunities to enhance our technology offering and expand ASN integrated solutions portfolio in the oil and gas domain.

We are already in exclusive discussions for the acquisition of a key technology to expand our scope of capabilities for oil and gas offshore. Considering that industrial project, and notably to finance its business development and its diversification, we are then announcing today that we explore the ASN capital opening through an IPO. Such transactions will also increase ASN visibility and optimize capital allocation. We will retain the majority of ownership. Subject to market conditions, we contemplate that IPO to take place first half of 2015.

To conclude, after a full year since we announced Shift, Alcatel-Lucent is in much better shape financially and the turnaround is well on track. As I indicated earlier, with the reimbursement of the secured loan, an important milestone has been passed, and we can now close the first chapter of Shift, which was centered around three priorities:

Defining our playing fields, meaning redefining our product scope, our service strategy and addressable markets. Restructuring; meaning redefining our operating model and setting an aggressive cost reduction plan. Refinancing; meaning fixing our balance sheets. Refinancing is done and now behind us, while restructuring is well underway.

On the first piece, our repositioning is clear and well understood by the customers. We are not yet where we would like to be in terms of diversification of the customer base, but resources have been mobilized and we are in a position to accelerate. Importantly, we are now starting to attract new talents and can address those new areas.

So we are in a position now to open the second chapter of Shift, which focuses on three axes: Innovation: this is all about how we can keep the lead, accelerate the innovation pipeline and enrich our product portfolio. Transformation: with the aim of being lean, agile and constantly adapt to a moving environment. This piece is about culture and processes, with a focus on operational excellence. Growth: with the aim of unlocking growth and expanding our footprint.

In all, I am very confident that Alcatel-Lucent is on the right path to execute its transformation plan and return to profitable growth and free cash flow generation. So I reiterate obviously all our commitments, but namely to be free cash flow positive in 2015.

We will have the opportunity to share more about this second chapter at our Investor Day, planned next November in the U.S.

With that, I hand it over to Jean.

Jean Raby – Chief Financial Officer

Thank you, Michel. Going to the second part of the book, given we are already nearly halfway through the call, I will try to make my comments brief and not address points that have been addressed already in one way or another by Michel.

So bringing you to slide 16, it’s the top part of the P&L. We talked about revenues. I’ll speak about the gross margin; the improvement, 140 basis points reflect fixed cost savings, as well as improved gross margins in certain business lines and those elements more than offset what we have flagged before, which is the relatively dilutive impact on margins of the LTE rollout in China, which represent a greater proportion of our revenues than in the past.

Our H1 gross margins were 32.4%, which is an increase of 260 basis points, reflecting an improved mix, as well as of course our fixed operations cost savings. In terms of savings, let me draw your attention to OpEx. They are down 9% year-on-year in Q2.

Within that, let me be granular on SG&A. They are down 14% in the quarter, but within that, G&A expenses are actually down 16%, which I think reflects the strong focus we have on corporate functions, while striking the right balance between cost savings and the needs of the business in sales and marketing and R&D of course.

Overall, our SG&A ratio declined 130 basis points to 12.1%, which actually brings now close to or at the level of our peers, substantial progress from where we were not even a year ago.

In terms of overall fixed cost savings, what does this mean? We have generated EUR94 million in Q2, bringing the total for the year to EUR237 million. We have said that for 2014 you should expect a small third of our cost saving objectives initially set at EUR1 billion in at constant comparable parameter, more like EUR950 million.

We stand by the assessment. Of course, we had translated that into EUR250 million to EUR300 million. I think it’s fair to say you could assume we are going to be in the upper-end of that range. That reflects continuing efforts on costs savings, but also certain discreet commercial initiatives, notably in channels, in order to move towards new segments. In order to improve our customer mix, and move away from our traditional customer expanse area, our customer base, to non-service providers.

Operating income was EUR136 million in Q2, an improvement of EUR91 million, essentially driven by performance in our access business. Overall, our operating margin for the quarter was 4.1% compared to 1.3%, so nearly triple the operating margin in Q2, 2013.

Moving onto the following slide, this is the P&L below the operating income line. Let me draw your attention to a couple of things. One, I’ll leave aside the impairments of assets in Q2, 2013, which skews of course a little bit the comparison.

More interestingly, I want to draw your attention to first, the significant increase in restructuring charges in Q2 2014. That actually reflects the advancement we have in our restructuring program, having basically completed the process of discussions with the unions in most European countries. Therefore, that allows us to record that charge in Q2, for an actual implementation through cash payments in the following months.

In financial result, you should note two trends. One is the lower finance costs, which are starting to, but not completely reflect the significant actions we have taken in our balance sheet, and that’s more than offset by an accelerated amortization of the issuance fees, ahead of the schedule reimbursement of our secured loan; Michel talked about it. We see that reimbursement as another positive element in our debt restructuring.

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Let me move onto the following slide, which gives revenues by region. North America is down 2.6% year-on-year; 1.8% for H1. Europe, excluding managed services shows significant growth in Q2 plus 6%, and that’s notably in Western Europe. Eastern Europe remains under pressure.

APAC, of course the story is partly a, if not mainly a China story, up 68% year-on-year in Q2. Japan, which is quite strong, you may recall and I had flagged it in Q1, is actually more flattish in Q2. The Rest of the World remains under pressure, with Middle East and Africa declining slightly, while CALA remains under pressure, notably in Mexico and to a much lesser extent in Brazil.

Moving onto the core networking segment analysis. Michel talked about the revenues of each of the line items. I will not dwell in it. I just would like to draw your attention to the fact that on an operating margin basis we are at 9% for Q2, 2014, for H1 at 8% and when you think about our 12.5% objective, well you can see that we are making significant progress and in a colloquial manner we could say that we are at least halfway there.

In segment operating cash flow, we also see a EUR103 million positive number, improvement in percentage of revenues by 60 basis points. In terms of KPI’s, Michel referred to them. I will not expand more.

So moving onto the following slide, which is access. We’ve talked about wireless, a significantly strong quarter of course, plus 28% year-on-year. Very strong growth in LTE in both China and the U.S.

Fixed line also showed some good growth, with demand for copper and fiber generating significant top-line growth, which was partly offset by decline in legacy businesses. You see the decrease in managed services significant, but frankly in line with our restructuring efforts on loss making contracts. And here we show a positive adjusted operating income in stark contrast to Q2, 2013.

Following onto the other slide, on Q2, 2014 cash flow statement. You see the numbers; of course there’s a part related to the improvement in operating income. I’d like to draw your attention to a couple of elements.

First, as Michel said, in the second quarter of 2014, we paid variable compensation in respect of 2013. This does not show in the operating income, but of course it shows in the operating cash flow. That is in stark contrast with the corresponding period in the second quarter of 2013, where in April 2013 we did not pay any variable compensation in respect of 2012, given the results of the group in that year.

We also have an increase in CapEx in second quarter of 2014, which is a reflection of one-offs element in terms of production capacity process and tools developments, and some of our sites restructuring.

Looking at a few items in the first half, segment operating cash flow increased by EUR357 million and restructuring cash outlays as you see are EUR225 million for the first part of the year.

Moving onto the following slide, which is a snap-shot on the refinancing part of the Shift Plan. The next two slides will deal with that. First, just to illustrate through the reimbursement of the secured loan, the improvement we have made. The loan was initially incurred for EUR2 billion in January 2013, at a time where the financial markets were essentially closed and the group would not raise capital in a normal manner on the financial markets. Since then as part of the Shift Plan we have reimbursed part of the secured loan in various tranches and repriced it twice.

Now given the convertible bond offering we have done in June, we are now able to fully reimburse it. That will be done on August 19. It’s not done before that, because there would be a penalty applicable to that. So we are going to implement it in August, and with that the related pledges on patents, as well as shares of certain subsidiaries will be released. Needless to say, this is generating a significant interest savings, not only in 2015, but also already in 2014.

This leads us to the snapshot of our balance sheet. At this very moment, at the end of last year we had net debt of EUR700 million and sizeable reimbursements to contemplate in the following three years; EUR1.5 billion to be exact. Since then we have basically gone to being cash neutral or debt neutral.

The amount of debt reimbursable within the next three years has actually decreased to EUR200 million, and interestingly and more importantly, our average yield, of course benefiting from the zero coupon and a convert, decreased from 6.7% to 4.8% and average maturity has actually been extended. So as far as we are concerned, this closes the refinancing part of the Shift Plan.

Again taking a step back, when we look at the improvement in our business over the past 12 months, which is really the period since the announcement of the Shift Plan, in every single important metric you see here on this slide, you see substantial improvement. I’m comparing the 12-month period July 1, 2013 to June 30, 2014, to the period July 1, 2012 to June 30, 2013, so comparable 12-month running basis.

In that period, gross margin improved by 370 basis points; adjusted operating income improved by EUR750 million; segment operating cash flow improved by EUR600 million; our OpEx decreased EUR350 million; the SG&A-to-sales ratio is now 12.3%, so a decrease of 170 basis points to 14% in the corresponding period; and free cash flow has improved by EUR316 million.

So in that rolling 12-month period we just completed, we had a cash burn of EUR469 million compared to a cash burn in the corresponding period of minus EUR800 million. So again (inaudible) a bit, but nonetheless it’s an interesting measure to have in mind, as we think about our objective for 2015. We’ve gone from minus EUR800 million to minus EUR400 million and the objective is zero. One can say we are halfway there.

So, on this, I conclude on the following slide with our traditional score card on the Shift Plan objective, again taking the same presentation we had used last year. On our own efforts, described as fixed cost savings and disposals. Fixed cost savings were 60% there and on disposals, where I factor in, of course proceeds from part of sales of shares in ASN as part of the contemplated IPO we have discussed, we will be 60% to two-thirds of the way there in our objective of EUR1 billion of proceeds.

Debt re-profiling as I’ve said, we consider it done and debt reduction, of course given the capital increase and the OCEANE being deeply in the money, we remain 80% on the way there.

On this note, I think that concludes my presentation. I was, again, a bit longer than I would have hoped for, but hopefully that leaves ample time for questions. Thank you.

Questions-and-Answers Session


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