AS FILED WITH THE SEC ON MAY 10, 2000 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2000 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 - Area Code 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 April 28, 2000, 3,256,392,823 common shares were outstanding.
2 Form 10-Q - Part I PART 1 - Financial Information Item 1. Financial Statements LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in Millions Except Per Share Amounts) (Unaudited) <TABLE> <CAPTION> For the Three For the Six Months Ended Months Ended March 31, March 31, 2000 1999 2000 1999 <C> <C> <C> <C> <C> Revenues............................. $10,256 $ 8,783 $ 20,161 $ 18,625 Costs................................ 5,939 4,546 11,198 9,176 Gross margin......................... 4,317 4,237 8,963 9,449 Operating Expenses: Selling, general and administrative expenses ........... 2,030 2,058 3,999 3,995 Research and development expenses ... 1,099 1,231 2,077 2,244 In-process research and development expenses............ 11 (6) 11 290 Total operating expenses............. 3,140 3,283 6,087 6,529 Operating income..................... 1,177 954 2,876 2,920 Other income (expense)- net ......... 31 (52) 286 64 Interest expense..................... 99 95 197 173 Income before income taxes........... 1,109 807 2,965 2,811 Provision for income taxes........... 355 272 961 1,040 Income before cumulative effect of accounting change................ 754 535 2,004 1,771 Cumulative effect of accounting change (net of income taxes of $842)....... - - - 1,308 Net income .......................... $ 754 $ 535 $ 2,004 $ 3,079 Earnings per common share - basic: Income before cumulative effect of accounting change............... $ 0.24 $ 0.17 $ 0.63 $ 0.57 Cumulative effect of accounting change ............................ - - - 0.43 Net income .......................... $ 0.24 $ 0.17 $ 0.63 $ 1.00 Earnings per common share - diluted: Income before cumulative effect of accounting change............... $ 0.23 $ 0.17 $ 0.61 $ 0.55 Cumulative effect of accounting change ............................ - - - 0.41 Net income........................... $ 0.23 $ 0.17 $ 0.61 $ 0.96 Dividends declared per common share................... $ 0.00 $ 0.00 $ 0.04 $ 0.04 </TABLE> See Notes to Consolidated Financial Statements.
3 Form 10-Q - Part I LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Millions Except Per Share Amounts) (Unaudited) <TABLE> <CAPTION> March 31, September 30, 2000 1999 <S> <C> <C> ASSETS Cash and cash equivalents.............. $ 1,709 $ 1,880 Receivables less allowances of $345 at March 31, 2000 and $376 at September 30, 1999 ....... 10,573 10,563 Inventories............................ 5,321 5,064 Contracts in process, net of contract billings of $5,778 at March 31, 2000 and $5,565 at September 30, 1999.................... 1,416 1,103 Deferred income taxes - net............ 1,579 1,609 Other current assets................... 1,816 2,065 Total current assets................... 22,414 22,284 Property, plant and equipment, net of accumulated depreciation of $7,671 at March 31, 2000 and $7,474 at September 30, 1999......... 7,051 6,895 Prepaid pension costs.................. 6,336 6,175 Capitalized software development costs. 555 470 Other assets........................... 3,641 3,426 TOTAL ASSETS........................... $39,997 $39,250 </TABLE> See Notes to Consolidated Financial Statements. (CONT'D)
4 Form 10-Q - Part I LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONT'D) (Dollars in Millions Except Per Share Amounts) (Unaudited) <TABLE> <CAPTION> March 31, September 30, 2000 1999 <S> <C> <C> LIABILITIES Accounts payable....................... $ 2,518 $ 2,901 Payroll and benefit-related liabilities.......................... 1,392 2,338 Postretirement and postemployment benefit liabilities.................. 87 137 Debt maturing within one year.......... 1,890 2,871 Other current liabilities.............. 3,405 3,661 Total current liabilities.............. 9,292 11,908 Postretirement and postemployment benefit liabilities.................. 5,954 6,305 Long-term debt ........................ 3,833 4,167 Other liabilities...................... 3,336 2,934 Total liabilities ..................... 22,415 25,314 Commitments and contingencies SHAREOWNERS' EQUITY Preferred stock-par value $1.00 per share Authorized shares: 250,000,000 Issued and outstanding shares: none... - - Common stock-par value $.01 per share Authorized shares: 10,000,000,000 Issued and outstanding shares: 3,203,813,453 at March 31, 2000 3,142,537,636 at September 30, 1999... 32 31 Additional paid-in capital............. 9,830 7,994 Guaranteed ESOP obligation............. (26) (33) Retained earnings...................... 8,050 6,188 Accumulated other comprehensive income (loss)......................... (304) (244) Total shareowners' equity.............. 17,582 13,936 TOTAL LIABILITIES AND SHAREOWNERS' EQUITY................... $39,997 $39,250 </TABLE> See Notes to Consolidated Financial Statements.
5 Form 10-Q - Part I LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Millions) (Unaudited) <TABLE> <CAPTION> For the Six Months Ended March 31, 2000 1999 <S> <C> <C> Operating Activities Net income............................... $ 2,004 $ 3,079 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Cumulative effect of accounting change - (1,308) Depreciation and amortization......... 1,046 865 Provision for uncollectibles.......... 83 20 Tax benefit from stock options........ 909 223 Deferred income taxes 30 243 Purchased in-process research and development......................... 11 15 Adjustment to conform pooled companies' fiscal years............. 11 170 Increase in accounts receivable ...... (784) (1,960) Increase in inventories and contracts in process............ (614) (1,073) (Decrease) increase in accounts payable............................. (386) 334 Changes in other operating assets and liabilities..................... (882) (1,387) Other adjustments for noncash items - net......................... (960) (429) Net cash provided by (used in) operating activities.................... 468 (1,208) Investing Activities Capital expenditures .................... (1,240) (844) Proceeds from the sale or disposal of property, plant and equipment.......... 21 58 Purchases of equity investments.......... (116) (116) Sales of equity investments.............. 789 1 Purchase of investment securities........ - (375) Sales or maturity of investment securities................... 42 320 Acquisitions of businesses, net of cash acquired.................... (164) (212) Dispositions of businesses............... 274 57 Other investing activities - net......... 41 (12) Net cash used in investing activities.... (353) (1,123) </TABLE> See Notes to Consolidated Financial Statements. (CONT'D)
6 Form 10-Q - Part I LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT'D) (Dollars in Millions) (Unaudited) <TABLE> <CAPTION> For the Six Months Ended March 31, 2000 1999 <S> <C> <C> Financing Activities Repayments of long-term debt ............ (387) (8) Issuance of long-term debt............... 16 1,840 Proceeds from issuance of common stock... 902 315 Dividends paid........................... (126) (106) S-Corp distribution to stockholder - (40) (Decrease) increase in short-term borrowings - net....................... (687) 455 Net cash (used in) provided by financing activities................... (282) 2,456 Effect of exchange rate changes on cash........................ (4) (21) Net (decrease) increase in cash and cash equivalents....................... (171) 104 Cash and cash equivalents at beginning of year................... 1,880 1,252 Cash and cash equivalents at end of period....................... $ 1,709 $ 1,356 </TABLE> 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 The accompanying unaudited consolidated financial statements have been prepared by Lucent Technologies Inc. ("Lucent" or the "Company") pursuant to the rules and regulations of the Securities and Exchange Commission and, in the opinion of management, include all adjustments necessary for a fair presentation of the results of operations, financial position and cash flows for each period shown. On October 15, 1999, Lucent merged with International Network Services ("INS"). On November 3, 1999, Lucent merged with Excel Switching Corporation. These mergers have been accounted for as "pooling-of-interests" and the consolidated financial statements of Lucent were restated for all periods prior to the mergers to include the accounts and operations of INS and Excel. Before merging with Lucent, INS had a June 30 fiscal year end and Excel had a December 31 fiscal year end. The unaudited consolidated statement of income for the quarter ended March 31, 1999 was derived by combining the historical results of operations of Lucent for the quarter ended March 31, 1999, with the historical results of operations of INS for the quarter ended December 31, 1998 and with the historical results of operations of Excel for the quarter ended March 31, 1999. The unaudited consolidated balance sheet at September 30, 1999 was derived by combining the historical financial position of Lucent at September 30, 1999, with the historical financial position of INS at June 30, 1999, and with the historical financial position of Excel at September 30, 1999, respectively. The unaudited consolidated statement of cash flows for the six months ended March 31, 1999 was derived by combining the historical cash flows of Lucent for the six months ended March 31, 1999, with the historical cash flows of INS for the six months ended December 31, 1998, and with the historical cash flows of Excel for the three months ended March 31, 1999. Intercompany transactions for the periods presented were not material. Excel's results of operations for the three months ended December 31, 1998, were included in Lucent's results of operations for the year ended September 30, 1998 and were also included in Lucent's consolidated results of operations for the year ended September 30, 1999. Excel's revenue and net loss for the three months ended December 31, 1998 were $37 and $1, respectively. As a result, the consolidated balance sheet of Lucent at September 30, 1999, includes an adjustment to retained earnings to eliminate the loss recognized by Excel for the three months ended December 31, 1998. In addition, information from the statement of cash flows for Excel for the three months ended December 31, 1998, has been excluded from the consolidated statements of cash flows for the six months ended March 31, 1999, since Excel's activity for this period has been included in the consolidated statements of cash flows for the year ended September 30, 1998.
8 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) In order to conform the fiscal year ends for INS and Lucent, INS's results of operations and cash flows for the three months ended September 30, 1999, will not be reflected in Lucent's financial statements for the six months ended March 31, 2000. INS's revenue and net income for the three months ended September 30, 1999 were $100 and $11, respectively. The consolidated balance sheet of Lucent at March 31, 2000, includes an adjustment to retained earnings to reflect the income recognized by INS for the three months ended September 30, 1999. On March 17, 2000, Lucent acquired, for approximately $100 in cash, the products and the design, marketing and sales teams of VTC Inc., a Bloomington, Minnesota-based privately held supplier of semiconductor components to computer hard disk drive manufacturers. Included in the purchase price was approximately $11 ($7 after-tax) of purchased in-process research and development, which resulted in a one-time, non-cash charge to earnings in the current quarter, and $84 allocated to goodwill, acquired technology and other intangible assets, to be amortized over periods not exceeding 7 years. The transaction was accounted for as a purchase. VTC will also be able to receive an additional $50 over two years based on it meeting certain performance-based manufacturing goals, which would be recorded as additional goodwill. The preparation of financial statements during interim periods requires management to make numerous estimates and assumptions that impact the reported amounts of assets, liabilities, revenues and expenses. Estimates and assumptions are reviewed periodically and the effect of revisions is reflected in the results of operations of the interim periods in which changes are determined to be necessary. During the six months ended March 31, 1999, improved performance on multi-year contracts and the resolution of certain contingencies had a positive impact on the reported results of operations. The reported results of operations and cash flows for interim periods are not necessarily indicative of financial results for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Lucent's Form 10-K for the year ended September 30, 1999, and the audited restated consolidated financial statements and notes thereto included in Exhibit 99.1 of the Company's Form 8-K (filed February 11, 2000) for the year ended September 30, 1999. The financial statements presented have been restated to reflect the two-for-one split of Lucent's common stock which became effective on April 1, 1999. Certain prior period amounts have been reclassified to conform to the current period presentation. 2. ANNOUNCED SPIN-OFF On March 1, 2000, Lucent announced plans to spin off its PBX, SYSTIMAX(R) structured cabling and LAN-based data businesses to shareowners, forming a separate company that will focus directly and independently on the enterprise networking market. The new company will start out as an $8 billion business with approximately 34,000 employees. - -------------------------------------- (R) Registered trademark of Lucent
9 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) The spin-off is expected to be accomplished through a tax-free distribution of shares to Lucent's shareowners. Lucent anticipates the spin-off should be completed by the close of the quarter ending September 30, 2000. It is anticipated that the new enterprise company will take a one-time charge for restructuring expenses. The spin-off is subject to several conditions, including receipt of a favorable tax ruling. 3. PHILIPS CONSUMER COMMUNICATIONS ("PCC") On October 1, 1997, Lucent contributed its Consumer Products business to a new venture formed by Lucent and Philips Electronics N.V. ("Philips") in exchange for 40% ownership of PCC. In December 1998, Lucent and Philips ended the PCC venture and regained control of their original businesses. The results of operations and net assets of the remaining businesses Lucent previously contributed to PCC have been consolidated as of October 1, 1998. The revenues are included in Other and Corporate. In December 1998, Lucent sold certain assets of the wireless handset portion of the remaining businesses to Motorola, Inc. During the quarter ended March 31, 2000, Lucent completed the sale of the remaining Consumer Products business. 4. ACCOUNTING CHANGE - EMPLOYEE BENEFIT PLANS Effective October 1, 1998, Lucent changed its method for calculating the market-related value of plan assets used in determining the expected return-on-asset component of annual net pension and postretirement benefit costs. Under the previous accounting method, the calculation of the market-related value of plan assets included only interest and dividends immediately, while all other realized and unrealized gains and losses were amortized on a straight-line basis over a five-year period. The new method used to calculate market-related value includes immediately an amount based on Lucent's historical asset returns and amortizes the difference between that amount and the actual return on a straight-line basis over a five-year period. The new method is preferable under Statement of Financial Accounting Standards No. 87 because it results in calculated plan asset values that are closer to current fair value, thereby lessening the accumulation of unrecognized gains and losses, while still mitigating the effects of annual market value fluctuations. The cumulative effect of this accounting change related to periods prior to fiscal year 1999 of $2,150 ($1,308 after-tax, or $0.43 and $0.41 per basic and diluted share, respectively) is a one-time, non-cash credit to fiscal 1999 earnings.
10 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) 5. COMPREHENSIVE INCOME Comprehensive Income represents net income plus the results of certain shareowners' equity changes not reflected in the statements of income. The components of comprehensive income, net of tax, are as follows: <TABLE> <CAPTION> Three Months Ended Six Months Ended March 31, March 31, 2000 1999 2000 1999 -------------------- ------------------- <S> <C> <C> <C> <C> Net income................... $ 754 $ 535 $ 2,004 $ 3,079 Other comprehensive income(loss): Foreign currency translation adjustments.............. (7) (96) (59) (45) Unrealized holding gains (losses) arising during the period............... (46) (13) (1) (2) Minimum pension liability adjustment............... - 7 - 7 ------- ------- ------- ------- Comprehensive income......... $ 701 $ 433 $ 1,944 $ 3,039 ------- ------- ------- ------- </TABLE> The after-tax components of accumulated other comprehensive income (loss) are as follows: <TABLE> <CAPTION> Total Accumulated Foreign Unrealized Minimum Other Currency Holding Pension Comprehensive Translation Gains Liability Income/ Adjustment Adjustment (Loss) ----------- ---------- ---------- ------------- <S> <C> <C> <C> <C> Accumulated other comprehensive income(loss) at September 30, 1999............ $ (313) $ 79 $ (10) $ (244) Current period change.......... (59) 170 - 111 Reclassification adjustment (net of tax of $110).......... - (171) - (171) Accumulated other comprehensive ------- ------- ------- ------- income(loss)at March 31, 2000............... $ (372) $ 78 $ (10) $ (304) ------- ------- ------- ------- </TABLE> The foreign currency translation adjustments are not currently adjusted for income taxes since they relate to indefinite investments in non-United States subsidiaries.
11 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) 6. SUPPLEMENTARY BALANCE SHEET INFORMATION Inventories at March 31, 2000 and September 30, 1999 were as follows: <TABLE> <CAPTION> March 31, September 30, 2000 1999 -------------- --------------- <S> <C> <C> Completed goods ............... $ 3,024 $ 2,951 Work in process and raw materials................ 2,297 2,113 -------- -------- Total inventories ............. $ 5,321 $ 5,064 -------- -------- </TABLE> 7. EARNINGS PER COMMON SHARE Basic earnings per common share was calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share was calculated by dividing net income by the sum of the weighted average number of common shares outstanding plus all additional common shares that would have been outstanding if potentially dilutive common shares had been issued. The following table reconciles the number of shares utilized in the earnings per share calculations for the three and six-month periods ended March 31, 2000 and 1999: <TABLE> <CAPTION> Three Months Ended Six Months Ended March 31, March 31, 2000 1999 2000 1999 ---------------------- --------------------- <S> <C> <C> <C> <C> Number of Shares (in millions) - ---------------------------------- Common shares - basic............. 3,183.4 3,097.7 3,168.8 3,093.8 Effect of dilutive securities: Stock options.................... 85.0 108.7 97.1 105.7 Other............................ 5.3 7.1 5.4 7.3 Common shares - diluted........... 3,273.7 3,213.5 3,271.3 3,206.8 Options excluded from the computation of earnings per share - diluted since option exercise price was greater than the average market price of the common shares for the period...... 39.6 2.1 11.3 4.2 </TABLE>
12 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) 8. OPERATING SEGMENTS Lucent adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," beginning with its financial statements for the fiscal year ended September 30, 1999. This standard requires disclosure of segment information on the same basis used internally for evaluating segment performance and for deciding how to allocate resources to segments. Lucent operates in the global telecommunications networking industry and has three reportable operating segments: Service Provider Networks ("SPN"), Enterprise Networks ("Enterprise"), and Microelectronics and Communications Technologies ("MCT"). SPN provides public networking systems and software to telecommunications service providers and public network operators around the world. Enterprise develops, manufactures, markets and services advanced communications products and data networking systems for business customers. MCT designs and manufactures high-performance integrated circuits, power systems and optoelectronic components for applications in the communications and computing industries. MCT also includes network products, new ventures and intellectual property. The three reportable operating segments are strategic market units that offer distinct products and services. These segments were determined based on the customers and the markets that Lucent serves. Each market unit is managed separately as each operation requires different technologies and marketing strategies. Intersegment transactions that occur are based on current market prices and all intersegment profit is eliminated in consolidation. Performance measurement and resource allocation for the reportable operating segments are based on many factors. The primary financial measure used is Operating income, exclusive of goodwill and existing technology amortization, and of purchased in-process R&D and other costs from business acquisitions (acquisition/integration-related costs). Lucent employs shared-service concepts to realize economies of scale and efficient use of resources. The costs of shared services, and other corporate center operations managed on a common basis, are allocated to the segments based on usage, where possible, or other factors based on the nature of the activity.
13 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) The following tables present Lucent's revenues and operating income by reportable operating segment: <TABLE> <CAPTION> Three Months Six Months Ended Ended March 31, March 31, 2000 1999 2000 1999 External Revenues ------------------ ---------------- <S> <C> <C> <C> <C> Service Provider Networks $ 6,470 $ 5,251 $12,686 $11,620 Enterprise Networks 1,950 2,113 3,955 4,042 Microelectronics and Communications Technologies 1,741 1,264 3,250 2,550 Total reportable segments 10,161 8,628 19,891 18,212 Other and corporate 95 155 270 413 Total External Revenues $10,256 $ 8,783 $20,161 $18,625 Intersegment Revenues Service Provider Networks $ 5 $ 21 $ 60 $ 63 Enterprise Networks 22 60 57 130 Microelectronics and Communications Technologies 320 334 603 636 Total reportable segments 347 415 720 829 Other and corporate (347) (415) (720) (829) Total Intersegment Revenues $ - $ - $ - $ - Total Revenues Service Provider Networks $ 6,475 $ 5,272 $12,746 $11,683 Enterprise Networks 1,972 2,173 4,012 4,172 Microelectronics and Communications Technologies 2,061 1,598 3,853 3,186 Total reportable segments 10,508 9,043 20,611 19,041 Other and corporate (252) (260) (450) (416) Total Revenues $10,256 $ 8,783 $20,161 $18,625 Operating Income Service Provider Networks $ 874 $ 760 $ 2,084 $ 2,708 Enterprise Networks 114 33 299 123 Microelectronics and Communications Technologies 316 241 674 510 Total reportable segments (a) 1,304 1,034 3,057 3,341 Acquisition/integration-related costs (11) (1) (72) (297) Goodwill and existing technology amortization (63) (91) (127) (150) Other and corporate (53) 12 18 26 Operating income 1,177 954 2,876 2,920 Other income(expense)-net 31 (52) 286 64 Interest expense (99) (95) (197) (173) Income before income taxes $ 1,109 $ 807 $ 2,965 $ 2,811 </TABLE> (a) Segment operating income excludes goodwill and existing technology amortization, and acquisition/integration-related costs.
14 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) 9. COMMITMENTS AND CONTINGENCIES In the normal course of business, Lucent is subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations related to environmental, litigation under federal securities laws and other matters. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. Consequently, the ultimate aggregate amount of monetary liability or financial impact with respect to these matters at March 31, 2000 cannot be ascertained. While these matters could affect the operating results of any one quarter when resolved in future periods and while there can be no assurance with respect thereto, management believes that after final disposition, any monetary liability or financial impact to Lucent in addition to that provided for at March 31, 2000 would not be material to the annual consolidated financial statements. Lucent's current and historical operations are subject to a wide range of environmental protection laws. In the United States, these laws often require parties to fund remedial action regardless of fault. Lucent has remedial and investigatory activities underway at numerous current and former facilities. In addition, Lucent was named a successor to AT&T Corp. as a potentially responsible party ("PRP") at numerous "Superfund" sites pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") or comparable state statutes. Under the Separation and Distribution Agreement ("Separation and Distribution Agreement"), among Lucent, AT&T and NCR Corporation, dated as of February 1, 1996 as amended and restated, Lucent is responsible for all liabilities primarily resulting from or relating to the operation of Lucent's business as conducted at any time prior to or after the separation from AT&T of the businesses and operations transferred to form Lucent (the "Separation") including related businesses discontinued or disposed of prior to the Separation, and Lucent's assets including, without limitation, those associated with these sites. In addition, under the Separation and Distribution Agreement, Lucent is required to pay a portion of contingent liabilities paid out in excess of certain amounts by AT&T and NCR, including environmental liabilities.
15 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) It is often difficult to estimate the future impact of environmental matters, including potential liabilities. Lucent records an environmental reserve when it is probable that a liability has been incurred and the amount of the liability is reasonably estimable. This practice is followed whether the claims are asserted or unasserted. Management expects that the amounts reserved will be paid out over the periods of remediation for the applicable sites which typically range from 5 to 30 years. Reserves for estimated losses from environmental remediation are, depending on the site, based primarily upon internal or third party environmental studies, estimates as to the number, participation level and financial viability of any other PRPs, the extent of the contamination and the nature of required remedial actions. Accruals are adjusted as further information develops or circumstances change. The amounts provided for in Lucent's consolidated financial statements for environmental reserves are the gross undiscounted amount of such reserves, without deductions for insurance or third party indemnity claims. In those cases where insurance carriers or third party indemnitors have agreed to pay any amounts and management believes that collectibility of such amounts is probable, the amounts are reflected as receivables in the financial statements. Although Lucent believes that its reserves are adequate, there can be no assurance that the amount of capital expenditures and other expenses which will be required relating to remedial actions and compliance with applicable environmental laws will not exceed the amounts reflected in Lucent's reserves or will not have a material adverse effect on Lucent's financial condition, results of operations or cash flows. Any possible loss or range of possible loss that may be incurred in excess of that provided for at March 31, 2000 cannot be estimated. 10. SUBSEQUENT EVENTS Ignitus Communications LLC. On April 4, 2000, Lucent acquired the remaining 44 percent of Ignitus Communications LLC, a start-up company that focuses on high-speed optical communications at the network edge. Lucent previously owned 56 percent of the company. DeltaKabel Telecom cv On April 5, 2000, Lucent acquired DeltaKabel TeleCom cv, of Gouda, the Netherlands, a privately-held developer of cable modem and Internet protocol (IP) telephony solutions for the European market. The transaction will be accounted for as a purchase.
16 Form 10-Q - Part I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions Except Per Share Amounts) (Unaudited) TeraBeam Corporation On April 9, 2000, Lucent and TeraBeam Corporation entered into an agreement to develop TeraBeam's fiberless optical networking system that provides high-speed data networking between local and wide area networks. Under the agreement, Lucent paid cash and contributed research and development assets, intellectual property, and free-space optical products, valued in the aggregate at $450. Lucent owns 30 percent of the venture that will develop the fiberless optical networking system, and which will be accounted for under the equity method of accounting. Lucent will also be a preferred supplier of optical components, networking equipment and professional services to TeraBeam. In addition, under certain conditions, Lucent will have the right to purchase TeraBeam's equity interest in the venture. Global Manufacturing Strategy On April 19, 2000, Lucent announced that it will be changing its global manufacturing strategy by expanding its relationships with contract manufacturing partners and focusing its internal manufacturing operations on high-end process manufacturing and systems integration, including new product introductions, supply chain management, and system testing. The Company estimates that most of the transition will be completed in the 18 to 24 months following the announcement. Agere, Inc. On April 20, 2000, Lucent acquired privately-held Agere, Inc., an Austin, Texas-based developer of programmable network processor technology, for $377 of Lucent common stock and options. The transaction will be accounted for as a purchase. Included in the purchase price was approximately $94 of in-process research and development, which will result in a one-time, non-tax deductible, non-cash charge to earnings in the quarter ending June 30, 2000, and $298 allocated to goodwill and other intangible assets, to be amortized over 7 years. Ortel Corporation On April 27, 2000, Lucent acquired Ortel Corporation, an Alhambra, California-based developer of optoelectronic components for cable TV networks, for approximately $2,998 of Lucent common stock and options. The transaction will be accounted for as a purchase. Included in the purchase price was $307 of in-process research and development, which will result in a one-time, non-tax deductible, non-cash charge to earnings in the quarter ending June 30, 2000, and $2,749 allocated to goodwill, acquired technology and other intangible assets, to be amortized over periods not exceeding 9 years. Announcement To Sell Power Systems Business On May 3, 2000, Lucent announced that it is seeking a buyer for its Power Systems business, a leading supplier of power products for the telecommunications and computer industries. Lucent's Power Systems, which is headquartered in Mesquite, Texas, has 4,700 employees working in 30 locations around the world. Lucent expects to begin discussions with potential buyers shortly and expects to identify a buyer within six months.
17 Form 10-Q - Part I Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION HIGHLIGHTS Lucent reported net income of $754 million, or $0.23 per share (diluted) for the quarter ended March 31, 2000, Lucent's second fiscal quarter of 2000. This compares with year-ago quarterly net income of $535 million, or $0.17 per share (diluted). For the six months ended March 31, 2000, Lucent reported net income of $2,004 million, or $0.61 per share (diluted) compared with net income of $3,079 million, or $0.96 per share (diluted) in the same period last year. Included in last year's results is a $1,308 million (or $0.41 per share-diluted) cumulative effect of accounting change related to Lucent's pension and postretirement benefits (see Note 4). Lucent's income before the cumulative effect of the accounting change was $1,771 million (or $0.55 per share-diluted) for the six months ended March 31, 1999. Net income for the current quarter includes $11 million ($7 million, after-tax) of purchased in-process research and development ("IPRD") expenses related to the acquisition of VTC Inc. Net income for the year-ago quarter includes $18 million ($15 million, after-tax) of purchased IPRD expenses related to the acquisitions of WaveAccess, Sybarus, and Enable Semiconductor's Ethernet LAN business; a $24 million reversal of purchased IPRD related to Stratus (non-tax impacting); and $7 million of merger-related costs associated with the acquisition of VitalSigns (non-tax impacting). In addition, net income for the six-month period ended March 31, 2000 includes a gain of $189 million, pre-tax ($115 million, after-tax) associated with the sale of an equity investment and a pre-tax charge of $61 million ($40 million, after-tax) to operating expenses primarily associated with the mergers with International Network Services ("INS"), Excel Switching Corp. and Xedia Corporation. Net income for the prior-year six-month period also includes $296 million ($287 million, after-tax) of purchased IPRD expenses primarily related to the acquisitions of Stratus and Quadritek. On March 1, 2000, Lucent announced plans to spin-off to shareowners its PBX, SYSTIMAX(R) structured cabling and LAN-based data businesses, forming a separate company that will focus directly and independently on the enterprise networking market. The spin-off is expected to be accomplished through a tax-free distribution of shares to Lucent's shareowners. Lucent anticipates the spin-off should be completed by the close of its fourth fiscal quarter, which ends September 30, 2000. It is anticipated that the new enterprise company will take a one-time charge for restructuring expenses. The spin-off is subject to several conditions, including receipt of a favorable tax ruling (see Note 2). In addition, during the quarter, Lucent completed the sale of its remaining consumer products business (see Note 3). On May 3, 2000, Lucent announced that it is seeking a buyer for its Power Systems business, a leading supplier of power products for the telecommunications and computer industries. Lucent's Power Systems, which is headquartered in Mesquite, Texas, has 4,700 employees working in 30 locations around the world. Lucent expects to begin discussions with potential buyers shortly and expects to identify a buyer within six months. - -------------------------------------- (R) Registered trademark of Lucent
18 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION On April 19, 2000, Lucent announced that it will be changing its global manufacturing strategy by expanding its relationships with contract manufacturing partners and focusing its internal manufacturing operations on high-end process manufacturing and systems integration, including new product introductions, supply chain management, and system testing. Lucent estimates that most of the transition will be completed in the 18 to 24 months following the announcement. Reference is made to Notes 1 and 10 of Notes to Consolidated Financial Statements for information regarding certain acquisitions and subsequent events. KEY BUSINESS CHALLENGES Lucent continues to face significant competition and expects that the level of competition on pricing and product offerings will intensify. Lucent expects that new competitors will enter its markets as a result of the trend toward global expansion by U.S. and non-U.S. competitors as well as continued changes in technology and public policy. These competitors may include entrants from the telecommunications, software, data networking, cable television and semiconductor industries. Existing competitors have, and new competitors may have, strong financial capabilities, technological expertise, well-recognized brand names and a global presence. Such competitors may include Alcatel, Cisco Systems, Inc., Ericsson, Nortel Networks, and Siemens AG. Lucent's management periodically assesses market conditions and redirects the Company's resources to meet new challenges. Steps Lucent may take include acquiring or investing in new businesses and ventures, partnering with other companies, delivering new technologies, closing and consolidating facilities, disposing of assets, reducing work force levels and withdrawing from markets. Historically, revenues and earnings had been higher in the first fiscal quarter primarily because many of Lucent's large customers delayed a disproportionate percentage of their capital expenditures until the fourth quarter of the calendar year (Lucent's first fiscal quarter). Lucent took measures to manage the seasonality of its business by changing the date on which its fiscal year ends to September 30 beginning September 30, 1996, and its compensation programs for employees, which resulted in a somewhat more uniform distribution of revenues and earnings throughout the year. The Company expects to see further shifts in seasonality as market conditions, industry-buying patterns and the composition of its customer base continue to change. Historically, the purchasing behavior of Lucent's largest customers has been characterized by the use of fewer, larger contracts. These contracts typically involve longer negotiating cycles, require the dedication of substantial amounts of working capital and other resources, and in general require costs that may substantially precede the recognition of associated revenues. Moreover, in return for larger, longer-term purchase commitments, customers often demand more stringent acceptance criteria, which can also cause revenue recognition delays. Lucent has increasingly provided or arranged long-term financing for customers as a condition to obtain or bid on infrastructure projects. Certain multiyear contracts involve new
19 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION technologies that may not have been previously deployed on a large-scale commercial basis. On its multiyear contracts, Lucent may incur significant initial cost overruns and losses that are recognized in the quarter in which they become ascertainable. Further, profit estimates on such contracts are revised periodically over the lives of the contracts, and such revisions can have a significant impact on reported earnings in any one quarter. Historically, a limited number of customers have provided a substantial portion of Lucent's total revenues. These customers include AT&T, which continues to be a significant customer, and the Regional Bell Operating Companies ("RBOCs"). The communications industry is experiencing a consolidation of both U.S. and non-U.S. companies. The loss of any of these customers, or any substantial reduction in orders by any of these customers, could materially adversely affect the Company's operating results. Changes in implementation plans by customers inside and outside the United States could lead to delays in network deployments by enterprises and service providers which could impact future results. Lucent is diversifying its customer base and seeking out new types of customers globally. These new types of customers include competitive access providers and local exchange carriers, wireless service providers, cable television network operators and computer manufacturers.
20 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS REVENUES Total revenues increased 16.8% to $10,256 million in the quarter compared with the same quarter of 1999, and 8.2% to $20,161 million for the six months compared to the same period in 1999, respectively, due to increases in sales from Service Provider Networks and Microelectronics and Communications Technologies partially offset by decreases in sales from Enterprise Networks. For the quarter, sales within the United States increased 10.8% compared with the same quarter last year. Sales outside the United States increased 31.8% compared with the same quarter last year, with revenue growth in all major regions. Sales outside of the United States represented 31.9% of revenues for the current quarter as compared to 28.3% of revenues for the same quarter last year. For the six months, sales within the United States increased 8.1% and sales outside the United States increased 8.6% compared with the same period in 1999. Sales outside of the United States represented 32.4% of revenues for the six months ended March 31, 2000 as compared to 32.3% of revenues for the same period in 1999. The following table presents Lucent's revenues by segment and the approximate percentage of total revenues for the three and six months ended March 31, 2000 and 1999: <TABLE> <CAPTION> Three Months Six Months Ended Ended March 31, March 31, Dollars in Millions ---------------------- ---------------------- 2000 1999 2000 1999 ------- ------- ------- ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Service Provider Networks $ 6,470 63% $5,251 60% $12,686 63% $11,620 62% Enterprise Networks 1,950 19 2,113 24 3,955 20 4,042 22 Microelectronics and Communications Technologies 1,741 17 1,264 14 3,250 16 2,550 14 Other and Corporate 95 1 155 2 270 1 413 2 Total Lucent $10,256 100% $8,783 100% $20,161 100% $18,625 100% </TABLE> Revenues from SERVICE PROVIDER NETWORKS increased $1,219 million, or 23.2% in the quarter compared with the same quarter in 1999 and $1,066 million, or 9.2% in the six months compared with the same period in 1999. These increases were driven by sales of wireless systems, service provider Internet infrastructure, optical networking equipment and NetworkCare(R) Professional Services. The increase for the six-month period was partially offset by faster than anticipated shifts in customers' purchases of new optical systems, resulting in manufacturing capacity and deployment constraints in the three months ended December 31, 1999 and lower than expected software revenues.
21 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Revenues generated from service providers in the United States increased 13.7% for the quarter and 10.1% for the six months compared to the same periods in 1999, and included revenue gains from sales to RBOCs and competitive local exchange carriers. Sales generated outside the United States increased 47.8% over the year-ago quarter, reflecting increases in all regions. For the six months, sales generated outside the United States increased 7.4% over the same prior-year period, reflecting gains in all regions, except Europe/Middle East/Africa. Revenues generated outside the United States represented 33.4% of revenues for the quarter compared with 27.9% for the same quarter of 1999 and 34.1% of revenues for the six months compared with 34.6% for the same period in 1999. Revenues from ENTERPRISE NETWORKS decreased $163 million, or 7.7% in the quarter compared with the same quarter in 1999 and $87 million, or 2.2% in the six months compared with the same period in 1999. Decreased sales of messaging systems and Systimax(R) structured cabling solutions were partially offset by increased sales of Definity(R) Enterprise Communication Servers, including those with Call Center applications, contributed to the decreased revenue for both the quarter and six-month period. Revenues within the United States decreased 10.4% for the quarter compared with the same quarter of 1999 and 4.2% for the six months compared with the same period in 1999. Revenues generated outside the United States increased by 2.0% for the quarter and 5.5% for the six months, with revenue growth in the Asia/Pacific and Europe/Middle East/Africa regions, as well as Canada for the six-month period. Revenues generated outside the United States represented 24.3% of revenues for the quarter compared with 22.0% in the same quarter in 1999 and 22.5% for the six months compared with 20.9% for the same period in 1999. Revenues from MICROELECTRONICS AND COMMUNICATIONS TECHNOLOGIES increased $477 million, or 37.7% in the quarter compared with the same quarter in 1999, and $700 million, or 27.5% in the six months compared with the same period in 1999. These increases were driven by sales of optoelectronic components and optical fiber, power systems, and customized chips for high-speed communications and data networking systems. Revenues within the United States increased 55.8% for the quarter compared with the same quarter of 1999 and 37.8% for the six months compared with the same period in 1999. Revenues generated outside the United States increased by 14.7% for the quarter and 14.8% for the six months, with revenue growth in all major regions, except the Europe/Middle East/Africa region for the quarter. Revenues generated outside the United States represented 36.6% of revenues for the quarter compared with 43.9% in the same quarter in 1999 and 40.4% for the six months compared with 44.9% for the same period in 1999. Revenues from OTHER AND CORPORATE decreased $60 million compared with the year-ago quarter and $143 million compared with the year-ago six month period. These decreases were primarily due to lower revenues from the Company's consumer products business (see Note 3).
22 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION COSTS AND GROSS MARGIN Total costs increased by $1,393 million, or 30.6% compared with the year-ago quarter and $2,022 million, or 22.0% compared with year-ago six-month period. As a percentage of revenue, gross margin decreased to 42.1% from 48.2% in the year-ago quarter and to 44.5% from 50.7% in the year-ago six-month period, respectively. These decreases are primarily due to a ramp-up of costs associated with the introduction and implementation of new products and a change in product mix, including lower software revenues. OPERATING EXPENSES Selling, general and administrative ("SG&A") expenses as a percentage of revenues were 19.8% for the quarter and the six-month period, a decrease of 3.6 percentage points compared with 23.4% for the same quarter in 1999, and a decrease of 1.7 percentage points for the six-month period compared with 21.5% for the same period in 1999. SG&A expenses decreased $28 million, or 1.4% compared with the same year-ago quarter and were essentially flat comparing the six-month periods. Included in the current six-month period expense is $61 million ($40 million, after-tax) primarily associated with the mergers of INS, Excel and Xedia. Amortization expense associated with goodwill and existing technology was $63 million for the quarter compared with $91 million for the same quarter in 1999 and $127 million for the six-month period compared with $150 million for the same period in 1999. Excluding the amortization of goodwill and existing technology, SG&A expenses as a percentage of revenues were 19.2% for the quarter and the six month period, a decrease of 3.2 percentage points and 1.4 percentage points, respectively, compared with 22.4% and 20.6% for the corresponding periods in 1999. Research and development ("R&D") expenses represented 10.7% of revenues for the quarter compared with 14.0% of revenues for the same quarter of 1999. For the six months, R&D expenses represented 10.3% of revenues compared with 12.0% for the same period of 1999. R&D expenses decreased $132 million, or 10.7%, during the quarter compared with the same quarter of 1999 and $167 million, or 7.4%, during the six-month period compared with the same period of 1999. This decrease was attributable to efficiencies in Lucent's research and development processes as well as increases in the capitalization of software expenses. Purchased IPRD expenses for the quarter were $11 million, reflecting the charges associated with the acquisition of VTC, compared with income of $6 million, reflecting an $18 million charge related to the acquisitions of WaveAccess, Sybarus, and Enable Semiconductor's Ethernet LAN business offset by a $24 million reversal of purchased IPRD related to Stratus. Purchased IPRD expenses for the six months were $11 million, related to the VTC acquisition as compared to $290 million related primarily to the acquisitions of WaveAccess, Sybarus, Enable Semiconductor's Ethernet LAN business, Stratus and Quadritek for the same period of 1999. The 1999 period also included the $24 million reversal related to Stratus.
23 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION OTHER Other income(expense)- net for the quarter increased $83 million to $31 million from an expense of $52 million in the year-ago quarter. For the six months other income (expense)- net increased $222 million to $286 million from $64 million in the year-ago period, resulting primarily from gains from the sale of various equity securities, including a $189 million gain from the sale of an equity investment, partially offset by fees associated with certain customer financing transactions. Interest expense for the quarter increased $4 million to $99 million compared with the same quarter in 1999 and for the six months increased $24 million to $197 million compared with the same period of 1999. The increases in interest expense are due to higher debt levels associated with long-term notes for the current periods compared with the same periods in 1999. The effective income tax rate of 32.0% for the quarter decreased from 33.7% for the prior year quarter. Excluding one-time costs associated with the VTC acquisition in 2000 and the Stratus, Enable, Sybarus, WaveAccess, and VitalSigns acquisitions in 1999, the effective income tax rate is 32.1% for the quarter compared with 34.0% in the prior year quarter. This decrease was primarily due to the tax impact of foreign activity. The effective income tax rate of 32.4% for the six months decreased from 37.0% for the year ago period. Excluding one-time merger related costs in 1999 and 2000 and the gain related to the sale of an equity investment in 2000, the effective income tax rate is 32.0% for the six months compared with 33.8% in the same year ago period. This decrease was primarily due to increased research tax credits. CASH FLOWS Cash provided by operating activities for the six months ended March 31, 2000 was $468 million compared with cash used in operating activities of $1,208 million in the same year-ago period. This increase in cash flows from operating activities was primarily due to higher collections of receivables. Cash used in investing activities for the six months ended March 31, 2000 was $353 million compared with $1,123 million in the same year-ago period. The reduction in cash used in investing activities was primarily due to increased proceeds from the sales of equity investments as well as the dispositions of businesses, partially offset by increased capital expenditures. Capital expenditures were $1,240 million and $844 million for the six-month periods ended March 31, 2000 and 1999, respectively. Capital expenditures relate to expenditures for equipment and facilities used in manufacturing and research and development, including expansion of manufacturing capacity, and expenditures for efficiency efforts and non-U.S. growth.
24 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Cash used in financing activities for the six months ended March 31, 2000 was $282 million compared with cash provided by financing activities of $2,456 million in the same year-ago period. This decrease in cash provided by financing activities was primarily due to decreased issuances of both short- and long-term debt, partially offset by the increase in proceeds from the issuance of common stock. FINANCIAL CONDITION Total assets increased $747 million, or 1.9%, from fiscal year-end 1999. This increase was due to increases in contracts in process, inventories, other assets, prepaid pension costs and property, plant and equipment of $313 million, $257 million, $215 million, $161 million and $156 million, respectively. These increases were partially offset by decreases in other current assets and cash of $249 million and $171 million, respectively. The increase in inventories resulted from the need to meet current and anticipated sales commitments to customers. Other assets increased due largely to the capitalization of internal use software. Other current assets decreased due to the cash settlement from the sale of an equity investment. Total liabilities decreased $2,899 million, or 11.5% from fiscal year-end 1999. This decrease was due primarily to lower payroll and benefit liabilities due to the pay-out of year-end bonuses and lower debt balances resulting from the payment of debt recorded in connection with the sale of certain customer receivables with recourse. Working capital, defined as current assets less current liabilities, increased $2,746 million from September 30, 1999, primarily resulting from the decrease in payroll and benefit liabilities and short-term debt and the increase in contracts in process and inventories, partially offset by the decrease in other current assets. The ratio of total debt to total capital (debt plus equity) was 24.6% at March 31, 2000 compared to 33.6% at September 30, 1999. LIQUIDITY AND CAPITAL RESOURCES At March 31, 2000, Lucent maintained approximately $5.0 billion in credit facilities of which a significant portion is used to support Lucent's commercial paper program. At March 31, 2000, approximately $4.7 billion was unused. Future financings will be arranged to meet Lucent's requirements with the timing, amount and form of issue depending on the prevailing market and general economic conditions. Lucent anticipates that borrowings under its bank credit facilities, the issuance of additional commercial paper, cash generated from operations, short- and long-term debt financings and receivable securitizations will be adequate to satisfy its future cash requirements, although there can be no assurance that this will be the case.
25 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Network operators worldwide are requiring their suppliers to arrange or provide long-term financing for them as a condition of obtaining or bidding on infrastructure projects. These projects may require financing in amounts ranging from modest sums to more than a billion dollars. Lucent has increasingly provided or arranged long-term financing for customers. As market conditions permit, Lucent's intention is to lay off these long-term financing arrangements, which may include both commitments and drawn-down borrowings, to financial institutions and other investors. This enables Lucent to reduce the amount of its commitments and free up additional financing capacity. As of March 31, 2000, Lucent had made commitments or entered into agreements to extend credit to certain customers, including PCS and wireless operators, for an aggregate of approximately $7.2 billion. Excluding amounts that are not available because the customer has not yet satisfied the conditions precedent for borrowing, at March 31, 2000, approximately $2.6 billion in loan commitments was undrawn and available for borrowing and approximately $1.1 billion had been advanced and was outstanding. In addition, Lucent had made commitments to guarantee customer debt of about $1.5 billion at March 31, 2000. Excluding amounts not available for guarantee because conditions precedent have not been satisfied, approximately $600 million of guarantees was undrawn and available and about $800 million was outstanding on March 31, 2000. As part of the revenue recognition process, Lucent determines whether the receivables under these contracts are reasonably assured of collection based on various factors among which is the ability of Lucent to sell these loans and commitments. Lucent intends to continue pursuing opportunities for the sale of future loans and commitments. In addition to the above arrangements, Lucent will continue to provide or commit to financing where appropriate for its business. The ability of Lucent to arrange or provide financing for its customers will depend on a number of factors, including Lucent's capital structure and level of available credit, and its continued ability to lay off commitments and drawn-down borrowings on acceptable terms. Lucent believes that it will be able to access the capital markets on terms and in amounts that will be satisfactory to Lucent and that it will be able to obtain bid and performance bonds, to arrange or provide customer financing as necessary, and to engage in hedging transactions on commercially acceptable terms, although there can be no assurance that this will be the case. RISK MANAGEMENT Lucent is exposed to market risk from changes in foreign currency exchange rates and interest rates that could impact its results of operations, financial condition and cash flows. Lucent manages its exposure to these market risks through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. Derivative financial instruments that are used to hedge foreign currency and interest rate exposure are viewed as risk management tools and are not used for speculative or trading purposes. In addition, derivative financial instruments are entered into with a diversified group of major financial institutions in order to manage Lucent's exposure to nonperformance on such instruments.
26 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Certain securities held in Lucent's equity and investment portfolio are subject to equity price risk. Lucent generally does not hedge its equity price risk, however on occasion, may use equity derivative financial instruments which are subject to equity price risks to complement its investment strategies. Lucent has entered into an equity swap agreement, which among the terms included in the agreement, Lucent is obligated to pay to a third party in July 2000 and September 2000 any depreciation in the market value of certain equity securities sold during the three months ended December 31, 1999 or receive any appreciation in such market value. Changes in the market value of this equity swap are reflected in net income. Lucent uses foreign currency exchange contracts, and to a lesser extent foreign currency options, to reduce significant exposure to the risk that the eventual net cash inflows and outflows resulting from the sale of products to non-U.S. customers and purchases from non-U.S. suppliers will be adversely affected by changes in exchange rates. Foreign currency exchange contracts are designated for recorded, firmly committed or anticipated purchases and sales. The use of these derivative financial instruments allows Lucent to reduce its overall exposure to exchange rate movements, since the gains and losses on these contracts substantially offset losses and gains on the assets, liabilities and transactions being hedged. Lucent manages its ratio of fixed to floating rate debt with the objective of achieving a mix that management believes is appropriate. To manage this mix in a cost-effective manner, Lucent, from time to time, enters into interest rate swap agreements, in which it agrees to exchange various combinations of fixed and/or variable interest rates based on agreed upon notional amounts. Lucent had no interest rate swap agreements in effect as of March 31, 2000 and September 30, 1999. Management does not foresee or expect any significant changes in its exposure to interest rate fluctuations or in how such exposure is managed in the near future. OTHER - Environmental Matters See discussion in Note 9 to the Consolidated Financial Statements. FORWARD-LOOKING STATEMENTS This Management's Discussion and Analysis of Results of Operations and Financial Condition and other sections of this report contain forward-looking statements that are based on current expectations, estimates, forecasts and projections about the industries in which Lucent operates, management's beliefs and assumptions made by management. In addition, other written or oral statements which constitute forward-looking statements may be made by or on behalf of Lucent. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Lucent undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
27 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Future Factors include increasing price and products and services competition by non-U.S. and U.S. competitors, including new entrants; rapid technological developments and changes and the Company's ability to continue to introduce competitive new products and services on a timely, cost-effective basis; the mix of products and services; the achievement of lower costs and expenses; customer demand for the Company's products and services; the ability to successfully integrate the operations and business of acquired companies; U.S. and non-U.S. governmental and public policy changes that may affect the level of new investments and purchases made by customers; changes in environmental and other U.S. and non-U.S. governmental regulations; protection and validity of patent and other intellectual property rights; reliance on large customers; technological, implementation and cost/financial risks in the use of large, multiyear contracts; the cyclical nature of the Company's business; the outcome of pending and future litigation and governmental proceedings and continued availability of financing, financial instruments and financial resources in the amounts, at the times and on the terms required to support the Company's future business. These are representative of the Future Factors that could affect the outcome of the forward-looking statements. In addition, such statements could be affected by general industry and market conditions and growth rates, general U.S. and non-U.S. economic conditions, including interest rate and currency exchange rate fluctuations and other Future Factors. For a further description of Future Factors that could cause actual results to differ materially from such forward-looking statements, see below in this report including the other sections referred to and also see the discussion in Lucent's Form 10-K for the year ended September 30, 1999 in Item 1 in the section entitled "X. OUTLOOK- A. Forward Looking Statements" and the remainder of the OUTLOOK section. Competition: See discussion above under KEY BUSINESS CHALLENGES. Dependence on New Product Development: The markets for the Company's principal products are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and evolving methods of building and operating communications systems for network operators and business customers. The Company's operating results will depend to a significant extent on its ability to continue to introduce new systems, products, software and services successfully on a timely basis and to reduce costs of existing systems, products, software and services. The success of these and other new offerings is dependent on several factors, including proper identification of customer needs, cost, timely completion and introduction, differentiation from offerings of the Company's competitors and market acceptance. In addition, new technological innovations generally require a substantial investment before any assurance is available as to their commercial viability, including, in some cases, certification by non-U.S. and U.S. standard-setting bodies. Reliance on Major Customers: See discussion above under KEY BUSINESS CHALLENGES.
28 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION European Monetary Union - Euro: On January 1, 1999, eleven member countries of the European Union established fixed conversion rates between their existing sovereign currencies, and adopted the Euro as their new common legal currency. The legacy currencies will remain legal tender in the participating countries for a transition period between January 1, 1999 and January 1, 2002. During the transition period, cash-less payments can be made in the Euro. Between January 1, 2002 and July 1, 2002, the participating countries will introduce Euro notes and coins and withdraw all legacy currencies so that they will no longer be available. Lucent has in place a joint European-United States team representing affected functions within the Company. This team is evaluating Euro-related issues affecting the Company that include its pricing/marketing strategy, conversion of information technology systems, existing contracts and currency risk and risk management in the participating countries. The Euro conversion may affect cross-border competition by creating cross-border price transparency. Lucent will continue to evaluate issues involving introduction of the Euro as further accounting, tax and governmental legal and regulatory guidance is available. Based on current information and Lucent's current assessment, Lucent does not expect that the Euro conversion will have a material adverse effect on its business or financial condition. Employee Relations: On March 31, 2000, Lucent employed approximately 151,000 persons, including 77.2% located in the United States. Of these domestic employees, approximately 38% are represented by unions, primarily the Communications Workers of America ("CWA")and the International Brotherhood of Electrical Workers ("IBEW"). Lucent has agreements with the CWA and IBEW expiring May 31, 2003. Multi-Year Contracts: Lucent has significant contracts for the sale of infrastructure systems to network operators which extend over a multi-year period, and expects to enter into similar contracts in the future, with uncertainties affecting recognition of revenues, stringent acceptance criteria, implementation of new technologies and possible significant initial cost overruns and losses. See also discussion above under LIQUIDITY AND CAPITAL RESOURCES and KEY BUSINESS CHALLENGES. Seasonality: See discussion above under KEY BUSINESS CHALLENGES. Future Capital Requirements: See discussion above under FINANCIAL CONDITION and LIQUIDITY AND CAPITAL RESOURCES.
29 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Growth Outside the U.S., Foreign Exchange and Interest Rates: Lucent intends to continue to pursue growth opportunities in markets outside the U.S. In many markets outside the U.S., long-standing relationships between potential customers of Lucent and their local providers, and protective regulations, including local content requirements and type approvals, create barriers to entry. In addition, pursuit of such growth opportunities outside the U.S. may require significant investments for an extended period before returns on such investments, if any, are realized. Such projects and investments could be adversely affected by reversals or delays in the opening of foreign markets to new competitors, exchange controls, currency fluctuations, investment policies, repatriation of cash, nationalization, social and political risks, taxation, and other factors, depending on the country in which such opportunity arises. Difficulties in foreign financial markets and economies, and of foreign financial institutions, could adversely affect demand from customers in the affected countries. See discussion above under RISK MANAGEMENT with respect to foreign exchange and interest rates. A significant change in the value of the dollar against the currency of one or more countries where Lucent sells products to local customers or makes purchases from local suppliers may materially adversely affect Lucent's results. Lucent attempts to mitigate any such effects through the use of foreign currency contracts, although there can be no assurances that such attempts will be successful. Lucent hedges certain foreign currency transactions. The decline in value of non-U.S. dollar currencies, may, if not reversed, adversely affect Lucent's ability to contract for product sales in U.S. dollars because Lucent's products may become more expensive to purchase in U.S. dollars for local customers doing business in the countries of the affected currencies. Legal Proceedings and Environmental: See discussion above in Note 9 - COMMITMENTS AND CONTINGENCIES. RECENT PRONOUNCEMENTS Effective October 1, 1999, Lucent adopted Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). As a result, certain costs of computer software developed or obtained for internal use have been capitalized and will be amortized over a three-year period. The impact of adopting SOP 98-1 was a reduction of costs and operating expenses of $68 million and $148 million during the three and six months ended March 31, 2000, respectively. In December 1999, the Securities and Exchange Commission staff released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. The Company is currently evaluating the impact of SAB No. 101 to determine what effect, if any, it could have on our financial position and results of operations.
30 Form 10-Q - Part I MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SUPPLEMENTAL PRO FORMA ONGOING LUCENT FINANCIAL INFORMATION (Supplemental Pro Forma net income excludes one-time acquisition and merger-related costs and amortization of goodwill and acquired technology) The following table presents supplemental pro forma financial information for Ongoing Lucent operations, which excludes the parts of the enterprise networks business that are expected to be spun off by September 30, 2000, and the consumer products business, which was sold during the current quarter. In addition, this supplemental pro forma information excludes purchased IPRD of $11 million ($7 million, after-tax) related to the acquisition of VTC in the current quarter and $18 million ($15 million, after-tax) of purchased IPRD expenses related to the acquisitions of WaveAccess, Sybarus, and Enable Semiconductor's Ethernet LAN business, a $24 million reversal of purchased IPRD related to Stratus (non-tax impacting), and $7 million of merger-related costs associated with the acquisition of VitalSigns (non-tax impacting) in the prior-year quarter. The financial information for Ongoing Lucent operations has been derived from the historical results of operations of total Lucent by excluding the results of operations of the parts of the enterprise networks business(including certain corporate income and expenses) expected to be spun and the consumer products business. The assumptions underlying the financial information may not necessarily reflect the results of operations of the ongoing businesses in the future, or what the results of operations would have been had the ongoing businesses been a separate, stand-alone entity during the periods presented. Lucent is providing the supplemental pro forma financial information presented below because the Company believes it will be meaningful to investors in evaluating Lucent's financial results. This information supplements, but should not be viewed as an alternative to, net income determined in accordance with Generally Accepted Accounting Principles or certain pro forma presentations under Securities and Exchange Commission regulations. This information is based upon the Company's current estimates and understanding of the assets that are expected to be spun and to the extent that the final structure differs, results may change. <TABLE> <CAPTION> * Three Months Ended Ongoing Lucent March 31, Dollars in Millions ---------------------- 2000 1999 ------- ------ <S> <C> <C> Revenues $ 8,325 $6,604 Gross margin 3,459 3,209 Total operating expenses 2,386 2,318 Operating income 1,073 891 Income before income taxes 945 745 Income tax expenses 303 253 Net income 642 492 Net income per share-diluted 0.20 0.15 Goodwill & acquired technology amortization, net 34 60 Supplemental Pro forma net income 676 552 Supplemental Pro forma net income per share-diluted 0.21 0.17 </TABLE> * Preliminary estimates that are subject to change.
31 Form 10-Q - Part II Part II - Other Information Item 4. Submission of Matters to a Vote of Security Holders. Lucent held its 2000 Annual Meeting of Shareowners on February 16, 2000. At that meeting, shareowners elected Carla Hills as a Director of the Company for a term to expire at the Annual Meeting to be held in the year 2003. In addition, shareowners approved one Company proposal and rejected three shareowner proposals. The director elected and the results of the voting are as follows: <TABLE> <CAPTION> Votes Votes For Withheld <S> <C> <C> Carla A. Hills 2,576,821,162 46,189,860 <CAPTION> Votes Votes Broker For Against Abstain Non-votes <S> <C> <C> <C> <C> Company proposal: Approve an Amendment to the Certificate of Incorporation to Increase Authorized Common Stock . . . . . . 2,395,113,456 209,154,979 18,742,587 0 Shareowner proposals: Eliminate classified board . . . . . . . . . 840,639,048 1,072,492,531 50,745,379 659,134,064 Adopt Different Confidential Voting Policy . . . . . 871,480,211 1,040,243,145 52,153,602 659,134,064 Adopt Different Anti-Slave Labor Policy . . . . . . 149,449,597 1,621,812,392 192,614,969 659,134,064 </TABLE> Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: Exhibit Number (3) Certificate of Incorporation (12) Computation of Ratio of Earnings to Fixed Charges (27) Financial Data Schedule
32 Form 10-Q - Part II Part II - Other Information (b) Reports on Form 8-K: Current Report on Form 8-K dated January 6, 2000 was filed on January 7, 2000 pursuant to Item 5 (Other Events). Current Report on Form 8-K dated February 10, 2000 was filed on February 11, 2000 pursuant to Item 5 (Other Events) and Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits) containing restated financial statements to reflect certain mergers accounted for as pooling of interests. Current Report on Form 8-K dated and filed March 1, 2000 pursuant to Item 5 (Other Events) and Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits). Current Report on Form 8-K dated March 9, 2000 was filed on March 10, 2000 pursuant to Item 5 (Other Events) and Item 7 (Financial Statements, Pro Forma Financial Information and Exhibits).
33 Form 10-Q SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Lucent Technologies Inc. Date May 10, 2000 /s/ James S. Lusk ------------------------------ James S. Lusk Senior Vice President and Controller (Principal Accounting Officer)
34 Form 10-Q Exhibit Index Exhibit Number (3) Certificate of Incorporation, as amended effective February 16, 2000 (incorporated by reference to Exhibit 3.1 to Registration Statement on Form S-4, File No. 333-31400) (12) Computation of Ratio of Earnings to Fixed Charges (27) Financial Data Schedule