<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------------
FORM 8-K/A #1
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
February 26, 1999
---------------------------------------------------
Lucent Technologies Inc.
--------------------------------------
(Exact name of registrant as specified in its charter)
Delaware
--------------------------------------------------
(State or other jurisdiction of incorporation)
1-11639 22-3408857
(Commission File Number) (IRS Employer Identification No.)
600 Mountain Avenue, Murray Hill, New Jersey 07974
---------------------------------------------- --------------
(Address of principal executive offices) (Zip Code)
(908) 582-8500
---------------------------------------------------
(Registrant's Telephone Number)
<PAGE>
Item 5. Other Events.
On February 26, 1999, pursuant to the Agreement and Plan of Merger (the "Merger
Agreement") dated as of January 11, 1999 by and among Lucent Technologies Inc.
("Lucent"), Lando Acquisition, Inc. ("Lando"), a wholly-owned subsidiary of
Lucent, Kenan Sahin and Kenan Systems Corporation ("Kenan"), Lando was merged
with and into Kenan (the "Merger"). Kenan was the surviving corporation in the
Merger and became a wholly owned subsidiary of Lucent. In accordance with the
Merger Agreement, all the outstanding common stock of Kenan was exchanged for
approximately 25.76 million shares (post-split) of Lucent common stock. The
Merger has been accounted for as a "pooling of interests" under generally
accepted accounting principles.
Included under Item 7 of this Report on Form 8-K/A #1 are (i) restated
consolidated financial information, including restated consolidated financial
statements, at September 30, 1998 and 1997 and for the years ended September 30,
1998 and 1997 and the nine months ended September 30, 1996 and (ii) restated
financial information, including restated condensed consolidated financial
statements, as of December 31, 1998 and for the three months ended December 31,
1998 and 1997, in each case giving retroactive effect to the Merger for all
periods presented. The restated consolidated financial statements are now the
historical financial statements of Lucent and supersede the historical financial
statements included in the Company's Annual Report on Form 10-K for the year
ended September 30, 1998 as amended by Form 10-K/A #1 filed on May 17, 1999.
Item 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) Not applicable
(b) Not applicable
(c) The following exhibits are included with this Report:
Exhibit 12.1 Ratio of Earnings to Fixed Charges for the years
ended September 30, 1998 and 1997, the nine months
ended September 30, 1996 and the years ended
December 31, 1995 and 1994
Exhibit 12.2 Ratio of Earnings to Fixed Charges for the Three
Months Ended December 31, 1998.
Exhibit 23 Consent of PricewaterhouseCoopers LLP
Exhibit 27.1 Financial Data Schedule at or for the Twelve Months
ended September 30, 1998
Exhibit 27.2 Financial Data Schedule at or for the Three Months
December 31, 1998
Exhibit 99.1 Restated financial information as of September 30,
1998 and 1997 and for the years ended September 30,
1998 and 1997 and the nine months ended September
30, 1996
Exhibit 99.2 Restated financial information as of December 31,
1998 and for the three months ended December 31,
1998 and 1997
Exhibit 99.3 Schedule II - Valuation and Qualifying Accounts
<PAGE>
SIGNATURE
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 hereunto duly authorized.
Lucent Technologies Inc.
Dated: May 18, 1999
By: /s/ James S. Lusk
------------------------------
James S. Lusk
Vice President and Controller
(Principal Accounting Officer)
<PAGE>
INDEX TO EXHIBITS
Exhibit 12.1 Ratio of Earnings to Fixed Charges for the years ended
September 30, 1998 and 1997, the nine months ended September
30, 1996 and the years ended December 31, 1995 and 1994
Exhibit 12.2 Ratio of Earnings to Fixed Charges for the Three Months Ended
December 31, 1998
Exhibit 23.1 Consent of PricewaterhouseCoopers LLP
Exhibit 27.1 Financial Data Schedule at or for the Twelve Months ended
September 30, 1998
Exhibit 27.2 Financial Data Schedule at or for the Three Months December
31, 1998
Exhibit 99.1 Restated financial information as of September 30, 1998 and
1997 and for the years ended September 30, 1998 and 1997 and
the nine months ended September 30, 1996
Exhibit 99.2 Restated financial information as of December 31, 1998 and for
the three months ended December 31, 1998 and 1997
Exhibit 99.3 Schedule II - Valuation and Qualifying Accounts
<PAGE>
EXHIBIT 12.1
LUCENT TECHNOLOGIES INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE TWELVE FOR THE TWELVE FOR THE NINE FOR THE YEAR FOR THE YEAR
MONTHS ENDED MONTHS ENDED MONTHS ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
1998 (B) 1997 (B) 1996 (B) 1995 1994
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Earnings Before
Income Taxes ........................... $2,396 $1,503 $375 $(1,136) $ 783
Less Interest Capitalized During
the Period ............................. 17 14 14 14 7
Less Undistributed Earnings of
Less than 50% Owned Affiliates ......... 11 3 1 2 21
Add Fixed Charges ....................... 498 457 311 327 338
------ ------ ---- ------- ------
Total Earnings ......................... $2,866 $1,943 $671 $ (825) $1,093
Fixed Charges
Total Interest Expense Including
Capitalized Interest ................... $ 297 $ 281 $209 $ 257 $ 277
Interest Portion of
Rental Expenses ........................ 137 109 61 70 61
------ ------ ---- ------- ------
Total Fixed Charges .................... $ 434 $ 390 $270 $ 327 $ 338
Ratio of Earnings to
Fixed Charges .......................... 6.6 5.0 2.5 (A) 3.2
</TABLE>
(A) For purposes of determining the ratio of earnings to fixed charges, earnings
are defined as income(loss) before income taxes, less interest capitalized,
less undistributed earnings of less than 50% owned affiliates and plus fixed
charges. Fixed charges consist of interest expense on all indebtedness and
that portion of operating lease rental expense that is representative of the
interest factor. Earnings were inadequate to cover fixed charges for the
year ended December 31, 1995 by $1,152.
(B) Certain prior year amounts have been reclassified to conform to the current
year presentation.
<PAGE>
EXHIBIT 12.2
Lucent Technologies Inc.
Computation of Ratio of Earnings to Fixed Charges
(Dollars in Millions)
(Unaudited)
For the Three
Months Ended
December 31, 1998
Income Before Income Taxes............................. $2,152
Less Interest Capitalized during
the Period........................................... 5
Less Undistributed Earnings of Less than 50%
Owned Affiliates..................................... 1
Add Fixed Charges...................................... 117
Total Earnings ........................................ $2,263
Fixed Charges
Total Interest Expense Including Capitalized Interest.. $ 80
Interest Portion of Rental Expense..................... 37
Total Fixed Charges................................ $ 117
Ratio of Earnings to Fixed Charges..................... 19.3
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
Lucent Technologies Inc. on Form S-3 (File no. 333-01223), and Forms S-8 (File
No.'s 333-45253, 333-64525, 333-46589, 333-52799, 333-52805, 333-56133,
333-08775, 333-37041, 333-33943, 333-18975, 333-18977, 333-08783, 333-42475,
333-23043 and 333-72425), of our report, dated February 26, 1999, except for the
fifth paragraph of Note 1, as to which the date is April 1, 1999, on our audit
of the consolidated financial statements of Lucent Technologies Inc. and
subsidiaries at September 30, 1998 and 1997 and for each of the two years in the
period ended September 30, 1998 and for the nine-month period ended September
30, 1996, which report appears in this Current Report on Form 8-K/A #1.
PricewaterhouseCoopers LLP
New York, New York
May 17, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the audited
balance sheet of Lucent at September 30, 1998 and the audited consolidated
statement of income for the year ended September 30, 1998 and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 712
<SECURITIES> 0
<RECEIVABLES> 7,406
<ALLOWANCES> 392
<INVENTORY> 3,081
<CURRENT-ASSETS> 14,182
<PP&E> 11,802
<DEPRECIATION> 6,392
<TOTAL-ASSETS> 26,831
<CURRENT-LIABILITIES> 10,458
<BONDS> 2,409
0
0
<COMMON> 27
<OTHER-SE> 5,588
<TOTAL-LIABILITY-AND-EQUITY> 26,831
<SALES> 30,328
<TOTAL-REVENUES> 30,328
<CGS> 16,171
<TOTAL-COSTS> 16,171
<OTHER-EXPENSES> 11,607
<LOSS-PROVISION> 132
<INTEREST-EXPENSE> 254
<INCOME-PRETAX> 2,396
<INCOME-TAX> 1,341
<INCOME-CONTINUING> 1,055
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,055
<EPS-PRIMARY> .40
<EPS-DILUTED> .39
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
unaudited balance sheet of Lucent at December 31, 1998 and the unaudited
consolidated statement of income for the three month period ended December 31,
1998 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 967
<SECURITIES> 0
<RECEIVABLES> 9,608
<ALLOWANCES> 348
<INVENTORY> 3,778
<CURRENT-ASSETS> 17,455
<PP&E> 12,548
<DEPRECIATION> 6,896
<TOTAL-ASSETS> 31,752
<CURRENT-LIABILITIES> 12,471
<BONDS> 2,404
0
0
<COMMON> 27
<OTHER-SE> 8,491
<TOTAL-LIABILITY-AND-EQUITY> 31,752
<SALES> 9,264
<TOTAL-REVENUES> 9,264
<CGS> 4,398
<TOTAL-COSTS> 4,398
<OTHER-EXPENSES> 952
<LOSS-PROVISION> (15)
<INTEREST-EXPENSE> 78
<INCOME-PRETAX> 2,152
<INCOME-TAX> 724
<INCOME-CONTINUING> 1,428
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 1,308
<NET-INCOME> 2,736
<EPS-PRIMARY> 1.03
<EPS-DILUTED> 1.00
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion of the results of operations and financial condition of
Lucent Technologies Inc. ("Lucent" or the "Company") and the accompanying
restated consolidated financial information has been prepared to give
retroactive effect to the merger of Lucent and Kenan Systems Corporation. The
restated consolidated financial information has been derived by combining the
financial information of Lucent for the twelve month periods ended September 30,
1998, 1997 and 1996, with the financial information of Kenan for the twelve
month periods ended December 31, 1998, 1997 and 1996, respectively. This
Management's Discussion and Analysis addresses the periods covered by the
financial statements contained in this Exhibit 99.1.
HIGHLIGHTS
For the year ended September 30, Lucent Technologies Inc. ("Lucent" or the
"Company") reported the following:
1998 1997
o Net income of $1,055 million, $0.39 o Net income of $574 million, $0.22
per share (diluted) per share (diluted)
The earnings per share data discussed above have been adjusted to reflect the
two-for-one splits of Lucent's common stock which became effective April 1, 1999
and April 1, 1998.
COMMUNICATIONS REVOLUTION
The communications industry is going through a revolution, centered on rapidly
growing demand by commercial and residential users for voice, data, Internet and
wireless services. As a result, the industry has undergone a global
consolidation of key players, including traditional telecommunications network
manufacturers and data networking companies, which compete in the same markets
as Lucent. This consolidation -- driven by the need for key technologies, new
distribution channels in untapped markets, economies of scale and global
expansion -- is expected to continue into the near future.
Lucent continues to evaluate its presence and product offerings in the
marketplace and may use acquisitions to enhance those offerings where that makes
good business sense. These acquisitions may occur through the use of cash, or
the issuance of debt or common stock, or any combination of the three.
ACQUISITIONS AND DIVESTITURES
As part of Lucent's efforts to focus on the fastest growing markets in the
communications industry, the Company has acquired a number of businesses,
complementing its existing product lines and its internal product development
efforts.
<PAGE>
1. In September 1998, Lucent acquired JNA Telecommunications Limited, an
Australian telecom equipment manufacturer, reseller and system integrator.
2. In August 1998, Lucent acquired LANNET, an Israeli-based supplier of Ethernet
and asynchronous transfer mode ("ATM") switching solutions.
3. In July 1998, Lucent acquired both SDX Business Systems plc, a United
Kingdom-based provider of business communications systems, and MassMedia
Communications Inc., a developer of next-generation network interoperability
software.
4. In May 1998, Lucent acquired Yurie Systems, Inc., a provider of ATM access
technology and equipment for data, voice and video networking.
5. In April 1998, Lucent acquired Optimay GmBH, a developer of software products
and services for chip sets to be used for Global System for Mobile
Communications ("GSM") cellular phones.
6. In January 1998, Lucent acquired Prominet Corporation, a participant in the
emerging Gigabit Ethernet networking industry.
7. In December 1997, Lucent acquired Livingston Enterprises, Inc., a global
provider of equipment used by Internet service providers to connect their
subscribers to the Internet.
8. In September 1997, Lucent acquired Octel Communications Corporation, a
provider of voice, fax and electronic messaging technologies that complement
those offered by Lucent.
-1-
<PAGE>
Lucent has also sought to divest itself of non-core businesses.
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 the venture. The venture, Philips Consumer Communications
("PCC"), was formed to create a worldwide provider of personal communications
products. On October 22, 1998, Lucent and Philips announced their intention to
end the venture in PCC. The venture was terminated in late 1998. In December
1998, Lucent sold certain assets of its wireless handset business to Motorola.
Lucent is currently looking for opportunities to sell its remaining consumer
products business.
o In October 1997, Lucent completed the sale of its ATS unit.
o In December 1996, Lucent sold its interconnect products and Custom
Manufacturing Services ("CMS") businesses.
o In July 1996, Lucent completed the sale of its Paradyne subsidiary.
LUCENT'S FORMATION
Lucent was formed from the systems and technology units that were formerly part
of AT&T Corp., including the research and development capabilities of Bell
Laboratories. Prior to February 1, 1996, AT&T conducted Lucent's original
business through various divisions and subsidiaries. On February 1, 1996, AT&T
began executing its decision to separate Lucent into a stand-alone company (the
"Separation") by transferring to Lucent the assets and liabilities related to
its business. In April 1996, Lucent completed the initial public offering of its
common stock ("IPO") and on September 30, 1996, became independent of AT&T when
AT&T distributed to its shareowners all of its Lucent shares.
Lucent's consolidated financial statements for periods prior to February 1, 1996
reflect the financial position, results of operations and cash flows of the
operations transferred to Lucent from AT&T in the Separation and were carved out
from the financial statements of AT&T using the historical results of operations
and historical basis of the assets and liabilities of the business. Management
believes the assumptions underlying these financial statements are reasonable,
although these financial statements may not necessarily reflect the results of
operations or financial position had Lucent been a separate, stand-alone entity.
In 1996, Lucent changed its fiscal year to begin October 1 and end September 30.
Due to this change, Lucent reported 1996 audited consolidated financial results
for a short fiscal period beginning on January 1, 1996 and ending on September
30, 1996. For comparability to the audited consolidated financial statements,
Lucent has provided unaudited consolidated statements of income and cash flows
for the twelve months ended September 30, 1996.
-2-
<PAGE>
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 foreign and domestic competitors as well as continued changes in
technology and public policy. These competitors may include entrants from the
telecommunications, software, data networking and semiconductor industries.
Existing competitors have, and new competitors may have, strong financial
capability, technological expertise, well-recognized brand names and a global
presence. Such competitors may include Cisco Systems, Inc., Nortel Networks,
Ericsson, Alcatel Alsthom and Siemens AG. As a result, Lucent's management
periodically assesses market conditions and redirects the Company's resources to
meet the challenges of competition. Steps Lucent may take include acquiring or
investing in new businesses and ventures, partnering with existing businesses,
delivering new technologies, closing and consolidating facilities, disposing of
assets, reducing work force levels or withdrawing from markets.
Lucent has taken measures to manage the seasonality of its business by changing
the date on which its fiscal year ends and its compensation programs for
employees. As a result, Lucent has achieved a more uniform distribution of
revenues -- accompanied by a related redistribution of earnings -- throughout
the year. Revenues and earnings still remain higher in the first fiscal quarter
primarily because many of Lucent's large customers historically delay a
disproportionate percentage of their capital expenditures until the fourth
quarter of the calendar year (Lucent's first fiscal quarter).
The purchasing behavior of Lucent's largest customers has increasingly 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 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 multi-year
contracts involve new technologies that may not have been previously deployed on
a large-scale commercial basis. On its multi-year 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.
Lucent has been successful in diversifying its customer base and seeking out new
types of customers globally. These new types of customers include competitive
access providers, competitive local exchange carriers, wireless service
providers, cable television network operators and computer manufacturers.
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, as well as other large carriers such as Sprint Spectrum
Holding LP ("Sprint PCS"), and the Regional Bell Operating Companies ("RBOCs").
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.
-3-
<PAGE>
The following summary financial data has been prepared giving effect to the
merger between Lucent and Kenan Systems Corporation under the pooling of
interests method of accounting. The summary combined financial information is
derived from the financial information of Lucent at or for the twelve months
ended September 30, 1998, 1997 and 1996, and the years ended December 31, 1995
and 1994 and the financial information of Kenan at or for the twelve month
periods ended December 31, 1998, 1997, 1996, 1995 and 1994, respectively. The
summary combined information at or for the nine month periods ended September
30, 1996 and 1995 is derived from the financial information of Lucent at or for
the nine month periods ended September 30, 1996 and 1995 and the financial
information of Kenan at or for the twelve month periods ended December 31, 1996
and 1995, respectively.
Lucent Technologies Inc. and Subsidiaries
Five-Year Summary
(Dollars in millions, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Year Ended
September 30, Nine Months Ended Year Ended December 31,
(Twelve Months) September 30, (Twelve Months)
-------------------------- ------------------ -----------------------
1998 1997 1996 1996 1995 1995 1994
<S> <C> <C> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS (1)
Revenues $30,328 $26,444 $23,324 $15,897 $14,004 $21,431 $19,777
Gross margin 14,157 11,539 8,927 6,602 6,158 8,483 8,436
Depreciation and
amortization expense 1,338 1,453 1,328 939 1,106 1,495 1,313
Operating income(loss) 2,550 1,666 (939) 495 436 (998) 970
Net income(loss) 1,055 574 (788) 229 151 (866) 481
Earnings(loss) per common
share - basic (2)(3) 0.40 0.22 (0.34) 0.10 0.07 (0.41) n/a
Earnings(loss) per common
share - diluted (2)(3) 0.39 0.22 (0.34) 0.10 0.07 (0.41) n/a
Earnings(loss) per common
share - pro forma(3)(4) n/a n/a (0.31) 0.09 0.06 (0.34) n/a
Dividends per common share(3) 0.0775 0.05625 0.0375 0.0375 - - n/a
FINANCIAL POSITION
Total assets 26,831 $23,868 $22,650 $22,650 $18,232 $19,735 $17,348
Working capital 3,724(5) 1,782 2,074 2,074 191 (382) 248
Total debt 4,640 4,203 3,997 3,997 4,192 4,014 3,164
Shareowners' equity 5,615 3,410 2,695 2,695 2,787 1,438 2,480
OTHER INFORMATION
Selling, general and
administrative expenses
as a percentage of revenues 21.4% 22.0% 31.3% 26.8% 28.9% 33.1% 27.1%
Research and development
expenses as a percentage
of revenues 12.2 11.5 11.0 11.6 12.0 11.1 10.6
Gross margin percentage 46.7 43.6 38.3 41.5 44.0 39.6 42.7
Ratio of total debt
to total capital
(debt plus equity) 45.2 55.2 59.7 59.7 60.1 73.6 56.1
Capital expenditures $1,634 $ 1,639 $ 1,435 $ 942 $ 785 $ 1,278 $ 878
</TABLE>
(1) Beginning September 30, 1996, Lucent changed its fiscal year end from
December 31 to September 30, and reported results for the nine-month
transition period ended September 30, 1996.
(2) The calculation of earnings per share on a historical basis includes the
retroactive recognition to January 1, 1995 of the 2,098,499,576 shares
(524,624,894 shares on a pre-split basis) owned by AT&T on April 10, 1996.
-4-
<PAGE>
(3) All per share data has been restated to reflect the two-for-one splits of
Lucent's common stock which became effective on April 1, 1998 and April 1,
1999.
(4) The calculation of earnings (loss) per share on a pro forma basis assumes
that all 2,572,405,300 shares outstanding on April 10, 1996 were
outstanding since January 1, 1995 and gives no effect to the use of
proceeds from the IPO.
(5) Reflects the reclassification from debt maturing within one year to
long-term debt as a result of the November 19, 1998 sale of $500 ($495 net
of unamortized costs) of ten-year notes.
n/a Not applicable
TWELVE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS TWELVE MONTHS ENDED SEPTEMBER 30,
1997
REVENUES
Total revenues increased to $30,328 million, or 14.7% compared with the same
period in 1997, primarily due to increases in sales from Systems for Network
Operators, Business Communications Systems and Microelectronic Products. The
overall revenue growth was impacted by the elimination of the Consumer Products
sales as a component of total revenue as well as lower revenues from Other
Systems and Products. The decline in Other Systems and Products was due
primarily to the sale of Lucent's ATS and CMS businesses in October 1997 and in
December 1996, respectively. Excluding revenues from Lucent's Consumer Products,
ATS and CMS businesses, total revenues increased 20.6% compared with the same
period in 1997. Revenue growth was driven by sales increases globally. For
fiscal year 1998, sales within the United States grew 12.0% compared with the
same period in 1997. Sales outside the United States increased 23.1% compared
with the same period in 1997. These sales represented 25.9% of total revenues
compared with 24.2% in 1997. Excluding revenues from Lucent's Consumer Products,
ATS and CMS businesses, sales within the United States increased 19.7% compared
with the same period in 1997.
GLOBAL REVENUE GROWTH-For the twelve months ended September 30,
(Dollars in billions)
Year Revenues
- ---- --------
1996 $23.3
1997 $26.4
1998 $30.3*
- -----------------
* Excluding the revenues from Lucent's Consumer Products, ATS and CMS
businesses, 1998 total revenues increased 20.6% compared with the same period
in 1997.
<PAGE>
The following table presents Lucent's revenues by product line, and the
approximate percentage of total revenues for the twelve months ended September
30, 1998 and 1997:
<TABLE>
<CAPTION>
Twelve Months Ended
September 30,
Dollars in Millions -----------------------------------------
As a Percentage As a Percentage
1998 of Total Revenue 1997 of Total Revenue
------- ---------------- ------- ----------------
<S> <C> <C> <C> <C>
Systems for Network Operators........ $18,933 62% $15,698 59%
Business Communications Systems...... 8,093 27 6,411 24
Microelectronic Products............. 3,027 10 2,755 11
Consumer Products.................... - - 1,013 4
Other Systems and Products........... 275 1 567 2
Total................................ $30,328 100% $26,444 100%
</TABLE>
Revenues from SYSTEMS FOR NETWORK OPERATORS increased $3,235 million, or 20.6%
compared with the same period in 1997. The increase resulted from higher sales
-5-
<PAGE>
of switching and wireless systems with associated software, optical networking
systems, communications software, and data networking systems for service
providers - including those provided by recently acquired Livingston. Demand for
those products was driven in part by second line subscriber growth in businesses
and residences for Internet services and data traffic.
Revenues from Systems for Network Operators in the United States increased by
20.6% over the year-ago period. The revenue increase in the United States was
led by sales to RBOCs, competitive local exchange carriers, wireless service
providers and long distance carriers. Revenues generated outside the United
States for 1998 increased 20.7% compared with the same period in 1997 due to
revenue growth in the Europe/Middle East/Africa, Canada, China and
Caribbean/Latin America regions. Revenues generated outside the United States
represented 25.3% of revenues for 1998 compared with 25.2% in the same period of
1997.
For 1998, sales of wireless infrastructure increased significantly compared with
1997 as customers accepted networks for commercial service in 1998 using various
digital technologies. These technologies include Code Division Multiple Access
("CDMA"), GSM and Time Division Multiple Access ("TDMA"). The Lucent digital
technologies continue to show acceptance in markets both within and outside the
United States.
Revenues from BUSINESS COMMUNICATIONS SYSTEMS increased $1,682 million, or 26.2%
compared with the same period in 1997. This increase was led by sales of
messaging systems, including systems provided by recently acquired Octel,
SYSTIMAX(R) structured cabling, enterprise data networking systems and services.
Revenues generated outside the United States increased by 53.9% due to growth in
all international regions, led by the Europe/Middle East/Africa region. Revenues
generated outside the United States represented 19.2% of the revenues for 1998
compared with 15.8% in the same period in 1997. For 1998, sales within the
United States increased 21.1% compared with the same period in 1997.
Revenues from MICROELECTRONIC PRODUCTS increased $272 million, or 9.9% for 1998
compared with the same period in 1997 due to higher sales of chips for computing
and communications, including components for broadband and narrowband networks,
data networking, wireless telephones and infrastructure, high-end workstations,
optoelectronic components, power systems and the licensing of intellectual
property. Sales within the United States increased 11.9% compared with the same
period in 1997. Revenues generated outside the United States increased 8.0%
compared with the same period in 1997. The increase in revenues generated
outside the United States was driven by sales in all international regions, led
by the Caribbean/Latin America region. Revenues generated outside the United
States represented 50.5% of sales compared with 51.3% for the same period in
1997.
Despite a nearly 8.0%(a) decline in the world semiconductor market,
Microelectronic Products achieved revenue growth of 9.9% for 1998.
On October 1, 1997, Lucent contributed its CONSUMER PRODUCTS unit to PCC in
exchange for 40% ownership of PCC. On October 22, 1998, Lucent and Philips
announced they would end their PCC venture. The venture was terminated in late
1998. In December 1998, Lucent sold certain assets of its wireless handset
business to Motorola. Lucent is currently looking for opportunities to sell its
remaining consumer products business.
Revenues from sales of OTHER SYSTEMS AND PRODUCTS decreased $292 million, or
51.5% compared with the same period in 1997. The reduction in revenues was
primarily due to the sale of Lucent's ATS and CMS businesses. ATS designed and
manufactured custom defense systems for the United States government.
- --------------------------------------
(R) Registered trademark of Lucent
(a) Source: World Semiconductor Trade Statistics, Inc.
-6-
<PAGE>
COSTS AND GROSS MARGIN
Total costs increased $1,266 million, or 8.5% compared with the same period in
1997 due to the increase in sales volume. Gross margin percentage increased to
46.7% from 43.6% in the year-ago period. The increase in gross margin percentage
for the current period was due to an overall favorable mix of higher margin
products and services sales.
OPERATING EXPENSES
Selling, general and administrative expenses as a percentage of revenues were
21.4% for 1998, a decrease of 0.6 percentage points from the same period in
1997. Excluding the amortization expense associated with goodwill and existing
technology for both years, selling, general and administrative expenses as a
percentage of revenues were 21.0%, a decrease of 0.9 percentage points from the
same period in 1997.
Selling, general and administrative expenses increased $682 million, or 11.7%
compared with the same period in 1997. This increase is attributed to the higher
sales volume, investment in growth initiatives, amortization expense associated
with goodwill and existing technology as well as the implementation of SAP, an
integrated software platform. Amortization expense associated with goodwill and
existing technology was $147 million for the year ended September 30, 1998, an
increase of $115 million from the same year-ago period. These increases were
offset by the reversal of $66 million of 1995 business restructuring charges. In
addition, the 1997 period included a $174 million reversal of 1995 business
restructuring charges.
Research and development expenses represented 12.2% of revenues for the period
as compared with 11.5% of revenues from the same period in 1997.
Research and development expenses increased $660 million compared with the same
period in 1997. This was primarily due to increased expenditures in support of
wireless, data networking, optical networking and software as well as switching
and access systems and microelectronic products.
The purchased in-process research and development expenses for 1998 were $1,416
million, reflecting the charges associated with the acquisitions of Livingston,
Prominet, Yurie, Optimay, SDX, MassMedia, LANNET and JNA compared with $1,024
million related to the acquisitions of Octel and Agile Networks, Inc. for the
same period in 1997.
<PAGE>
OTHER INCOME, INTEREST EXPENSE AND PROVISION FOR INCOME TAXES
Other income -- net increased $25 million for 1998 compared with the same period
in 1997. This increase was primarily due to gains recorded on the sale of
certain business operations, including $149 million associated with the sale of
Lucent's ATS business. These gains were offset by higher net losses associated
with Lucent's equity investments, primarily from the PCC investment. Also,
included in Other income -- net for 1998 is a charge of $110 million related to
a write-down associated with Lucent's investment in the PCC venture. This charge
was offset by one-time gains of $103 million primarily related to the sale of an
investment and the sale of certain business operations including Bell Labs
Design Automation Group.
Interest expense was $254 million for the 1998 fiscal year, an increase of $16
million compared with the same period in 1997. The increase in interest expense
is due to higher debt levels in 1998 as compared with the prior year.
The effective income tax rate of 56.0% for 1998 decreased from the effective
income tax rate of 61.8% in the same year-ago period. These rates exceed the
U.S. federal statutory income tax rate primarily due to the book write-off of
in-process research and development costs which are not deductible for tax
purposes. Excluding the impact of the purchased in-process research and
development expenses associated with Livingston, Prominet, Yurie, Optimay, SDX,
LANNET and JNA acquisitions, as well as the similar impact of the Octel and
Agile acquisitions in 1997, the effective income tax rate was 35.3% for 1998, a
decrease from the year-ago rate of 36.8%. This decrease was primarily due to a
reduced state effective tax rate and increased research tax credits. The
effective income tax rate does not include a federal income tax provision for
Kenan since Kenan was an S-Corporation for 1997 and 1998.
-7-
<PAGE>
CASH FLOWS
Cash provided by operating activities was $1,412 million in 1998, a decrease of
$563 million compared with the same period in 1997. This decrease in cash was
largely due to the increase in accounts receivable, partially offset by the
increase in payroll and benefit-related liabilities.
Cash payments of $176 million were charged against the December 1995 business
restructuring reserves in 1998 compared with $483 million in 1997. Of the 23,000
positions that Lucent announced it would eliminate in connection with the 1995
restructuring charges, approximately 19,900 positions had been eliminated
through September 30, 1998. Actual experience in employee separations, combined
with redeploying employees into other areas of the business, resulted in lower
separation costs than originally anticipated. Lucent expects employee reductions
in positions to be substantially complete by September 1999.
The restructuring reserves were established in December 1995 after AT&T decided
to spin off the Company, but before the formal transfer of assets and personnel
to the Company. The restructuring reserves were in support of Lucent's intention
to focus on the technologies and markets it viewed as critical to its long-term
success as a stand-alone entity. Lucent performed a comprehensive review of all
of its operations, including its organizational structure, products and markets,
with a view toward maximizing its return on investments. Actions such as the
closing of the Phone Center stores, the consolidation of international
facilities and the exiting from non-core businesses such as the circuit board
business, have increased Lucent's profitability.
Part of the restructuring plan included workforce reductions which resulted from
Lucent's decisions to form a single corporate structure that eliminated
duplicative management and streamlined administrative functions, and to
outsource certain corporate functions. An example of this activity is the
outsourcing of information technology and production application work to ISSC,
an IBM subsidiary. The efficiencies that resulted from the restructuring have
enabled Lucent to reduce its selling, general and administrative expenses as a
percentage of revenue over the past three fiscal years.
Many of the 1995 restructuring projects were significant and complex
initiatives, some of which could not be completed until new enterprise-wide
information technology systems, centralized back office support hubs and
provisioning centers were in place. At the time the restructuring plans were
adopted, the estimated time lines and project plans indicated that substantially
all projects would be complete within two years. Some of the restructuring
projects have taken longer than anticipated to complete due to their complicated
nature and size, and the complicated nature and size of other projects that
needed to be completed first. As a result, approximately 13% of the original
reserves remained at September 30, 1998.
Lucent's remaining restructuring plans consist primarily of: (1) the elimination
of back office support facilities due to the replacement of legacy information
technology systems and the consolidation of corporate functions in certain
locations outside the United States, each of which will result in employee
separation costs, (2) facility closing costs for continuing payments under
building leases for properties that Lucent no longer occupies and (3) other
costs related to the closing, sale or consolidation of certain owned facilities
and product lines.
The remaining employee separation costs will be used to reduce approximately
1,200 employees performing transaction processing and financial reporting and to
downsize the number of employees in our Customer Service Centers. These
headcount reductions were included in the original restructing plans and will
occur as soon as the replacement of the legacy information technology systems
and consolidation of corporate functions are complete.
<PAGE>
As a result of the workforce reductions and consolidation efforts, the Company
reduced the amount of leased space it occupied from 19 million square feet to
14 million square feet. The remaining facility closing costs include ongoing
rental payments for the leased space the Company no longer occupies and the
reserves will be utilized over the remaining lease terms.
Other costs remaining include primarily reserves for remediation expenses,
outstanding litigation and sales and use tax issues related to the closing, sale
or consolidation of certain owned facilities or product lines which were being
exited. Management believes that the remaining reserves for business
restructuring plans are adequate and that the plans will be completed by
September 1999.
Comparing 1998 and 1997, cash used in investing activities decreased to $2,816
million from $3,125 million primarily due to a decrease in cash used for
acquisitions as well as an increase in cash received from dispositions. In 1998,
cash was used in the acquisitions of Yurie, Optimay, SDX, LANNET and JNA. The
acquisitions of Livingston and Prominet in 1998 were completed through the
issuance of stock and options and did not require the use of cash. The use of
cash in 1998 was partially offset by proceeds from the sale of ATS. In 1997,
Lucent acquired Octel and Agile and disposed of its interconnect products and
CMS businesses.
Capital expenditures were $1,634 million and $1,639 million for 1998 and 1997,
respectively. Capital expenditures include expenditures for equipment and
facilities used in manufacturing and research and development, including
expansion of manufacturing capacity and international growth.
Cash provided by financing activities for 1998 was $812 million compared with
$276 million in 1997. The increase in cash provided by financing activities was
due to higher debt levels and increased issuances of common stock when compared
with the prior period.
-8-
<PAGE>
TWELVE MONTHS ENDED SEPTEMBER 30, 1997 VERSUS TWELVE MONTHS ENDED SEPTEMBER 30,
1996
REVENUES
Total revenues increased $3,120 million or 13.4% for 1997 compared with 1996,
primarily due to gains in sales from Systems for Network Operators, Business
Communications Systems and Microelectronic Products. The overall revenue growth
was partially offset by the expected decline in revenue from Consumer Products
and Other Systems and Products. Revenues for Lucent's three core businesses
increased 18.1% for 1997 compared with 1996. Revenue growth continued to be
generated from sales both within and outside the United States. Sales outside
the United States increased 12.6% compared with 1996 and represented 24.2% of
total revenues in 1997. The increased sales outside of the United States
reflected Lucent's targeted approach toward revenue expansion outside the United
States for increased profitability. The following table presents Lucent's
revenues by product line, and the related percentage of total revenues for the
twelve months ended September 30, 1997 and 1996:
<TABLE>
<CAPTION>
Twelve Months Ended
September 30,
Dollars in Millions -----------------------------------------
As a Percentage As a Percentage
1997 of Total Revenue 1996 of Total Revenue
------- ---------------- ------- ----------------
<S> <C> <C> <C> <C>
Systems for Network Operators........ $15,698 59% $13,230 57%
Business Communications Systems...... 6,411 24 5,509 24
Microelectronic Products............. 2,755 11 2,315 10
Consumer Products.................... 1,013 4 1,431 6
Other Systems and Products........... 567 2 839 3
Total................................ $26,444 100% $23,324 100%
</TABLE>
Revenues from SYSTEMS FOR NETWORK OPERATORS increased $2,468 million or 18.7%
compared with 1996. The increase resulted from higher sales of both switching
and wireless systems with associated software, fiber-optic cable and
professional services. Demand for second lines in businesses and residences for
Internet services and data connectivity contributed to the revenue growth for
1997.
Sales from Systems for Network Operators in the United States increased 22.2%.
The revenue increase in the United States was led by sales to traditional
service providers and non-traditional customers such as personal communications
services ("PCS") wireless providers, competitive access providers and cable
television companies. Sales outside the United States increased 9.3% compared
with 1996, resulting from increased sales in the Europe/Middle East/Africa,
Asia/Pacific and Caribbean/Latin America regions. Sales outside the United
States represented 25.2% of Systems for Network Operators revenues for 1997.
<PAGE>
For 1997, sales of wireless infrastructure increased significantly compared with
the same period in 1996 primarily due to PCS contracts as customers accepted
networks for commercial service in 1997 using various digital technologies.
These technologies include CDMA, GSM and TDMA. The Lucent digital technologies
continue to show acceptance in markets both within and outside the United
States.
Revenues from BUSINESS COMMUNICATIONS SYSTEMS increased $902 million or 16.4%
compared with the same period in 1996. This increase was led by sales of
DEFINITY(R) products, SYSTIMAX structured cabling, messaging systems, integrated
offers such as call centers and higher revenues from service contracts. This
increase was partially offset by the continued erosion of the rental base.
Revenues in the United States increased 17.0% compared with 1996. Revenues
outside the United States increased by 13.2%, reflecting growth in all
international regions. The increases both within and outside the United States
were primarily due to sales of DEFINITY products, call centers and messaging
systems. In addition, higher sales of SYSTIMAX structured cabling contributed to
the revenue growth in the United States. Sales outside the United States
represented 15.8% of revenue for 1997.
- --------------------------------------
(R) Registered trademark of Lucent
-9-
<PAGE>
Sales of MICROELECTRONIC PRODUCTS increased $440 million or 19.0% compared with
1996, due to higher sales of customized chips for computing and communications,
including components for local area networks, data networking, high-end computer
workstations and wireless telephones. Higher sales of power systems and
optoelectronic components also contributed to the increase for 1997. Sales
within the United States increased 12.5% compared with 1996, led by sales to
original equipment manufacturers ("OEMs"). The 25.9% growth in revenues outside
the United States was driven by application specific integrated circuits
("ASICs") sales in the Asia/Pacific region as well as the growth of wireless and
multimedia integrated circuits and power products sold to customers in Europe
for cellular applications. Sales outside the United States represented 51.3% of
the Microelectronic Products sales for 1997. Microelectronic Products continued
to bring to market new technologies, such as the introduction of the K56flex(TM)
modem technology.
Revenues from CONSUMER PRODUCTS decreased $418 million or 29.2% compared with
1996. The decline in revenues was primarily due to decreased product sales
related to the closing of the Phone Center Stores, the discontinuation of
unprofitable product lines and the continued decrease in phone rental revenues.
Lucent's Consumer Products unit was contributed to the venture between Lucent
and Philips on October 1, 1997.
Revenues from OTHER SYSTEMS AND PRODUCTS decreased $272 million or 32.4%
compared with 1996. The decrease is largely due to the sale of Lucent's CMS
business in fiscal year 1997 and its Paradyne subsidiary in fiscal year 1996.
GROSS MARGIN
Gross margin percentage increased to 43.6% from 38.3% in 1996 primarily due to
the restructuring charges recorded in the quarter ended December 31, 1995.
Excluding restructuring charges, gross margin for 1996 was 42.1%. The increase
in gross margin percentage for 1997 was due to an overall favorable mix of
higher margin product revenues and the benefits associated with Lucent's
business productivity improvement initiatives.
- --------------------------------------
(TM) Trademark of Lucent
-10-
<PAGE>
OPERATING EXPENSES
Selling, general and administrative expenses decreased $1,490 million or 20.4%
compared with 1996. Excluding the $1,645 million of restructuring charges
recorded in December 1995, selling, general and administrative expenses
increased $155 million compared with 1996. This increase was due to expenditures
associated with higher sales levels, investment in growth initiatives, and the
implementation of SAP, an integrated software platform. These increases were
partially offset by the reversal of $174 million of business restructuring
liabilities in 1997, the lower start-up costs incurred in 1997, and business
productivity improvement initiatives, including lower expenses since some
businesses were exited in fiscal 1997 and 1996. Selling, general and
administrative expenses as a percentage of revenue declined 9.3 percentage
points to 22.0% of revenues compared with 31.3% of revenues, due to
restructuring charges in 1996.
Research and development expenses increased $473 million or 18.5% compared with
1996. Excluding the impact of restructuring charges recorded in the quarter
ended December 31, 1995, research and development expenses increased by $737
million, primarily due to expenditures in support of wireless infrastructure,
microelectronic products and advanced multimedia communications systems as well
as a $127 million write-down of special-purpose Bell Labs assets no longer being
used. Research and development expenses represented 11.5% of revenues as
compared with 11.0% of revenues in 1996. Research and development expenses as a
percentage of revenues increased 1.7 percentage points from 9.8%, excluding
restructuring charges in 1996.
Purchased in-process research and development for 1997 reflects one-time
write-offs totaling $1,024 million of in-process research and development in
connection with the acquisitions of Octel and Agile. Agile is a provider of
advanced intelligent data switching products acquired by Lucent in October 1996.
OTHER INCOME, INTEREST EXPENSE AND PROVISION FOR INCOME TAXES
Other income-net decreased $88 million compared with 1996. This decrease was
largely due to gains recognized on the sale of certain investments and insurance
recoveries in 1996, offset in part by increased interest income in 1997.
Interest expense was flat compared with 1996.
The effective tax rate of 61.8% for 1997 increased from the effective tax rate
of 22.3% for the same period of 1996 due to the 1997 write-offs of purchased
in-process research and development costs and the tax impact of restructuring
charges incurred in 1996. The 1997 rate exceeds the U.S. federal statutory
income tax rate primarily due to the book write-off of in-process research and
development costs which are not deductible for tax purposes. Excluding charges
related to the acquisitions of Agile and Octel, the effective tax rate for 1997
was 36.8%, a decrease of 3.9 percentage points from the 1996 effective tax rate
of 40.7% before considering the effects of restructuring charges incurred in
1996. This decrease is primarily attributable to the tax impact of foreign
earnings.
-11-
<PAGE>
CASH FLOWS
Cash provided by operating activities was $1,975 million in 1997, an increase of
$989 million compared with the same period in 1996. This increase in cash was
largely due to the retention of $2,000 million of customer accounts receivable
by AT&T in 1996 as well as the increase in cash collections associated with
higher sales. This was offset by changes in accounts payable due to the end of
payments to AT&T related to the Separation and the change in other operating
assets and liabilities over 1996. The change in other operating assets and
liabilities was primarily due to the receipt of a $500 million cash advance made
to Lucent in April 1996 by AT&T and the utilization by AT&T of that advance in
1997.
Cash payments of $483 million were charged against the December 1995 business
restructuring reserves in 1997. As of September 30, 1997, the workforce had been
reduced by approximately 17,900 positions in connection with business
restructuring. In addition, approximately 1,000 employees left Lucent's
workforce as part of the sale of Paradyne in 1996. Actual experience in employee
separations, combined with redeploying employees into other areas of the
business, has resulted in lower separation costs than originally anticipated.
Comparing 1997 and 1996, cash used in investing activities increased to $3,125
million from $1,641 million primarily due to the acquisition of Octel.
Capital expenditures were $1,639 million and $1,435 million for 1997 and 1996,
respectively. Capital expenditures include expenditures for equipment and
facilities used in manufacturing and research and development, including
expansion of manufacturing capacity and international growth.
Cash provided by financing activities for 1997 was $276 million compared with
$2,503 million in 1996. This decrease was primarily due to the proceeds received
from the IPO in the year-ago period.
In 1995, Lucent relied on AT&T to provide financing for its operations. The cash
flows from financing activities for the year ended September 30, 1996 reflect
changes in the Company's assumed capital structure. These cash flows are not
necessarily indicative of the cash flows that would have resulted if Lucent had
been a stand-alone entity.
-12-
<PAGE>
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Total assets as of September 30, 1998 increased $2,963 million, or 12.4%, from
September 30, 1997. This increase was primarily due to increases in accounts
receivable and other assets of $1,603 million and $1,001 million, respectively.
The increase in accounts receivable was primarily due to higher sales. The
increase in other assets was largely due to the increase in goodwill and
existing technology associated with the Livingston, Prominet, Yurie, Optimay,
SDX, LANNET and JNA acquisitions, and an increase in equity investments as a
result of Lucent's contribution of its Consumer Products business to PCC.
Total liabilities increased $758 million, or 3.7%, from September 30, 1997. This
increase was largely due to the increases in payroll and benefit-related
liabilities and postretirement and postemployment benefit liabilities. These
increases are primarily related to the increase in employee headcount as a
result of Lucent's recent acquisitions as well as year end payroll and benefit
accruals.
Working capital, defined as current assets less current liabilities, increased
$1,942 million from fiscal year end 1997 primarily resulting from the increase
in accounts receivable, and the following reclassification of $500 million ($495
million net of unamortized costs) from short-term debt to long-term debt. On
November 19, 1998, Lucent sold $500 million of ten-year notes and reclassified
the amount from debt maturing within one year to long-term debt. The proceeds
were used to pay down a portion of Lucent's commercial paper during the first
quarter of fiscal 1999.
For the year ended September 30, 1998, Lucent's inventory turnover ratio was 4.6
times compared with 4.0 times for the year ended September 30, 1997. The
increase was primarily due to improved inventory management at the factories and
in the distribution channels. Inventory turnover is defined as cost of sales
(excluding costs related to long-term contracts) divided by average inventory
during the year.
Accounts receivable were outstanding an average of 64 days for the years ended
September 30, 1998 and 1997, respectively.
The fair value of Lucent's pension plan assets is greater than the projected
pension obligations. Lucent records pension income when the expected return on
plan assets plus amortization of the transition asset is greater than the
interest cost on the projected benefit obligation plus service cost for the
year. Consequently, Lucent continued to have a net pension credit that added to
prepaid pension costs in 1998 and which is expected to continue in the near
term.
Lucent expects that, from time to time, outstanding commercial paper balances
may be replaced with short- or long-term borrowings as market conditions permit.
At September 30, 1998, Lucent maintained approximately $5,200 million in credit
facilities, of which a portion is used to support Lucent's commercial paper
program. At September 30, 1998, approximately $4,850 million 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, and
short- and long-term debt financings will be adequate to satisfy its future cash
requirements, although there can be no assurance that this will be the case.
-13-
<PAGE>
Network operators, inside and outside the United States, increasingly have
required their suppliers to arrange or provide long-term financing for them as a
condition to obtaining or bidding on infrastructure projects. These projects may
require financing in amounts ranging from modest sums to over 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 other financial institutions and investors. This enables Lucent
to reduce the amount of its commitments and free up additional financing
capacity.
As of September 30, 1998, Lucent had made commitments or entered into an
agreement to extend credit to certain customers, including Sprint PCS, up to an
aggregate of approximately $2,300 million. As of September 30, 1998,
approximately $400 million had been advanced and was outstanding. Included in
the $2,300 million is approximately $1,230 million to six other PCS or wireless
network operators (including fixed wireless) for possible future sales. As of
September 30, 1998, approximately $130 million had been advanced under four of
these arrangements. In addition, Lucent had made commitments or entered into
agreements to extend credit up to an aggregate of approximately $370 million for
two network operators other than PCS or wireless network operators. As of
September 30, 1998, no amount was advanced under either of these agreements. In
November 1998, a commitment for $110 million, included in the $370 million, was
terminated.
In October 1996, Lucent entered into a credit agreement to provide Sprint PCS
long-term financing of $1,800 million for purchasing Lucent's equipment and
services for its PCS network. In May 1997, under the $1,800 million credit
facility provided by Lucent to Sprint PCS, Lucent closed transactions to lay off
$500 million of loans and undrawn commitments and $300 million of undrawn
commitments to a group of institutional investors and Sprint Corporation (a
partner in Sprint PCS), respectively. As of September 30, 1998, all of these
commitments were drawn down by Sprint PCS. On June 8, 1998, Lucent sold $645
million of loans in a private sale. As of September 30, 1998, Lucent has $253
million of undrawn commitments and $226 million of drawn loans outstanding.
As part of the revenue recognition process, Lucent has assessed the
collectibility of the accounts receivable relating to the Sprint PCS purchase
contract in light of its financing commitment to Sprint PCS. Lucent has
determined that the receivables under the contract are reasonably assured of
collection based on various factors among which was the ability of Lucent to
sell the loans and commitments without recourse. Lucent intends to continue
pursuing opportunities for the sale of the $226 million of loans outstanding,
and the future loans and commitments to Sprint PCS.
<PAGE>
On October 22, 1998, Lucent announced that it had entered into a five-year
agreement with WinStar Communications, Inc. to provide WinStar with a fixed
wireless broadband telecommunications network in major domestic and
international markets. In connection with this agreement, Lucent entered into a
credit agreement with WinStar to provide up to $2,000 million in equipment
financing to fund the buildout of this network. The maximum amount of credit
that Lucent is obligated to extend to WinStar at any one time is $500 million.
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.
The ratio of total debt to total capital (debt plus equity) was 45.2% at
September 30, 1998 compared with 55.2% at September 30, 1997. The decrease in
the ratio was primarily due to the increase in shareowners' equity, which
resulted from net income and the issuance of common stock, partially offset by
the increase in debt.
-14-
<PAGE>
IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisitions of Octel, Livingston, Prominet, and Yurie,
Lucent allocated a significant portion of the purchase price to purchased
in-process research and development. As part of the process of analyzing each of
these acquisitions, Lucent made a decision to buy technology that had not yet
been commercialized rather than develop the technology internally. Lucent based
this decision on factors such as the amount of time it would take to bring the
technology to market. Lucent also considered Bell Labs' resource allocation and
its progress on comparable technology, if any. Lucent management expects to use
the same decision process in the future.
Lucent estimated the fair value of in-process research and development for each
of the above acquisitions using an income approach. This involved estimating the
fair value of the in-process research and development using the present value of
the estimated after-tax cash flows expected to be generated by the purchased
in-process research and development, using risk adjusted discount rates and
revenue forecasts as appropriate. The selection of the discount rate was based
on consideration of Lucent's weighted average cost of capital, as well as other
factors including the useful life of each technology, profitability levels of
each technology, the uncertainty of technology advances that were known at the
time, and the stage of completion of each technology. Lucent believes that the
estimated in-process research and development amounts so determined represent
fair value and do not exceed the amount a third party would pay for the
projects.
Where appropriate, Lucent deducted an amount reflecting the contribution of the
core technology from the anticipated cash flows from an in-process research and
development project. At the date of acquisition, the in-process research and
development projects had not yet reached technological feasibility and had no
alternative future uses. Accordingly, the value allocated to these projects was
capitalized and immediately expensed at acquisition. If the projects are not
successful or completed timely, management's product pricing and growth rates
may not be achieved and Lucent may not realize the financial benefits expected
from the projects.
Octel
- ----------
On September 29, 1997, Lucent completed the purchase of Octel for $1,819
million. Octel was a public company involved in the development of voice, fax,
and electronic messaging technologies. The allocation to in-process research and
development of $945 million represented its estimated fair value using the
methodology described above.
In-Process Research and Development Overview
At the acquisition date, Octel was conducting development, engineering, and
testing activities associated with the completion of six projects. These
projects and their respective in-process research and development values were:
Unified Messenger ($245 million), Phoenix/Intelligent Messaging Architecture
("IMA") ($540 million), Octel Network Services ("ONS") Projects ($111 million),
and three other projects ($49 million in total). Briefly described below are the
effort and assumptions related to the Unified Messenger, Phoenix/IMA, and ONS
projects.
-15-
<PAGE>
Unified Messenger. This project, which had been in development for over three
years at acquisition, was a next-generation messaging system for accessing both
voice and e-mail messages with either a telephone or a computer. Messages are
stored in a single mailbox, which allows users to access all of their messages.
The product consists of a voice server implemented on a Microsoft NT platform,
using digital signal processing cards as links to a private branch exchange.
Research and development efforts in progress at the acquisition date involved
work on an initial and several enhanced versions of Unified Messenger.
The major achievements related to this project at September 29, 1997 included
the development of the telephone access interface to enable listening to both
voice and text mail stored in Microsoft Exchange and of the text-to-speech
function needed for listening to e-mail.
The primary remaining risks at the acquisition date were related to
functionality and integration issues with Microsoft Exchange that affected
overall product reliability, and addressing inadequate application response time
relative to customer market demands. The first version of Unified Messenger was
not expected to reach technological feasibility until December 1997 at which
time Lucent would begin generating economic benefits. At the acquisition date,
costs to complete the research and development efforts related to the initial
release of the project were expected to be $3 million.
Phoenix/IMA. The Phoenix/IMA research and development project involved two
phases of development focused on developing a next generation server, Phoenix,
to replace the existing product and on providing a migration path to the next
generation messaging platform, IMA. The existing product was inflexible,
obsolete, and did not have the ability to provide customers with the
technological capabilities that were required in the digital and wireless
network environments at the acquisition date. Upon release, the Phoenix server
was expected to function as a media server for the IMA platform. IMA was being
designed to be a distributed, open-system architecture that would allow for
greater speed of product improvement, and enable service providers to create
customized applications more easily for various countries or communities.
The major achievements related to this project at September 29, 1997 included
development of hardware prototypes for Phoenix and optimizing and adding
functionality to the IMA operating support systems.
The primary risks remaining at September 29, 1997 were related to the following
development areas: (I) performance issues related to new line cards, (ii) a new
asynchronous processor, and (iii) IMA's new and unproven architecture. At the
acquisition date, costs to complete the research and development efforts related
to Phoenix/IMA were expected to be $49 million. Phoenix was scheduled to reach
technological feasibility in September 1998, and IMA was expected to reach
technological feasibility in January 1999.
ONS Projects. At the acquisition date, ONS, which operates and maintains voice
messaging systems for service providers, was involved in designing new software
to provide additional capabilities demanded by its outsourcing customers as well
as to handle new voice messaging systems that Octel would produce. The existing
software was outdated and lacked required functionality. The goal of the ONS
Projects was to produce software to be used in a platform that would be easily
upgradeable with greater functionality.
The major achievements related to these projects at September 29, 1997 included
the development of functional and design specifications, development and testing
related to call collection processes, and testing of provisioning.
The primary remaining risks at September 29, 1997 were related to the completion
of remaining specifications, migration activities, and completion of core
software capabilities. Lucent anticipated that development related to this
project would be completed in the 1998 calendar year, after which Lucent
expected to begin generating economic benefits. At the acquisition date, costs
to complete the research and development efforts related to the ONS Projects
were expected to be less than $1 million.
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<PAGE>
Valuation Assumptions
Unified Messenger. Revenues attributable to Unified Messenger were estimated to
be $5 million in 1998 and $46 million in 1999. Revenue was expected to peak in
2004 and decline thereafter through the end of the product's life (2008) as new
product technologies were expected to be introduced by Lucent. Revenue growth
was expected to decrease from 179% in 2000 to 20% in 2004, and be negative for
the remainder of the projection period.
Phoenix/IMA. Revenues attributable to Phoenix/IMA were estimated to be $94
million in 1998 and $508 million in 1999. Revenue was expected to peak in 2004
and decline thereafter through the end of the product's life (2010) as new
product technologies were expected to be introduced by Lucent. Revenue growth
was expected to decrease from 59% in 2000 to 10% in 2004, and be negative for
the remainder of the projection period.
ONS Projects. Revenues attributable to the ONS Projects were estimated to be $18
million in 1998 and $93 million in 1999. Revenue was expected to peak in 2003
and decline thereafter through the end of the product's life (2006) as new
product technologies were expected to be introduced by Lucent. Revenue growth
was expected to decrease from 52% in 2000 to 10% in 2003, and be negative for
the remainder of the projection period.
An average risk adjusted discount rate of 20% was utilized to discount projected
cash flows.
Current Status
There have not been any significant departures from the planned efforts for
Unified Messenger. The Phoenix and ONS efforts have been completed. The IMA
research and development effort has been delayed twice as the result of the
inclusion of new capability specifications, first, in January 1998 to include
unified messaging capabilities and, second, in September 1998, to include
significant new hardware platform capabilities and incorporate Internet software
capabilities. This enhanced version is scheduled to reach technological
feasibility, a beta stage, in August 1999, and is scheduled for introduction in
October 1999. Since intermediate milestones for IMA have been met on schedule
and Phoenix will continue to earn revenues through completion of IMA
development, the completion and exploitation of this project and current market
conditions make it reasonable that estimated revenue and cash flow levels will
be achieved, although on a delayed basis. The IMA version enhancements and the
rescheduled market introduction are not expected to impact the originally
forecasted market penetration rates.
<PAGE>
Livingston
- ----------
On December 15, 1997, Lucent completed the purchase of Livingston for $610
million. Livingston was involved in the development of equipment used by
Internet service providers to connect subscribers to the Internet. The
allocation to in-process research and development of $427 million represented
its estimated fair value using the methodology described above.
In-Process Research and Development Overview
At the acquisition date, Livingston was conducting development, engineering, and
testing activities associated with the completion of PortMaster4, a remote
access concentrator targeted at large independent telecommunication companies,
cable television companies, and Internet service providers. PortMaster4 was
valued at $421 million and $6 million was allocated to another project. Briefly
described below are the effort and assumptions related to PortMaster4.
The PortMaster4 was being designed with a multi-generation architecture capable
of scaling to the greater bandwidth and density requirements of the future. It
was also being designed to incorporate remote access and packet processing
capabilities based on an Asynchronous Transfer Mode ("ATM") switch fabric and to
be a low-cost/price per port solution with the ability to add functionality and
new interface types to meet the range of Internet service provider requirements.
The PortMaster4 represented Livingston's entry into the high capacity remote
access concentrator market.
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<PAGE>
The PortMaster4 was targeted at a new customer base for Livingston (high
capacity remote access concentrator customers), which had very different
requirements than the small internet service providers served by Livingston's
existing product, PortMaster3. PortMaster3 did not have the scalability,
density, or reliability that the higher capacity customers were requiring at the
acquisition date.
The major achievements related to this product at the time of acquisition
included development of the product specifications and design concept. Included
in these achievements were customer surveys for feature match, standards
requirements research, critical vendor selection, system modeling, aesthetic
design, and establishment of hardware and software design criteria.
The primary remaining risks at the acquisition date were related to
semiconductor technology development, development of new device drivers which
were not carried over from the existing product, development of an operating
system to work in a multi-processing environment, and processor capacity and
portability issues. At the acquisition date, costs to complete the research and
development efforts related to the PortMaster4 were expected to be $5 million.
The development related to this product was expected to be completed in March
1998, with commercial release planned for April 1998, at which time Lucent
expected to begin generating economic benefits.
Valuation Assumptions
Revenues attributable to the PortMaster4 were estimated to be $48 million in
1998 and $261 million in 1999. Revenue was expected to peak in 2002 and decline
thereafter through the end of the product's life (2007) as new product
technologies were expected to be introduced by Lucent. Revenue growth was
expected to decrease from 69% in 2000 to 11% in 2002, and be negative for the
remainder of the projection period.
A risk adjusted discount rate of 20% was utilized to discount projected cash
flows.
Current Status
PortMaster4 was commercially released in July 1998 and started generating
revenues immediately after commercial launch. There have not been any
significant departures from the planned effort for PortMaster4.
Prominet
- ----------
On January 23, 1998, Lucent completed the purchase of Prominet for $199 million.
Prominet was a start up company involved in the development of technology in the
emerging gigabit ethernet networking industry. The allocation to in-process
research and development of $157 million represented its estimated fair value
using the methodology described above.
In-Process Research and Development Overview
At the acquisition date, Prominet was conducting development, engineering, and
testing activities associated with the completion of a gigabit ethernet local
area network switch. The initial product, called the P550 (Phase I), enabled
customers with traditional Ethernet networks to upgrade the capacity and speed
of their networks. Besides performing Ethernet switching (sometimes referred to
as Layer 2 switching) Prominet was designing the new switches to perform higher
level network routing decisions based on networking protocols like Internet
protocol (sometimes called Layer 3 switching) that traditionally were handled by
separate devices called routers. By integrating the ability to handle Layer 3
switching in the same box as the Layer 2 switching, products like the P550
reduced the need for separate router products, while also providing much higher
performance than traditional software based routers.
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<PAGE>
Development related to Prominet's gigabit ethernet switch was planned in several
phases. Phase I, a Layer 2 Ethernet switch with no Layer 3 routing capabilities,
had just been introduced at the acquisition date and was capitalized as existing
technology. Phase II was focused on implementing limited Layer 3 switching by
adding Layer 3 routing code to a common central processing card. With this
addition, the P550 could perform Layer 3 switching at limited speeds. It wasn't
until Phase III, when new custom silicon chips were to be added to the
input/output cards, that the P550 would achieve its maximum performance levels,
enabling Layer 3 switching at full speed across all input/output ports
simultaneously. This third phase was critical since routing in the supervisor
module alone would not enable full speed Layer 3 switching across all
input/output ports. Being able to replace traditional slow and expensive
software-based routers with new high speed, lower cost Layer 3 switches was
considered an appealing proposition to customers. Phase IV development was aimed
at achieving a fixed configuration (i.e., a pizza box size device instead of a
multi-slot chassis), Layer 2 gigabit ethernet switch to address fully the needs
of the potential gigabit ethernet LAN market. Upon completion of this phase,
Prominet would have both chassis and box products in the gigabit ethernet market
niche.
The in-process research and development values assigned to each phase were as
follows: (I) Phase II ($12 million); (ii) Phase III ($92 million); and (iii)
Phase IV ($53 million).
Phase II. Overall, substantial progress had been made related to research and
development in this phase. Phase II milestones reached as of the acquisition
date were: development of Internet protocol routing software, port routing
software to target runtime environment, development of interfaces to simulated
packet routing engine hardware, design of packet routing engine application
specific integrated circuit ("ASIC"), design of a new CPU interface ASIC, design
of a new Layer 3 supervisor module assembly, and integration of Layer 3 features
into a web-based manager. The milestones that were still to be accomplished in
order to achieve technological feasibility in Phase II were: completion of the
packet routing engine ASIC, completion of the Layer 3 supervisor module
hardware, integration of Layer 3 software and hardware and addition of the
necessary Layer 3 features, system testing of Layer 3 routing and beta testing
the product. Costs to complete the research and development efforts related to
Phase II were expected to be $2 million at the acquisition date. The development
related to this phase was expected to be completed in June 1998.
Phase III. The primary Phase III milestone reached as of the acquisition date
was the development of Layer 3 routing architecture. The milestones that were
still to be accomplished in order to achieve technological feasibility in Phase
III were: availability of Layer 3 supervisor software and hardware from Phase II
development, completion of the packet routing engine ASIC, completion of Layer 3
Gigabit input/output card hardware, completion of Layer 3 Fast Ethernet line
card hardware, integration of Layer 3 software with Layer 3 line card hardware,
and system beta testing. Costs to complete the research and development efforts
related to Phase III were expected to be $4 million at the acquisition date. The
development related to this phase was expected to be completed in June 1998.
Phase IV. The Phase IV milestones reached as of the acquisition date were
related to the product's system architecture and custom ASICs. The milestones
that were still to be accomplished in order to achieve technological feasibility
in Phase IV were: design completion of a subset of the P550 supervisor software,
integration of the hardware and software, system testing, and acceptance
testing. Costs to complete research and development efforts related to Phase IV
were expected to be $3 million. The development related to this phase was
expected to be completed in September 1998.
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<PAGE>
Valuation Assumptions
Phase II. Revenues attributable to Phase II were estimated to be $8 million in
1999. Revenue was expected to peak in 2004 and decline thereafter through the
end of the product's life (2009) as new product technologies were expected to be
introduced by Lucent. Revenue growth was expected to decrease from 112% in 2000
to 8% in 2004, and be negative for the remainder of the projection period.
Phase III. Revenues attributable to Phase III were estimated to be $47 million
in 1999. Revenue was expected to peak in 2004 and decline thereafter through the
end of the product's life (2009) as new product technologies were expected to be
introduced by Lucent. Revenue growth was expected to decrease from 112% in 2000
to 8% in 2004, and be negative for the remainder of the projection period.
Phase IV. Revenues attributable to Phase IV were estimated to be $38 million in
1999. Revenue was expected to peak in 2004 and decline thereafter through the
end of the product's life (2009) as new product technologies were expected to be
introduced by Lucent. Revenue growth was expected to decrease from 106% in 2000
to 7% in 2004, and be negative for the remainder of the projection period.
A risk adjusted discount rate of 25% was utilized to discount projected cash
flows.
Current Status
Phase II, Phase III and Phase IV were all completed on time and are performing
within the budgets as estimated at the time of acquisition. There have been no
significant departures from the planned development efforts.
Yurie
- ----------
On May 29, 1998, Lucent completed the purchase of Yurie for $1,056 million.
Yurie is involved in the development of ATM access solutions. The allocation to
in-process research and development of $620 million represents its estimated
fair value using the methodology described above.
In-Process Research and Development Overview
At the acquisition date, Yurie was conducting development, engineering, and
testing activities associated with the completion of several projects. These
projects included: (I) development related to the LDR 200, the LDR 50, and the
LDR 250 (collectively referred to as the "LDR 50/200/250" product category) and
(ii) development related to the LDR 4. The in-process research and development
values assigned to each project are as follows: (I) LDR 50/200/250 ($607
million) and (ii) LDR 4 ($11 million). Briefly described below are the effort
and assumptions related to the LDR 50/200/250.
LDR 50/200/250. The LDR 200 is a high capacity ATM access concentrator that acts
as an edge device in an ATM network. The LDR 50 is a medium capacity ATM access
concentrator and functions as a scaled down version of the LDR 200 with lower
throughput and a smaller size. An ATM access concentrator is electronic
equipment that allows two or more signals to pass over one communications
circuit. The LDR 200 and the LDR 50 are similar existing products aimed at
different customer sets and similar development efforts were associated with
both products. At the acquisition date, research and development related to the
LDR 200 and LDR 50 involved significant efforts related to the development of
next generation products and involved increasing the conversion and transmission
capacity of the existing products, maximizing bandwidth utilization, reducing
power consumption, increasing functionality, increasing reliability and
addressing scalability issues.
At the acquisition date, the LDR 250 was a new ATM edge product that was being
developed. The LDR 250 was being designed to capture emerging market
opportunities in telephony traffic over ATM, allowing for seamless movement from
Time Division Multiplex ("TDM") networks to ATM networks.
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<PAGE>
Overall, substantial progress had been made related to the research and
development of the LDR 50/200/250 at the acquisition date. The major
achievements related to this product category at May 29, 1998 included:
development related to certain functions including creation of the platform
which is the core related to the research and development effort; demonstration
of inverse multiplexing over ATM capabilities, which would increase the
products' ability to handle different types of traffic; demonstration of digital
signal processing capabilities, primarily in the areas of echo canceling, and
voice compression; and design of requirements to address other key capabilities.
The primary remaining risks at the acquisition date were the development of
Signaling Systems 7 compatible technology which would improve the routing and
transfer of signaling messages; design and development related to carrier scale
internetworking technology which would speed up network connection services via
Internet Protocols; ASIC development; addressing compatibility and integration
issues; and systems testing.
Costs to complete the research and development efforts related to the LDR
50/200/250 were expected to be $29 million at the acquisition date. Lucent
anticipated that development related to this product category would be completed
in stages through fiscal year 2000.
Valuation Assumptions
Revenues attributable to the LDR 50/200/250 were estimated to be $132 million in
1999. Revenue was expected to peak in 2000 and decline thereafter through the
end of the product's life (2009) as new product technologies were expected to be
introduced by Lucent. Revenue growth was expected to decrease from 84% in 2000
to 9% in 2007, and be negative for the remainder of the projection period.
A risk adjusted discount rate of 20% was utilized to discount projected cash
flows.
Current Status
The LDR 50, LDR 200 and LDR 250 were all completed on time or have met all of
their scheduled milestones. Some of the product releases have been renamed.
RISK MANAGEMENT
Lucent is exposed to market risk from changes in foreign currency exchange rates
and interest rates, which could impact its results of operations and financial
condition. 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. Lucent uses derivative financial
instruments as risk management tools and not 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.
Lucent uses foreign currency exchange contracts, and to a lesser extent, foreign
currency purchased options to reduce its exposure to the risk that the eventual
net cash inflows and outflows resulting from the sale of products to foreign
customers and purchases from foreign suppliers will be adversely affected by
changes in exchange rates. Foreign currency exchange contracts are designated
for firmly committed or forecasted 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. As of September 30, 1998, Lucent's primary net
foreign currency market exposures include Deutsche marks and British pounds. As
of September 30, 1997, Lucent's primary net foreign currency market exposures
included Deutsche marks, Japanese yen and Dutch guilders. Lucent has not changed
its policy regarding how such exposures are managed since the year ended
September 30, 1997. Management does not foresee or expect any significant
changes in foreign currency exposure in the near future.
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<PAGE>
The fair value of foreign currency exchange contracts is sensitive to changes in
foreign currency exchange rates. As of September 30, 1998 and 1997, a 10%
appreciation in foreign currency exchange rates from the prevailing market rates
would increase the related net unrealized gain by $11 million and $27 million,
respectively. Conversely, a 10% depreciation in these currencies from the
prevailing market rates would decrease the related net unrealized gain by $18
million and $35 million, as of September 30, 1998 and 1997 respectively.
Unrealized gains/losses in foreign currency exchange contracts are defined as
the difference between the contract rate at the inception date of the foreign
currency exchange contract and the current market exchange rates. Consistent
with the nature of the economic hedge of such foreign currency exchange
contracts, such unrealized gains or losses would be offset by corresponding
decreases or increases, respectively, of the underlying instrument or
transaction being hedged.
While Lucent hedges actual and anticipated transactions with customers, the
decline in value of the Asia/Pacific currencies or currencies in other regions
may, if not reversed, adversely affect future product sales because Lucent
products may become more expensive for customers to purchase in their local
currency.
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
material interest rate swap agreements in effect as of September 30, 1998 and
1997. The strategy employed by Lucent to manage its exposure to interest rate
fluctuations is unchanged from September 30, 1997. 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.
The fair value of Lucent's fixed rate long-term debt is sensitive to changes in
interest rates. Interest rate changes would result in gains/losses in the market
value of this debt due to differences between the market interest rates and
rates at the inception of the debt obligation. Based upon a hypothetical
immediate 150 basis point increase in interest rates at September 30, 1998 and
1997, the market value of Lucent's fixed rate long-term debt would be impacted
by a net decrease of $209 million and $113 million, respectively. Conversely, a
150 basis point decrease in interest rates would result in a net increase in the
market value of Lucent's fixed rate long-term debt outstanding at September 30,
1998 and 1997 of $247 million and $121 million, respectively. As a result of the
change in market conditions in 1998, Lucent used a hypothetical 150 basis point
change, versus 100 basis points used in the fiscal year 1997 presentation, to
determine the change in market value of this debt.
OTHER
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 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,
among AT&T, Lucent and NCR Corporation dated as of February 1, 1996, as amended
and restated, Lucent is responsible for all liabilities primarily resulting from
or related to the operation of Lucent's business as conducted at any time prior
to or after 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.
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<PAGE>
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 period of remediation for the applicable site which ranges
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, and 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 in respect to 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 and other expenditures that 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 September 30, 1998 cannot be
estimated.
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 the
Company. 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. The Company undertakes no obligation to
update publicly any forward- looking statements, whether as a result of new
information, future events or otherwise.
<PAGE>
Future Factors include increasing price and product/services competition by
foreign and domestic 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/services; the achievement of lower costs and expenses; the ability
to successfully integrate the operations and business of Ascend Communications,
Inc., Kenan and other acquired companies; the outcome and impact of Year 2000;
domestic and foreign governmental and public policy changes which may affect the
level of new investments and purchases made by customers; changes in
environmental and other domestic and foreign governmental regulations;
protection and validity of patent and other intellectual property rights;
reliance on large customers; technological, implementation and cost/financial
risks in the increasing use of large, multi-year 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 domestic and
international economic conditions including interest rate and currency exchange
rate fluctuations and other Future Factors.
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<PAGE>
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 international
and domestic standards-setting bodies.
Reliance on Major Customers:
See discussion above under KEY BUSINESS CHALLENGES.
Readiness for Year 2000:
Lucent is engaged in a major effort to minimize the impact of the Year 2000 date
change on Lucent's products, information technology systems, facilities and
production infrastructure. Lucent has targeted June 30, 1999 for completion of
these efforts.
The Year 2000 challenge is a priority within Lucent at every level of the
Company. Primary Year 2000 preparedness responsibility rests with program
offices which have been established within each of Lucent's product groups and
corporate centers. A corporate-wide Lucent Year 2000 Program Office ("LYPO")
monitors and reports on the progress of these offices. Each program office has a
core of full-time individuals augmented by a much larger group who have been
assigned specific Year 2000 responsibilities in addition to their regular
assignments. Further, Lucent has engaged third parties to assist in its
readiness efforts in certain cases. LYPO has established a methodology to
measure, track and report Year 2000 readiness status consisting of five steps:
inventory; assessment; remediation; testing and deployment.
Lucent is completing programs to make its new commercially available products
Year 2000 ready and has developed evolution strategies for customers who own
non-Year 2000 ready Lucent products. The majority of the upgrades and new
products needed to support customer migration are already generally available.
By the end of 1998, all but a few of these products are targeted for general
availability.
<PAGE>
Lucent has launched extensive efforts to alert customers who have non-Year 2000
ready products, including direct mailings, phone contacts and participation in
user and industry groups. Recently, Lucent has set up a Year 2000 website
www.lucent.com/y2k that provides Year 2000 product information. Lucent continues
to cooperate in the Year 2000 information sharing efforts of the Federal
Communications Commission and other governmental bodies.
Lucent believes it has sufficient resources to provide timely support to its
customers that require product migrations or upgrades. However, because this
effort is heavily dependent on customer cooperation, Lucent continues to monitor
customer response and will take steps to improve customer responsiveness, as
necessary. Also, Lucent has begun contingency planning to address potential
spikes in demand for customer support resulting from the Year 2000 date change.
These plans are targeted for completion by April 30, 1999.
Lucent has largely completed the inventory and assessment phases of the program
with respect to its factories, information systems, and facilities.
Approximately, two-thirds of the production elements included in the factory
inventory were found to be Year 2000 ready. The factories have commenced the
remediation phase of their effort through a combination of product upgrades and
replacement. Plans have been developed to facilitate the completion of this
work, as well as the related testing and deployment, by June 30, 1999.
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<PAGE>
Currently, approximately 65% of Lucent's information technology infrastructure
has been determined to be Year 2000 ready and is deployed for use.
Approximately, 65% of our business applications lines of code that are supported
by Lucent's information technology group are now Year 2000 ready and have been
deployed or are awaiting deployment. LYPO is monitoring the progress of
readiness efforts across Lucent, with a special emphasis on the early
identification of any areas where progress to-date could indicate difficulty in
meeting Lucent's June 1999 internal readiness target date. Lucent is developing
specific contingency plans, as appropriate.
Lucent is also assessing the Year 2000 readiness of the large number of
facilities that it owns or leases world-wide. Priority is being placed on
Lucent-owned facilities, leased facilities that Lucent manages and other
critical facilities that house large numbers of employees or significant
operations. Based on the results of these assessment activities, Lucent plans to
complete remediation efforts by March 31, 1999 and complete development of
applicable contingency plans by May 31, 1999.
To ensure the continued delivery of third party products and services, Lucent's
procurement organization has analyzed Lucent's supplier base and has sent
surveys to approximately 5,000 suppliers. Follow-up efforts have commenced to
obtain feedback from critical suppliers. To supplement this effort, Lucent plans
to conduct readiness reviews of the Year 2000 status of the suppliers ranked as
most critical based on the nature of their relationship with Lucent, the
product/service provided and/or the content of their survey responses. Almost
all of Lucent's suppliers are still deeply engaged in executing their Year 2000
readiness efforts and, as a result, Lucent cannot, at this time, fully evaluate
the Year 2000 risks to its supply chain. Lucent will continue to monitor the
Year 2000 status of its suppliers to minimize this risk and will develop
appropriate contingent responses as the risks become clearer.
<PAGE>
The risk to Lucent resulting from the failure of third parties in the public and
private sector to attain Year 2000 readiness is the same as other firms in
Lucent's industry or other business enterprises generally. The following are
representative of the types of risks that could result in the event of one or
more major failures of Lucent's information systems, factories or facilities to
be Year 2000 ready, or similar major failures by one or more major third party
suppliers to Lucent: (1) information systems--could include interruptions or
disruptions of business and transaction processing such as customer billing,
payroll, accounts payable and other operating and information processes, until
systems can be remedied or replaced; (2) factories and facilities--could include
interruptions or disruptions of manufacturing processes and facilities with
delays in delivery of products, until non-compliant conditions or components can
be remedied or replaced; and (3) major suppliers to Lucent--could include
interruptions or disruptions of the supply of raw materials, supplies and Year
2000 ready components which could cause interruptions or disruptions of
manufacturing and delays in delivery of products, until the third party supplier
remedied the problem or contingency measures were implemented. Risks of major
failures of Lucent's principal products could include adverse functional impacts
experienced by customers, the costs and resources for Lucent to remedy problems
or replace products where Lucent is obligated or undertakes to take such action,
and delays in delivery of new products.
Lucent believes it is taking the necessary steps to resolve Year 2000 issues;
however, given the possible consequences of failure to resolve significant Year
2000 issues, there can be no assurance that any one or more such failures would
not have a material adverse effect on Lucent. Lucent estimates that the costs of
efforts to prepare for Year 2000 from calendar year 1997 through 2000 is about
$535 million, of which an estimated $210 million has been spent as of September
30, 1998. Lucent has been able to reprioritize work projects to largely address
Year 2000 readiness needs within its existing organizations. As a result, most
of these costs represent costs that would have been incurred in any event. These
amounts cover costs of the Year 2000 readiness work for inventory, assessment,
remediation, testing and deployment including fees and charges of contractors
for outsourced work and consultant fees. Costs for previously contemplated
updates and replacements of Lucent's internal systems and information systems
infrastructure have been excluded without attempting to establish whether the
timing of non-Year 2000 replacement or upgrading was accelerated.
-25-
<PAGE>
While the Year 2000 cost estimates above include additional costs, Lucent
believes, based on available information, that it will be able to manage its
total Year 2000 transition without any material adverse effect on its business
operations, products or financial prospects.
The actual outcomes and results could be affected by Future Factors including,
but not limited to, the continued availability of skilled personnel, cost
control, the ability to locate and remediate software code problems, critical
suppliers and subcontractors meeting their commitments to be Year 2000 ready and
provide Year 2000 ready products, and timely actions by customers.
European Monetary Union - Euro:
On January 1, 1999, several 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. Since that date, the Euro has
traded on currency exchanges. 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, and
parties can elect to pay for goods and services and transact business using
either the Euro or a legacy currency. 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 begun planning for the Euro's introduction. For this purpose, Lucent
has in place a joint European-United States team representing affected functions
within the Company.
The Euro conversion may affect cross-border competition by creating cross-border
price transparency. Lucent is assessing its pricing/marketing strategy in order
to insure that it remains competitive in a broader European market. Lucent is
also assessing its information technology systems to allow for transactions to
take place in both the legacy currencies and the Euro and the eventual
elimination of the legacy currencies, and reviewing whether certain existing
contracts will need to be modified. Lucent's currency risk and risk management
for operations in participating countries may be reduced as the legacy
currencies are converted to the Euro. Final accounting, tax and governmental
legal and regulatory guidance generally has not been provided in final form.
Lucent will continue to evaluate issues involving introduction of the Euro.
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, results of operations, cash flows or financial condition.
-26-
<PAGE>
Employee Relations:
On September 30, 1998, Lucent employed approximately 142,300 persons, including
78.9% located in the United States. Of these domestic employees, about 40% are
represented by unions, primarily the Communications Workers of America ("CWA")
and the International Brotherhood of Electrical Workers ("IBEW"). Lucent signed
new five-year 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 FINANCIAL CONDITION, 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, LIQUIDITY AND CAPITAL RESOURCES.
Growth Outside the United States, Foreign Exchange and Interest Rates: Lucent
intends to continue to pursue growth opportunities in markets outside the United
States. In many markets outside the United States, 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
United States 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.
Legal Proceedings and Environmental:
See discussion above under OTHER.
-27-
<PAGE>
REPORT OF MANAGEMENT
Management is responsible for the preparation of Lucent Technologies Inc.'s
consolidated financial statements and all related information appearing in this
Report. The consolidated financial statements and notes have been prepared in
conformity with generally accepted accounting principles and include certain
amounts which are estimates based upon currently available information and
management's judgment of current conditions and circumstances.
To provide reasonable assurance that assets are safeguarded against loss from
unauthorized use or disposition and that accounting records are reliable for
preparing financial statements, management maintains a system of accounting and
other controls, including an internal audit function. Even an effective internal
control system, no matter how well designed, has inherent limitations -
including the possibility of circumvention or overriding of controls - and
therefore can provide only reasonable assurance with respect to financial
statement presentation. The system of accounting and other controls is improved
and modified in response to changes in business conditions and operations and
recommendations made by the independent public accountants and the internal
auditors.
The Audit and Finance Committee of the Board of Directors, which is composed of
directors who are not employees, meets periodically with management, the
internal auditors and the independent auditors to review the manner in which
these groups of individuals are performing their responsibilities and to carry
out the Audit and Finance Committee's oversight role with respect to auditing,
internal controls and financial reporting matters. Periodically, both the
internal auditors and the independent auditors meet privately with the Audit and
Finance Committee and have access to its individual members.
Lucent engaged PricewaterhouseCoopers LLP, independent public accountants, to
audit the consolidated financial statements in accordance with generally
accepted auditing standards, which include consideration of the internal control
structure. Their report appears on the following page.
Richard A. McGinn Donald K. Peterson
Chairman and Executive Vice President and
Chief Executive Officer Chief Financial Officer
-28-
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareowners of Lucent Technologies Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and changes in shareowners' equity and of cash
flows present fairly, in all material respects, the financial position of Lucent
Technologies Inc. and its subsidiaries at September 30, 1998 and 1997, the
results of their operations and their cash flows for each of the two years in
the period ended September 30, 1998 and for the nine-month period ended
September 30, 1996, in conformity with generally accepted accounting principles.
In addition, in our opinion, the accompanying financial statement schedule
presents fairly, in all material respects, the informatin set forth therein when
read in conjunction with the related consolidated financial statements. These
financial statements and financial statement schedule are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
New York, New York
February 26, 1999,
except for the fifth paragraph of
Note 1, as to which the date is
April 1, 1999
-29-
<PAGE>
Lucent Technologies Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Millions, Except Per-Share Amounts)
<TABLE>
<CAPTION>
Year Ended
September 30, Nine Months Ended
(twelve months) September 30,
----------------------------------- -------------------
1998 1997 1996 1996
- --------------------------------------------------------------------------------------
UNAUDITED
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $30,328 $26,444 $23,324 $15,897
Costs 16,171 14,905 14,397 9,295
Gross margin 14,157 11,539 8,927 6,602
Operating expenses
Selling, general
and administrative 6,502 5,820 7,310 4,264
Research and development 3,689 3,029 2,556 1,843
Purchased in-process
research and development 1,416 1,024 - -
Total operating expenses 11,607 9,873 9,866 6,107
Operating income (loss) 2,550 1,666 (939) 495
Other income - net 100 75 163 55
Interest expense 254 238 238 175
Income (loss) before
income taxes 2,396 1,503 (1,014) 375
Provision (benefit) for
income taxes 1,341 929 (226) 146
Net income (loss) $ 1,055 $ 574 $ (788) $ 229
Earnings (loss) per
common share - basic $ 0.40 $ 0.22 $ (0.34) $ 0.10
Earnings (loss) per
common share - diluted $ 0.39 $ 0.22 $ (0.34) $ 0.10
Dividends per
common share $ 0.0775 $ 0.05625 $ 0.0375 $0.0375
</TABLE>
See Notes to Consolidated Financial Statements.
-30-
<PAGE>
Lucent Technologies Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions, Except Per Share Amounts)
September 30, September 30,
1998 1997
------------- ------------
ASSETS
Cash and cash equivalents $ 712 $ 1,365
Accounts receivable less allowances
of $392 in 1998 and $352 in 1997 7,014 5,411
Inventories 3,081 2,926
Contracts in process (net of progress
billings of $3,036 in 1998 and
$2,003 in 1997) 1,259 1,046
Deferred income taxes - net 1,623 1,333
Other current assets 493 473
Total current assets 14,182 12,554
Property, plant and equipment - net 5,410 5,151
Prepaid pension costs 3,754 3,172
Deferred income taxes - net 750 1,262
Capitalized software development costs 298 293
Other assets 2,437 1,436
Total assets $ 26,831 $ 23,868
LIABILITIES
Accounts payable $ 2,044 $ 1,933
Payroll and benefit-related liabilities 2,515 2,180
Postretirement and postemployment
benefit liabilities 187 239
Debt maturing within one year 2,231 2,538
Other current liabilities 3,481 3,882
Total current liabilities 10,458 10,772
Postretirement and postemployment
benefit liabilities 6,380 6,073
Long-term debt 2,409 1,665
Other liabilities 1,969 1,948
Total liabilities $ 21,216 $ 20,458
Commitments and contingencies
SHAREOWNERS' EQUITY
Preferred stock - par value $1 per share
Authorized 250,000,000 shares $ - $ -
Issued and outstanding shares: none
Common stock - par value $.01 per share
Authorized shares: 6,000,000,000
Issued and outstanding shares:
2,658,545,914 at September 30, 1998;
2,594,008,200 at September 30, 1997 27 27
Additional paid-in capital 4,566 3,070
Guaranteed ESOP obligation (49) (77)
Foreign currency translation (279) (191)
Retained earnings 1,350 581
Total shareowners' equity $ 5,615 $ 3,410
Total liabilities and shareowners' equity $ 26,831 $ 23,868
See Notes to Consolidated Financial Statements.
-31-
<PAGE>
Lucent Technologies Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREOWNERS' EQUITY
(Dollars in Millions)
<TABLE>
<CAPTION>
Year Ended Year Ended
September 30, 1998 September 30, 1997 Nine Months Ended
(twelve months) (twelve months) September 30, 1996
--------------------- ------------------ ------------------
<S> <C> <C> <C>
PREFERRED STOCK - - -
COMMON STOCK
Balance at beginning of period $ 27 $ 27 $ -
Issuance of common stock - - 6
Two-for-one common stock splits - - 21
Balance at end of period 27 27 27
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period 3,070 2,604 1,410
Issuance of common stock 608 260 2,881
Issuance of common stock for
acquisitions 689 - -
Conversion of stock options
related to acquisitions 186 116 -
Net loss from 1/1/96 through 1/31/96 - - (72)
Dividends declared - - (7)
Accounts receivable holdback
by AT&T - - (2,000)
Unrealized (loss) gain on investments (37) 40 15
Acceptance of ESOP - - 120
Other contributions from AT&T - - 252
Reclass of undistributed earnings
of S-Corp 84 33 5
S-Corp distributions (26) (19) 0
Other (8) 36 -
Balance at end of period 4,566 3,070 2,604
GUARANTEED ESOP OBLIGATION
Balance at beginning of period (77) (106) -
Acceptance of ESOP - - (120)
Amortization of ESOP obligation 28 29 14
Balance at end of period (49) (77) (106)
FOREIGN CURRENCY TRANSLATION
Balance at beginning of period (191) (16) 28
Translation adjustments (88) (175) (44)
Balance at end of period (279) (191) (16)
RETAINED EARNINGS
Balance at beginning of period 581 186 -
Net income 970 541 -
Net income from 2/1/96
through 9/30/96 - - 296
Two-for-one common stock split - - (21)
Dividends declared (201) (146) (89)
Balance at end of period 1,350 581 186
TOTAL SHAREOWNERS' EQUITY $ 5,615 $ 3,410 $ 2,695
</TABLE>
See Notes to Consolidated Financial Statements.
-32-
<PAGE>
Lucent Technologies Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
<TABLE>
<CAPTION>
Year Ended
September 30, Nine Months Ended
(twelve months) September 30,
----------------------------- ------------------
1998 1997 1996 1996
- -----------------------------------------------------------------------------------------
UNAUDITED
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating Activities:
Net income(loss) $ 1,055 $ 574 $ (788) $ 229
Adjustments to reconcile
net income(loss)
to net cash provided by
(used in) operating activities,
net of effects from
acquisitions of businesses:
Business restructuring
(reversal) charge (100) (201) 2,515 (98)
Asset impairment
and other charges - 81 293 105
Depreciation and
amortization 1,338 1,453 1,328 939
Provision for
uncollectibles 132 127 73 54
Deferred income taxes 113 9 (996) (251)
Purchased in-process
research and development 1,416 1,024 - -
Increase in accounts
receivable - net (2,026) (417) (3,120) (1,512)
Increase in inventories
and contracts in process (365) (273) (309) (524)
Increase(decrease) in
accounts payable 172 (12) 1,021 629
Changes in other operating
assets and liabilities 125 (298) 1,046 543
Other adjustments for
noncash items - net (448) (92) (77) (111)
Net cash provided by(used in)
operating activities 1,412 1,975 986 3
Investing Activities:
Capital expenditures (1,634) (1,639) (1,435) (942)
Proceeds from the sale or
disposal of property, plant
and equipment 57 108 119 15
Purchases of
equity investments (212) (149) (96) (46)
Sales of equity investments 71 12 102 102
Dispositions of businesses 329 181 58 58
Acquisitions of businesses -
net of cash acquired (1,347) (1,568) (234) (234)
Other investing
activities - net (80) (70) (155) (22)
Net cash used in
investing activities (2,816) (3,125) (1,641) (1,069)
</TABLE>
See Notes to Consolidated Financial Statements.
(CONT'D)
-33-
<PAGE>
Lucent Technologies Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONT'D)
(Dollars in Millions)
<TABLE>
<CAPTION>
Year Ended
September 30, Nine Months Ended
(twelve months) September 30,
----------------------------- ------------------
1998 1997 1996 1996
- -----------------------------------------------------------------------------------------
UNAUDITED
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financing Activities:
Repayments of long-term debt (93) (16) (53) (39)
Issuance of long-term debt 375 52 1,499 1,499
Proceeds from issuance
of common stock 608 260 2,887 2,887
Dividends paid (201) (192) (48) (48)
S-Corp distribution
to stockholder (26) (19) - -
Increase (decrease) in
short-term borrowings - net 149 191 (1,525) (1,436)
Repayments of
debt sharing
agreement - net - - (67) -
Transfers (to) from AT&T - - (190) 13
Net cash provided by
financing activities 812 276 2,503 2,876
Effect of exchange rate
changes on cash
and cash equivalents (61) (11) (16) (13)
Net (decrease)increase
in cash and
cash equivalents (653) (885) 1,832 1,797
Cash and cash equivalents
at beginning of period 1,365 2,250 418 453
Cash and cash equivalents
at end of period $ 712 $ 1,365 $ 2,250 $ 2,250
</TABLE>
See Notes to Consolidated Financial Statements.
-34-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars In Millions, Except Per Share Amounts)
1. BACKGROUND AND BASIS OF PRESENTATION
BACKGROUND
Lucent Technologies Inc. ("Lucent" or the "Company") was formed from the systems
and technology units of AT&T Corp. and the associated assets and liabilities of
those units, including Bell Laboratories (the "Separation"). Lucent was
incorporated on November 29, 1995 with 1,000 shares of common stock ("Common
Stock"), authorized and outstanding, all of which were owned by AT&T. On April
2, 1996, AT&T obtained an additional 524,623,894 shares (pre-split basis) of
Common Stock and on April 10, 1996, Lucent issued 112,037,037 shares (pre-split
basis) in its Initial Public Offering. On September 30, 1996, AT&T distributed
to its shareowners all of its remaining interest in Lucent (the "Distribution").
BASIS OF PRESENTATION
The restated consolidated financial statements of Lucent give retroactive effect
to the merger with Kenan Systems Corporation on February 26, 1999. Under the
terms of the merger agreement, Kenan shareholders received 25.76 million shares
of Lucent common stock. The restated consolidated financial statements reflect
the combination of the historical consolidated financial statements of Lucent at
or for the fiscal years ended September 30, 1998 and 1997, and for the nine
month period ended September 30, 1996, with the historical financial statements
of Kenan at or for the fiscal years ended December 31, 1998, 1997 and 1996,
respectively.
The restated consolidated financial statements at and for the nine months ended
September 30, 1996 also reflect the results of operations, changes in
shareowners' equity and cash flows, and the financial position of the business
that was transferred to Lucent from AT&T as if Lucent were a separate entity.
The consolidated financial statements have been prepared using the historical
basis of the assets and liabilities and historical results of operations of
these businesses. Additionally, the aforementioned financial statements include
an allocation of certain AT&T corporate headquarters assets, liabilities and
expenses related to the businesses that were transferred to Lucent from AT&T.
Management believes the allocations reflected in the consolidated financial
statements are reasonable. The aforementioned financial statements may not
necessarily reflect Lucent's consolidated results of rations, financial
position, changes in shareowners' equity or cash flows in the future or what
they would have been had Lucent been a separate, stand-alone company during such
period.
On April 1, 1998, and April 1, 1999, two-for-one splits of Lucent's common stock
became effective. Shareowners' equity has been restated to give retroactive
recognition to the stock splits for all periods presented by reclassifying from
retained earnings to common stock the par value of the additional shares arising
from the split. In addition, all references in the financial statements and
notes to number of shares, per share amounts, stock option data and market
prices have been restated to reflect these stock splits.
On November 19, 1998, Lucent sold $500 ($495 net of unamortized costs) of
10-year notes and reclassified the amount from debt maturing within one year to
long-term debt. The proceeds were used to pay down a portion of Lucent's
commercial paper during the first quarter of fiscal 1999.
-35-
<PAGE>
ACQUISITIONS
The following table presents information about certain acquisitions by Lucent in
the fiscal years ended September 30, 1998 and 1997. All charges were recorded in
the quarter in which the transaction was completed.
<TABLE>
<CAPTION>
JNA LANNET MassMedia SDX YURIE OPTIMAY PROMINET LIVINGSTON OCTEL
(1) (2) (3) (4) (5) (6) (7) (8) (9)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Acquisition
Date 9/98 8/98 7/98 7/98 5/98 4/98 1/98 12/97 9/97
Purchase $67 $115 N/S $207 $1,056 $64 $199 $610 $1,819
price cash cash cash cash & cash stock & stock & cash &
options options options options
Goodwill 37 2 1 96 292 1 35 114 181
Existing
technology 18 15 0 16 40 18 23 69 186
Purchased in-process
R&D costs
(after tax) 3 67 8 82 620 48 157 427 945
Amortization period-
goodwill (years) 10 7 5 10 7 5 5 5 7
Amortization period-
existing technology
(years) 10 5 N/A 5 5 5 6 8 5
</TABLE>
(1) JNA Telecommunications Limited was an Australian telecom manufacturer,
reseller and system integrator.
(2) LANNET, a subsidiary of Madge Networks N.V., was an Israeli-based supplier
of Ethernet and asynchronous transfer mode ("ATM") switching solutions for
local area networks.
(3) MassMedia Communications, Inc., was a privately held start-up developer of
highly- reliable, next-generation network interoperability software.
(4) SDX Business Systems plc was a United Kingdom-based provider of business
communications systems.
(5) Yurie Systems, Inc. was a provider of ATM access technology and equipment
for data, voice and video networking.
(6) Optimay GmbH specialized in the development of software products and
services for chip sets to be used for Global System for Mobile
Communications cellular phones.
(7) Prominet Corporation was a participant in the emerging Gigabit Ethernet
networking industry. The merger involved $164 of Lucent stock and options.
In addition, under the terms of the agreement, Lucent had contingent
obligations to pay former Prominet shareowners $35 in stock. The $35 of
stock was paid by Lucent, in July 1998 and recorded primarily as goodwill.
(8) Livingston Enterprises, Inc. was a global provider of equipment used by
Internet service providers to connect their subscribers to the Internet.
(9) Octel Communications Corporation was a provider of voice, fax and
electronic messaging technologies.
N/A Not applicable
N/S Not significant
<PAGE>
All the above acquisitions were accounted for under the purchase method of
accounting, and the acquired technology valuation included both existing
technology and purchased in-process research and development.
Included in the purchase price for the above acquisitions was purchased
in-process research and development, which was a noncash charge to earnings as
this technology had not reached technological feasibility and had no future
alternative use. The remaining purchase price was allocated to tangible assets
and intangible assets, including goodwill and existing technology, less
liabilities assumed.
-36-
<PAGE>
The value allocated to purchased in-process research and development was
determined utilizing an income approach that included an excess earnings
analysis reflecting the appropriate cost of capital for the investment.
Estimates of future cash flows related to the in-process research and
development were made for each project based on Lucent's estimates of revenue,
operating expenses, and income taxes from the project. These estimates were
consistent with historical pricing, margins, and expense levels for similar
products.
Revenues were estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles, and the estimated
life of each product's underlying technology. Estimated operating expenses,
income taxes, and charges for the use of contributory assets were deducted from
estimated revenues to determine estimated after-tax cash flows for each project.
Estimated operating expenses include cost of goods sold, selling, general and
administrative expenses, and research and development expenses. The research and
development expenses include estimated costs to maintain the products once they
have been introduced into the market and generate revenues and costs to complete
the in-process research and development.
The discount rates utilized to discount the projected cash flows were based on
consideration of Lucent's weighted average cost of capital, as well as other
factors including the useful life of each project, the anticipated profitability
of each project, the uncertainty of technology advances that were known at the
time, and the stage of completion of each project.
Management is primarily responsible for estimating the fair value of the assets
and liabilities acquired, and has conducted due diligence in determining the
fair value. Management has made estimates and assumptions that affect the
reported amounts of assets, liabilities, and expenses resulting from such
acquisitions. Actual results could differ from those amounts.
-37-
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include all majority-owned subsidiaries in
which Lucent exercises control. Investments in which Lucent exercises
significant influence, but which it does not control (generally a 20% - 50%
ownership interest), are accounted for under the equity method of accounting.
All material intercompany transactions and balances have been eliminated.
USE OF ESTIMATES
The preparation of financial statements and related disclosures in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and revenue and expenses during the period reported.
Actual results could differ from those estimates. Estimates are used when
accounting for long-term contracts, allowance for uncollectible accounts
receivable, inventory obsolescence, product warranty, depreciation, employee
benefits, taxes, restructuring reserves and contingencies, among others.
FOREIGN CURRENCY TRANSLATION
For operations outside the United States that prepare financial statements in
currencies other than the United States dollar, results of operations and cash
flows are translated at average exchange rates during the period, and assets and
liabilities are translated at end of period exchange rates. Translation
adjustments are included as a separate component of shareowners' equity.
REVENUE RECOGNITION
Revenue is generally recognized when all significant contractual obligations
have been satisfied and collection of the resulting receivable is reasonably
assured. Revenue from product sales of hardware and software is recognized at
time of delivery and acceptance, and after consideration of all the terms and
conditions of the customer contract. Sales of services are recognized at time of
performance and rental revenue is recognized proportionately over the contract
term. Revenues and estimated profits on long-term contracts are generally
recognized under the percentage of completion method of accounting using either
a units-of-delivery or a cost-to-cost methodology. Profit estimates are revised
periodically based on changes in facts. Any losses on contracts are recognized
immediately.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to expense as incurred. However, the
costs incurred for the development of computer software that will be sold,
leased or otherwise marketed are capitalized when technological feasibility has
been established. These capitalized costs are subject to an ongoing assessment
of recoverability based on anticipated future revenues and changes in hardware
and software technologies. Costs that are capitalized include direct labor and
related overhead.
Amortization of capitalized software development costs begins when the product
is available for general release. Amortization is provided on a
product-by-product basis on either the straight-line method over periods not
exceeding two years or the sales ratio method. Unamortized capitalized software
development costs determined to be in excess of net realizable value of the
product are expensed immediately.
-38-
<PAGE>
CASH AND CASH EQUIVALENTS
All highly liquid investments with original maturities of three months or less
are considered to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (determined principally on a
first-in, first-out basis) or market.
CONTRACTS IN PROCESS
Contracts in process are valued at cost plus accrued profits less progress
billings.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost less accumulated depreciation.
Depreciation is determined using primarily the unit and group methods. The unit
method is used for manufacturing and laboratory equipment and large computer
systems. The group method is used for other depreciable assets. When assets that
were depreciated using the unit method are sold or retired, the gains or losses
are included in operating results. When assets that were depreciated using the
group method are sold or retired, the original cost is deducted from the
appropriate account and accumulated depreciation. Any gains or losses are
applied against accumulated depreciation.
The accelerated depreciation method is used for certain high technology computer
processing equipment. All other facilities and equipment are depreciated on a
straight-line basis over their estimated useful lives.
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. If the
fair value is less than the carrying amount of the asset, a loss is recognized
for the difference.
FINANCIAL INSTRUMENTS
Lucent uses various financial instruments, including foreign currency exchange
contracts and interest rate swap agreements to manage and reduce risk to Lucent
by generating cash flows, which offset the cash flows of certain transactions in
foreign currencies or underlying financial instruments in relation to their
amount and timing. Lucent's derivative financial instruments are for purposes
other than trading and are not entered into for speculative purposes. Lucent's
nonderivative financial instruments include letters of credit, commitments to
extend credit and guarantees of debt. Lucent generally does not require
collateral to support its financial instruments.
GOODWILL
Goodwill is the excess of the purchase price over the fair value of identifiable
net assets acquired in business combinations accounted for as purchases.
Goodwill is amortized on a straight-line basis over the periods benefited,
principally in the range of 5 to 15 years. Goodwill is reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
-39-
<PAGE>
3. RECENT PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes new
accounting and reporting standards for derivative financial instruments and for
hedging activities. SFAS 133 requires an entity to measure all derivatives at
fair value and to recognize them in the balance sheet as an asset or liability,
depending on the entity's rights or obligations under the applicable derivative
contract. Lucent will designate each derivative as belonging to one of several
possible categories, based on the intended use of the derivative. The
recognition of changes in fair value of a derivative that affect the income
statement will depend on the intended use of the derivative. If the derivative
does not qualify as a hedging instrument, the gain or loss on the derivative
will be recognized currently in earnings. If the derivative qualifies for
special hedge accounting, the gain or loss on the derivative will either (1) be
recognized in income along with an offsetting adjustment to the basis of the
item being hedged or (2) be deferred in other comprehensive income and
reclassified to earnings in the same period or periods during which the hedged
transaction affects earnings. SFAS 133 will be effective for Lucent no later
than the quarter ending December 31, 1999. SFAS 133 may not be applied
retroactively to financial statements of prior periods. SFAS 133 is not expected
to have a material impact on Lucent's consolidated results of operations,
financial position or cash flows.
In February 1998, FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits" ("SFAS 132"). SFAS 132 revises
employers' disclosures about pension and other postretirement benefit plans.
SFAS 132 is effective for fiscal years beginning after December 15, 1997.
Restatement of disclosures for earlier periods provided for comparative purposes
is required unless the information is not readily available. Lucent is in the
process of evaluating the disclosure requirements. The adoption of SFAS 132 will
have no impact on Lucent's consolidated results of operations, financial
position or cash flows.
In June 1997, FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
SFAS 131 is effective for financial statements for fiscal years beginning after
December 15, 1997. Financial statement disclosures for prior periods are
required to be restated. Lucent is in the process of evaluating the disclosure
requirements. The adoption of SFAS 131 will have no impact on Lucent's
consolidated results of operations, financial position or cash flows.
In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in the financial statements. SFAS 130 is effective for
fiscal years beginning after December 15, 1997. Reclassification of financial
statements for earlier periods provided for comparative purposes is required.
Lucent is in the process of determining its preferred format. The adoption of
SFAS 130 will have no impact on Lucent's consolidated results of operations,
financial position or cash flows.
In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use.
-40-
<PAGE>
This pronouncement identifies the characteristics of internal use software and
provides guidance on new cost recognition principles. SOP 98-1 is effective for
financial statements for fiscal years beginning after December 15, 1998. Lucent
currently expenses its costs of computer software developed or obtained for
internal use and is evaluating the impacts of adopting SOP 98-1.
In October 1997, the AICPA issued Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2"). SOP 97-2 provides guidance on when revenue should be
recognized and in what amounts for licensing, selling, leasing or otherwise
marketing computer software. SOP 97-2 is effective for financial statements for
fiscal years beginning after December 15, 1997. During March 1998, the AICPA
issued Statement of Position 98-4, "Deferral of the Effective Date of a
Provision of SOP 97-2, Software Revenue Recognition",("SOP 98-4"). SOP 98-4
defers for one year the limitation of what is considered vendor-specific
objective evidence of the fair value of the various elements in a
multiple-element arrangement, a requirement to recognize revenue for elements
delivered early in the arrangement. Effective October 1, 1998, Lucent has
adopted SOP 97-2 and the adoption is not expected to have a material impact on
Lucent's consolidated results of operations, financial position or cash flows.
4. SUPPLEMENTARY FINANCIAL INFORMATION
SUPPLEMENTARY INCOME STATEMENT INFORMATION
<TABLE>
<CAPTION>
Nine
Year Ended Year Ended Months Ended
September 30, September 30, September 30,
1998 1997 1996
(Twelve Months) (Twelve Months)
<S> <C> <C> <C>
INCLUDED IN COSTS
Amortization of software development costs $ 234 $ 380 $ 219
INCLUDED IN SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES
Amortization of goodwill and existing
technology $ 147 $ 32 $ 25
INCLUDED IN COSTS AND OPERATING EXPENSES
Depreciation and amortization of property,
plant and equipment $ 923 $1,011 $ 675
OTHER INCOME -- NET
Interest income $ 84 $ 133 $ 71
Minority interests in earnings of subsidiaries (24) (35) (21)
Net equity losses from investments (209) (64) (26)
Net decrease in cash surrender value
of life insurance (12) (13) (6)
Loss on foreign currency transactions (44) (12) (4)
Gains on businesses sold 208 - -
Miscellaneous -- net 97 66 41
------ ------ -----
Total other income -- net $ 100 $ 75 $ 55
</TABLE>
-41-
<PAGE>
DEDUCTED FROM INTEREST EXPENSE
Capitalized interest $ 17 $ 14 $ 14
SUPPLEMENTARY BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
INVENTORIES
Completed goods $ 1,578 $ 1,611
Work in process and raw materials 1,503 1,315
-------- -------
Inventories $ 3,081 $ 2,926
PROPERTY, PLANT AND EQUIPMENT -- NET
Land and improvements $ 301 $ 299
Buildings and improvements 3,132 2,853
Machinery, electronic and other equipment 8,369 8,411
-------- -------
Total property, plant and equipment 11,802 11,563
Less: Accumulated depreciation and amortization (6,392) (6,412)
-------- -------
Property, plant and equipment -- net $ 5,410 $ 5,151
OTHER CURRENT LIABILITIES
Advance billings and customer deposits $ 517 $ 844
</TABLE>
SUPPLEMENTARY CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Nine
Year Ended Year Ended Months Ended
September 30, September 30, September 30,
1998 1997 1996
(twelve months) (twelve months)
------------- ------------- -------------
<S> <C> <C> <C>
Interest payments, net of amounts capitalized $ 319 $ 307 $ 209
Income tax payments $ 716 $ 781 $ 145
Acquisitions of businesses:
Fair value of assets acquired $2,341 $1,812 $ 527
Less: Fair value of liabilities assumed $ 994 $ 244 $ 293
------ ------ ------
Acquisitions of businesses $1,347 $1,568 $ 234
</TABLE>
On October 1, 1997, Lucent contributed its Consumer Products business to a new
venture formed by Lucent and Philips Electronics N.V. in exchange for 40%
ownership of Philips Consumer Communications ("PCC"). For the year ended
September 30, 1998, the statement of cash flows excludes Lucent's contribution
of its Consumer Products business.
-42-
<PAGE>
For the year ended September 30, 1998, Other income -- net includes a charge of
$110 related to a write-down associated with Lucent's investment in the PCC
venture. This charge was offset by gains of $103, primarily related to the sale
of an investment and the sale of certain business operations, including Bell
Labs Design Automation Group.
For the year ended September 30, 1998, the statement of cash flows excludes the
issuance of common stock related to the acquisitions of Livingston and Prominet
and the conversion of stock options related to the acquisitions of Livingston,
Prominet, Yurie and Optimay.
For the year ended September 30, 1997, the statement of cash flows excludes the
conversion of stock options related to the acquisition of Octel. For information
on the 1998 and 1997 acquisitions, see Note 1.
For the year ended September 30, 1997, research and development costs include a
$127 write-down of special purpose Bell Labs assets no longer being used.
The statement of cash flows for the nine-month period ended September 30, 1996
excludes $2,000 of customer accounts receivable retained by AT&T as well as net
asset transfers of $239 received from AT&T. These transactions have not been
reflected on the consolidated statement of cash flows because they were noncash
events accounted for as changes in paid-in capital.
-43-
<PAGE>
5. 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.
Included in the calculation of the weighted-average shares is the retroactive
recognition to January 1, 1996 of the 2,098.5 million shares (524.6 million
shares on a pre-splits basis) owned by AT&T and the 25.76 million shares issued
on February 26, 1999 in connection with the Kenan merger. The following table
reconciles the number of shares utilized in the earnings per share calculations:
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
September 30, September 30,
1998 1997 1996
(twelve months)
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $ 1,055 $ 574 $ 229
Earnings per common share - basic $ 0.40 $ 0.22 $ 0.10
Earnings per common share - diluted $ 0.39 $ 0.22 $ 0.10
Number of shares (in millions)
- ---------------------------------
Common shares - basic 2,635.0 2,582.6 2,408.8
Effect of dilutive securities:
Stock options 53.6 19.8 0.0
Other 4.0 0.2 0.4
Common shares - diluted 2,692.6 2,602.6 2,409.2
</TABLE>
6. BUSINESS RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of calendar year 1995, a pre-tax charge of $2,801 was
recorded to cover restructuring costs of $2,613 and asset impairment and other
charges of $188. The restructuring plans included restructuring Lucent's
Consumer Products business, including closing all of the Company-owned retail
Phone Center Stores; consolidating and re- engineering numerous corporate and
business unit operations; and selling the Microelectronics' interconnect and
Paradyne businesses.
The 1995 business restructuring charge of $2,613 included restructuring
liabilities of $1,774, asset impairments of $497 and $342 of benefit plan
losses. The asset impairments included write-downs for inventory and fixed
assets for product lines and businesses that the Company exited as part of its
restructuring activities. The write-downs were determined based on the net book
value of the assets at December 31, 1995. The assets did not benefit activities
that were to continue nor were they used to generate future revenues.
Depreciation was suspended for the fixed assets that were written down as part
of the 1995 business restructuring. Benefit plan losses were related to pension
and other employee benefit plans and primarily represented losses in 1995 from
the actuarial changes that otherwise might have been amortized over future
periods.
-44-
<PAGE>
The pre-tax total charge for restructuring, impairments and other charges of
$2,801 for 1995 was recorded as $892 of costs, $1,645 of selling, general and
administrative expenses, and $264 of research and development expenses. The
charges included $1,509 for employee separations; $627 for asset write-downs;
$202 for closing, selling and consolidating facilities; and $463 for other
items. The total charges reduced net income by $1,847.
The restructuring charge of $2,613 incorporated the separation costs, both
voluntary and involuntary, for nearly 22,000 employees. As of September 30,
1998, the work force had been reduced by approximately 19,900 positions due to
business restructuring. In addition, approximately 1,000 employees left Lucent's
work force as part of the sale of Paradyne in 1996. Actual experience in
employee separations, combined with redeploying employees into other areas of
the business, has resulted in lower separation costs than originally
anticipated. Lucent expects employee reductions in positions to be substantially
complete by September 1999.
The following table displays a rollforward of the liabilities for business
restructuring from September 30, 1996 to September 30, 1998:
<TABLE>
<CAPTION>
September 30, 1997 September 30, 1998 September 30,
Type of Cost 1996 Balance Deductions 1997 Balance Deductions 1998 Balance
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Employee Separation $ 766 $(418) $ 348 $ (235) $ 113
Facility Closing 175 (109) 66 (23) 43
Other 348 (193) 155 (60) 95
Total $ 1,289 $(720) $ 569 $(318) $ 251
</TABLE>
Lucent's remaining restructuring plans consist primarily of: (1) the elimination
of back office support facilities due to the replacement of legacy information
technology systems and the consolidation of corporate functions in certain
locations outside the United States, each of which will result in employee
separation costs, (2) facility closing costs for continuing payments under
building leases for properties that the Company no longer occupies and (3) other
costs related to the closing, sale or consolidation of certain owned facilities
and product lines.
The remaining employee separation costs will be used to reduce approximately
1,200 employees performing transaction processing and financial reporting and to
downsize the number of employees in our Customer Service Centers. These
headcount reductions were included in the original restructing plans and will
occur as soon as the replacement of the legacy information technology systems
and consolidation of corporate functions are complete.
As a result of the workforce reductions and consolidation efforts, the Company
reduced the amount of leased space it occupied from 19 million square feet to
14 million square feet. The remaining facility closing costs include ongoing
rental playments for th leased space the Company no longer occupies and the
reserves will be utilized over the remaining lease terms.
<PAGE>
Other costs remaining include primarily reserves for remediation expenses,
outstanding litigation and sales and use tax issues related to the closing, sale
or consolidation of certain owned facilities or product lines which were being
exited. Management believes that the remaining reserves for business
restructuring are adequate and that the plans will be completed by September
1999.
Total deductions to Lucent's business restructuring reserves were $318 and $720
for the years ended September 30, 1998 and 1997, respectively. Included in these
deductions were cash payments of $176 and $483 and noncash related charges of
$42 and $36 for the years ended September 30, 1998 and 1997, respectively. The
noncash related charges were primarily related to assets for product lines and
businesses that Lucent exited as part of its restructuring activities. The
related costs were included in the 1995 restructuring plan. The assets did not
benefit activities that were to continue nor were they used to generate future
revenues. The reserves were charged as the product lines and businesses were
exited during 1998 and 1997. In addition, Lucent reversed $100 and $201 of
business restructuring reserves primarily related to favorable experience in
employee separations for the years ended September 30, 1998 and 1997,
respectively.
-45-
<PAGE>
7. INCOME TAXES
The following table presents the principal reasons for the difference between
the effective tax rate and the United States federal statutory income tax rate:
<TABLE>
<CAPTION>
Year Ended Year Ended Nine
September 30, September 30, Months Ended
1998 1997 September 30,
(twelve months) (twelve months) 1996
------------ ------------- -----------
<S> <C> <C> <C>
United States federal statutory
income tax rate 35.0% 35.0% 35.0%
----- ----- -----
State and local income taxes, net of
federal income tax effect 3.2 5.4 1.4
Foreign earnings and dividends taxed at
different rates 1.1 0.9 4.1
Research credits (2.8) (2.6) (5.0)
Purchased in-process research and
development costs 20.7 25.0 0.0
Other differences - net (1.2) (1.9) 3.5
----- ----- -----
Effective income tax rate 56.0% 61.8% 39.0%
===== ===== =====
</TABLE>
The following table presents the United States and foreign components of income
before income taxes and the provision for income taxes:
<TABLE>
<CAPTION>
Year Ended Year Ended Nine
September 30, September 30, Months Ended
1998 1997 September 30,
(twelve months) (twelve months) 1996
------------ ------------- ------------
<S> <C> <C> <C>
INCOME BEFORE INCOME TAXES
United States $ 2,043 $ 911 $ 110
Foreign 353 592 265
------- ------- --------
Income before income taxes $ 2,396 $ 1,503 $ 375
======= ======= ========
PROVISION FOR INCOME TAXES
CURRENT
Federal $ 823 $ 464 $ 244
State and local 143 131 53
Foreign 208 226 98
------- ------- --------
Sub-Total 1,174 821 395
------- ------- --------
DEFERRED
Federal 113 36 (197)
State and local 43 77 ( 45)
Foreign and other 11 ( 5) ( 7)
------- ------- --------
Sub-Total 167 108 (249)
------- ------- --------
Provision for income taxes $ 1,341 $ 929 $ 146
======= ======= ========
</TABLE>
-46-
<PAGE>
As of September 30, 1998, Lucent had tax credit carryforwards of $32 and
federal, state and local, and foreign net operating loss carryforwards (tax
effected) of $179, all of which expire primarily after the year 2000.
The components of deferred tax assets and liabilities at September 30, 1998 and
1997 are as follows:
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
DEFERRED INCOME TAX ASSETS
Employee pensions and other benefits - net $ 1,510 $ 1,777
Business restructuring 165 112
Reserves and allowances 1,063 887
Net operating loss/credit carryforwards 211 107
Valuation allowance (261) (234)
Other 463 664
------- -------
Total deferred income tax assets $ 3,151 $ 3,313
======= =======
DEFERRED INCOME TAX LIABILITIES
Property, plant and equipment $ 397 $ 478
Other 380 240
------- ------
Total deferred income tax liabilities $ 777 $ 718
======= ======
</TABLE>
Lucent has not provided for United States deferred income taxes or foreign
withholding taxes on $2,432 of undistributed earnings of its non-United States
subsidiaries as of September 30, 1998, since these earnings are intended to be
reinvested indefinitely.
8. DEBT OBLIGATIONS
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
DEBT MATURING WITHIN ONE YEAR
Commercial paper (net of $495*
refinanced after September 30, 1998) $ 2,106 $ 2,364
Long-term debt 39 25
Other 86 149
------- -------
Total debt maturing within one year $ 2,231 $ 2,538
WEIGHTED AVERAGE INTEREST RATES
Commercial paper 5.6% 5.5%
Long-term debt and other 7.9% 6.3%
</TABLE>
Lucent had revolving credit facilities at September 30, 1998 aggregating $5,211
(a portion of which is used to support Lucent's commercial paper program),
$4,000 with domestic lenders and $1,211 with foreign lenders. At September 30,
1998, $4,000 with domestic lenders and $855 with foreign lenders were available.
-47-
<PAGE>
September 30, September 30,
1998 1997
------------- -------------
LONG-TERM DEBT
6.90% notes due July 15, 2001 $ 750 $ 750
7.25% notes due July 15, 2006 750 750
6.50% debentures due January 15, 2028 300 -
Commercial paper refinanced after
September 30, 1998 495* -
Long-term lease obligations 1 2
Other 164 198
Less: Unamortized discount 12 10
------ ------
Total long-term debt 2,448 1,690
Less: Amounts maturing within one year 39 25
------ ------
Net long-term debt $ 2,409 $ 1,665
====== ======
Lucent has an effective shelf registration statement for the issuance of debt
securities up to $3,500, of which $1,160* remains available at September 30,
1998, giving effect to the refinancing.
This table shows the maturities, by year, of the $2,448 in total long-term debt
obligations:
September 30,
----------------------------------------------
1999 2000 2001 2002 2003 Later Years
$39 $71 $773 $14 $14 $1,537*
* On November 19, 1998, Lucent sold $500 ($495 net of unamortized costs) of
10-year 5.5% notes due November 15, 2008 and reclassified the amount from debt
maturing within one year to long-term debt. The proceeds were used to pay down
a portion of Lucent's commercial paper during the first quarter of fiscal
1999.
-48-
<PAGE>
9. EMPLOYEE BENEFIT PLANS
PENSION AND POSTRETIREMENT BENEFITS
Lucent maintains noncontributory defined benefit pension plans covering the
majority of its employees and retirees, and postretirement benefit plans for the
majority of its retirees that include health care benefits and life insurance
coverage. Prior to October 1, 1996, Lucent's financial statements reflect
estimates of the costs experienced for its employees and retirees while they
were included in AT&T pension and postretirement plans.
Pension-related benefits for management employees are based principally on
career-average pay while benefits for nonmanagement employees are not directly
pay-related. Pension contributions are determined principally using the
aggregate cost method and are made primarily to trust funds held for the sole
benefit of plan participants.
The following table shows the Lucent plans' funded status reconciled with
amounts reported in Lucent's consolidated balance sheets, and the assumptions
used in determining the actuarial present value of the benefit obligation:
<TABLE>
<CAPTION>
Pension Postretirement
Benefits Benefits
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------
Plan assets at fair value $ 36,191 $ 36,204 $ 3,959 $ 4,152
Less: benefit obligation 27,846 23,187 9,193 7,939
- ---------------------------------------------------------------------------------------------------------
Funded(Unfunded) status of the plan 8,345 13,017 (5,234) (3,787)
Unrecognized prior service costs 1,509 1,048 533 261
Unrecognized transition asset (944) (1,244) - -
Unrecognized net gain (5,175) (9,669) (408) (1,256)
Net minimum liability of nonqualified
plans (27) (23) - -
- ---------------------------------------------------------------------------------------------------------
Prepaid(Accrued) benefit cost $ 3,708 $ 3,129 $(5,109) $(4,782)
=========================================================================================================
Accumulated pension benefit obligation $ 26,799 $ 22,669 n/a n/a
Vested pension benefit obligation $ 25,112 $ 21,246 n/a n/a
- ---------------------------------------------------------------------------------------------------------
Accumulated postretirement benefit obligation:
Retirees n/a n/a $ 6,662 $ 5,902
Fully eligible active plan
participants n/a n/a 1,131 777
Other active plan participants n/a n/a 1,400 1,260
- ---------------------------------------------------------------------------------------------------------
Accumulated postretirement benefit
obligation n/a n/a $ 9,193 $ 7,939
=========================================================================================================
Assumptions:
Weighted average discount rate 6.00% 7.25% 6.00% 7.25%
Rate of increase in future
compensation levels 4.50% 4.50% n/a n/a
=========================================================================================================
</TABLE>
-49-
<PAGE>
Pension plan assets consist primarily of listed stocks (of which $126 and $73
represent Lucent common stock at September 30, 1998 and 1997, respectively).
Postretirement plan assets include listed stocks (of which $11 and $2 represent
Lucent common stock at September 30, 1998 and 1997, respectively). Assets in
both plans also include corporate and governmental debt, and cash and cash
equivalents. Pension plan assets also include real estate investments, and
postretirement plan assets also include life insurance contracts.
The prepaid pension benefit costs shown above are net of pension liabilities for
plans where accumulated plan benefits exceed assets. Such liabilities are
included in other liabilities in the consolidated balance sheets.
The following table shows the components of pension and postretirement costs for
the periods indicated:
<TABLE>
<CAPTION>
Year Ended Year Ended Nine
September 30, September 30, Months Ended
1998 1997 September 30,
PENSION COST (twelve months) (twelve months) 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost-benefits
earned during the period $ 331 $ 312 $ 277
Interest cost on projected
benefit obligation 1,631 1,604 1,172
Expected return on plan
assets (1) (2,384) (2,150) (1,589)
Amortization of unrecognized
prior service costs 164 149 113
Amortization of transition
asset (300) (300) (222)
Charges(credits) for plan
curtailments (2) - 56 (16)
- ---------------------------------------------------------------------------------------
Net pension credit $ (558) $ (329) $ (265)
=======================================================================================
POSTRETIREMENT COST
- ---------------------------------------------------------------------------------------
Service cost-benefits earned
during the period $ 63 $ 57 $ 51
Interest cost on accumulated
postretirement benefit
obligation 540 554 408
Expected return on plan
assets (3) (263) (264) (189)
Amortization of unrecognized
prior service costs 53 35 53
Amortization of net loss (gain) 3 (15) 8
Charges(credits) for plan
curtailments(2) - 26 (2)
- ---------------------------------------------------------------------------------------
Net postretirement benefit cost $ 396 $ 393 $ 329
=======================================================================================
</TABLE>
<PAGE>
(1) A 9.0% long-term rate of return on pension plan assets was assumed for 1998,
1997 and 1996. The actual return on plan assets was $1,914 and $8,523 for
the years ended September 30, 1998 and 1997, respectively, and $2,204 for
the nine-month period ended September 30, 1996.
(2) The 1997 pension and postretirement charges for plan curtailments of $56 and
$26, respectively, reflect the final determination of 1996 curtailment
effects.
(3) A 9.0% long-term rate of return on postretirement plan assets was assumed
for 1998, 1997 and 1996. The actual return on plan assets was $349 and
$1,040 for the years ended September 30, 1998 and 1997, respectively, and
$219 for the nine-month period ended September 30, 1996.
-50-
<PAGE>
Pension cost was computed using the projected unit credit method. Lucent is
amortizing over approximately 16 years the unrecognized pension transition asset
related to the adoption of SFAS No. 87, "Employers' Accounting for Pensions," in
1986. Prior service pension costs are amortized primarily on a straight-line
basis over the average remaining service period of active employees.
For postretirement benefit plans, Lucent assumed a 5.5% annual rate of increase
in the per capita cost of covered health care benefits (the health care cost
trend rate) for 1999, gradually declining to 4.9% by the year 2005, after which
the costs would remain level. This assumption has a significant effect on the
amounts reported. Increasing the assumed trend rate by 1% in each year would
increase Lucent's accumulated postretirement benefit obligation as of September
30, 1998 by $358 and the interest and service cost by $30 for the year then
ended.
SAVINGS PLANS
Lucent's savings plans allow employees to contribute a portion of their pre-tax
and/or after tax income in accordance with specified guidelines. Lucent matches
a percentage of employee contributions up to certain limits. Beginning in 1998,
Lucent changed its savings plan for management employees to provide for both a
fixed and a variable matching contribution. The fixed match is 50% of qualified
management employee contributions and the variable match is based on Company
performance. For 1998, Lucent's total match of qualified management employee
contributions is 109%, as compared with 66 2/3% in prior years. Qualified
nonmanagement employee contributions continued to be matched at a 66 2/3% rate.
Savings plan expense amounted to $312 and $180 for the years ended September 30,
1998 and 1997, respectively, and $131 for the nine-month period ended September
30, 1996.
EMPLOYEE STOCK OWNERSHIP PLAN
Lucent's leveraged Employee Stock Ownership Plan ("ESOP")funds the employer's
contributions to the Long Term Savings and Security Plan ("LTSSP") for
nonmanagement employees. The ESOP obligation is reported as debt and as a
reduction in shareowners' equity. Cash contributions to the ESOP are determined
based on the ESOP's total debt service less dividends paid on ESOP shares. As of
September 30, 1998, the ESOP contained 20.8 million shares of Lucent's common
stock. Of the 20.8 million shares, 16.4 million have been allocated to the LTSSP
and 4.4 million were unallocated. As of September 30, 1998, the unallocated
shares had a fair value of $154.
-51-
<PAGE>
10. STOCK COMPENSATION PLANS
Lucent has stock-based compensation plans under which certain employees receive
stock options and other equity-based awards. Effective October 1, 1996, any AT&T
awards held by Lucent employees were replaced by substitute awards under the
Lucent Technologies Inc. 1996 Long Term Incentive Program ("1996 LTIP").
The 1996 LTIP provides for the grant of stock options, stock appreciation
rights, performance awards, restricted stock awards and other stock unit awards.
Awards under the 1996 LTIP are generally made to executives. Lucent also awards
stock options to selected employees below executive levels under the Lucent
Technologies Inc. 1997 Long-Term Incentive Plan ("1997 LTIP"). In addition, the
Company has made special, broad-based grants under the Lucent Technologies Inc.
Founders Grant Stock Option Plan ("FGP")(1996 world-wide option grants) and the
Lucent Technologies Inc. 1998 Global Stock Option Plan ("GSOP")(1998 world-wide
option grants to management employees).
Stock options are granted with an exercise price equal to or greater than 100%
of market value at the date of grant, generally have a ten-year term and vest
within four years from the date of grant. Subject to customary anti-dilution
adjustments and certain exceptions, the total number of shares of Common Stock
authorized for option grants under the 1996 LTIP is 128 million shares between
February 1998 and February 2003. Under the 1997 LTIP, the number of shares
authorized for option grants in each calendar year is 1.3% of the total number
of outstanding shares of Common Stock as of the first day of the calendar year.
The total number of shares of Common Stock originally authorized for grant under
the FGP and GSOP are 60 million and 36 million, respectively.
In connection with several of Lucent's acquisitions (see Note 1), outstanding
stock options held by employees of acquired companies will become exercisable,
according to their terms, for Lucent common stock effective at the acquisition
date. The fair value of these options was included as part of the purchase price
related to the acquisition. These options did not reduce the shares available
for grant under any of Lucent's other option plans.
Lucent established an Employee Stock Purchase Plan (the "ESPP") effective
October 1, 1996. Under the terms of the ESPP, eligible employees may have up to
10% of eligible compensation deducted from their pay to purchase Common Stock
through June 30, 2001. On the date of exercise, which is the last trading day of
each month, the per share purchase price is 85% of the average high and low per
share trading price of Common Stock on the New York Stock Exchange on that date.
The amount that may be offered pursuant to this plan is 200 million shares. In
1998 and 1997, 8.4 million and 12.4 million shares, respectively, were purchased
under the ESPP at a weighted average price of $24.51 and $12.58, respectively.
-52-
<PAGE>
Lucent has adopted the disclosure requirements of SFAS No. 123, "Accounting for
Stock- Based Compensation" and, as permitted under SFAS No. 123, applies
Accounting Principles Board Opinion ("APB") No. 25 and related interpretations
in accounting for its plans. Compensation expense recorded under APB No. 25 was
$73 and $36 for the years ended September 30, 1998 and 1997, respectively, and
$11 for the nine months ended September 30, 1996. If Lucent had elected to adopt
the optional recognition provisions of SFAS No. 123 for its stock option plans
and the ESPP, net income and earnings per share would have been changed to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
Year Ended Year Ended Nine
September 30, September 30, Months Ended
1998 1997 September 30,
(twelve months) (twelve months) 1996
--------------------------------------------------------
<S> <C> <C> <C>
Net income
As reported $1,055 $574 $229
Pro forma $884 $477 $207
--------------------------------------------------------
Earnings per share - basic
As reported $0.40 $0.22 $0.10
Pro forma $0.34 $0.18 $0.09
Earnings per share - diluted
As reported $0.39 $0.22 $0.10
Pro forma $0.32 $0.18 $0.09
--------------------------------------------------------
</TABLE>
Note: The pro forma disclosures shown include the incremental fair value of the
Lucent stock options that were substituted for AT&T stock options at the time of
the Distribution and may not be representative of the effects on net income and
earnings per share in other years.
The fair value of stock options used to compute pro forma net income and
earnings per share disclosures is the estimated fair value at grant date using
the Black-Scholes option-pricing model with the following assumptions:
- ------------------------------------------------------------------------------
Lucent AT&T
-----------------------------
Weighted Average Assumptions (1) (2) (3) (4)
- -----------------------------
Dividend yield 0.26% 0.65% 0.75% 2.4%
Expected volatility 28.2% 22.4% 22.4% 19.4%
Risk-free interest rate 5.5% 6.4% 6.1% 6.4%
Expected holding period(in years) 4.7 5.1 4.5 5.0
- ------------------------------------------------------------------------------
(1) Assumptions for Lucent options awarded during 1998.
(2) Assumptions for Lucent options awarded during 1997.
(3) Assumptions for Lucent options substituted for AT&T options effective
October 1, 1996.
(4) Assumptions for AT&T options awarded in 1996.
-53-
<PAGE>
Presented below is a summary of the status of Lucent stock options and the
related transactions for the years ended September 30, 1998 and 1997. Also shown
is a summary of the status of the AT&T stock options held by Lucent's employees
and the related transactions for the nine months ended September 30, 1996.
Weighted
Average
Shares Exercise
(000's) Price
- -----------------------------------------------------------------------
AT&T options outstanding at December 31, 1995 25,568 $ 11.86
- -----------------------------------------------------------------------
Granted 6,760 16.46
Exercised (732) 9.57
Forfeited/Expired (12) 15.80
- -----------------------------------------------------------------------
AT&T options outstanding at September 30, 1996 31,584 12.84
- -----------------------------------------------------------------------
- -----------------------------------------------------------------------
Lucent options substituted for AT&T options, and
outstanding at October 1, 1996 39,144 10.36
- -----------------------------------------------------------------------
Granted(1)(2) 102,490 11.60
Exercised (8,088) 8.39
Forfeited/Expired (3,920) 11.90
- -----------------------------------------------------------------------
Lucent options outstanding at September 30, 1997 129,626 11.42
- -----------------------------------------------------------------------
Granted (2)(3) 83,226 29.04
Exercised (21,562) 8.82
Forfeited/Expired (4,090) 12.06
- -----------------------------------------------------------------------
Lucent options outstanding at September 30, 1998 187,200 $ 19.53
- -----------------------------------------------------------------------
(1) Includes options covering 51,012 shares of Common Stock granted under the
FGP in 1996 (at a weighted average exercise price of $11.16). No additional
options will be granted under the FGP.
(2) Includes options covering 10,384 and 9,884 shares of Common Stock, which
resulted from the conversion of options of acquired companies for the years
ended September 30, 1998 and 1997, respectively (at a weighted average
exercise price of $5.05 and $10.00, respectively). No additional options
will be granted under the converted plans of acquired companies.
(3) Includes options covering 32,356 shares of Common Stock granted under the
GSOP on September 1, 1998 (at a weighted average exercise price of $37.35).
The weighted average fair value of Lucent stock options, calculated using the
Black- Scholes option-pricing model, granted during the years ended September
30, 1998 and 1997 is $12.27 and $3.65 per share, respectively. The weighted
average fair value of AT&T stock options, calculated using the Black-Scholes
option-pricing model, granted during the nine months ended September 30, 1996 is
$3.54 per share.
-54-
<PAGE>
The following table summarizes the status of Lucent's stock options outstanding
and exercisable at September 30, 1998:
---------------------------------- --------------------
Stock Options Stock Options
Outstanding Exercisable
- --------------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Shares Contractual Exercise Shares Exercise
Prices (000's) Life(Years) Price (000's) Price
- --------------------------------------------------------------------------------
$ 0.02 to $10.65 19,122 5.2 $ 7.71 13,062 $ 8.31
$10.66 to $11.14 64,436(1) 8.0 11.14 1,442 11.10
$11.15 to $13.14 21,174 7.9 12.51 2,400 12.37
$13.15 to $21.67 30,828 8.5 19.34 5,690 15.82
$21.68 to $45.83 51,640 9.9 37.38 158 30.81
- --------------------------------------------------------------------------------
Total 187,200 $19.53 22,752 $10.95
- --------------------------------------------------------------------------------
(1) Note: One-half of the options granted to nonmanagement employees under the
FGP, covering approximately 7,780 shares, became exercisable on October 1,
1998.
Other stock unit awards are granted under the 1996 LTIP. Presented below is the
total number of shares of Common Stock represented by awards granted to Lucent
employees for the years ended September 30, 1998 and 1997, and the total number
of AT&T shares represented by awards granted to Lucent employees for the
nine-month period ended September 30, 1996:
Year Ended Year Ended Nine Months
September 30, September 30, Ended
1998 1997 September 30,
(twelve months) (twelve months) 1996
- --------------------------------------------------------------------------------
Lucent shares granted (000's) 1,590 8,564 n/a
AT&T shares granted (000's) n/a n/a 1,048
Weighted average market
value of shares granted
during the period $22.08 $11.60 $16.56
- --------------------------------------------------------------------------------
-55-
<PAGE>
11. SEGMENT INFORMATION
INDUSTRY SEGMENT
Lucent operates in the global communications networking industry segment. This
segment includes wire-line and wireless systems, software and products used for
voice, data and video communications.
GEOGRAPHIC SEGMENTS
Transfers between geographic areas are on terms and conditions comparable with
sales to external customers. The methods followed in developing the geographic
segment data require the use of estimates and do not take into account the
extent to which product development, manufacturing and marketing depend on each
other. Thus, the information may not be indicative of results if the geographic
areas were independent organizations.
Corporate assets are principally cash and temporary cash investments. Data on
other geographic areas pertain to operations that are located outside the United
States. Revenues from all international activities (other geographic areas
revenues plus export revenues) provided 25.9% and 24.2% of consolidated revenues
for the years ended September 30, 1998 and 1997, respectively, and 23.1% for the
nine-month period ended September 30, 1996.
<TABLE>
<CAPTION>
Year Ended Year Ended Nine
September 30, September 30, Months Ended
1998 1997 September 30,
(twelve months) (twelve months) 1996
------------- ------------- -------------
<S> <C> <C> <C>
REVENUES
United States $24,597 $21,891 $13,372
Other geographic areas 5,731 4,553 2,525
------- ------- -------
$30,328 $26,444 $15,897
======= ======= =======
TRANSFERS BETWEEN GEOGRAPHIC AREAS
(Eliminated in Consolidation)
United States $ 2,371 $ 1,927 $ 1,353
Other geographic areas 1,544 1,267 648
------- ------- -------
$ 3,915 $ 3,194 $ 2,001
======= ======= =======
OPERATING INCOME(LOSS)
United States $ 2,418(1) $ 1,550(2) $ 948
Other geographic areas 525 410 (108)
Corporate, eliminations and nonoperating (547) (457) (465)
------- ------- -------
Income before income taxes $ 2,396 $ 1,503 $ 375
======= ======= =======
ASSETS (End of Period)
United States $19,776 $17,111 $16,516
Other geographic areas 6,755 5,600 3,912
Corporate assets 1,282 1,778 2,744
Eliminations (982) (621) (522)
------- ------- -------
$26,831 $23,868 $22,650
======= ======= =======
</TABLE>
(1) Includes charges of $1,416 of purchased in-process research and development
costs associated with the acquisitions of Livingston, Prominet, Optimay,
Yurie, SDX, LANNET, MassMedia and JNA.
(2) Includes charges of $1,024 of purchased in-process research and development
costs associated with the acquisitions of Octel and Agile.
-56-
<PAGE>
CONCENTRATIONS
Historically, Lucent has relied on a limited number of customers for a
substantial portion of its total revenues. In terms of total revenues, Lucent's
largest customer has been AT&T, although other customers may purchase more of
any particular system or product line. Revenues from AT&T were $3,780 and $3,736
for the years ended September 30, 1998 and 1997, respectively, and $1,973 for
the nine-month period ended September 30, 1996. Lucent expects that a
significant portion of its future revenues will continue to be generated by a
limited number of customers. The loss of any of these customers or any
substantial reduction in orders by any of these customers could materially
adversely affect Lucent's operating results. Lucent does not have a
concentration of available sources of supply materials, labor, services or other
rights that, if suddenly eliminated, could severely impact its operations.
12. FINANCIAL INSTRUMENTS
The carrying values and estimated fair values of financial instruments,
including derivative financial instruments were as follows:
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
<S> <C> <C> <C> <C>
ASSETS
Derivative and Off Balance Sheet
Instruments:
Foreign currency forward exchange
contracts/purchased options $ 26 $ 4 $ 28 $ 54
Letters of credit - 2 - 2
LIABILITIES
Long-term debt(1)(2) $2,408 $2,559 $1,663 $1,748
Derivative and Off Balance Sheet
Instruments:
Foreign currency forward exchange
contracts/purchased options 25 (4) 31 36
</TABLE>
(1) Excluding long-term lease obligations of $1 at September 30, 1998 and $2 at
September 30, 1997.
(2) Reflects the reclassification from debt maturing within one year to
long-term debt as a result of the November 19, 1998, sale of $500 ($495 net
of unamortized costs) of 10-year notes.
The following methods were used to estimate the fair value of each class of
financial instruments:
<TABLE>
<CAPTION>
Financial Instrument Valuation Method
- ------------------------------------------------------------------------------------------
<S> <C>
Long-term debt Market quotes for instruments with similar terms
and maturities
Foreign currency forward exchange
contracts/purchased options Market quotes
Letters of credit Fees paid to obtain the obligations
</TABLE>
The carrying values of cash and cash equivalents, accounts receivable and debt
maturing within one year contained in the consolidated balance sheets
approximate fair value.
-57-
<PAGE>
CREDIT RISK AND MARKET RISK
By their nature, all financial instruments involve risk, including credit risk
for nonperformance by counterparties. The contract or notional amounts of these
instruments reflect the extent of involvement Lucent has in particular classes
of financial instruments. The maximum potential loss may exceed any amounts
recognized in the consolidated balance sheets. However, Lucent's maximum
exposure to credit loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and financial guarantees
is limited to the amount drawn and outstanding on those instruments.
Lucent seeks to reduce credit risk on financial instruments by dealing only with
financially secure counterparties. Exposure to credit risk is controlled through
credit approvals, credit limits and monitoring procedures. Lucent seeks to limit
its exposure to credit risks in any single country or region.
All financial instruments inherently expose the holders to market risk,
including changes in currency and interest rates. Lucent manages its exposure to
these market risks through its regular operating and financing activities and
when appropriate, through the use of derivative financial instruments.
DERIVATIVE FINANCIAL INSTRUMENTS
Lucent conducts its business on a multi-national basis in a wide variety of
foreign currencies. Consequently, Lucent enters into various foreign exchange
forward and purchased option contracts to manage its exposure against adverse
changes in those foreign exchange rates. The notional amounts for foreign
exchange forward and purchased option contracts represent the U.S. dollar
equivalent of an amount exchanged. Generally, foreign currency forward exchange
contracts are designated for firmly committed or forecasted sales and purchases
that are expected to occur in less than one year. Gains and losses on firmly
committed transactions are deferred in other current assets and liabilities, are
recognized in income when the transactions occur and are not material to the
consolidated financial statements at September 30, 1998 and 1997. Gains and
losses on foreign currency exchange contracts that are designated for forecasted
transactions are not deferred and are recognized in other income as the exchange
rates change.
Lucent engages in foreign currency hedging activities to reduce the risk that
changes in exchange rates will adversely affect the eventual net cash flows
resulting from the sale of products to foreign customers and purchases from
foreign suppliers. Hedge accounting treatment is appropriate for a derivative
instrument when changes in the value of the derivative instrument are
substantially equal, but opposite, to changes in the value of the exposure being
hedged. Lucent believes that it has achieved risk reduction and hedge
effectiveness, because the gains and losses on its derivative instruments
substantially offset the gains on the assets, liabilities and transactions being
hedged. Hedge effectiveness is periodically measured by comparing the change in
fair value of each hedged foreign currency exposure at the applicable market
rate to the change in market value of the corresponding derivative instrument.
If a high correlation exists between these items, then hedge accounting is
applied. If not, the change in market value of the derivative instrument is
recognized immediately in income.
-58-
<PAGE>
The following table presents the gross notional amounts of these derivative
financial instruments in U.S. dollars:
Gross Notional Amount
September 30,
1998 1997
Foreign exchange forward contracts:
Singapore dollars $247 $ 59
Deutsche marks 189 558
British pounds 185 136
Australian dollars 142 1
Japanese yen 120 249
Spanish pesetas 113 109
Dutch guilders 110 186
Brazilian reals 82 58
French francs 81 116
Other 186 270
Total $1,455 $1,742
Foreign exchange purchased option
contracts:
Canadian dollars $ 66 $ -
Singapore dollars 60 -
Other 4 -
Total $ 130 $ -
Lucent enters into certain interest rate swap agreements to manage its risk
between long-term fixed rate and short-term variable rate instruments. Interest
rate swap agreements were not material during 1998 and 1997.
-59-
<PAGE>
NONDERIVATIVE AND OFF BALANCE SHEET INSTRUMENTS
Requests for providing commitments to extend credit and financial guarantees are
reviewed and approved by senior management. Management regularly reviews all
outstanding commitments, letters of credit and financial guarantees, and the
results of these reviews are considered in assessing the adequacy of Lucent's
reserve for possible credit and guarantee losses. At September 30, 1998 and
1997, in management's opinion, there was no significant risk of loss in the
event of nonperformance of the counterparties to these financial instruments.
The following table presents the contract amount of Lucent's nonderivative and
off balance sheet instruments and the amounts drawn down on such instruments.
These instruments may exist or expire without being drawn upon. Therefore, the
total contract amount does not necessarily represent future cash flows.
Amounts Drawn
Down and
Contract Amount Outstanding
September 30, September 30,
1998 1997 1998 1997
------- ------- ------- -------
Letters of credit $ 805 $ 832 $ - $ -
Commitments to extend credit 2,312 1,898 399 25
Guarantees of debt 292 309 205 118
LETTERS OF CREDIT
Letters of credit are purchased guarantees that ensure Lucent's performance or
payment to third parties in accordance with specified terms and conditions.
COMMITMENTS TO EXTEND CREDIT
Commitments to extend credit to third parties are legally binding, conditional
agreements generally having fixed expiration or termination dates and specific
interest rates and purposes.
Lucent may enter into credit agreements to provide long-term financing for
customers. In October 1996, Lucent entered into an agreement to extend $1,800 of
long-term financing to Sprint Spectrum Holdings LP ("Sprint PCS") for its
purchase of Lucent's equipment and services for its nationwide personal
communication services ("PCS") network. In 1997, Lucent closed transactions
under this facility to lay off $500 of loans and undrawn commitments and $300 of
undrawn commitments to a group of institutional investors and Sprint Corporation
(a partner in Sprint PCS), respectively. In 1998, Lucent sold $645 of loans in a
private sale. As of September 30, 1998 and 1997, the balance of these
commitments not yet drawn down by Sprint PCS were $253 and $146, respectively,
and the total drawn loans due were $226 and $17, respectively.
As part of the revenue recognition process, Lucent has assessed the
collectibility of the accounts receivable relating to the Sprint PCS purchase
contract in light of its financing commitment to Sprint PCS. Lucent has
determined that the receivables under the contract are reasonably assured of
collection based on various factors among which was the ability of Lucent to
sell the loans and commitments without recourse. Lucent intends to continue
pursuing opportunities for the sale of future loans and commitments.
In addition, Lucent also entered into agreements with others to extend credit up
to an aggregate of approximately $1,371 in 1998 and $850 in 1997 for possible
future sales.
GUARANTEES OF DEBT
From time to time, Lucent guarantees the financing for product purchases by
customers and the debt of certain unconsolidated joint ventures. Requests for
providing such guarantees are reviewed and approved by senior management.
Certain financial guarantees are backed by amounts held in trust for Lucent or
assigned to a third party reinsurer.
-60-
<PAGE>
13. 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 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 September 30, 1998 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 beyond that provided for at September
30, 1998 would not be material to the annual consolidated financial statements.
In connection with the Separation and Distribution, Lucent, AT&T and NCR
Corporation executed and delivered the Separation and Distribution Agreement,
dated as of February 1, 1996, as amended and restated (the "Separation and
Distribution Agreement"), and certain related agreements. The Separation and
Distribution Agreement, among other things, provides that Lucent will indemnify
AT&T and NCR for all liabilities relating to Lucent's business and operations
and for all contingent liabilities relating to Lucent's business and operations
or otherwise assigned to Lucent. In addition to contingent liabilities relating
to the present or former business of Lucent, any contingent liabilities relating
to AT&T's discontinued computer operations (other than those of NCR) were
assigned to Lucent. The Separation and Distribution Agreement provides for the
sharing of contingent liabilities not allocated to one of the parties, in the
following proportions: AT&T: 75%, Lucent: 22%, and NCR: 3%. The Separation and
Distribution Agreement also provides that each party will share specified
portions of contingent liabilities related to the business of any of the other
parties that exceed specified levels.
-61-
<PAGE>
ENVIRONMENTAL MATTERS
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 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,
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 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 such 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.
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 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, and 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 September 30, 1998 cannot be estimated.
LEASE COMMITMENTS
Lucent leases land, buildings and equipment under agreements that expire in
various years through 2016. Rental expense under operating leases was $411 and
$326 for the years ended September 30, 1998 and 1997, respectively, and $183 for
the nine-month period ended September 30, 1996. The table below shows the future
minimum lease payments due under noncancelable operating leases at September 30,
1998. Such payments total $929.
<TABLE>
<CAPTION>
Year Ended September 30,
Later
1999 2000 2001 2002 2003 Years
----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Operating leases $255 $194 $118 $78 $59 $225
</TABLE>
-62-
<PAGE>
14. QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FISCAL YEAR QUARTERS
FIRST SECOND THIRD FOURTH TOTAL
----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C>
Year Ended
September 30, 1998
Revenues $ 8,775 $6,184 $7,271 $8,098 $ 30,328
Gross margin 4,252 2,748 3,318 3,839 14,157
Net income(loss) 825(a) 29(b) (216)(c) 417(d) 1,055(a,b,c,d)
Earnings(loss) per
common share - basic $ 0.32(a) $ 0.01(b) $(0.08)(c) $ 0.16(d) $ 0.40(a,b,c,d)
Earnings(loss) per
common share - diluted $ 0.31(a) $ 0.01(b) $(0.08)(c) $ 0.15(d) $ 0.39(a,b,c,d)
Dividends per share $ 0.0375 $ 0.00 $ 0.02 $ 0.02 $ 0.0775
Stock price:(f)
High 22 35/64 32 1/16 41 27/32 54 1/4 54 1/4
Low 18 3/32 18 23/64 32 34 3/16 18 3/32
Quarter-end close 19 31/32 31 31/32 41 19/32 34 5/8 34 5/8
Year Ended
September 30, 1997
Revenues $ 7,947 $5,172 $6,367 $6,958 $ 26,444
Gross margin 3,650 2,189 2,625 3,075 11,539
Net income(loss) 859 78 227 (590)(e) 574 (e)
Earnings(loss) per
common share - basic $ 0.33 $ 0.03 $ 0.09 $(0.23)(e) $ 0.22 (e)
Earnings(loss) per
common share - diluted $ 0.33 $ 0.03 $ 0.09 $(0.23)(e) $ 0.22 (e)
Dividends per share $0.01875 $ 0.00 $ 0.01875 $ 0.01875 $0.05625
Stock price:(f)
High 13 9/32 15 5/32 18 35/64 22 11/16 22 11/16
Low. 10 17/32 11 3/16 12 15/32 18 3/64 10 17/32
Quarter-end close 11 9/16 13 1/8 18 1/64 20 11/32 20 11/32
</TABLE>
(a) As a result of the 1998 acquisition of Livingston, Lucent recorded a non-tax
charge of $427 in the first quarter for purchased in-process research and
development.
(b) As a result of the 1998 acquisition of Prominet, Lucent recorded a non-tax
charge of $157 in the second quarter for purchased in-process research and
development.
(c) As a result of the 1998 acquisitions of Yurie and Optimay, Lucent recorded a
non-tax charge of $668 in the third quarter for purchased in-process
research and development.
(d) As a result of the 1998 acquisitions of SDX, MassMedia, LANNET and JNA,
Lucent recorded a charge of $164 ($160 after tax) in the fourth quarter for
purchased in- process research and development.
(e) As a result of the 1997 acquisition of Octel, Lucent recorded a charge of
$979 ($966 after tax) in the fourth quarter for purchased in-process
research and development and other charges.
(f) Obtained from the Composite Tape. Stock prices have been restated to reflect
the two-for-one splits of the Company's common stock effective April 1, 1998
and April 1, 1999.
-63-
<PAGE>
15. SUBSEQUENT EVENTS
Quadritek Systems, Inc.
- ------------------------------------
On October 1, 1998, Lucent acquired Quadritek Systems, Inc. for approximately
$50 in cash. Quadritek is a privately held start-up company which develops
next-generation Internet Protocol ("IP") network administration software
solutions. The acquisition will be accounted for using the purchase method of
accounting.
Included in the purchase price was approximately $21 ($13 after tax) of
in-process research and development which will result in a noncash charge to
earnings in the quarter ending December 31, 1998. The remaining purchase price
will be allocated to tangible assets and intangible assets, including goodwill
and existing technology, less liabilities assumed.
Philips Consumer Communications
- --------------------------------------------------------
On October 22, 1998, Lucent and Philips announced their intention to end the PCC
venture. On October 1, 1997, Lucent contributed its Consumer Products business
in exchange for 40% ownership of the PCC venture. It is expected Lucent and
Philips will each regain control of their original businesses by November 30,
1998. The venture was terminated in late 1998. In December 1998, Lucent sold
certain assets of its wireless handset business to Motorola. Lucent is currently
looking for opportunities to sell its remaining consumer products business.
WinStar Communications, Inc.
- -------------------------------------------
On October 22, 1998, Lucent announced that it had entered into a five-year
agreement with WinStar Communications, Inc. to provide WinStar with a fixed
wireless broadband telecommunications network in major domestic and
international markets. In connection with this agreement, Lucent entered into a
credit agreement with WinStar to provide up to $2,000 in equipment financing to
fund the buildout of this network. The maximum amount of credit that Lucent is
obligated to extend to WinStar at any one time is $500.
Ascend Communications, Inc.
- ---------------------------
On January 13, 1999, Lucent announced that it had entered into a definitive
agreement to merge with Ascend Communications, Inc. Under the terms of the
agreement, which was approved by each company's board of directors, each share
of Ascend common stock will be converted into 1.65 shares of Lucent common
stock. Based on Lucent's closing stock price of $53 15/16 on January 12, 1999,
the transaction would be valued at approximately $20 billion.
The transaction, which is subject to customary conditions and regulatory
approvals, is expected to be completed during Lucent's third fiscal quarter,
which ends June 30, 1999, and is expected to be accounted for as a pooling of
interests.
WaveAccess Ltd.
- ---------------
On January 22, 1999, Lucent completed the acquisition of the remaining 80
percent of WaveAccess Ltd. for $45 in cash. In May 1998, Lucent had acquired a
20 percent stake in the company. WaveAccess is a developer of high-speed systems
for wireless data communications. The acquisition will be accounted for using
the purchase method of accounting.
The purchase is expected to result in a one-time, non-tax deductible, non-cash
charge to earnings for purchased in-process research and development in the
quarter ending March 31, 1999. The amount of the charge has not yet been
determined. The remaining purchase price will be allocated to tangible assets
and intangible assets, including goodwill and existing technology, less
liabilities assumed.
-64-
<PAGE>
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 $0.49 and $0.48 per basic and
diluted share, respectively) is a one-time, non-cash credit to fiscal 1999
earnings. This accounting change also resulted in a reduction in benefit costs
as a result of the change in Lucent's pension and postretirement accounting in
the three months ended December 31, 1998 that increased income by $108 ($65
after-tax, or $0.02 per basic and diluted share) as compared to the previous
accounting method. A comparison of pro forma amounts is presented below showing
the effects if the accounting change were applied retroactively:
Three Months Ended December 31,
1998 1997
-------- --------
Net Income $1,428 $ 858
Earnings per share-basic $ 0.54 $ 0.32
Earnings per share-diluted $ 0.52 $ 0.31
-65-
<PAGE>
1
Exhibit 99.2
The accompanying unaudited restated condensed consolidated financial statements
have been prepared to give retroactive effect to the merger of Lucent and Kenan
Systems Corporation. The unaudited restated condensed consolidated financial
statements have been derived by combining the unaudited condensed consolidated
financial statements of Lucent for the three month periods ended December 31,
1998 and 1997 with the unaudited condensed financial statements of Kenan for the
three month periods ended December 31, 1998 and 1997. The Management's
Discussion and Analysis addresses the periods covered by the financial
statements contained in this Exhibit 99.2.
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
For the Three
Months Ended
December 31,
1998 1997
------- -------
Revenues............................. $ 9,264 $ 8,748
Costs................................ 4,398 4,521
Gross margin......................... 4,866 4,227
Operating Expenses:
Selling, general and
administrative expenses............ 1,786 1,569
Research and development expenses.... 931 830
In-process research
and development expenses........... 21 427
Total operating expenses............. 2,738 2,826
Operating income..................... 2,128 1,401
Other income - net................... 102 146
Interest expense..................... 78 62
Income before income taxes........... 2,152 1,485
Provision for income taxes........... 724 686
Income before cumulative effect of
accounting change.................. 1,428 799
Cumulative effect of accounting change
(net of income taxes of $842)...... 1,308 -
Net income........................... $ 2,736 $ 799
Earnings per common share - basic:
Income before cumulative effect of
accounting change.................. $ 0.54 $ 0.31
Cumulative effect of accounting
change ............................ 0.49 -
Net income.......................... $ 1.03 $ 0.31
Earnings per common share - diluted:
Income before cumulative effect of
accounting change.................. $ 0.52 $ 0.30
Cumulative effect of accounting
change............................. 0.48 -
Net Income.......................... $ 1.00 $ 0.30
Dividends declared per common share.. $ 0.04 $0.0375
See Notes to Consolidated Financial Statements.
<PAGE>
2
Exhibit 99.2
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
December 31, September 30,
1998 1998
------------ -------------
ASSETS
Cash and cash equivalents.............. $ 967 $ 712
Accounts receivable less allowances
of $348 at December 31, 1998 and
$392 at September 30, 1998 ........... 9,260 7,014
Inventories............................ 3,778 3,081
Contracts in process, net of progress
billings of $3,995 at December 31, 1998
and $3,036 at September 30, 1998...... 1,060 1,259
Deferred income taxes - net............ 1,620 1,623
Other current assets................... 770 493
Total current assets................... 17,455 14,182
Property, plant and equipment, net
of accumulated depreciation of
$6,896 at December 31, 1998 and
$6,392 at September 30, 1998.......... 5,652 5,410
Prepaid pension costs.................. 6,068 3,754
Deferred income taxes - net............ - 750
Capitalized software development costs. 306 298
Other assets........................... 2,271 2,437
TOTAL ASSETS........................... $31,752 $26,831
(CONT'D)
See Notes to Consolidated Financial Statements.
<PAGE>
3
Exhibit 99.2
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONT'D)
(Dollars in Millions, Except Per Share Amounts)
(Unaudited)
December 31, September 30,
1998 1998
----------- -------------
LIABILITIES
Accounts payable....................... $ 2,472 $ 2,044
Payroll and benefit-related
liabilities.......................... 1,861 2,515
Postretirement and postemployment
benefit liabilities.................. 186 187
Debt maturing within one year.......... 3,763 2,231
Other current liabilities.............. 4,189 3,481
Total current liabilities.............. 12,471 10,458
Postretirement and postemployment
benefit liabilities.................. 6,413 6,380
Long-term debt ........................ 2,404 2,409
Other liabilities...................... 1,946 1,969
Total liabilities ..................... 23,234 21,216
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: 6,000,000,000
Issued and outstanding shares:
2,666,247,698 at December 31, 1998
2,658,545,914 at September 30, 1998... 27 27
Additional paid-in capital............. 4,809 4,569
Guaranteed ESOP obligation............. (49) (49)
Retained earnings...................... 3,951 1,350
Accumulated other comprehensive
income(loss).......................... (220) (282)
Total shareowners' equity.............. 8,518 5,615
TOTAL LIABILITIES AND
SHAREOWNERS' EQUITY................... $31,752 $26,831
See Notes to Consolidated Financial Statements.
<PAGE>
4
Exhibit 99.2
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
For the Three Months
Ended December 31,
1998 1997
Operating Activities
Net income............................... $2,737 $ 799
Adjustments to reconcile net income
to net cash (used in)provided by
operating activities:
Cumulative effect of
accounting change.................... (1,308) -
Depreciation and amortization......... 346 344
Provision for uncollectibles.......... (15) 54
Deferred income taxes................. 206 (22)
Purchased in-process research and
development......................... 21 427
Increase in accounts receivable - net. (2,257) (1,263)
(Increase)decrease in inventories
and contracts in process - net....... (425) 152
Increase(decrease) in
accounts payable..................... 354 (385)
Changes in other operating assets
and liabilities..................... (493) 523
Other adjustments for non-cash
items - net......................... (248) (231)
Net cash (used in)provided by
operating activities.................... (1,082) 398
Investing Activities
Capital expenditures .................... (344) (263)
Proceeds from the sale or disposal of
property, plant and equipment.......... 28 27
Purchases of equity investments.......... (17) (47)
Sales of equity investments.............. 1 25
Acquisitions of businesses,
net of cash acquired................... (115) -
Dispositions of businesses............... 57 281
Other investing activities - net......... 22 (35)
Net cash used in investing activities.... (368) (12)
Financing Activities
Repayments of long-term debt ............ (8) (20)
Issuance of long-term debt............... 495 3
Proceeds of issuance of common stock..... 239 72
Dividends paid........................... (54) (48)
S-corp distribution to stockholder....... - (8)
Increase(decrease) in short-term
borrowings - net....................... 1,041 (485)
Net cash provided by
(used in) financing activities.......... 1,713 (486)
(CONT'D)
See Notes to Consolidated Financial Statements.
<PAGE>
5
Exhibit 99.2
LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT'D)
(Dollars in Millions)
(Unaudited)
For the Three Months
Ended December 31,
1998 1997
Effect of exchange rate
changes on cash........................ 10 (22)
Net increase(decrease) in cash and
cash equivalents....................... 273 (122)
Cash and cash equivalents
at beginning of period................. 694 1,362
Cash and cash equivalents
at end of period....................... $ 967 $ 1,240
See Notes to Consolidated Financial Statements.
<PAGE>
6
Exhibit 99.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed 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 ("SEC") 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.
The accompanying unaudited condensed consolidated financial statements give
retroactive effect to the merger with Kenan Systems Corporation. The financial
statements of Lucent for the three month periods ended December 31, 1998 and
1997, have been combined with the financial statements of Kenan for the three
month periods ended December 31, 1998 and 1997, respectively.
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 three months ended December 31, 1998, improved
performance on multi-year contracts and the resolution of certain contingencies
had a positive impact on the reported results of operations.
The financial statement results 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 Exhibit 99.1 of this filing.
The financial statements presented have been restated to reflect the two-for-one
splits of Lucent's common stock which became effective on April 1, 1998 and
April 1, 1999. Certain prior period amounts have been reclassified to conform to
the current period presentation.
<PAGE>
2. 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 $0.49 and $0.48 per basic and
diluted share, respectively) is a one-time, non-cash credit to fiscal 1999
earnings. This accounting change also resulted in a reduction in benefit costs
as a result of the change in Lucent's pension and postretirement accounting in
the three months ended December 31, 1998 that increased income by $108 ($65
after-tax, or $0.02 per basic and diluted share) as compared to the previous
accounting method. A comparison of pro forma amounts is presented below showing
the effects if the accounting change were applied retroactively:
Three Months Ended December 31,
1998 1997
-------- -------
Net Income............................ $1,428 $ 858
Earnings per share-basic.............. $ 0.54 $ 0.32
Earnings per share-diluted............ $ 0.52 $ 0.31
<PAGE>
7
Exhibit 99.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
3. COMPREHENSIVE INCOME
Lucent has adopted Statement of Financial Accounting Standards No. 130
"Reporting Comprehensive Income" as of October 1, 1998 which requires new
standards for reporting and display of comprehensive income and its components
in the financial statements. However, it does not affect net income or total
shareowners' equity. The components of comprehensive income are as follows:
Three Months Ended
December 31,
1998 1997
------- ------
Net income......................... $ 2,736 $ 799
Other comprehensive income(loss):
Foreign currency translation
adjustments.................... 51 (82)
Unrealized holding gains(losses)
arising during the period...... 11 (21)
Comprehensive income............... $ 2,798 $ 696
The components of accumulated other comprehensive income(loss) are as follows:
<TABLE>
<CAPTION>
Foreign Currency Total Accumulated
Translation Other Comprehensive
Adjustments Other Income(Loss)
----------- ----- -------------------
<S> <C> <C> <C>
Accumulated other comprehensive income
(loss) at September 30, 1998........ $ (279) $ (3) $ (282)
Other comprehensive income
for the period....................... 51 11 62
Accumulated other comprehensive income
(loss) at December 31, 1998......... $ (228) $ 8 $ (220)
</TABLE>
The foreign currency translation adjustments are not currently adjusted for
income taxes since they relate to indefinite investments in non-United States
subsidiaries.
4. ACQUISITION
Quadritek Systems, Inc.
- -----------------------
On October 1, 1998, Lucent completed the purchase of Quadritek Systems, Inc. for
$50 in cash. Quadritek was a privately-held company involved in the development
of Internet Protocol ("IP") network administration software solutions. The
transaction was accounted for under the purchase method of accounting and the
excess purchase price over the estimated fair value of net tangible assets was
allocated to various intangible assets, primarily consisting of developed
technology of $5 and goodwill of $24. These assets are being amortized over six
and eight years, respectively. In addition to the intangible assets acquired,
Lucent recorded a charge of $21 ($14 after-tax), representing the write-off of
in-process research and development ("IPR&D").
The allocation of $21 represents the estimated fair value related to incomplete
projects based on risk-adjusted cash flows. Lucent believes that such fair value
is reasonable and does not exceed the amount a third party would pay for these
projects. At the date of the acquisition, the projects associated with the IPR&D
efforts had not yet reached technological feasibility and had no alternative
future uses. Accordingly, these costs were expensed during the period.
<PAGE>
8
Exhibit 99.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
At the acquisition date, Quadritek was conducting development, engineering, and
testing activities associated with the completion of a number of new product
offerings ("New Product Offerings"). The IPR&D projects were in various stages
of development. Overall, substantial progress had been made. The IPR&D projects
ranged in completion from 20% to 80%. Remaining efforts necessary to complete
the New Product Offerings relate primarily to additional coding, testing, and
addressing performance issues. In total, costs to complete the New Product
Offerings are expected to total approximately $5.
In making its purchase price allocation, Lucent's management was primarily
responsible for estimates and assumptions which gave consideration to present
value calculations of income, an analysis of project accomplishments and
completion costs, an assessment of overall contributions, as well as project
risks. The values assigned to IPR&D were determined by estimating the costs to
develop the purchased technology into commercially viable products, estimating
the resulting net cash flows from each project, excluding the cash flows related
to the portion of each project that was incomplete at the acquisition date, and
discounting the resulting net cash flows to their present value. Each of the
project forecasts was based upon future discounted cash flows, taking into
account the stage of development of each in-process project, the cost to
complete that project, the expected income stream, the life cycle of the product
ultimately developed, and the associated risks. Projected future net cash flows
attributable to the in-process technology, assuming successful development of
such technologies, were discounted to their present values using a discount rate
of 20%.
The aforementioned estimates are subject to change, given the uncertainties of
the development process, and no assurance can be given that deviations from
these estimates will not occur. Management expects to continue development of
these efforts and believes there is a reasonable chance of successfully
completing such development. However, there is risk associated with the
completion of the in-process projects and there can be no assurance that any of
the projects will meet with either technological or commercial success. Failure
to successfully develop and commercialize the in-process projects would result
in the loss of the expected economic return inherent in the fair value
allocation.
<PAGE>
9
Exhibit 99.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
5. SUPPLEMENTARY BALANCE SHEET INFORMATION
Inventories at December 31, 1998 and September 30, 1998 were as follows:
December 31, September 30,
1998 1998
------------ -------------
Completed goods ............... $ 1,777 $ 1,578
Work in process and
raw materials................ 2,001 1,503
Total inventories ............. $ 3,778 $ 3,081
6. BUSINESS RESTRUCTURING
For the three months ended December 31, 1998 and 1997, $13 and $26,
respectively, were applied to the 1995 business restructuring reserve. The
remaining reserve for business restructuring at December 31, 1998 was $238.
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.
Earnings per share amounts for the periods presented have been restated to
reflect the two-for-one splits of Lucent's common stock, which became effective
on April 1, 1998 and April 1, 1999. The following table reconciles the number of
shares utilized in the earnings per share calculations for the three months
ended December 31, 1998 and 1997:
<PAGE>
10
Exhibit 99.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
Three Months Ended
December 31,
1998 1997
------------------
Net income........................ $ 2,736 $ 799
Earnings per common share - basic:
Income before cumulative effect
of accounting change........... $ 0.54 $ 0.31
Cumulative effect of accounting
change......................... 0.49 -
Net Income....................... $ 1.03 $ 0.31
Earnings per common share - diluted:
Income before cumulative effect
of accounting change........... $ 0.52 $ 0.30
Cumulative effect of accounting
change......................... 0.48 -
Net Income....................... $ 1.00 $ 0.30
Number of Shares (in millions)
- ---------------------------------
Common shares - basic............. 2,660.4 2,600.4
Effect of dilutive securities:
Stock options................... 64.8 36.7
Other........................... 4.8 0.7
Common shares - diluted........... 2,730.0 2,637.8
Shares excluded from the
computation of earnings
per common share - diluted since
option exercise price was greater
than the average market price of
the common shares for the period.. 5.6 10.8
8. 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. ("Phillips") in exchange
for 40% ownership of PCC. On October 22, 1998, Lucent and Phillips announced
their intention to end the PCC venture and agreed to regain 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 Systems and Products. In
December 1998, Lucent sold certain assets of the wireless handset portion of the
remaining businesses to Motorola. Lucent is continuing to look for opportunities
to sell the remaining consumer products businesses.
<PAGE>
11
Exhibit 99.2
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 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 December 31, 1998 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 beyond that provided for at December 31, 1998 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. ("AT&T") 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 ("NCR"), 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.
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 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, and 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 December 31, 1998 cannot be estimated.
<PAGE>
12
Exhibit 99.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions Except Per Share Amounts)
(Unaudited)
10. SUBSEQUENT EVENTS
Ascend Communications, Inc.
- ---------------------------
On January 13, 1999, Lucent announced that it had entered into a definitive
agreement to merge with Ascend Communications, Inc. Under the terms of the
agreement, which was approved by each company's board of directors, each share
of Ascend common stock will be converted into 1.65 shares of Lucent common
stock. Based on Lucent's closing stock price of $53 15/16 on January 12, 1999,
the transaction would be valued at approximately $20 billion.
The transaction, which is subject to customary conditions and regulatory
approvals, is expected to be completed during Lucent's third fiscal quarter,
which ends June 30, 1999, and is expected to be accounted for as a pooling of
interests.
WaveAccess Ltd.
- ---------------
On January 22, 1999, Lucent completed the acquisition of the remaining 80
percent of WaveAccess Ltd. for $45 in cash. In May 1998, Lucent had acquired a
20 percent stake in the company. WaveAccess is a developer of high-speed systems
for wireless data communications. The acquisition will be accounted for using
the purchase method of accounting.
The purchase is expected to result in a one-time, non-tax deductible, non-cash
charge to earnings for purchased in-process research and development in the
quarter ending March 31, 1999. The amount of the charge has not yet been
determined. The remaining purchase price will be allocated to tangible assets
and intangible assets, including goodwill and existing technology, less
liabilities assumed.
<PAGE>
13
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The accompanying unaudited restated condensed consolidated financial information
has been prepared to give retroactive effect to the merger of Lucent with Kenan
Systems Corporation. The following unaudited restated condensed financial
information has been derived by combining the historical financial information
of Lucent for the three month periods ended December 31, 1998 and 1997, with the
financial information of Kenan for the three month periods ended December 31,
1998 and 1997, respectively.
HIGHLIGHTS
Lucent reported net income of $2,736 million, or $1.00 per share (diluted) for
the quarter ended December 31, 1998. Included in net income is a $1,308 million
(or $0.48 per share-diluted) cumulative effect of an accounting change related
to Lucent's pension and postretirement benefits (see Note 2). The year-ago
quarterly net income was $799 million, or $0.30 per share (diluted). Lucent's
income before cumulative effect of accounting change was $1,428 million, or
$0.52 per share (diluted) for the three months ended December 31, 1998.
Gross margin increased $639 million for the quarter ended December 31, 1998
compared with the year-ago quarter. The increase in gross margin was primarily
due to higher sales volume and improved performance on multi-year contracts
compared with the same quarter last year.
Operating income of $2,128 million reflects an increase of $727 million in the
quarter compared with the same quarter in 1997 and was 23.0% of revenues. The
increase was primarily due to the increased gross margin described above and a
noncash reduction in benefits costs of $108 million resulting from the change in
Lucent's pension and postretirement accounting as described in Note 2.
On October 1, 1998, Lucent completed the purchase of Quadritek for $50 million
in cash. The acquisition was accounted for using the purchase method of
accounting and has been included in the balance sheet at December 31, 1998.
On January 13, 1999, Lucent announced that it had entered into a definitive
agreement to merge with Ascend Communications, Inc. Under the terms of the
agreement, which was approved by each company's board of directors, each share
of Ascend common stock will be converted into 1.65 shares of Lucent common
stock. Based on Lucent's closing stock price of $53-15/16 on January 12, 1999,
the transaction would be valued at approximately $20 billion. The transaction,
which is subject to customary conditions and regulatory approvals, is expected
to be completed during Lucent's third fiscal quarter, which ends June 30, 1999,
and is expected to be accounted for as a pooling of interests.
On January 22, 1999, Lucent completed the acquisition of the remaining 80%
interest in WaveAccess for $45 million in cash. The acquisition will be
accounted for using the purchase method of accounting and will be included in
financial statements for the quarter ending March 31, 1999.
<PAGE>
14
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
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 foreign and domestic competitors as well as continued changes in
technology and public policy. These competitors may include entrants from the
telecommunications, software, data networking and semiconductor industries.
Existing competitors have, and new competitors may have, strong financial
capability, technological expertise, well-recognized brand names and a global
presence. As a result, Lucent's management periodically assesses market
conditions and redirects the Company's resources to meet the challenges of
competition. Steps Lucent may take include acquiring or investing in new
businesses and ventures, partnering with existing businesses, delivering new
technologies, closing and consolidating facilities, disposing of assets,
reducing work force levels or withdrawing from markets.
Lucent has taken measures to manage the seasonality of its business by changing
the date on which its fiscal year ends and its compensation programs for
employees. As a result, Lucent has achieved a more uniform distribution of
revenues -- accompanied by a related redistribution of earnings -- throughout
the year. Revenues and earnings still remain higher in the first fiscal quarter
primarily because many of Lucent's large customers historically delay a
disproportionate percentage of their capital expenditures until the fourth
quarter of the calendar year (Lucent's first fiscal quarter).
The purchasing behavior of Lucent's largest customers has increasingly 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 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 multi-year
contracts involve new technologies that may not have been previously deployed on
a large-scale commercial basis. On its multi-year 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.
Lucent has been successful in diversifying its customer base and seeking out new
types of customers globally. These new types of customers include competitive
access providers, competitive local exchange carriers, wireless service
providers, cable television network operators and computer manufacturers.
Historically, a limited number of customers have provided a substantial portion
of Lucent's total revenues. The loss of any of these customers, or any
substantial reduction in orders by any of these customers, could materially
adversely affect Lucent's operating results.
<PAGE>
15
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
REVENUES - THREE MONTHS ENDED DECEMBER 31, 1998 VERSUS THREE MONTHS ENDED
DECEMBER 31, 1997
Total revenues increased 5.9% to $9,264 million in the quarter compared with the
same quarter of 1997, due to increases in sales from Systems for Network
Operators, Business Communications Systems, Microelectronic Products and Other
Systems and Products. For the quarter, sales within the United States decreased
by 9.5% compared with the same quarter in 1997 and sales outside the United
States increased 50.0% compared with the same quarter last year.
The following table presents Lucent's revenues by product line, and the
approximate percentage of total revenues for the three months ended December 31,
1998 and 1997:
Three Months
Ended
December 31,
Dollars in Millions --------------------------------
1998 1997
------ ------
Systems for Network Operators........ $6,175 67% $5,967 68%
Business Communications Systems...... 1,975 21 1,930 22
Microelectronic Products............. 821 9 775 9
Other Systems and Products........... 293 3 76 1
Total................................ $9,264 100% $8,748 100%
Revenues from SYSTEMS FOR NETWORK OPERATORS increased $208 million, or 3.5% in
1998 compared with the same quarter in 1997. Revenues were driven by sales of
switching systems with associated software, optical networking systems, data
networking systems for service providers, and services. Continued demand for
data services and Internet access in businesses and residences contributed to
the group's quarterly revenues.
Revenues from Systems for Network Operators in the United States decreased by
18.8% over the year-ago quarter. The revenue decrease in the United States was
primarily due to expected software revenues that were delayed into the second
and third quarters. Another factor was an exceptionally strong comparative
quarter in fiscal 1998 when Lucent benefited from revenues associated with
personal communications services ("PCS") wireless buildouts. Revenues generated
outside the United States increased 68.0% compared with the same quarter in 1997
due to revenue growth in the Europe/Middle East/Africa and Caribbean/Latin
America regions and China. Revenues generated outside the United States
represented 41.7% of revenues for the quarter compared with 25.7% for the same
quarter of 1997.
Revenues from BUSINESS COMMUNICATIONS SYSTEMS increased $45 million, or 2.3%
compared with the year-ago quarter. Increased sales of DEFINITY(R) enterprise
communication servers, including those with Call Center applications, messaging
systems, and enterprise data networking systems contributed to the increased
revenue for the quarter. Sales within the United States increased 3.2% for the
quarter compared with the same quarter of 1997. Revenues generated outside the
United States decreased by 1.7%. Revenues generated outside the United States
represented 17.9% of revenues for the quarter compared with 18.7% in the same
quarter in 1997.
- --------------------------------------
(R) Registered trademark of Lucent
<PAGE>
16
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Revenues from MICROELECTRONIC PRODUCTS increased $46 million, or 5.9% compared
with the year-ago quarter driven by sales of chips for high-speed
communications, mass storage, data networking and optoelectronic components.
These increases were partially offset by decreased sales of power systems. Sales
within the United States decreased 7.8% compared to the same quarter in 1997.
Revenues generated outside the United States increased 20.3%. The growth in
revenues outside the United States was driven by sales in the Asia/Pacific and
Europe/Middle East/Africa regions. Revenues generated outside the United States
represented 55.4% of sales for the quarter compared with 48.8% for the same
quarter of 1997.
Revenues from OTHER SYSTEMS AND PRODUCTS increased $217 million compared with
the year-ago quarter primarily due to the consolidation of the businesses
regained from the PCC venture (see Note 8).
COSTS AND GROSS MARGIN - THREE MONTHS ENDED DECEMBER 31, 1998 VERSUS THREE
MONTHS ENDED DECEMBER 31, 1997
Total costs decreased by $123 million, or 2.7% in 1998 compared with the same
quarter in 1997 primarily due to better performance on multi-year contracts and
improved cost management partially offset by the costs related to the high sales
volume. As a percentage of revenue, gross margin increased to 52.5% from 48.3%
in the year-ago quarter. The increase this quarter compared with the same
quarter in 1997 reflects improved performance on multi-year contracts and higher
profits on certain products offset by a delayed recognition of software
revenues. Based on current planning assumptions, Lucent expects that its full
1999 fiscal year gross margin will exceed fiscal year 1998, but at a lower level
than achieved for the first fiscal quarter.
OPERATING EXPENSES - THREE MONTHS ENDED DECEMBER 31, 1998 VERSUS THREE MONTHS
ENDED DECEMBER 31, 1997
Selling, general and administrative expenses as a percentage of revenues were
19.3% for the quarter, up 1.4 percentage points compared with 17.9% for the same
quarter in 1997. Excluding the amortization expense associated with goodwill and
existing technology for both years, selling, general and administrative expenses
as a percentage of revenues was 18.7%, an increase of 1.0 percentage points from
the same quarter in 1997.
Selling, general and administrative expenses increased $217 million, or 13.8%
compared with the same year-ago quarter. This increase was attributed to
investment in growth initiatives as well as the increase in amortization expense
associated with goodwill and existing technology. Amortization expense
associated with goodwill and existing technology was $57 million for the
quarter, an increase of $34 million from the year-ago quarter.
<PAGE>
Research and development expenses represented 10.0% of revenues for the quarter
compared with 9.5% of revenues for the same quarter of 1997.
Research and development expenses increased $101 million during the quarter
compared with the same year-ago quarter. This was primarily due to increased
expenditures in support of wireless, data networking, optical networking and
switching and access systems.
The purchased in-process research and development expenses for the quarter were
$21 million associated with the acquisition of Quadritek compared with $427
million related to the acquisition of Livingston for the same quarter of 1997.
OTHER INCOME, INTEREST EXPENSE AND PROVISION FOR INCOME TAXES - THREE
MONTHS ENDED DECEMBER 31, 1998 VERSUS THREE MONTHS ENDED DECEMBER 31, 1997
Other income - net decreased $44 million to $102 million for the quarter
compared with the same quarter in 1997. The decrease was primarily due to the
gain on Advanced Technology Systems ("ATS") recorded in the prior quarter
partially offset by lower net equity losses and lower losses on foreign exchange
in the current quarter.
<PAGE>
17
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Interest expense for the quarter increased $16 million to $78 million compared
with the same quarter in 1997. The increase in interest expense is due to higher
debt levels for the quarter ended December 31, 1998 compared with the same
quarter in 1997.
The effective income tax rate of 33.6% for the quarter ended December 31, 1998
decreased from 46.2% for the prior year quarter. Excluding the purchased
in-process research and development expenses associated with the Quadritek
acquisition in 1998 and the Livingston acquisition in 1997, the effective income
tax rate remained at 33.6% for the quarter ended December 31, 1998 compared with
35.9% in the prior year quarter. This decrease was primarily due to increased
research and experimentation tax credits and the tax impact of foreign activity.
TOTAL ASSETS, WORKING CAPITAL AND LIQUIDITY
Total assets increased $4,921 million, or 18.3%, from fiscal year-end 1998. This
increase was largely due to increases in accounts receivable and prepaid pension
costs of $2,246 million and $2,314 million, respectively. The increase in
accounts receivable was primarily related to higher sales volume in the last
month of the quarter. Prepaid pension costs increased due to the change in
accounting for pensions.
Total liabilities increased $2,018 million, or 9.5% from fiscal year-end 1998.
This increase was due primarily to higher commercial paper balances.
Working capital, defined as current assets less current liabilities, increased
$1,260 million from September 30, 1998, primarily resulting from the increase in
accounts receivable and inventories partially offset by higher commercial paper
balances.
Lucent expects that, from time to time, outstanding commercial paper balances
may be replaced with short- or long-term borrowings as market conditions permit.
At December 31, 1998, Lucent maintained approximately $5,400 million in credit
facilities of which a portion is used to support Lucent's commercial paper
program. At December 31, 1998, approximately $4,900 million 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 and
short- and long-term debt financings will be adequate to satisfy its future cash
requirements, although there can be no assurance that this will be the case.
Network operators, inside and outside the United States, increasingly have
required their suppliers to arrange or provide long-term financing for them as a
condition to obtaining or bidding on infrastructure projects. These projects may
require financing in amounts ranging from modest sums to over 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 investors. This enables Lucent to
reduce the amount of its commitments and free up additional financing capacity.
As of December 31, 1998, Lucent had made commitments or entered into an
agreement to extend credit to certain network operators, including PCS and
wireless operators, for an aggregate of approximately $3,190 million. As of
December 31, 1998, approximately $440 million had been advanced and was
outstanding. Included in the $3,190 million is approximately $2,810 million to
twelve network operators for possible future sales. As of December 31, 1998,
approximately $350 million had been advanced and outstanding under seven of
these arrangements.
<PAGE>
18
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
As part of the revenue recognition process, Lucent assesses the collectibility
of its receivables relating to contracts with customers for which Lucent
provides financing.
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, which could impact its results of operations, financial
condition and cash flow. 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 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 by the counterparties on
such instruments.
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
material interest rate swap agreements in effect as of December 31, 1998 and
September 30, 1998. 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.
CASH FLOWS
Cash used in operating activities for the three months ended December 31, 1998
was $1,082 million compared with cash provided by operating activities of $398
in the same year-ago quarter. This reduction in cash was primarily due to
increases in accounts receivable and inventories, offset by a decrease in
payroll and benefit related liabilities.
Cash payments of $13 million were made for the quarter ended December 31, 1998,
for the 1995 business restructuring charge. Of the 23,000 positions that Lucent
announced it would eliminate in connection with the restructuring charges,
approximately 20,100 positions have been eliminated as of December 31, 1998.
<PAGE>
19
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Comparing the quarters ended December 31, 1998 and 1997, cash used in investing
activities increased to $368 million from $12 million primarily due to the cash
used for acquisitions and a reduction in cash from dispositions.
Capital expenditures were $344 million and $263 million for the quarters ended
December 31, 1998 and 1997, 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
cost reduction efforts and international growth.
Cash provided by financing activities for the quarter ended December 31, 1998
was $1,713 million compared with $486 million used in financing activities in
the same quarter a year-ago. This increase in cash provided by financing
activities was primarily due to increased issuances of both short- and long-term
debt.
The ratio of total debt to total capital (debt plus equity) was 42.0% at
December 31, 1998 compared to 45.2% at September 30, 1998.
OTHER
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 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,
among AT&T, Lucent and NCR Corporation dated as of February 1, 1996, as amended
and restated, Lucent is responsible for all liabilities primarily resulting from
or related to the operation of Lucent's business as conducted at any time prior
to or after 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.
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 period of remediation for the applicable site which ranges
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, and 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
<PAGE>
20
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
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 and other expenditures that 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 December 31, 1998 cannot be estimated.
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.
Future Factors include increasing price and product/services competition by
foreign and domestic competitors, including new entrants; rapid technological
developments and changes and Lucent's ability to continue to introduce
competitive new products and services on a timely, cost-effective basis; the mix
of products/services; the achievement of lower costs and expenses; the ability
to successfully integrate the operations and business of Ascend, Kenan and other
acquired companies; the outcome and impact of Year 2000; domestic and foreign
governmental and public policy changes which may affect the level of new
investments and purchases made by customers; changes in environmental and other
domestic and foreign governmental regulations; protection and validity of patent
and other intellectual property rights; reliance on large customers; customer
demand for Lucent's products and services; technological, implementation and
cost/financial risks in the increasing use of large, multi-year contracts; the
cyclical nature of Lucent 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 Lucent'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 domestic and international
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, 1998 in Item 1 in the section
entitled "OUTLOOK-Forward Looking Statements" and the remainder of the OUTLOOK
section.
<PAGE>
21
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Competition:
See discussion above under KEY BUSINESS CHALLENGES.
Dependence On New Product Development:
The markets for Lucent'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. Lucent'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 Lucent'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 international and domestic
standards-setting bodies.
Reliance on Major Customers:
See discussion above under KEY BUSINESS CHALLENGES.
Readiness for Year 2000:
Lucent is engaged in a major effort to minimize the impact of the Year 2000 date
change on Lucent's products, information technology systems, facilities and
production infrastructure. Lucent has targeted June 30, 1999 for completion of
these efforts.
The Year 2000 challenge is a priority within Lucent at every level of Lucent.
Primary Year 2000 preparedness responsibility rests with program offices which
have been established within each of Lucent's product groups and corporate
centers. A corporate-wide Lucent Year 2000 Program Office ("LYPO") monitors and
reports on the progress of these offices. Each program office has a core of
full-time individuals augmented by a much larger group who have been assigned
specific Year 2000 responsibilities in addition to their regular assignments.
Further, Lucent has engaged third parties to assist in its readiness efforts in
certain cases. LYPO has established a methodology to measure, track and report
Year 2000 readiness status consisting of five steps: inventory; assessment;
remediation; testing and deployment.
Lucent is completing programs to make its new commercially available products
Year 2000 ready and has developed evolution strategies for customers who own
non-Year 2000 ready Lucent products. The majority of the upgrades and new
products needed to support customer migration are already generally available.
By the end of 1998, all but a few of these products were generally available.
Lucent has launched extensive efforts to alert customers who have non-Year 2000
ready products, including direct mailings, phone contacts and participation in
user and industry groups. Lucent also has a Year 2000 website www.lucent.com/y2k
that provides Year 2000 product information. Lucent continues to cooperate in
the Year 2000 information sharing efforts of the Federal Communications
Commission and other governmental bodies.
Lucent believes it has sufficient resources to provide timely support to its
customers that require product migrations or upgrades. However, because this
effort is heavily dependent on customer cooperation, Lucent continues to monitor
customer response and will take steps to improve customer responsiveness, as
necessary. Also, Lucent is continuing contingency planning to address potential
spikes in demand for customer support resulting from the Year 2000 date change.
These plans are targeted for completion by April 30, 1999.
<PAGE>
22
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Lucent has largely completed the inventory and assessment phases of the program
with respect to its factories, information systems, and facilities.
Approximately, two-thirds of the production elements included in the factory
inventory were found to be Year 2000 ready. The factories have commenced the
remediation phase of their effort through a combination of product upgrades and
replacement. Plans have been developed to facilitate the completion of this
work, as well as the related testing and deployment, by June 30, 1999.
Currently, approximately 65% of Lucent's information technology infrastructure
has been determined to be Year 2000 ready and is deployed for use.
Approximately, 65% of our business applications lines of code that are supported
by Lucent's information technology group are now Year 2000 ready and have been
deployed or are awaiting deployment. LYPO is monitoring the progress of
readiness efforts across Lucent, with a special emphasis on the early
identification of any areas where progress to-date could indicate difficulty in
meeting Lucent's June 1999 internal readiness target date. Lucent is developing
specific contingency plans, as appropriate.
Lucent is also assessing the Year 2000 readiness of the large number of
facilities that it owns or leases world-wide. Priority is being placed on
Lucent-owned facilities, leased facilities that Lucent manages and other
critical facilities that house large numbers of employees or significant
operations. Based on the results of these assessment activities, Lucent plans to
complete remediation efforts by March 31, 1999 and complete development of
applicable contingency plans by May 31, 1999.
To ensure the continued delivery of third party products and services, Lucent's
procurement organization has analyzed Lucent's supplier base and has sent
surveys to approximately 5,000 suppliers. Follow-up efforts have commenced to
obtain feedback from critical suppliers. To supplement this effort, Lucent is
conducting readiness reviews of the Year 2000 status of the suppliers ranked as
most critical based on the nature of their relationship with Lucent, the
product/service provided and/or the content of their survey responses. Almost
all of Lucent's suppliers are still deeply engaged in executing their Year 2000
readiness efforts and, as a result, Lucent cannot, at this time, fully evaluate
the Year 2000 risks to its supply chain. Lucent will continue to monitor the
Year 2000 status of its suppliers to minimize this risk and will develop
appropriate contingent responses as the risks become clearer.
The risk to Lucent resulting from the failure of third parties in the public and
private sector to attain Year 2000 readiness is the same as other firms in
Lucent's industry or other business enterprises generally. The following are
representative of the types of risks that could result in the event of one or
more major failures of Lucent's information systems, factories or facilities to
be Year 2000 ready, or similar major failures by one or more major third party
suppliers to Lucent: (1) information systems--could include interruptions or
disruptions of business and transaction processing such as customer billing,
payroll, accounts payable and other operating and information processes, until
systems can be remedied or replaced; (2) factories and facilities--could include
interruptions or disruptions of manufacturing processes and facilities with
delays in delivery of products, until non-compliant conditions or components can
be remedied or replaced; and (3) major suppliers to Lucent--could include
interruptions or disruptions of the supply of raw materials, supplies and Year
2000 ready components which could cause interruptions or disruptions of
manufacturing and delays in delivery of products, until the third party supplier
remedied the problem or contingency measures were implemented. Risks of major
failures of Lucent's principal products could include adverse functional impacts
experienced by customers, the costs and resources for Lucent to remedy problems
or replace products where Lucent is obligated or undertakes to take such action,
and delays in delivery of new products.
<PAGE>
23
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Lucent believes it is taking the necessary steps to resolve Year 2000 issues;
however, given the possible consequences of failure to resolve significant Year
2000 issues, there can be no assurance that any one or more such failures would
not have a material adverse effect on Lucent. Lucent estimates that the costs of
efforts to prepare for Year 2000 from calendar year 1997 through 2000 is about
$535 million, of which an estimated $280 million has been spent as of December
31, 1998. Lucent has been able to reprioritize work projects to largely address
Year 2000 readiness needs within its existing organizations. As a result, most
of these costs represent costs that would have been incurred in any event. These
amounts cover costs of the Year 2000 readiness work for inventory, assessment,
remediation, testing and deployment including fees and charges of contractors
for outsourced work and consultant fees. Costs for previously contemplated
updates and replacements of Lucent's internal systems and information systems
infrastructure have been excluded without attempting to establish whether the
timing of non-Year 2000 replacement or upgrading was accelerated.
While the Year 2000 cost estimates above include additional costs, Lucent
believes, based on available information, that it will be able to manage its
total Year 2000 transition without any material adverse effect on its business
operations, products or financial prospects.
The actual outcomes and results could be affected by Future Factors including,
but not limited to, the continued availability of skilled personnel, cost
control, the ability to locate and remediate software code problems, critical
suppliers and subcontractors meeting their commitments to be Year 2000 ready and
provide Year 2000 ready products, and timely actions by customers.
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. As of that date, the Euro is
trading on currency exchanges, and 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, and
parties can elect to pay for goods and services and transact business using
either the Euro or a legacy currency. 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 begun planning for the Euro's introduction. For this purpose, Lucent
has in place a joint European-United States team representing affected functions
within the Company.
The Euro conversion may affect cross-border competition by creating cross-border
price transparency. Lucent is assessing its pricing/marketing strategy in order
to insure that it remains competitive in a broader European market. Lucent is
also assessing its information technology systems to allow for transactions to
take place in both the legacy currencies and the Euro and the eventual
elimination of the legacy currencies, and reviewing whether certain existing
contracts will need to be modified. Lucent's currency risk and risk management
for operations in participating countries may be reduced as the legacy
currencies are converted to the Euro. Final accounting, tax and governmental
legal and regulatory guidance is not available. Lucent will continue to evaluate
issues involving introduction of the Euro. 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.
<PAGE>
24
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Employee Relations:
On December 31, 1998, Lucent employed approximately 144,500 persons, of whom 78%
were located in the United States. Of these domestic employees, 40% are
represented by unions, primarily the Communications Workers of America
("CWA")and the International Brotherhood of Electrical Workers ("IBEW"). Lucent
has concluded new five year 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 TOTAL ASSETS, WORKING CAPITAL AND LIQUIDITY, and KEY BUSINESS
CHALLENGES.
Seasonality:
See discussion above under KEY BUSINESS CHALLENGES.
Future Capital Requirements:
See discussion above under TOTAL ASSETS, WORKING CAPITAL AND LIQUIDITY.
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.
While Lucent hedges transactions with non-U.S. customers, the decline in value
of the Asia/Pacific currencies, or declines in currency values in other regions,
may, if not reversed, adversely affect future product sales because Lucent's
products may become more expensive to purchase 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 and OTHER.
<PAGE>
25
Exhibit 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RECENT PRONOUNCEMENTS
In December 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-9, Modification of SOP 97-2, "Software Revenue
Recognition," with Respect to Certain Transactions ("SOP 98-9"). SOP 98-9 amends
SOP 97-2 to require recognition for multiple-element arrangements by means of
the "residual method" in certain circumstances. The provisions of SOP 98-9 that
extend the deferral of certain passages of SOP 97-2 became effective December
15, 1998. All other provisions are effective for transactions entered into in
fiscal years beginning after March 15, 1999. Earlier application for financial
statements or information that has not been issued is permitted and retroactive
application is prohibited. SOP 98-9 is not expected to have a material impact on
Lucent's consolidated results of operations, financial position or cash flows.
<PAGE>
EXHIBIT 99.3
<TABLE>
<CAPTION>
Lucent Technologies Inc.
Schedule II - Valuation and Qualifying Accounts
Dollars In Millions
Column A Column B Column C Column D Column E
- ------------------------------- ------------ ---------------------------- ---------- -----------
-------Additions-------
Balance at Charged to Charged to Balance at
Beginning of Costs & Other Accounts End
Description Period Expenses (net) Deductions of Period
- ------------------------------- ------------ ---------------------------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Year 1998
Allowance for doubtful accounts 352 115 (59) 16(a) 392
Reserves related to business restructuring
and facility consolidation (d) 569 - - 318(b) 251
Deferred tax asset valuation allowance 234 31 45 49 261
Inventory valuation 637 146 30 177 636
Year 1997
Allowance for doubtful accounts 273 111 5 37(a) 352
Reserves related to business restructuring
and facility consolidation (d) 1,289 - - 720(b) 569
Deferred tax asset valuation allowance 208 86 3 63 234
Inventory valuation 644 221 19 247 637
Year 1996
Allowance for doubtful accounts 248 64 - 39(a) 273
Reserves related to business restructuring
and facility consolidation (d) 1,907 - - 618(b) 1,289
Deferred tax asset valuation allowance 142 7 102(c) 43 208
Inventory valuation 790 92 9 247 644
</TABLE>
(a) Amounts written off as uncollectible, payments or recoveries.
(b) Included in these deductions were cash payments of $176, $483 and $456 for
the years ended September 30, 1998 and 1997, and for the nine months ended
September 30, 1996, respectively. In addition, Lucent reversed $100, $201
and $98 for the years ended September 30, 1998 and 1997, and for the nine
months ended September 30, 1996, respectively. See Note 6 of the Notes to
Restated Consolidated Financial Statements in Exhibit 99.1 for Background
information.
(c) Relates to net asset additions and net liability reductions from AT&T. See
Note 1 of the Notes to Restated Consolidated Financial Statements in Exhibit
99.1 for Background information.
(d) Certain prior year amounts have been reclassified to conform to the 1998
presentation
