Lucent Numbers Raise Pension Question

The big cheeses at Lucent Technologies Inc. (NYSE: LU) took to the stage at the vendor's analyst conference yesterday and set out a picture of stability and future growth.

CFO Frank D'Amelio reviewed the firm's recent financial performance, which has shown stable revenues at around the $2.2 billion per quarter mark, and reiterated that Lucent was on course for a profit from the full year, following a decent run of quarterly figures (see Lucent Continues Down Profit Path).

He also reaffirmed long-term guidance of gross margins in the low 40 percent range (compared with 13 percent in 2002 and 31 percent in 2003), and operating margins (the operating income as a percentage of revenue) of between 10 percent and 15 percent. That would be a considerable improvement on 2002's margin of minus 57 percent, and the negative margin of 3 percent in 2003.

In addition, Lucent has been delivering some positive news of late to cheer its followers (see Lucent Expects Monster Tax Rebate and Telica: Lucent's Good Buy). Some believe the vendor may still look to cut its cost base further to improve its margins (see Report: More Lucent Cuts Ahead? ).

But following D'Amelio's presentation, Jefferies & Co. analyst George Notter warned investors that they should watch Lucent's pension credits, which as noted in these pages, famously gave the company its leg up into profitability (see Notter Nixes Lucent, Lucent's Back in Black, Another LU-LU, and Lucent Punched Post Profit).

In a research note issued today, Notter notes that D'Amelio provided guidance that Lucent's pension credit will decline, and that this will create "a drag on Lucent’s ability to grow reported operating margins."

This worries Notter, as he believes margin expansion is key to earnings power at Lucent "given a flat-to-slightly-up capex environment."

He says that if Lucent's restructuring process is complete, the company will have to find other ways to improve its operating margins, which currently stand at just over 10 percent. This is difficult enough, he reckons, without having to make up the shortfall created by a decreasing pension credit. And while D'Amelio provided examples of how Lucent will improve its margins (more outsourcing, product cost reductions, simpler internal functions, a generally tighter wallet), Notter is struggling to see how the vendor can meet its margin improvement targets.

Notter says it's not all gloom and doom... he also believes that Lucent is well placed to win any new metro optical business from Verizon Communications Inc. (NYSE: VZ). He believes the RBOC is running close to its capacity limit on some portions of its metro infrastructure as capex has been switched over to the carrier's high-profile FTTP projects.

"At some point the operator will have address these high utilization rates with some incremental spending on optical transport... Lucent should be a primary beneficiary here," Notter says.

— Ray Le Maistre, International News Editor, Light Reading

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