Alcatel-Lucent 20-F 2010
Documents found in this filing:
Washington, D.C. 20549
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 1-11130
(Exact name of Registrant as specified in its charter)
(Translation of Registrants name into English)
Republic of France
(Jurisdiction of incorporation or organization)
3, Avenue Octave Greard (3 S. 016)
75007 Paris, France
(Address of principal executive offices)
Telephone Number 33 (1) 40 76 10 10
Facsimile Number 33 (1) 40 76 14 00
3, Avenue Octave Greard (3 S. 016)
75007 Paris, France
(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report.
2,318,060,818 ordinary shares, nominal value €2 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d)
Note checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those sections.
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP [ ] International Financial Reporting Standards as issued by the International Accounting Standards Board [X] Other [ ]
If Other has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
This Annual Report on Form 20-F/A is being filed as an amendment (Amendment No. 1) to our Annual Report on Form 20-F for the year ended December 31, 2009 (2009 Annual Report on Form 20-F) filed with the U.S. Securities and Exchange Commission on March 23, 2010, solely to amend Item 19: Exhibits by replacing Exhibits 12.1, 12.2, 13.1 and 13.2 (which are the certifications of the Chief Executive Officer and Chief Financial Officer), included in Section 11.8 Exhibits of our 2009 Annual Report on Form 20-F. Due to an inadvertent mechanical error, the conformed copies of these exhibits, which were executed on March 22, 2010, were not filed.
We are including conformed copies of Exhibits 12.1, 12.2, 13.1 and 13.2 as exhibits to this Amendment No. 1 under Section 11.8 Exhibits hereof.
Other than as set forth above, this Amendment No. 1 does not, and does not purport to, amend, update or restate any other information or disclosure included in our 2009 Annual Report on Form 20-F or reflect any events that occurred after the March 23, 2010 filing date of our 2009 Annual Report on Form 20-F in any way.
Table of Contents
1 SELECTED FINANCIAL DATA
2 ACTIVITY OVERVIEW
3 RISK FACTORS
4 INFORMATION ABOUT THE GROUP
5 DESCRIPTION OF THE GROUPS ACTIVITIES
6 OPERATING AND FINANCIAL REVIEW AND PROSPECTS
7 CORPORATE GOVERNANCE
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8 INFORMATION CONCERNING OUR CAPITAL
9 STOCK EXCHANGE AND SHAREHOLDING
10 ADDITIONAL INFORMATION
11 CONTROLS AND PROCEDURES, STATUTORY AUDITORS FEES AND OTHER MATTERS
12 CONSOLIDATED FINANCIAL STATEMENTS AT DECEMBER 31, 2009
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1 SELECTED FINANCIAL DATA
Our consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union. IFRS, as adopted by the European Union, differs in certain respects from the International Financial Reporting Standards issued by the International Accounting Standards Board. However, our consolidated financial statements presented in this document in accordance with IFRS would be no different if we had applied International Financial Reporting Standards issued by the International Accounting Standards Board. As permitted by U.S. securities laws, we no longer provide a reconciliation of our net income and shareholders equity as reflected in our consolidated financial statements to U.S. GAAP.
On November 30, 2006, historical Alcatel and Lucent Technologies Inc., since renamed Alcatel-Lucent USA Inc. (Lucent), completed a business combination pursuant to which Lucent became a wholly owned subsidiary of Alcatel. On December 1, 2006, we and Thales signed a definitive agreement for the acquisition by Thales of our ownership interests in two joint ventures in the space sector created with Finmeccanica and our railway signaling business and integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services. In January 2007, the railway signaling business and integration and services activities were contributed to Thales, and in April 2007, we completed the sale of our ownership interests in the two joint ventures in the space sector.
As a result of the Lucent transaction, our 2006 consolidated financial results include (i) 11 months of results of only historical Alcatel and (ii) one month of results of the combined company. As a result of the Thales transaction, our 2005 and 2006 financial results pertaining to the businesses transferred to Thales are treated as discontinued operations. Further, our 2005 and 2006 financial results take into account the effect of the change in accounting policies on employee benefits with retroactive effect from January 1, 2005 and our 2006 and 2007 financial results take into account the effect of the application of the interpretation IFRIC 14 with retroactive effect from January 1, 2006, as described in Note 4 of our consolidated financial statements included elsewhere in this document.
As a result of the purchase accounting treatment of the Lucent business combination required by IFRS, our results for 2009, 2008, 2007 and 2006 included several negative, non-cash impacts of purchase accounting entries.
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1.1 CONDENSED CONSOLIDATED INCOME STATEMENT AND STATEMENT OF FINANCIAL POSITION DATA
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1.2 EXCHANGE RATE INFORMATION
The table below shows the average noon buying rate of euro from 2005 to 2009. As used in this document, the term noon buying rate refers to the rate of exchange for the euro, expressed in U.S. dollars per euro, as certified by the Federal Reserve Bank of New York for customs purposes.
The table below shows the high and low noon buying rates expressed in U.S. dollars per euro for the previous six months.
On March 12, 2010, the noon buying rate was € 1.00 = $ 1.3753.
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2 ACTIVITY OVERVIEW
The charts below set forth the four business segments that comprised our organization in 2009: Carrier, Applications Software, Enterprise and Services. In 2009, our Carrier segment was organized into four businesses: IP, Optics, Wireless and Wireline. Effective January 1, 2010, we reorganized our business into three groups: Applications, Networks and Services.
2.1 CARRIER SEGMENT
INTERNET PROTOCOL (IP)
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2.2 APPLICATIONS SOFTWARE SEGMENT
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2.3 ENTERPRISE SEGMENT
2.4 SERVICES SEGMENT
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3 RISK FACTORS
Our business, financial condition or results of operations could suffer material adverse effects due to any of the following risks. We have described the specific risks that we consider material to our business but the risks described below are not the only ones we face. We do not discuss risks that would generally be equally applicable to companies in other industries, due to the general state of the economy or the markets, or other factors. Additional risks not known to us or that we now consider immaterial may also impair our business operations.
3.1 RISKS RELATING TO THE BUSINESS
We adopted a new strategic focus in 2009 and we continue to shift our resources to support that focus. If our strategic plan is not aligned with the direction our customers take as they invest in the evolution of their networks, customers may not buy our products or use our services.
We adopted a new strategic plan as of January 1, 2009, when we initiated a strategic transformation and realignment of our operations in support of that plan. The transformation includes reduced spending on research and development as we accelerate the shift in our investments from mature technologies that previously generated significant revenue for us toward certain next-generation technologies. Our choices of specific technologies to pursue and those to de-emphasize may prove to be inconsistent with our customers investment spending.
The telecommunications industry fluctuates and is affected by many factors, including the economic environment, decisions by service providers regarding their deployment of technology and their timing of purchases, as well as demand and spending for communications services by businesses and consumers.
Spending trends in the global telecommunications industry were negatively impacted by the global macroeconomic environment in 2009, and we expect only moderate improvement in the global economy in 2010. We expect the global telecommunications equipment and related services market to increase between 0% and 5% at constant currency in 2010, but actual market conditions could be very different from what we expect and are planning for due to the high levels of volatility and subsequent lack of visibility created by the global economic environment. Moreover, market conditions could vary geographically and across different technologies, and are subject to substantial fluctuations. Conditions in the specific industry segments in which we participate may be weaker than in other segments. In that case, the results of our operations may be adversely affected.
If capital investment by service providers is weaker than the 0% to 5% increase at constant currency rates that we anticipate, our revenues and profitability may be adversely affected. The level of demand by service providers can change quickly and can vary over short periods of time, including from month to month. As a result of the uncertainty and variations in the telecommunications industry, accurately forecasting revenues, results and cash flow remains difficult.
In addition, our sales volume and product mix will affect our gross margin. Therefore, if reduced demand for our products results in lower than expected sales volume, or if we have an unfavorable product mix, we may not achieve the expected gross margin rate, resulting in lower than expected profitability. These factors may fluctuate from quarter to quarter.
Our business requires a significant amount of cash, and we may require additional sources of funds if our sources of liquidity are unavailable or insufficient to fund our operations.
Our working capital requirements and cash flows have historically been, and they are expected to continue to be, subject to quarterly and yearly fluctuations, depending on a number of factors. If we are unable to manage fluctuations in cash flow, our business, operating results and financial condition may be materially adversely affected. Factors which could lead us to suffer cash flow fluctuations include:
the level of sales;
the collection of receivables;
the timing and size of capital expenditures;
costs associated with potential restructuring actions; and
customer financing obligations.
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We derive our capital resources from a variety of sources, including the generation of positive cash flow from on-going operations, the issuance of debt and equity in various forms, and banking facilities, including our revolving credit facility of € 1.4 billion maturing in April 2012 (with an extension until April 5, 2013 for an amount of € 837 million) and on which we have not drawn. Our ability to draw upon these resources is dependent upon a variety of factors, including our customers’ ability to make payments on outstanding accounts receivable; the perception of our credit quality by lenders and investors; our ability to meet the financial covenant for our revolving credit facility; and debt and equity market conditions generally. Given current conditions, access to the debt and equity markets may not be relied upon at any time. Based on our current view of our business and capital resources and the overall market environment, we believe we have sufficient resources to fund our operations. If, however, the business environment were to materially worsen, or the credit markets were to limit our access to bid and performance bonds, or our customers were to dramatically pull back on their spending plans, our liquidity situation could deteriorate. If we cannot generate sufficient cash flow from operations to meet cash requirements in excess of our current expectations, we might be required to obtain supplemental funds through additional operating improvements or through external sources, such as capital market proceeds, assets sales or financing from third parties. We cannot provide any assurance that such funding will be available on terms satisfactory to us. If we were to incur high levels of debt, this would require a larger portion of our operating cash flow to be used to pay principal and interest on our indebtedness. The increased use of cash to pay indebtedness could leave us with insufficient funds to finance our operating activities, such as Research and Development expenses and capital expenditures, which could have a material adverse effect on our business.
Our ability to have access to the capital markets and our financing costs will be, in part, dependent on Standard & Poors, Moodys or similar agencies ratings with respect to our debt and corporate credit and their outlook with respect to our business. Our current short-term and long-term credit ratings, as well as any possible future lowering of our ratings, may result in higher financing costs and reduced access to the capital markets. We cannot provide any assurance that our credit ratings will be sufficient to give us access to the capital markets on acceptable terms, or that once obtained, such credit ratings will not be reduced by Standard & Poors, Moodys or similar rating agencies.
Credit and commercial risks and exposures could increase if the financial condition of our customers declines.
A substantial portion of our sales are to customers in the telecommunications industry. Some of these customers require their suppliers to provide extended payment terms, direct loans or other forms of financial support as a condition to obtaining commercial contracts. We have provided and in the future we expect that we will provide or commit to financing where appropriate for our business. Our ability to arrange or provide financing for our customers will depend on a number of factors, including our credit rating; our level of available credit; and our ability to sell off commitments on acceptable terms. More generally, we expect to routinely enter into long-term contracts involving significant amounts to be paid by our customers over time. Pursuant to these contracts, we may deliver products and services representing an important portion of the contract price before receiving any significant payment from the customer. As a result of the financing that may be provided to customers and our commercial risk exposure under long-term contracts, our business could be adversely affected if the financial condition of our customers erodes. Over the past few years, certain of our customers have sought protection under the bankruptcy or reorganization laws of the applicable jurisdiction, or have experienced financial difficulties. As a result of the global recession, in 2009 we saw some increase in the number of our customers who experienced such difficulties, especially in many emerging markets where our customers were affected not only by the recession, but also by deteriorating local currencies and a lack of credit. We cannot predict whether the conditions for our customers in emerging markets will improve in 2010, when we expect only moderate improvement in the global economy. Upon the financial failure of a customer, we may experience losses on credit extended and loans made to such customer, losses relating to our commercial risk exposure, and the loss of the customers ongoing business. If customers fail to meet their obligations to us, we may experience reduced cash flows and losses in excess of reserves, which could materially adversely impact our results of operations and financial position.
The Groups U.S. pension and post-retirement benefit plans are large and have funding requirements that fluctuate based of how their assets are invested, the performance of financial markets worldwide, interest rates, medical price increases, and changes in legal requirements. These plans are costly, and our efforts to fund or control these costs may be ineffective.
Many former and current employees and retirees of the Group in the U.S. participate in one or more of our major defined benefit plans that provide post-retirement pension, health care and group life benefits.
Current pension benefit payments to retirees are significant and are expected to continue to be significant. Pension benefit payments are paid from a trust maintained for that purpose. We are required by law to maintain adequate funding as determined by the value of trust assets relative to the present value of all future pension benefits (the benefit obligation). Therefore, volatility in both asset values and the discount rates used to determine the benefit obligation significantly impact our need to fund this trust.
In 2009, we modified the asset allocation of our U.S. pension funds by reducing investments in equities, including alternative investments such as real estate and private equity, and increasing fixed income investments with a significant shift into corporate bonds. These changes were intended to reduce the volatility usually associated with equity investments, more closely match the fixed income durations with that of expected future benefit cash flows, and increase the correlation of asset values to benefit obligations which are discounted using corporate bond yields. We cannot assure you that these changes will be sufficient if either equities or bond yields decline, resulting in a drop in the funded status of our pension plans.
Our significant U.S. pension plans met the legal funding requirements on January 1, 2008 and January 1, 2009; and although final asset data is not yet available for January 1, 2010, our preliminary assessment, from a regulatory perspective, of the companys US plans suggests that no funding contribution should be required through at least 2011. We are unable to provide an estimate of funding requirements beyond 2011.
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As required by law, the actuarial assumptions that we use to determine pension plan funding in the United States differ from those used in connection with the preparation of our financial statements. Therefore no direct or automatic relation exists between the funding status recorded in our financial statements and that used to determine funding. We cannot assure you that unfavorable developments in these assumptions will not lead to a significant increase in future contributions after 2011.
The mortality assumption differs for funding and financial reporting purposes. For financial reporting, we use plan-specific experience which we update approximately every four years, whereas for funding we use a table issued by the IRS. As mentioned in Note 25g to our consolidated financial statements included elsewhere in this annual report, we updated the mortality assumption used for financial reporting which resulted in a significant increase in the benefit obligations of our pension plans as of December 31, 2009, and negatively affected the plans funded status. When the IRS issues an updated table we do not expect it will include significantly different assumptions. However, we cannot be certain that an updated table will not show significant improvements in mortality and lead to a significant increase in future contributions and reductions in the excess assets necessary to make future Section 420 Transfers that are described below.
Retiree Healthcare Benefits
There are no legislative or IRS requirements to pre-fund retiree healthcare benefits. The amount of assets currently set aside for retiree healthcare is small and is almost completely invested in short-term fixed income investments, so volatility in asset return does not play a significant role in funding retiree healthcare. However, the impact of year-over-year medical price increases and the availability of excess pension assets that can be used to fund retiree healthcare are significant.
We expect to fund our current post-retirement healthcare obligation for formerly represented retirees with transfers of pension assets from our Occupational-inactive pension plan; such transfers are called Section 420 Transfers (see Note 25g to our consolidated financial statements included elsewhere in this annual report). We may select among numerous methods available for valuing plan assets and obligations for funding purposes and for determining the amount of excess assets available for Section 420 Transfers. The assumptions to be used for the January 1, 2010 valuation have not been chosen at this time. Also, asset values for private equity, real estate, and certain alternative investments, and the obligation based on January 1, 2010 census data will not be final until late in the third quarter of 2010. However, using variations of the available methods, we estimate that as of December 31, 2009, the excess assets above 120% of the plan obligations is between U.S. $1.7 billion and U.S. $3.2 billion, and the excess above 125% of plan obligations is between U.S. $1.2 billion and U.S. $2.7 billion. Depending on the type of Section 420 Transfer we choose to make, the excess asset amounts would be available to fund our post-retirement healthcare obligation for formerly represented retirees. In December 2008, we made a collectively bargained multi-year Section 420 Transfer of U.S. $653 million covering our U.S. funding obligation for 2008 and part of 2009. In November 2009, we made another collectively bargained, multi-year transfer of U.S. $343 million covering the remainder of 2009 and part of 2010. However, a deterioration in the funded status of our Occupational-inactive pension plan could negatively impact our ability to make future Section 420 Transfers.
We fund our management retiree healthcare obligation with cash because no assets are set aside to fund it and no excess assets are available in our management pension plan for Section 420 Transfers. Recently, we have made changes to reduce these healthcare costs. For 2009, we introduced a Medicare Advantage plan called Private Fee For Service (PFFS). With PFFS, Medicare payments are made directly to the PFFS plan, and the payments are greater than they would be if they were made directly to the individual. As a result, the PFFS significantly reduced our cost for Medicare-eligible retirees and their Medicare-eligible dependents. For 2010, we increased the PFFS out-of-pocket-maximums, which is the amount that a participant must themselves pay, by U.S. $1,000 to compensate for lower than expected Medicare payments to PFFS plans. We may take additional steps over time to reduce the overall cost of our retiree healthcare benefit plans, and the share of these costs borne by us, consistent with legal requirements and any collective bargaining obligations. However, cost increases may exceed our ability to reduce these costs. In addition, the reduction or elimination of U.S. retiree healthcare benefits by us has led to lawsuits against us. Any other initiatives that we undertake to control or reduce these costs may lead to additional claims against us.
Our financial condition and results of operations may be harmed if we do not successfully reduce market risks through the use of derivative financial instruments.
Since we conduct operations throughout the world, a substantial portion of our assets, liabilities, revenues and expenses are denominated in various currencies other than the euro and the U.S. dollar. Because our financial statements are denominated in euros, fluctuations in currency exchange rates, especially the U.S. dollar against the euro, could have a material impact on our reported results.
We also experience other market risks, including changes in interest rates and in prices of marketable equity securities that we own. We may use derivative financial instruments to reduce certain of these risks. If our strategies to reduce market risks are not successful, our financial condition and operating results may be harmed.
An impairment of other intangible assets or goodwill would adversely affect our financial condition or results of operations.
We have a significant amount of goodwill and intangible assets, including acquired intangibles, development costs for software to be sold, leased or otherwise marketed and internal use software development costs as of December 31, 2009. In connection with the combination between Alcatel and Lucent, a significant amount of additional goodwill and acquired intangible assets were recorded as a result of the purchase price allocation.
Goodwill and intangible assets with indefinite useful lives are not amortized but are tested for impairment annually, or more often, if an event or circumstance indicates that an impairment loss may have been incurred. Other intangible assets are amortized on a straight-line basis over their estimated useful lives and reviewed for impairment whenever events such as product discontinuances, plant closures, product dispositions or other changes in circumstances indicate that the carrying amount may not be wholly recoverable.
Historically, we have recognized significant impairment charges due to various reasons, including some of those noted above as well as potential restructuring actions or adverse market conditions that are either specific to us or the broader telecommunications industry or more general in nature. For instance, we accounted for an impairment loss of € 4.7 billion in 2008 related to a re-assessment of our near-term outlook, our decision to streamline our portfolio and our weaker than expected CDMA business. Additional impairment charges may be incurred in the future that could be significant and that could have an adverse effect on our results of operations or financial condition.
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We operate in a highly competitive industry with many participants. Our failure to compete effectively would harm our business.
We operate in a highly competitive environment in each of our businesses, competing on the basis of product offerings, technical capabilities, quality, service and pricing. Competition for new service provider and enterprise customers as well as for new infrastructure deployments is particularly intense and increasingly focused on price. We offer customers and prospective customers many benefits in addition to competitive pricing, including strong support and integrated services for quality, technologically-advanced products; however, in some situations, we may not be able to compete effectively if purchasing decisions are based solely on the lowest price.
We have a number of competitors, many of which currently compete with us and some of which are very large, with substantial technological and financial resources and established relationships with global service providers. Some of these competitors have very low cost structures. In addition, new competitors may enter the industry as a result of acquisitions or shifts in technology. These new competitors, as well as existing competitors, may include entrants from the telecommunications, computer software, computer services and data networking industries. We cannot assure you that we will be able to compete successfully with these companies. Competitors may be able to offer lower prices, additional products or services or a more attractive mix of products or services, or services or other incentives that we cannot or will not match or offer. These competitors may be in a stronger position to respond quickly to new or emerging technologies and may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to customers, prospective customers, employees and strategic partners.
Technology drives our products and services. If we fail to keep pace with technological advances in the industry, or if we pursue technologies that do not become commercially accepted, customers may not buy our products or use our services.
The telecommunications industry uses numerous and varied technologies and large service providers often invest in several and, sometimes, incompatible technologies. The industry also demands frequent and, at times, significant technology upgrades. Furthermore, enhancing our services revenues requires that we develop and maintain leading tools. We will not have the resources to invest in all of these existing and potential technologies. As a result, we concentrate our resources on those technologies that we believe have or will achieve substantial customer acceptance and in which we will have appropriate technical expertise. However, existing products often have short product life cycles characterized by declining prices over their lives. In addition, our choices for developing technologies may prove incorrect if customers do not adopt the products that we develop or if those technologies ultimately prove to be unviable. Our revenues and operating results will depend, to a significant extent, on our ability to maintain a product portfolio and service capability that is attractive to our customers; to enhance our existing products; to continue to introduce new products successfully and on a timely basis and to develop new or enhance existing tools for our services offerings.
The development of new technologies remains a significant risk to us, due to the efforts that we still need to make to achieve technological feasibility; due as mentioned above to rapidly changing customer markets; and due to significant competitive threats.
Our failure to bring these products to market in a timely manner could result in a loss of market share or a lost opportunity to capitalize on emerging markets, and could have a material adverse impact on our business and operating results.
We depend on a limited number of internal and external manufacturing organizations, distribution centers, suppliers and service providers. Their failure to deliver or to perform according to our requirements may adversely affect our ability to deliver our products, services and solutions on-time, and in sufficient volumes while meeting our quality, safety or security standards.
Our Global Supply Chain is a complex network of internal and external organizations responsible for the supply, manufacture, logistics and implementation of advanced telecommunications solutions and services anywhere in the world. Failure by any of our suppliers, including contract manufacturers, to supply materials, components, subassemblies, finished goods and software could significantly impact our ability to satisfy our customer commitments. We are significantly dependent on our logistics network to efficiently and effectively move materials and products across global boundaries. Accordingly, we are vulnerable to abrupt changes in customs, tax and currency regulations that may have significant negative impact on our supply chain. Strikes, boycotts and the lack of appropriately skilled resources within our organization or at our contract manufacturers would put at risk our ability to satisfy our customer commitments.
Many of our current and planned products are highly complex and may contain defects or errors that are detected only after deployment in telecommunications networks. If that occurs, our reputation may be harmed.
Our products are highly complex, and we cannot assure you that our extensive product development, manufacturing and integration testing is, or will be, adequate to detect all defects, errors, failures and quality issues that could affect customer satisfaction or result in claims against us. As a result, we might have to replace certain components and/or provide remediation in response to the discovery of defects in products that have been shipped.
The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by customers or customers end users and other losses to us or to our customers or end users. These occurrences could also result in the loss of or delay in market acceptance of our products and loss of sales, which would harm our business and adversely affect our revenues and profitability.
Rapid changes to existing regulations or technical standards or the implementation of new regulations or technical standards for products and services not previously regulated could be disruptive, time-consuming and costly to us.
We develop many of our products and services based on existing regulations and technical standards, our interpretation of unfinished technical standards or the lack of such regulations and standards. Changes to existing regulations and technical standards, or the implementation of new regulations and technical standards relating to products and services not previously regulated, could adversely affect our development efforts by increasing compliance costs and causing delay. Demand for those products and services could also decline.
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Our ten largest customers accounted for 41% of our revenues in 2009, and most of our revenues come from telecommunications service providers. The loss of one or more key customers or reduced spending of these service providers could significantly reduce our revenues, profitability and cash flow.
Our ten largest customers accounted for 41% of our revenues in 2009. As service providers increase in size, it is possible that an even greater portion of our revenues will be attributable to a smaller number of large service providers going forward. Our existing customers are typically not obligated to purchase a fixed amount of products or services over any period of time from us and may have the right to reduce, delay or even cancel previous orders. We, therefore, have difficulty projecting future revenues from existing customers with certainty. Although historically our customers have not made sudden supplier changes, our customers could vary their purchases from period to period, even significantly. Combined with our reliance on a small number of large customers, this could have an adverse effect on our revenues, profitability and cash flow. In addition, our concentration of business in the telecommunications service provider industry makes us extremely vulnerable to a downturn in spending in that industry, like the one that took place in 2009. We believe some service providers are planning additional cuts in their 2010 capital expenditure budgets despite the expected improvement in the global economic environment, and their reduced spending will have adverse effects on our results of operations.
We have long-term sales agreements with a number of our customers. Some of these agreements may prove unprofitable as our costs and product mix shift over the lives of the agreements.
We have entered into long-term sales agreements with a number of our large customers, and we expect that we will continue to enter into long-term sales agreements in the future. Some of these existing sales agreements require us to sell products and services at fixed prices over the lives of the agreements, and some require, or may in the future require, us to sell products and services that we would otherwise discontinue, thereby diverting our resources from developing more profitable or strategically important products. Since our strategic plan entails a streamlined set of product offerings, it may increase the likelihood that we may have to sell products that we would otherwise discontinue. The costs incurred in fulfilling some of these sales agreements may vary substantially from our initial cost estimates. Any cost overruns that cannot be passed on to customers could adversely affect our results of operations.
We have significant international operations and a significant amount of our revenues are earned in emerging markets and regions.
In addition to the currency risks described elsewhere in this section, our international operations are subject to a variety of risks arising out of the economy, the political outlook and the language and cultural barriers in countries where we have operations or do business. We expect to continue to focus on expanding business in emerging markets in Asia, Africa and Latin America. In many of these emerging markets, we may be faced with several risks that are more significant than in other countries. These risks include economies that may be dependent on only a few products and are therefore subject to significant fluctuations, weak legal systems which may affect our ability to enforce contractual rights, possible exchange controls, unstable governments, privatization actions or other government actions affecting the flow of goods and currency.
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3.2 LEGAL RISKS
We are involved in lawsuits and investigations which, if determined against us, could require us to pay substantial damages, fines and/or penalties.
We are defendants in various lawsuits. These lawsuits against us include such matters as commercial disputes, claims regarding intellectual property, customer financing, product discontinuance, asbestos claims, labor, employment and benefit claims and others. We are also involved in certain investigations by government authorities. For a discussion of some of these legal proceedings and investigations, you should read Legal Matters in Section 6.10 of this annual report and Note 34 to our consolidated financial statements included elsewhere in this document. We cannot predict the extent to which any of the pending or future actions will be resolved in our favor, or whether significant monetary judgments will be rendered against us. Any material losses resulting from these claims and investigations could adversely affect our profitability and cash flow.
If we fail to protect our intellectual property rights, our business and prospects may be harmed.
Intellectual property rights, such as patents, are vital to our business and developing new products and technologies that are unique is critical to our success. We have numerous French, U.S. and foreign patents and numerous pending patents. However, we cannot predict whether any patents, issued or pending, will provide us with any competitive advantage or whether such patents will be challenged by third parties. Moreover, our competitors may already have applied for patents that, once issued, could prevail over our patent rights or otherwise limit our ability to sell our products. Our competitors also may attempt to design around our patents or copy or otherwise obtain and use our proprietary technology. In addition, patent applications currently pending may not be granted. If we do not receive the patents that we seek or if other problems arise with our intellectual property, our competitiveness could be significantly impaired, which would limit our future revenues and harm our prospects.
We are subject to intellectual property litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling certain products.
From time to time, we receive notices or claims from third parties of potential infringement in connection with products or services. We also may receive such notices or claims when we attempt to license our intellectual property to others. Intellectual property litigation can be costly and time-consuming and can divert the attention of management and key personnel from other business issues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. A successful claim by a third party of patent or other intellectual property infringement by us could compel us to enter into costly royalty or license agreements or force us to pay significant damages and could even require us to stop selling certain products. Further, if one of our important patents or other intellectual property rights is invalidated, we may suffer losses of licensing revenues and be prevented from attempting to block others, including competitors, from using the related technology.
We are involved in significant joint ventures and are exposed to problems inherent to companies under joint management.
We are involved in significant joint venture companies. The related joint venture agreements may require unanimous consent or the affirmative vote of a qualified majority of the shareholders to take certain actions, thereby possibly slowing down the decision-making process. Our largest joint venture, Alcatel-Lucent Shanghai Bell Co., Ltd, has this type of requirement. We own 50% plus one share of Alcatel-Lucent Shanghai Bell Co., Ltd, the remainder being owned by the Chinese government.
We are subject to environmental, health and safety laws that restrict our operations.
Our operations are subject to a wide range of environmental, health and safety laws, including laws relating to the use, disposal and clean up of, and human exposure to, hazardous substances. In the United States, these laws often require parties to fund remedial action regardless of fault. Although we believe our aggregate reserves are adequate to cover our environmental liabilities, factors such as the discovery of additional contaminants, the extent of required remediation and the imposition of additional cleanup obligations could cause our capital expenditures and other expenses relating to remediation activities to exceed the amount reflected in our environmental reserves and adversely affect our results of operations and cash flows. Compliance with existing or future environmental, health and safety laws could subject us to future liabilities, cause the suspension of production, restrict our ability to utilize facilities or require us to acquire costly pollution control equipment or incur other significant expenses.
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3.3 RISKS RELATING TO OWNERSHIP OF OUR ADSS
The trading price of our ADSs may be affected by fluctuations in the exchange rate for converting euro into U.S. dollars.
Fluctuations in the exchange rate for converting euro into U.S. dollars may affect the market price of our ADSs.
If a holder of our ADSs fails to comply with the legal notification requirements upon reaching certain ownership thresholds under French law or our governing documents, the holder could be deprived of some or all of the holders voting rights and be subject to a fine.
French law and our governing documents require any person who owns our outstanding shares or voting rights in excess of certain amounts specified in the law or our governing documents to file a report with us upon crossing this threshold percentage and, in certain circumstances, with the French stock exchange regulator (Autorité des Marchés Financiers).
If any shareholder fails to comply with the notification requirements:
the shares or voting rights in excess of the relevant notification threshold may be deprived of voting power on the demand of any shareholder;
all or part of the shareholders voting rights may be suspended for up to five years by the relevant French commercial court; and
the shareholder may be subject to a fine.
Holders of our ADSs will have limited recourse if we or the depositary fail to meet obligations under the deposit agreement between us and the depositary.
The deposit agreement expressly limits our obligations and liability and the obligations and liability of the depositary.
Neither we nor the depositary will be liable despite the fact that an ADS holder may have incurred losses if the depositary:
is prevented or hindered in performing any obligation by circumstances beyond our control;
exercises or fails to exercise its discretionary rights under the deposit agreement;
performs its obligations without negligence or bad faith;
takes any action based upon advice from legal counsel, accountants, any person presenting our ordinary shares for deposit, any holder or any other qualified person; or
relies on any documents it believes in good faith to be genuine and properly executed.
This means that there could be instances where you would not be able to recover losses that you may have suffered by reason of our actions or inactions or the actions or inactions of the depositary pursuant to the deposit agreement.
In addition, the depositary has no obligation to participate in any action, suit or other proceeding in respect of our ADSs unless we provide the depositary with indemnification that it determines to be satisfactory.
We are subject to different corporate disclosure standards that may limit the information available to holders of our ADSs.
As a foreign private issuer, we are not required to comply with the notice and disclosure requirements under the Securities Exchange Act of 1934, as amended, relating to the solicitation of proxies for shareholder meetings. Although we are subject to the periodic reporting requirements of the Exchange Act, the periodic disclosure required of non-U.S. issuers under the Exchange Act is more limited than the periodic disclosure required of U.S. issuers. Therefore, there may be less publicly available information about us than is regularly published by or about most other public companies in the United States.
Judgments of U.S. courts, including those predicated on the civil liability provisions of the federal securities laws of the United States in French courts, may not be enforceable against us.
An investor located in the United States may find it difficult to:
effect service of process within the United States against us and our non-U.S. resident directors and officers;
enforce U.S. court judgments based upon the civil liability provisions of the U.S. federal securities laws against us and our non-U.S. resident directors and officers in both the United States and France; and
bring an original action in a French court to enforce liabilities based upon the U.S. federal securities laws against us and our non-U.S. resident directors and officers.
Preemptive rights may not be available for U.S. persons.
Under French law, shareholders have preemptive rights to subscribe for cash issuances of new shares or other securities giving rights to acquire additional shares on a pro rata basis. U.S. holders of our ADSs or ordinary shares may not be able to exercise preemptive rights for their shares unless a registration statement under the Securities Act of 1933 is effective with respect to such rights or an exemption from the registration requirements imposed by the Securities Act is available.
We may, from time to time, issue new shares or other securities giving rights to acquire additional shares at a time when no registration statement is in effect and no Securities Act exemption is available. If so, U.S. holders of our ADSs or ordinary shares will be unable to exercise their preemptive rights.
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4 INFORMATION ABOUT THE GROUP
We provide products, solutions, and transformation services offerings that enable service providers, enterprises, governments and strategic industries (such as transportation or energy) worldwide, to deliver voice, data and video communication services to end-users. As a leader in fixed, mobile and converged broadband networking, IP technologies, applications and services, Alcatel-Lucent leverages the technical and scientific expertise of Bell Labs, one of the largest innovation powerhouses in the communications industry. With operations in more than 130 countries, we are a local partner with global reach. We also have one of the most experienced global services teams in the industry.
Alcatel-Lucent is a French société anonyme, established in 1898, originally as a listed company named Compagnie Générale dÉlectricité. Our corporate existence will continue until June 30, 2086, which date may be extended by shareholder vote. We are subject to all laws governing business corporations in France, specifically the provisions of the commercial code and the financial and monetary code.
Our registered office and principal place of business is 54, rue La Boétie, 75008 Paris, France, our telephone number is +33 (0)1 40 76 10 10 and our website address is www.alcatel-lucent.com. The contents of our website are not incorporated into this document. Effective May 17, 2010, we will move our headquarters to 3, avenue Octave Gréard, 75007 Paris, France.
The address for Stephen R. Reynolds, our authorized representative in the United States, is Alcatel-Lucent USA Inc., 600 Mountain Avenue, Murray Hill, New Jersey 07974.
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4.2 HISTORY AND DEVELOPMENT
Set forth below is an outline of certain significant events of Alcatel-Lucent from formation until 2006:
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No 2009 dividend. Our Board has determined that it is not prudent to pay a dividend on our ordinary shares and ADSs based on 2009 results. Our Board will present this proposal at our Annual Shareholders Meeting on June 1, 2010.
Repurchases of convertible bonds. In February and March 2010, some of the Lucent. 2.875% U.S.$ Series A convertible bonds due June 2023 were repurchased and cancelled using U.S.$ 74.8 million in cash excluding accrued interest, corresponding to a nominal value of U.S.$ 75.0 million.
Highlights of transactions during 2009
Thales. In May 2009, we completed the sale of our 20.8% stake in Thales to Dassault Aviation for € 1.566 billion (refer to Highlights of transactions during 2008, below).
Electrical motors. On December 31, 2009, we completed the sale of Dunkermotoren GmbH, our electrical fractional horsepower motors and drives subsidiary, to Triton, a leading European private equity firm, for an enterprise value of € 145 million.
Joint venture with Bharti Airtel. On April 30, 2009, we announced the formation of a joint venture with Bharti Airtel to manage Bharti Airtels pan-India broadband and telephone services and help Airtels transition to a next generation network across India.
Co-sourcing and joint marketing arrangement with Hewlett-Packard (HP). On June 18, 2009, we and HP jointly announced a 10-year co-sourcing agreement which is expected to help improve the efficiency of our IS/IT (Information Systems/Information Technology) infrastructure and create a joint go-to-market approach. Under the joint marketing agreement, the two companies will be able to jointly and separately deliver integrated IT and telecom products and services to service providers and mid- to large-size enterprise customers. Definitive agreements were signed on October 20, 2009, and were implemented beginning December 2009.
Changes in credit ratings. On November 9, 2009, Standard & Poors lowered to B from B+ its long-term corporate credit ratings and senior unsecured ratings on Alcatel-Lucent and on Alcatel-Lucent USA Inc. The B short-term credit ratings of Alcatel-Lucent and of Alcatel-Lucent USA Inc. were affirmed. The rating on the trust preferred notes of Lucent Technologies Capital Trust was lowered from CCC+ to CCC. The negative outlook was maintained.
On March 3, 2009, Standard & Poors lowered to B+ from BB- its long-term corporate credit ratings and senior unsecured ratings on Alcatel-Lucent and on Alcatel-Lucent USA Inc.. The rating on the trust preferred notes of Lucent Technologies Capital Trust was lowered to CCC+. The B short-term rating on Alcatel-Lucent was affirmed. The B1 short-term credit rating on Alcatel-Lucent USA Inc. was withdrawn and a negative outlook was issued.
On February 18, 2009, Moodys lowered the Alcatel-Lucent Corporate Family Rating as well as the rating for senior debt of the Group from Ba3 to B1. The trust preferred notes of Lucent Technologies Capital Trust were downgraded from B2 to B3. The Not-Prime rating for the Groups short-term debt was confirmed. The negative outlook of the ratings was maintained.
Issuance and repurchases of convertible bonds. On September 2, 2009, we launched a convertible bond offering. The bonds are convertible into and/or exchangeable for new or existing shares of Alcatel-Lucent (we refer to these convertible bonds as OCEANE). The bonds carry a 5% annual interest rate and the initial conversion price is € 3.23, equivalent to a conversion premium of 35%. They are redeemable in cash, at par, on January 1, 2015. Early redemption at our option is possible under certain conditions. On settlement date (September 10, 2009), the proceeds of this offering, including the over-allotment option, were approximately € 1 billion.
Concurrently, we offered to repurchase and cancel some of our existing convertible bonds due 2011. On settlement date for the repurchase (September 11, 2009), we purchased 11.97% of the outstanding 2011 bonds. The price per bond was € 16.70 (including accrued interest) and the total amount paid was € 126 million.
Repurchases of the 2011 bonds also took place after the closing of the repurchase offer. Overall, in 2009, we repurchased bonds of a nominal value of € 204 million, corresponding to 19.98% of the outstanding 2011 bonds, for a total cash amount paid of € 204 million, excluding accrued interest.
We also partially repurchased and cancelled outstanding Lucent 7.75% U.S.$ convertible bond due March 2017 in 2009, using a total cash amount of U.S.$ 28 million, corresponding to a nominal value of U.S.$ 99 million.
We partially repurchased and cancelled outstanding Lucent 2.875% U.S.$ Series A convertible bonds due June 2023 in 2009, using U.S.$ 218 million in cash excluding accrued interest, corresponding to a nominal value of U.S.$ 220 million.
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Developments in Microsoft cases. On December 15, 2008, we and Microsoft executed a settlement and license agreement whereby the parties agreed to settle the majority of a series of patent litigations that had been outstanding between them. This settlement included dismissing pending patent claims by Microsoft against us and provided us with licenses to all Microsoft patents-in-suit in these cases. Also, on May 13, 2009, we and Dell agreed to a settlement and dismissal of certain issues appealed after a trial involving us, Dell and Microsoft, held in April, 2008. Thereafter, the only matter that remained pending was the appeal filed by Microsoft with the Court of Appeals for the Federal Circuit in Washington, D.C. relating to the Day Patent, which relates to a computerized form entry system. On June 19, 2008, the District Court had entered a judgment based on a jury award to us of approximately U.S.$ 357 million in damages for Microsofts infringement of the Day Patent in the April 2008 trial, and had also awarded us prejudgment interest exceeding U.S.$ 140 million.
Oral argument before the Federal Circuit was held on June 2, 2009, and on September 11, 2009, the Federal Circuit issued its opinion affirming that the Day Patent is both a valid patent and infringed by Microsoft in Microsoft Outlook, Microsoft Money, and Windows Mobile products. However, the Federal Circuit vacated the jurys damages award and ordered a new trial in the District Court in San Diego to re-calculate the amount of damages owed to us for Microsofts infringement. On November 23, 2009, the Federal Circuit denied Microsofts en banc petition for a rehearing on the validity of the Day Patent. A date has not been set for the new trial on damages.
In a parallel proceeding, Dell filed a reexamination of the Day Patent with the United States Patent and Trademark Office (Patent Office) in May of 2007, alleging that prior art existed that was not previously considered in the original examination and the Day patent should therefore be re-examined for patentability. The Patent Office granted Dells reexamination request and the examiner issued three office actions rejecting the two claims of the Day patent at issue in the April 2008 trial as unpatentable. In the appeal of that decision, the Patent Office withdrew its rejection of the Day Patent and confirmed that the Day Patent is a valid patent.
FCPA investigations: In December 2009 we reached agreements in principle with the SEC and the U.S. Department of Justice with regard to the settlement of their ongoing investigations involving our alleged violations of the Foreign Corrupt Practices Act (FCPA) in several countries, including Costa Rica, Taiwan, and Kenya. Under the agreement in principle with the SEC, we would enter into a consent decree under which we would neither admit nor deny violations of the antibribery, internal controls and books and records provisions of the FCPA and would be enjoined from future violations of U.S. securities laws, pay U.S. $ 45.4 million in disgorgement of profits and prejudgment interest and agree to a three-year French anticorruption compliance monitor. Under the agreement in principle with the DOJ, we would enter into a three-year deferred prosecution agreement (DPA), charging us with violations of the internal controls and books and records provisions of the FCPA, and we would pay a total criminal fine of U.S. $ 92 million, payable in four installments over the course of three years. In addition, three of our subsidiaries Alcatel-Lucent France, Alcatel-Lucent Trade International AG and Alcatel Centroamerica would each plead guilty to violations of the FCPAs antibribery, books and records and internal accounting controls provisions. If we fully comply with the terms of the DPA, the DOJ would dismiss the charges upon conclusion of the three-year term. Final agreements must still be reached with the agencies and accepted in court.
Highlights of transactions during 2008
Acquisition of Motive Networks. On October 7, 2008, we completed the acquisition of Motive, Inc., a U.S.-based company, through a tender offer for an aggregate purchase price of U.S. $ 67.8 million. The acquisition solidified the existing three-year relationship between the two companies, which had jointly developed and sold remote management software solutions for automating the deployment, configuration and support of advanced home networking devices called residential gateways (RGs). As a result of this combination, more than 70 service providers worldwide can now rely on a single solution to deliver a seamless, consistent, converged customer experience across a range of services, networks and devices, both fixed and mobile.
Thales. On December 19, 2008, we announced the signature of a definitive agreement regarding the acquisition by Dassault Aviation of our interest in Thales (41,262,481 shares).The total purchase price is based on a price of € 38 per Thales share, representing approximately € 1.57 billion.
Moody’s. On April 3, 2008, Moody’s affirmed the Alcatel-Lucent Corporate Family Rating as well as that of the debt instruments originally issued by historical Alcatel and Lucent. The outlook was changed from stable to negative.
Highlights of transactions during 2007
Acquisition of Informiam. On December 11, 2007, we acquired Informiam LLC, a privately-held U.S.-based company and a pioneer in software that optimizes customer service operations through real-time business performance management. Informiam is now a business unit within Genesys.
Acquisition of NetDevices. On May 24, 2007, we acquired privately-held NetDevices, based in California. NetDevices sells enterprise networking technology designed to facilitate the management of branch office networks.
Acquisition of Tropic Networks. On April 13, 2007, we acquired substantially all the assets, including all intellectual property, of privately-held Tropic Networks. Canada-based Tropic Networks designs, develops and markets regional and metro-area optical networking equipment for use in telephony, data, and cable applications.
The financial terms of these all-cash transactions were not disclosed, but were not material to the Group.
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Sale of interest in Draka Comteq. In December 2007, we sold our 49.9% interest in Draka Comteq to Draka Holding NV, our joint venture partner in this company, for € 209 million in cash. Historical Alcatel formed this joint venture with Draka Holding in 2004 by combining its optical fiber and communication cable business with that of Draka Holding.
Sale of interest in Avanex. In October 2007, we sold our 12.4% interest in Avanex to Pirelli and entered into supply agreements with both Pirelli and Avanex for related components. We had acquired these shares in July 2003 when historical Alcatel sold its optronics business to Avanex.
Completion of transactions with Thales. On April 6, 2007, following the authorization of the European Commission on April 4, 2007, we sold our 67% interest in the capital of Alcatel Alenia Space (a joint venture company, created in 2005 with the space assets from Finmeccanica and historical Alcatel) and our 33% interest in the capital of Telespazio (a worldwide leader in satellite services) to Thales for € 670 million in cash, subject to adjustment. We had previously completed, on January 5, 2007, the contribution to Thales of our railway signaling business and our integration and services activities for mission-critical systems not dedicated to operators or suppliers of telecommunications services in exchange for 25 million newly issued Thales shares and € 50 million in cash, including purchase price adjustments.
Conclusion of Class A and Class O litigation. Beginning in May 2002, several purported Class Action lawsuits were filed against us and certain of our officers and Directors challenging the accuracy of certain public disclosures that were made in the prospectus for the initial public offering of historical Alcatels Class O shares (which are no longer outstanding) and the accuracy of other public statements regarding the market for our former Optronics divisions products. The actions were consolidated in the U.S. District Court for the Southern District of New York. In June 2007, the court dismissed the plaintiffs amended complaint and the time to appeal has expired.
Change in credit rating. On September 13, 2007, Standard & Poors revised our outlook, together with Lucents, from Positive to Stable. At the same time, our BB- long-term corporate rating, which had been set on December 5, 2006, was affirmed. Our B short-term corporate credit rating and Lucents B1 short-term credit rating, both of which had been affirmed on December 5, 2006, were also affirmed.
On November 7, 2007, Moodys lowered the Alcatel-Lucent Corporate Family Rating as well as the rating of the senior debt of the Group, from Ba2 to Ba3. The Not-Prime rating was confirmed for the short-term debt. The stable outlook was maintained. The trust preferred notes of Lucent Technologies Capital Trust were downgraded from B1 to B2.
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4.3 STRUCTURE OF THE PRINCIPAL COMPANIES CONSOLIDATED IN THE GROUP AS OF DECEMBER 31, 2009
By percentage of share capital held.
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4.4 REAL ESTATE AND EQUIPMENT
We occupy, as an owner or tenant, a large number of buildings, production sites, laboratories and service sites around the world. There are two distinct types of sites with the following features:
production and assembly sites dedicated to our various businesses;
sites that house research and innovation activities and support functions, which cover a specific region and all businesses.
A significant portion of production, assembly and research activities are carried out in Europe, in the United States and in China for all of our businesses. We also have operating subsidiaries and production and assembly sites in Canada, Mexico, Brazil and India.
At December 31, 2009, our total production capacity was equal to approximately 322,000 sq. meters and the table below shows the breakdown by region and by business segment.
We believe that these properties are in good condition and meet the needs and requirements of the Groups current and future activity and do not present an exposure to major environmental risks that could impact the Groups earnings.
The environmental issues that could affect how these properties are used are mentioned in Section 5.13 (Environmental matters) of this annual report.
The sites mentioned in the tables below were selected among our portfolio of 730 sites to illustrate the diversity of the real estate we use, applying four main criteria: region, business segment, type of use (production/assembly, research/innovation or support function), and whether the property is owned or leased.
Alcatel-Lucent, production capacity at December 31, 2009
The main features of our production sites are as follows:
site of Shanghai Pudong (China): 142,000 sq. meters, of which 24,000 sq. meters is used for the production for Wireline and Wireless Access activities, the remainder of the site is used mainly for offices and laboratories;
site of Calais (France): 79,000 sq. meters, of which 61,000 sq. meters is used for the production of submarine cables;
site of Eu (France): 31,000 sq. meters, of which 16,000 sq. meters is used for the production of boards;
site of Greenwhich (United Kingdom): 34,000 sq. meters, of which 19,500 sq. meters is used for the production of submarine cables;
site of Battipaglia (Italy): 22,000 sq. meters, of which 16,000 sq. meters is used for the manufacturing of products for the Optics Division;
site of Meriden (United States): 31,000 sq. meters, used for the manufacturing of products for RFS (Radio Frequency Systems);
site of Nogales (United States): 28,830 sq. meters, of which 22,000 sq. meters is used for the manufacturing of products for the Wireline and Wireless Access activities.
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Research and innovation and support sites
The occupation rate of these sites varies between 50 and 100 % (average rate is 86%); the space which is not occupied by Alcatel-Lucent is leased to other companies or remains vacant.
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4.5 MATERIAL CONTRACTS
Overview. On December 1, 2006, we signed an agreement with Thales for the transfer of our transportation, security and space activities to Thales and on the future industrial cooperation of the two groups. This agreement followed the execution in 2006 of an agreement among Thales, Finmeccanica S.p.A., an Italian aerospace and defense company, and us, in which Finmeccanica agreed to the transfer to Thales of our 67% interest in Alcatel Alenia Space and our 33% interest in Telespazio Holding, our two joint ventures with Finmeccanica.
On January 5, 2007, our transportation and security activities were contributed to Thales and we received 25 million new Thales shares and a cash payment of €50 million, plus purchase price adjustments. The transfer of our space activities to Thales for a cash payment of €670 million closed on April 6, 2007.
On December 19, 2008, we announced the signature of a definitive agreement regarding the acquisition by Dassault Aviation of our Thales shares. The closing of the transaction took place on May 19, 2009. For more detail about this sale, please refer to Section 4.2, History and Development Highlights of transactions during 2009 Dispositions and History and Development Highlights of transactions during 2008 Dispositions. Since that date, the cooperation agreement, shareholders agreement and the agreement regarding the strategic interest of the French State described below are no longer in force.
The description below is a summary of the historical context, as the agreements applied for a portion of 2009.
Cooperation Agreement. In connection with the transfer of certain of our transportation, security and space activities to Thales, we entered into a cooperation agreement on December 1, 2006 with Thales and the French government (the French State) governing the relationship between Thales and us after completion of the transaction. The cooperation agreement required that Thales give preference to the equipment and solutions developed by us, in consideration for our agreement not to submit offers to military clients in certain countries, subject to certain exceptions protecting, in particular, the continuation of Lucents business with U.S. defence agencies. The agreement also included non compete commitments by us with respect to our businesses being contributed to Thales, and by Thales with respect to our other businesses, in each case, subject to limited exceptions. The agreement also provided for cooperation between Thales and us in certain areas relating to Research and Development.
In connection with the Thales transaction, we entered into an amended shareholders agreement on December 28, 2006 with TSA, a French company wholly owned by the French State, which governed the relationship of the shareholders in Thales. The key elements of this relationship were as described below.
Board of Directors of Thales. The Thales Board of Directors was comprised of 16 persons and included (i) five Directors, proposed by the French State, represented by TSA; (ii) four Directors proposed by us, each of whom had to be a citizen of the European Union, unless otherwise agreed by the French State; (iii) two Thales employee representatives; (iv) one representative of the employee shareholders of Thales; and (v) four independent Directors. The French State and we had to consult with each other on the appointment of independent Directors. At least one Director appointed by the French State and one Director appointed by us sat on each of the board committees.
The French State and we each had the right to replace members of the Thales Board of Directors, such that the number of Directors appointed by each of the French State and us was equal to the greater of:
the total number of Directors (excluding employee representatives and independent Directors), multiplied by a fraction, the numerator of which was the percentage of shares held by the French State or us, as the case may be, and the denominator of which was the total shares held by the French State and us; and
the number of employee representatives and representatives of employee shareholders on the Thales Board of Directors.
Joint Decision-Making. The following decisions of the Thales Board of Directors required the approval of a majority of the Directors appointed by us:
the election and dismissal of the chairman/chief executive officer of Thales (or of the chairman and of the chief executive officer, if the functions were split) and the splitting of the functions of the chairman/chief executive officer;
the adoption of the annual budget and strategic plan of Thales;
any decision threatening the cooperation between us and Thales; and
significant acquisitions and sales of shares or assets (with any transaction representing €150 million in revenues or commitments deemed significant).
If the French State and we disagreed on (i) major strategic decisions deemed by the French State to negatively affect its strategic interests or (ii) the nomination of a chairman/chief executive officer in which we exercised our veto power, the French State and we had to consult in an effort to resolve the disagreement. If the parties had not been able to reach a joint agreement within 12 months (reduced to three months in the case of a veto exercised on the nomination of the chairman/chief executive officer), either the French State or we could unilaterally terminate the shareholders agreement.
Shareholding in Thales. We would have lost our rights under the shareholders agreement unless we held at least 15% of the capital and voting rights of Thales. The shareholders agreement provided that the participation of the French State in Thales could not exceed 49.9% of the share capital and voting rights of Thales, including the French States golden share in Thales (described below under Agreement Regarding the Strategic Interests of the French State).
Duration of Shareholders Agreement. The amended shareholders agreement took effect on January 5, 2007 and was to remain in force until December 31, 2011. The agreement provided that, unless one of the parties made a non-renewal request at least six months before the expiration date, the agreement would be automatically renewed for five years. If the French States or our equity ownership had droped below 15% of the then outstanding share capital of Thales, the following provisions would have applied:
the party whose ownership decreased below 15% of Thales share capital would, one year following the date on which such shareholding fell below 15%, no longer have rights under the shareholders agreement unless such party had acquired during that one-year period Thales shares so that it again owned in excess of 15% of the Thales share capital. If a partys ownership decreased below 15%, the party had to take the necessary actions to cause the resignation of the board members it had appointed so that their number reflected the proportion of Thales share capital and voting rights that such party maintained;
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the party whose shareholding had not decreased below the 15% threshold had a right of first refusal to acquire any shares the other party offered for sale to a third party in excess of 1% of the then outstanding share capital of Thales.
Breach of Our Obligations. In the case of a material breach by us of our obligations under the agreement relating to the strategic interests of the French State, which was defined as a breach that the French State determined could jeopardize substantially the protection of its strategic interests, the French State had the power to enjoin us to cure the breach immediately. If we did not promptly cure the breach or if the French State determined that foreign rules of extra territorial application that were applicable to us imposed constraints on Thales likely to substantially jeopardize the strategic interests of the French State, the French State was entitled to exercise its termination remedies as described below.
If any natural person’s or entity’s equity ownership of us increased above the 20%, 33.33%, 40% or 50% thresholds, in capital or voting rights, we and the French State had to consult as to the consequences of this event and the appropriateness of the agreement respecting the strategic interests of the French State to the new situation. If, after a period of six months following the crossing of the threshold, the French State determined that the share ownership of us was no longer compatible with its strategic interests and that the situation could not be remedied through an amendment to the shareholders agreement, the French State was entitled to exercise its termination remedies as described below.
Termination Remedies. Upon a breach of our obligations described above or if a third party acquired significant ownership in us as described above and an amendment to the shareholders agreement had not remedied the concerns of the French State, the French State could have:
terminated the shareholders agreement immediately;
if the French State deemed necessary, required us to immediately suspend the exercise of our voting rights that exceeded 10% of the total voting rights in Thales; or
if the French State deemed necessary, required us to reduce our shareholding in Thales below 10% of the total share capital of Thales by selling our shares of Thales in the marketplace. If, after a period of six months, we had not reduced our shareholding, the French State could have forced us to sell all of our Thales shares to the French State or a third party chosen by the French State.
Agreement Regarding the Strategic Interests of the French State. On December 28, 2006, we entered into a revised agreement with the French State in order to strengthen the protection of the strategic interests of the French State in Thales. The terms of this agreement included, either as an amendment to, or as a separate agreement supplementing the shareholders agreement, the following:
we had to maintain our executive offices in France;
Thales board members appointed by us had to be citizens of the European Union, unless otherwise agreed by the French State, and one of our executives or board members who was a French citizen had to be the principal liaison between us and Thales;
access to classified or sensitive information with respect to Thales was limited to our executives who were citizens of the European Union, and we were required to maintain procedures (including the maintenance of a list of all individuals having access to such information) to ensure appropriate limitations to such access;
normal business and financial information with respect to Thales was available to our executives and Directors (regardless of nationality);
the French State would continue to hold a golden share in Thales, giving it veto rights over certain transactions that might otherwise be approved by the Thales Board of Directors, including permitting a third party to own more than a specified percentage of the shares of certain subsidiaries or affiliates holding certain sensitive assets of Thales, and preventing Thales from disposing of certain sensitive assets;
the French State had the ability to restrict access to the Research and Development operations of Thales, and to other sensitive information; and
we had to use our best efforts to avoid any intervention or influence of foreign state interests in the governance or activities of Thales.
National Security Agreement and Specialty Security Agreement
On November 17, 2006, the Committee on Foreign Investment in the United States (CFIUS), approved our business combination with Lucent. In the final phase of the approval process CFIUS recommended to the President of the United States that he not suspend or prohibit our business combination with Lucent, provided that we execute a National Security Agreement (NSA) and Specialty Security Agreement (SSA) with certain U.S. Government agencies within a specified time period. As part of the CFIUS approval process, we entered into a NSA with the Department of Justice, the Department of Homeland Security, the Department of Defense and the Department of Commerce (collectively, the USG Parties) effective on November 30, 2006. The NSA provides for, among other things, certain undertakings with respect to our U.S. businesses relating to the work done by Bell Labs and to the communications infrastructure in the United States. Under the NSA, in the event that we materially fail to comply with any of its terms, and the failure to comply threatens to impair the national security of the United States, the parties to the NSA have agreed that CFIUS, at the request of the USG Parties at the cabinet level and the Chairman of CFIUS, may reopen review of the business combination with Lucent and revise any recommendations submitted to the President. In addition, we agreed to establish a separate subsidiary to perform certain work for the U.S. government, and hold government contracts and certain sensitive assets associated with Bell Labs. This separate subsidiary has a Board of Directors including at least three independent Directors who are resident citizens of the United States who have or are eligible to possess personnel security clearances from the Department of Defense. These Directors are former U.S. Secretary of Defense William Perry, former National Security Agency Director Lt. Gen. Kenneth A. Minihan, USAF (Ret.) and former Assistant Secretary of the U.S Navy Dr. H. Lee Buchanan. The SSA, effective December 20, 2006, that governs this subsidiary contains provisions with respect to the separation of certain employees, operations and facilities, as well as limitations on control and influence by the parent company and restrictions on the flow of certain information.
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5 DESCRIPTION OF THE GROUPS ACTIVITIES
5.1 BUSINESS ORGANIZATION
Strategic Focus. Our strategic vision that we call Application Enablement, launched in 2009, is to improve the Internet or web experience of service providers, enterprises and end-users while improving our customers return on their investments. To do that, we are working to provide consumers and business users with a rich and more trusted web experience by combining:
the speed and creative innovation of the web;
the unique capabilities of our customers networks such as quality, security, reliability, billing, privacy, user context (location); and
the trusted relationship our customers have with their subscribers.
A key foundation of our Application Enablement strategy is what we call the High Leverage NetworkTM architecture. A High Leverage NetworkTM addresses the key challenge faced by our customers, which is delivering innovative, revenue-generating, value-added services to their customers at the lowest possible cost.
A High Leverage NetworkTM
is a converged, IP (Internet protocol)-based network that can provide for continually scalable bandwidth (i.e., bandwidth that can be readily increased as needed) anywhere from the access to the core layer of the network;
is subscriber-aware, application-aware, and service-aware in order to provide quality of service and enhanced traffic optimization as it delivers advanced services to end users at the optimum cost;
requires state of the art capabilities in IP, Optics, wireless and wireline broadband access as well as the software and services that together provide the foundation to support Application Enablement.
We believe that our Application Enablement vision, in combination with the High Leverage NetworkTM, will yield a sustainable business model that is beneficial for network operators as well as application and content creators. This model is intended to fuel innovation and the capital investment required to expand the overall web experience to more people and businesses. Application Enablement includes all aspects of open network architecture that need to be accessible to over-the-top application providers, those that now provide services on a best-efforts basis over the Internet, so they can develop more compelling, high value services for delivery over service provider networks. Our products, software and services capabilities are all integral parts of our Application Enablement vision and our High Leverage NetworkTM concept. Application Enablement presents strategic opportunities for us to partner with our customers as they transform their networks while they also define and execute their business strategies to address new market challenges and opportunities.
Organization. On January 1, 2009 we implemented a new organizational structure as part of a realignment of our operations in support of our Application Enablement strategy. Effective January 1, 2010, we made additional organizational changes to better align our structure with Application Enablement and the High Leverage NetworkTM architecture, and to take better advantage of the fact that our former Enterprise product group is evolving to a business with an R&D and a customer focus that have much in common with our Applications product group. The new organization makes a clear distinction between the groups that are responsible for the products and services we sell and the customer-facing organizations that sell them.
The new organization structure effective January 1, 2010 includes:
New Product Groups. Three, rather than four, product groups align our R&D focus with the High Leverage NetworkTM framework. The three groups are:
Applications develops and maintains software products for our applications business. The Applications group consists of the Applications Software group that was in place in 2009 and the Enterprise Solutions (voice telephony and data networking) business that was part of the Enterprise Product group in 2009. The enterprise voice and data businesses are increasingly focused on software-based platforms, as is the case with applications, and also share an increasingly common enterprise customer base with our applications business;
Networks which is essentially the same as the Carrier Product group in place in 2009. The four main businesses of the Networks group IP, Optics, Wireless and Wireline provide end-to-end communications networks and individual network elements. Our Networks group also includes another smaller business: Radio Frequency Systems;
Services designs, integrates, manages and maintains networks worldwide. This group remains unchanged from 2009.
The Enterprise group in place in 2009 no longer exists as a product-focused group. Its voice and data businesses have been moved to Applications, as noted above. A portion of the Enterprise groups Industrial Components business (electrical motors and drives) was sold to Triton in 2009 (See Section 4.2 Highlights of Transactions during 2009) and the remaining Industrial Components business is now included in a segment that we call Other. The customer-facing Enterprise sales organization is part of our Customer sales organization and remains globally focused on small, medium and large enterprises and selected verticals, where customers in transportation, energy, health, defense and the public sector need large, complex communications networks;
Customer sales organizations. We have three customer-facing regional organizations, the Americas, Asia Pacific, and EMEA (Europe, the Middle East and Africa), that are accountable for serving customers and growing the business profitably. The primary mission of these organizations is to sell and ensure the highest customer satisfaction. The three regions share responsibility for customer-focused activities with separate, dedicated sales teams for these vertically integrated units: submarine systems, radio frequency systems, Genesys, the enterprise marketing organization, and a separate selected verticals unit;
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Sales support and operations. We have three organizations designed to sharpen our customer focus and reinforce our focus on operations. The Solutions and Marketing organization brings together the right products and services to create the complex solutions required by customers to address new opportunities. The Quality Assurance and Customer Care organization works with the regional organizations and the Groups to insure that our solutions, products and services are of the highest quality and will work seamlessly in our customer environments. The global Operations function is focused on our IT and procurement infrastructure, including manufacturing, logistics, supply chain and underlying processes, systems and IT.
As a result, starting in 2010, we no longer organize our business according to the four former business segments Carrier, Applications Software, Enterprise and Services. However, in this annual report, we discuss the Carrier, Applications Software, Enterprise and Services segments that were in place for 2009.
The 2009 organization is shown in the table below.
For financial information by operating segment (also called business segment) and geographic market, see Note 5 to our consolidated financial statements and Chapter 6 Operating and financial review and prospects, included elsewhere in this document.
This table shows how the 2009 organization was changed to create the 2010 organization.
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5.2 CARRIER SEGMENT
Globally, end-user demand for high-bandwidth services that are delivered with an enhanced quality of experience is surging. In addition, global market dynamics are dictating that service providers must have the agility to support multiple business models to deliver innovative revenue-generating services. To meet all these challenges, service providers need to evolve their networks to a next-generation, all-IP multiservice infrastructure that is fully converged, optimized and scalable. The Carrier segment supplies a broad portfolio of products and solutions used by fixed, wireless and converged service providers to address these needs, as well as enterprises and governments for their business critical communications.
The High Leverage Network™ is Alcatel-Lucent’s vision of the how networks need to evolve, leveraging fundamental technology shifts in wireline and wireless broadband access, IP and optics to address evolving networking needs. It allows service providers to address the key challenge of how to simultaneously deliver innovative, revenue-generating services and provide scalable, low-cost bit delivery. It is also a critical enabler of and the foundation for Alcatel-Lucents Application Enablement vision. In order to achieve this objective, in 2009 we increased our investment in end-to-end LTE (Long Term Evolution, or fourth generation wireless), next-generation IP core platforms including the Evolved Packet Core (EPC), a fixed access converged platform, 100 Gigabit/second optical technology, converged network management and a portfolio of services to help service operators migrate to a High Leverage Network™.
In 2009, our Carrier segment revenues were € 9,076 million including intersegment revenues and € 9,047 million excluding intersegment revenues, representing 60% of our total revenues.
Our portfolio of third generation IP routers and switches is designed to support IP-based applications and services while helping service providers monetize their network investment and reduce customer churn. Over 300 service providers in over 100 countries use our IP routers and switches, earning us the #2 position in IP edge routing (based on revenue) with greater than 20% global market share. Leveraging our innovation in delivering the worlds first 100 Gigabit per second network processor, we were the first to announce a 100 Gigabit Ethernet interface, which is a leading-edge technology that helps service providers deliver data and voice at the highest speeds without compromising quality of service.
Our IP portfolio consists of three product families that deliver multiple services including residential broadband triple play; Ethernet and IP Virtual Private Network (VPN) business services; and wireless 2G, 3G and LTE services. The main product families are:
Internet Protocol/Multiprotocol Label Switching (or IP/MPLS) service routers. These products direct traffic within and between carriers national and international networks to enable delivery of a broad range of IP-based services (including Internet access, Internet Protocol TV (IPTV), Voice over IP, mobile phone and data, and managed business VPNs) on a single common network infrastructure with superior performance, with application intelligence, and with scalability. When we refer to scalability, we mean the ability to deliver required capacity at an affordable cost;
Carrier Ethernet service switches. These switches enable carriers to deliver residential, business and wireless services more cost-effectively than traditional methods due to their higher capacity and performance. These products are mainly used in metropolitan area networks;
Multi-service wide-area-network (or MS WAN) switches. These switches enable fixed line and wireless carriers to transition their existing networks to support newer technologies and services.
The applicability of our service router portfolio continues to expand to meet the needs of service providers. With the migration to all-IP wireless networks underway, the service router plays a key role in the Evolved Packet Core (EPC) within the LTE fourth generation wireless architecture. Our Converged Backbone Transformation Solution increases the communication and collaboration between the traditionally independent IP and optical layers of the network by tightly integrating IP and optical network elements as well as network management and control layers. Service router functionality continues to evolve to ensure that cost per bit is minimized while new revenue generating services and applications are enabled. This is the fundamental premise of a High Leverage NetworkTM.
The IP/MPLS and Carrier Ethernet products are designed to facilitate the development and availability of applications for the more participatory and interactive Web 2.0 business and consumer services. These products offer carriers the opportunity to increase the profitability of their fixed and mobile networks and services without relying on subscriber growth alone. The products make it possible for service providers to offer and deliver quality services.
Our service routers and Carrier Ethernet service switches share a single network management system that provides consistency of features, quality of service and operations, administration and maintenance capabilities from the network core to the customer edge. These capabilities are critical as carriers transform their networks to support new Internet-based services. Our service routers are particularly well suited to deliver complex services to business, residential and mobile end-users, ensuring the high capacity, reliability and quality of service required to support HDTV channels, voice calls and high bandwidth Internet access. Our IP/MPLS service routers and Carrier Ethernet service switches are often used in conjunction with our DSL and GPON (Gigabit Passive Optical Network) access products to deliver these newer triple-play services, or with our wireless access products to deliver LTE solutions, or with our DWDM (Dense Wave Division Multiplexing) and optical switching products to deliver converged backbone transformation solutions for optimizing IP transport.
In July 2009, we acquired Velocix, a UK-based company specializing in the construction and optimization of content delivery networks. This acquisition aligns with and supports our High Leverage NetworkTM strategy by providing new products for carriers to deliver a wide variety of video and other content to businesses and consumers in more cost-effective ways.
Our Optics division designs and markets equipment for the long distance transportation of data over fiber optic connections via land (terrestrial) and under sea (submarine), as well as for short distances in metropolitan and regional areas. Our leading transport portfolio also includes our microwave wireless transmission equipment.
Our terrestrial optical products offer a portfolio designed to seamlessly support service growth from the metro to the network core. With our products, carriers manage voice, data and video traffic patterns based on different applications or platforms and can introduce a wide variety of managed data services, including multiple service quality capabilities, variable service rates and traffic congestion management. Most importantly, these products allow carriers to leverage their existing network infrastructure to offer these new services.
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As a leader in optical networking, we play a key role in the transformation of optical transport networks and have created our vision of a High Leverage NetworkTM to ensure the delivery of data at the lowest cost while enabling new revenue generating services and applications. Our wavelength-division multiplexing (WDM) products address a variety of markets, from the enterprise to the ultra-long-haul, to meet service provider requirements for cost-effective, scalable networks that can handle their increased data networking needs. Our WDM product portfolio is based on the Zero Touch Photonics approach which eliminates the need for frequent on-site configuration and provisioning. Our WDM products allow operators to solve bandwidth bottlenecks, while offering the lowest cost per transported bit. This new approach facilitates the design and installation of a more flexible WDM network that is easier to operate, manage and monitor.
In 2009, the Terrestrial division focused its R&D efforts on:
100 Gigbit per second and other transmission capabilities that allow service providers to address increased IP-based service growth;
traffic aggregation, where our new packet optical transport technology facilitates the migration to new IP-based services;
next-generation optical switching, where our intelligent switches maximize the efficient utilization of network resources;
our Converged Backbone Transformation Solution, that increases the communication and collaboration between the optical and IP layers of the network, helping service providers optimize their transport infrastructure to profitably meet the growing demands of multimedia traffic growth.
These products and technologies provide cost-effective, managed platforms that support different services and are suitable for many different network configurations.
We are an industry leader in the development, manufacturing, installation and management of undersea telecommunications cable networks. Our submarine cable networks can connect continents (using optical amplification required over long distances), a mainland and an island, several islands together, or many points along a coast. This market is characterized by relatively few large contracts that often require more than one year to complete. Projects are currently concentrated on links between Europe and India, West and East Africa, the Mediterranean and Southeast Asia, as well as around the Indian sub-continent. In addition to new cable systems, this market also includes significant activity upgrading existing submarine networks as our service provider customers add capacity in response to surging broadband traffic volumes.
We offer a comprehensive point-to-point portfolio of microwave radio products meeting both European telecommunications standards (or ETSI) and American standards-based (or ANSI) requirements. These products include high, medium and low capacity microwave transmission systems for mobile backhaul applications, fixed broadband access applications, and private applications in markets like digital television broadcasting, defense and security, energy and utilities. As a complement to optical fiber and other wireline systems, our portfolio of wireless transmission equipment supports a full range of network/radio configurations, network interfaces and frequency bands with high spectral efficiency. Our next-generation packet microwave radio links enable operators to quickly and efficiently adapt their networks in line with traffic and service growth. We are the market leader in the long haul microwave market segment where microwave radio is used to transport signals over long distances.
In 2009, the CDMA market declined as operators shifted their focus from expansion to achieving operational savings through upgrades that provide a smaller footprint, higher efficiency and a migration path to LTE. We maintained our #1 position in the market (based on revenues) and played a significant role supporting China Telecoms deployment of its third generation EV-DO (Evolution Data Only) network and providing the capacity and new equipment required to meet surging growth in mobile data use in North America.
Our CDMA strategy is focused on maintaining our installed base by delivering quality, capacity and OA&M (operations, administration and management) improvements while we position ourselves to migrate our customers to LTE. In 2009, we emphasized improving our customers total cost of ownership with products that can reduce capital expenditures and operating expenses, like high-efficiency amplifiers which reduce base station power consumption by up to 60%. We are also aggressively deploying LTE-ready products that support EV-DO growth with enhanced system capacity, reliability and performance. These enhancements provide an evolution to LTE for operators with an embedded base of our 3G technology, allowing them to reuse base station assets, while at the same time, minimizing the footprint and improving the power efficiency of the products. This reinforces our commitment to eco-sustainability.
The current version of CDMA technology, known as 1X EV-DO Revision A, enables operators to offer two-way, real-time, high-speed data applications such as VoIP (Voice over Internet Protocol), mobile video, push-to-talk and push-to-multimedia. The next enhancement, Revision B, increases throughput performance with minimal upgrades. We are working with customers in Asia to launch Revision B services.
We develop mobile radio products for the second generation (or 2G) GSM (or Global System for Mobile communications) standard, including GPRS/EDGE (or General Packet Radio Service/Enhanced Data Rates for GSM Evolution) technology upgrades to that standard. While GSM is a mature technology, emerging markets, such as China and India, continue to experience subscriber growth.
Our GSM product strategy focuses on providing operators with total cost of ownership savings and eco-sustainability without compromising performance, scalability or future evolution. For example, we launched our new SDR- (Software Defined Radio) based multi-technology radio module (the MC-TRX) in February 2010. This product gives mobile operators the flexibility to support any mix of 2G, 3G, and 4G (LTE) services simultaneously, thus enabling the introduction of newer wireless technologies while maintaining the GSM capability of the base station. Since 1999, our product strategy has focused on the ability to upgrade our radio technology while maintaining compatibility with earlier versions.
As part of our innovation program, we are active in the Green base station market with products powered by renewable energy sources. We have already deployed more than 350 solar powered base stations worldwide and have recently installed a base station with our customer Vodafone Qatar using two alternative energy sources, wind and solar.
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Wideband Code Division Multiple Access, referred to as W-CDMA or Universal Mobile Telephone Communications Systems (UMTS), is the third generation wireless technology derived from the GSM standard deployed worldwide. The focus on W-CDMA and other 3G wireless technologies has increased along with increasing end-user demand for mobile broadband capabilities. This demand has driven increased investment in 3G networks so that our service provider customers can offer new mobile high-speed data capabilities to end-users. 2009 was a very important year for W-CDMA, with a massive 3G deployment in China and the emergence of mobile broadband Internet, including mobile video. The iPhone® and other smartphone phenomenon has shown that there is strong demand for W-CDMAs mobile broadband capabilities, especially when they are offered via a user-friendly device with easy access to user-friendly applications. The recent introduction of High Speed Packet Access (HSPA) and evolved HSPA (the latest evolutions of W-CDMA technology) on networks and devices has led to significant increases in data speeds available to broadband devices. The demand for 3G services delivered over W-CDMA networks has also been driven by increasingly common flat-rate offers, at least for the data part of the end user subscription.
We are a key supplier of some of the W-CDMA networks carrying the highest amount of traffic in the world, including AT&T in the U.S. (13,000+ base stations deployed), KT and SK Telecom in Korea, and Vodafone Italy. Our portfolio strategy is based on improving network capacity while reducing total cost of ownership, consistent with our High Leverage NetworkTM concept. For example, our MC-TRX multi-technology and multi-carrier radio module noted above is a key component of our converged RAN (radio access network) solution that allows for smooth technology evolution to LTE.
We have an alliance with Datang Mobile to foster the development of the TD-SCDMA (or Time Division-Synchronized Code Division Multiple Access) 3G mobile standard in China, where we deployed trial TD-SCDMA networks in 2006. In 2008, we were awarded the phase II trial of the TD-SCDMA network for China Mobile, leveraging our experience accumulated in the first phase that started in early 2007. In 2009, we were selected, along with Datang Mobile, by China Mobile for deployment of its phase III TD-SCDMA mobile networks in 11 provinces.
LTE (LONG-TERM EVOLUTION)
Fuelled by the proliferation of 3G-enabled devices, the increasing number of multimedia applications and the resulting surge of mobile broadband data traffic, the market for LTE, or fourth-generation wireless, will materialize faster than originally predicted in certain geographies. Several large new commercial deployments were announced in 2009 and in early 2010, and there are also a significant number of service providers who are trialling the technology. LTE offers service providers a highly compelling evolution path from all existing networks (GSM, W-CDMA, CDMA or WiMAX) by simplifying the radio access network and converging on a common IP base, leading to better network performance and a lower cost per bit. LTE creates an environment in which consumers will be able to use wireless networks to access high-bandwidth content at optimal cost, enabling a new generation of affordable services.
We have entered into contracts with Verizon Wireless (which includes RAN, the EPC or evolved packet core network, and IMS) and AT&T. We currently have 40 LTE trials or commercial agreements underway with 23 operators worldwide, and in many cases we are engaged in multiple trials with a single operator, covering different geographies, frequencies and applications.
We are focusing our R&D spending on LTE to develop a differentiating, end-to-end solution that includes our converged RAN (radio access network), a high performing evolved packet core and a full set of differentiating 4G services and applications. With the recent launch of our multi-carrier, multi-technology radio modules that are based on Software Defined Radio (SDR) technology, we can offer operators a seamless transition from 2G/3G to LTE. Our ngConnect program addresses the services and applications aspect of our 4G offering by linking operators with a broad coalition of device, content and applications partners. Finally, we are leveraging our strong IP transformation skills in assisting our customers with their evolution towards an all-IP LTE network.
RADIO FREQUENCY SYSTEMS (RFS)
RFS designs and sells cable, antenna, tower systems and their related electronic components, providing an end-to-end suite of radio frequency products. RFS serves OEMs, distributors, system integrators, network operators and installers in the broadcast, wireless communications, microwave and defense sectors. Specific applications for RFS products include cellular sites, in-tunnel and in-building radio coverage, microwave links, TV and radio.
We are the worldwide leader in the fixed broadband access market, supporting the largest mass deployments of video, voice and data services. According to Dell'Oro (November 2009) , we are the largest global supplier of digital subscriber line (or DSL) technology, with 41% of global DSL revenues, and we currently lead the Gigabit Passive Optical Networking (or GPON) market, with 29% of global revenues (for the GPON Optical Line Terminals that sit in the service providers central office). Today, one out of three fixed broadband subscribers around the world is served through one of our access networks, which now include more than 200 million DSL lines.
With the wireline broadband access market largely built out in developed economies, growth in the fixed access market today is driven by the increased penetration of broadband in developing economies such as China and India and by the technology migration to fiber-based broadband access. Triple play offerings (high speed Internet, and Internet-based telephony and TV) by service providers are also driving the market. These enhanced services require increased bandwidth delivered closer to the end user over copper telephone lines, using DSL and its very high-speed variant VDSL (where, according to Dell'Oro, we have a 46% share of the market) and optical fiber.
Our family of IP-based fixed access products provides support for both copper- and fiber-based broadband access. These products allow service providers to extend DSL and fiber to the customers premises or to use them in highly optimized combinations, depending on the specific cost, performance, engineering and business objectives of the installation. Our fixed access solutions allow carriers to offer triple-play services over a single access line. Both residential and business customers benefit from a large number broadcast channels, video on demand, HDTV, VoIP (or Voice over IP), high speed Internet, and business access services. The functionality of our products serves the needs of carriers urban, suburban and rural customers. For our carrier customers, this means adding new revenue streams at the lowest possible cost.
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We offer products that extend from legacy switching systems to IP multimedia subsystem (IMS) solutions for fixed, mobile, and converged operators. We have deployed our NGN (next-generation network) products in more than 170 fixed NGN networks, and we have provided the core network for more than 40 full IMS fixed and mobile networks. Carriers have expressed a strong desire to migrate their embedded base with products that are scalable, beginning with basic voice services and growing into enriched multimedia services enabled by IMS. Using our IMS architecture, operators can differentiate the services they offer their end-users with quality of service controls and deliver new services that go beyond simple voice and Internet usage.
Our IMS products are designed to meet a diverse set of network objectives such as consumer and business VoIP to enhanced and multimedia communications services, for both fixed and mobile operators. We achieve these objectives by delivering a single set of software assets that are highly scalable. Our IMS products work across all types of access (wireline and wireless) and all network technologies.
The IMS portfolio can be deployed in either a distributed or integrated configuration. In either case, the same software supports both traditional POTS (plain old telephone service) and IP endpoints. The integrated product is packaged within a single hardware platform (or server) while the distributed product is packaged based on a customers business needs and network topology (multiple chassis). As an added capability, the product elements can be located in different sites (geo-redundancy) for high reliability.
5.3 APPLICATIONS SOFTWARE SEGMENT
The Applications Software segment develops software-based applications that contribute to enrich the personal communications experience for end-users. Our global customers include over 300 service providers and more than 40% of the companies included in the Fortune 500. The Applications Software group is divided into two businesses Genesys, our contact center business and carrier applications, which develops applications used by service providers to deliver a variety of services to their customers, and which also includes Motive, which provides software for service providers to remotely manage their customers at-home networks, networked devices and broadband and mobile data services.
The Applications Software segment is investing resources and money in:
customer contact, customer engagement and service management areas addressed by our Genesys and Motive divisions;
carrier applications such as enriched communication and messaging, next-generation telephony, digital media and multi-screen delivery of content and personalized advertising, device agnostic location based address book services;
technologies such as, Long Term Evolution (LTE), IMS (IP multimedia subsystem), and Application Enablement.
At the same time, the Applications Software segment is streamlining its product offerings in mature portfolios such as traditional Intelligent Network (IN) applications (such as toll-free dialing, number portability, call forwarding), unified messaging and real-time converged payment.
In 2009, our Applications Software segment revenues were € 1,135 million including intersegment revenues and € 1,084 million intersegment revenues, representing 7% of our total revenues.
Genesys is the market leader in contact centers worldwide and is a leading provider of the software used by enterprises and service providers to manage all aspects of their interaction with their customers through the Web, by phone or other mobile device. Genesys software connects customers with resources from across the organization (including self-service and assisted-service capabilities) to efficiently fulfill customer requests and meet customer care goals. The contact center market includes inbound call routing (automatic call distributors and computer telephony integration that links the contact center with other in-house data systems), inbound and outbound interactive voice response systems and quality monitoring systems. Genesys software directs more than 100 million customer interactions daily for 4,000 companies and government agencies in 80 countries, including market leaders in 28 global industries.
The carrier applications business is a leading provider of software that allows service providers to offer new end-user communications and digital entertainment services across any connected device including mobile phones, PCs, TVs, and the Web. The carrier applications software portfolio focuses on three areas the consumer experience, the network enablers and the creation of new services. The carrier applications Subscriber Data Management portfolio is focused on providing information about end-users, including information about location, preferences and billing, that can be used to create personalized services. The carrier applications Digital Media and Enhanced Communications portfolios allow service providers to launch a wide variety of new applications that combine capabilities such as video, advertising, next generation messaging, and IP-based communications into new offerings. The carrier application payment portfolio is a set of applications that include real-time rating, charging, billing and payment for voice and data services.
The newest addition to the carrier applications portfolio is the Application Exposure Suite which was announced in December 2009 as an integral part of our Application Enablement vision. Our Application Exposure Suite allows service providers to securely open their networks to provide key customer-specific information such as subscriber location, service preferences and connection guarantees, to application developers and content providers to speed the development of new innovative services.
In 2008, we acquired Motive Inc., a leading provider of service management software. Motive products are used by fixed, mobile, cable and satellite operators worldwide to deliver better customer care. Motive software makes it easier for communications providers to offer, activate, support and manage a wide range of high-speed Internet, VoIP, video, mobile and converged services. Motive software gives communications providers the tools they need to help customers set up and manage their home and mobile devices and services.
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5.4 ENTERPRISE SEGMENT
Our enterprise segment provides end-to-end offerings of software, hardware and services that interconnect a business enterprises networks, people and processes. We refer to this interconnectivity as The Dynamic Enterprise. Our projects range in size from small/home office installations to highly complex, fully-integrated global network deployments. We market our products through a combination of direct and indirect sales channels, including some of the largest service providers and through third-party businesses (including developers and integrators). A network of over 2,100 indirect sales partners helps us support our global customer base.
The groups portfolio includes:
communications products for the enterprise to converge voice and data over fixed and mobile communication applications;
applications for conferencing, collaboration and customer service;
fixed and mobile unified communications software and contact center products;
products that integrate communications networks with in-house data, systems and business process platforms to provide anytime, anywhere access to business data across the enterprise;
product offerings that combine real-time communications (instant messaging, video conferencing, IP telephony) with our enterprise 2.0 software applications in order to facilitate knowledge sharing;
carrier-grade portfolio for customers in select vertical markets such as energy, transportation and the public sector that require complex communications networks;
comprehensive project management and professional services offerings for customers in select vertical markets.
One source of future growth is the strategic alliance we formed with Hewlett-Packard (HP). The alliance includes a joint go-to-market program that will integrate our enterprise products and applications including IP telephony, unified communications, mobility, security and contact centers with HPs IT solutions. The joint solutions will be sold to mid- and large-size enterprises and public sector organizations through the extensive network of HP resellers or as a managed service supported by both companies capabilities.
Other areas of focus in 2009 include what we call select verticals and various product development efforts designed to position this group for anticipated growth in 2010 and beyond. Select verticals are an important area that we anticipate will drive future growth for this group. Our emphasis on verticals in 2009 resulted in several large contracts with customers in healthcare, connected medicine, energy, smart metering and the transportation sectors. In the product development area:
Open standards: During 2009, we continued to enhance our voice and data platforms to support open standards. We are specifically focused on Session Initiation Protocol (SIP), the dominant signaling protocol, or standard, used to control IP-based multimedia communications, in support of our Application Enablement vision;
Applications: In 2009, we released the OmniTouch™ 8600 My Instant Communicator software, which added smartphones like the iPhone and the Blackberry to the list of devices supported by our unified communications (UC) platform. With this launch, our UC platform took another step towards the vision of “enterprise ubiquity”, where all forms of communications within an enterprise (voice, data, messaging, mail, for example) are available on any device, located anywhere, via a common interface;
Data networking: The OmniSwitch™ 9000E, released in 2009, is the latest addition to our OmniSwitch LAN switch portfolio. This switch offers enhanced capabilities and improved performance, adding Gigabit capacity with extremely low power consumption to our OmniSwitch family of data networking switches;
Security: The release of Version 3.0 of our OmniAccess™ 8550 Web Services Gateway introduced additional security and control capabilities that let enterprises and service providers deliver an open and secure Web services environment for their customers’ business-to-business transactions and Web 2.0 services.
In 2009, our enterprise segment revenues were € 1,036 million including intersegment revenues and € 1,006 million excluding intersegment revenues, representing 7% of our total revenues.
5.5 SERVICES SEGMENT
Our services segment is focused on helping our service provider customers realize the full potential of telecommunication technologies in support of their business strategy in a cost-efficient manner. These professional services address the full life cycle of our customers networks and operations with business consulting, systems design and integration, maintenance and managed services. Our customers include both communication service providers and cable operators.
The group's mission statement is to partner with our customers throughout their transformation projects as they migrate their networks, organizations, business processes and customers from their legacy technology and platforms to the IP world. Our services offerings are organized around the four areas where we believe our customers benefit the most from our multi-vendor IT/telecommunications practices:
network and system integration;
managed and outsourcing solutions;
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Within the Network and Systems Integration (NSI) organization, our business and technology industry experts consult with and support our customers throughout their transformation from legacy to IP platforms. The IP network transformation services within NSI include network planning, design, consulting, roll-out, project management, and optimization services. Our IP Transformation Centers located in Antwerp (Belgium), Murray Hill (USA), Chennai (India) and Singapore, allow our customers to fully test their target network in a live, multi-vendor environment, thereby minimizing risk and time to market. Our IP network transformation services also support the evolution of our customers to a High Leverage NetworkTM. Our NSI consultants also assist customers in the deployment of multimedia services and networks, such as next generation interactive TV; the design, migration and roll-out of 2G/3G/4G wireless networks; mobile backhaul; and eco-sustainability, work that includes the deployment of base stations powered by solar and wind energy. Due to our expertise, we believe our NSI customers benefit from reduced time required to bring new services to market, streamlined and enhanced operational processes, and the ability to integrate their new service delivery platforms with their operational and business support systems. We offer a combination of network and IT expertise, and we continue to invest in our tools and process.
Managed services consist of a wide range of outsourced network operations, including the migration of the service providers customers from legacy platforms to new IP platforms. These services reduce our clients' operating expenses, enhance network reliability and manage the quality of the end-user experience. Managed services provide a seamless (for the end-user) transition to an outsourced environment utilizing a standard set of tools and other resources (technology and people) to manage our customers networks. These functions can be performed at our own network operations centers, at our four IP Transformation Centers, or at the customers own network operations center. We have also introduced innovative business models to our managed and outsourcing solutions. For example, in 2009, we created a joint venture with Bharti Airtel to manage its pan-India broadband and traditional wireline networks and to help Airtels transition to a next generation network. Through the joint venture, both partners derive financial benefit from the efficiency gains created from the outsourcing. Elsewhere in India, in 2009, we expanded the scope of our managed services joint venture with Reliance Communications to include additional responsibilities and a wider geographic area.
We are a global player in the delivery of multi-vendor maintenance services. Multi-vendor maintenance services create operational efficiencies for customers by restructuring and streamlining traditional maintenance functions and delivering improved service levels at a lower total cost. Our global reach, multi-vendor technology skills, integrated delivery capability, and delivery track record characterize our offerings. Multi-vendor services include technical support to diagnose, restore, and resolve network problems, and spare parts management to improve asset utilization. They include remote and on-site technical support services for both proactive and reactive maintenance services.
Product-attached services include network build and implementation (NBI) and maintenance services that are provided for our equipment and systems. Our NBI services support networks of all sizes and complexity whether they be wireless, wireline or converged. These activities are carried out by our own global workforce, supplemented by a network of qualified partners who ensure that our customers new networks are delivered cost-effectively and with minimum risk for our customers.
In 2009, our services segment revenues were € 3,569 million including intersegment revenues and € 3,537 million excluding intersegment revenues, representing 24% of our total revenues.
5.6 MARKETING AND DISTRIBUTION OF OUR PRODUCTS
We sell substantially all of our products and services to the worlds largest telecommunications service providers through our direct sales force, except in China where our products are also marketed through indirect channels and joint ventures that we have formed with Chinese partners. For sales to Tier 2 and Tier 3 service providers, we use our direct sales force and value-added resellers. Our three regionally focused sales organizations have primary responsibility for all customer-focused activities, and share that responsibility with the sales teams at certain integrated units such as submarine systems, radio frequency systems, Genesys and the select verticals piece of our enterprise business. Our enterprise communications products are sold through channel partners and distributors that are supported by our direct sales force.
In order to strengthen our customer focus, we discontinued the use of third party sales agents in 2009. We created the Solutions and Marketing organization in 2009 to focus on pre-sales activities and to combine the right products and services to create the solutions required by customers. This group provides the link between the business groups experts and the regional sales teams knowledge of their customers needs. Our Quality Assurance and Customer Care organization is dedicated to insuring that our solutions, products, and services are of the highest quality and will work seamlessly and reliably in our customers networks.
We have one of the broadest portfolios of product and services offerings in the telecommunications equipment and related services market, both for the carrier and non-carrier markets. Our addressable market segment is very broad and our competitors include large companies, such as Avaya, Cisco Systems, Ericsson, Fujitsu, Huawei, ZTE, Motorola and Nokia Siemens Networks (NSN). Some of our competitors, such as Ericsson, NSN and Huawei, compete across many of our product lines while others including a number of smaller companies compete in one segment or another. In recent years, consolidation has reduced the number of networking equipment vendors, and the list of our competitors may continue to change as the intensely competitive environment drives more consolidation. However, it is too early to predict the changes that may occur.
We believe that technological advancement, product and service quality, reliable on-time delivery, product cost, flexible manufacturing capacities, local field presence and long-standing customer relationships are the main factors that distinguish competitors within each of our segments in their respective markets. In todays tight-credit environment another factor that may serve to differentiate competitors, particularly in emerging markets, is the ability and willingness to offer some form of financing.
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We expect that the level of competition in the global telecommunications networking industry will remain intense, for several reasons. First, although consolidation among vendors results in a smaller set of competitors, it also triggers competitive attacks to increase established positions and market share, pressuring margins.
Consolidation also allows some vendors to enter new markets with acquired technology and capabilities, effectively backed by their size, relationships and resources. In addition, carrier consolidation is continuing in both developed and emerging markets, resulting in fewer customers overall. In those regions where capital expenditures remain under pressure in 2010, spending cuts will compound the competitive impact of a smaller set of customers. Most vendors are also targeting the same set of the worlds largest service providers because they account for the bulk of carrier spending for new equipment. Competition is also accelerating around IP network technologies as carriers continue to shift capital to areas that support the migration to next-generation networks. Furthermore, competitors providing low-priced products and services from Asia are gaining significant market share worldwide. They have been gaining share both in developed markets and in emerging markets, which account for a growing share of the overall market and which are particularly well-suited for those vendors low-cost, basic communications offerings. As a result, we continue to operate in an environment of intensely competitive pricing.
5.8 TECHNOLOGY, RESEARCH AND DEVELOPMENT
We place a priority on research and development because innovation creates technologies and products that can differentiate us from our competitors and can potentially generate new sources of revenue. Research is undertaken by Bell Labs, our research arm. The respective business units build on the research from Bell Labs and enhance products and solutions across our portfolio. We believe our R&D efforts in Applications Enablement and the High Leverage NetworkTM, with technologies such as network computing, LTE, optical networking, IP routing and fixed access may provide us with the best way to differentiate ourselves.
In 2009, Bell Labs played a lead role in laying the foundations of our Applications Enablement strategy and High Leverage NetworkTM architecture. Applications Enablement requires products that allow service providers to securely make their network assets available to application and content providers in order to accelerate application innovation. Our personal content management application product. It provides a collaborative Web 2.0 environment that allows users to access all their content premium (broadcast channels), private (pictures, home videos) and Web 2.0 community (YouTube movies, Flickr photoshows) on any device no matter where the content physically resides. This personal content management application is representative of a broad range of converged multimedia services that draw upon both fixed and mobile network assets.
Our High Leverage NetworkTM architecture requires network products that meet the need for high bandwidth while minimizing network transport costs. Specific examples of products for the High Leverage NetworkTM that we announced in 2009 include:
the Converged Backbone Transformation Solution, which tightly integrates a networks IP and optical layers;
the industrys first 100 Gigabit/second edge routers.
Network computing, another area of research focus, entails the transition from applications that run on a fixed set of resources to applications that run on a network of shared servers with dynamically-allocated resources that are delivered via the network or the cloud. Our research focuses on the technology required for real-time, interactive cloud-based services.
We have significantly increased our R&D emphasis on Long-Term Evolution (LTE), as momentum in the market builds behind this fourth-generation (4G) wireless technology. We aim to be strongly positioned to capitalize on LTE and, in the longer term, advanced LTE. For example, we conducted field trials of Coordinated Multipoint Transmission (CoMP) technology, which uses multiple antennas to deliver consistent performance and quality of service when a user accesses and shares any high-bandwidth service, whether the user is located close to the center of an LTE cell or at its outer edges. The CoMP technology builds on MIMO (Multiple Input-Multiple Output) antenna technology that was invented by Bell Labs.
Optical networking continues to be a core area of focus for us. In particular, we are making significant advances in 100 Gigabit/second optical transmission, a technology that will become critical for service providers as demand for high-speed broadband service builds. Although in the early development stages, we achieved a significant breakthrough using 155 lasers to sustain a record transmission speed of 100 Petabits per second. Our strength in optical transmission can be measured by the number of industry commendations received by our technical staff, including two Marconi Award winners, one of the optical networking industrys most prestigious commendations. Complementing our R&D in optical networking is our research in intelligent IP terabit routing platforms and converged IP and optical networks.
2009 also saw advances in broadband wireline access covering a broad spectrum of technologies, including VDSL2, a very high-speed evolution of traditional DSL technology, and 10G GPON, which will yield a tenfold increase over the speeds and capacity of todays GPON deployments. R&D efforts were also focused on components, notably Photonic Integrated Circuits (PICs) that are able to increase functionality and boost performance of optical networking equipment within a drastically reduced footprint.
Our ongoing research in the areas of mathematics, physical sciences, computer and software sciences serves as the backbone of our research in the areas mentioned above.
On December 17, 2009, Bell Labs extended its global scope by opening a new research facility in Seoul, South Korea. With Seoul, Bell Labs has eight locations around the globe: USA, France, Belgium, Germany, Ireland, India, China and South Korea.
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During 2009, several current and past members of the Bell Labs research community and the broader Alcatel-Lucent technical community were the recipients of more than 30 prestigious awards. Some of the most notable included:
the Nobel Prize in Physics for the invention and development of the charge-coupled device (CCD);
the Marconi Prize for optical transmission;
the John Tyndall Award for seminal contributions to advanced lightwave communications networks;
IEEE Eric Sumner Award for pioneering contributions to multi antennas systems and microwave propagation;
National Inventors Hall of Fame Award; and
To better advance the Groups innovation strategy, Bell Labs has defined five major themes that will serve as a focus for research efforts and to better serve our customers.
Efficient Networks: We are focused on increasing the overall efficiency of networks, with research projects to maximize spectral efficiency and improve the energy efficiency of communications networks. This research fits within our Green TouchTM initiative and consortium that we announced in January 2010 to create the technologies needed to make communications networks more energy efficient than they are today.
100% Coverage: Focused on ensuring universal access to high speed broadband networks.
Network Virtualization: Focused on inventing technologies to allow a single physical network to operate as if it were multiple networks, each with a distinct function or supporting a different service provider. This technology will have clear cost benefits and make it possible for service providers to more easily scale and accommodate exponential growth in traffic.
Everything as a Service: Focused on utilizing cloud computing (on-demand network access to a shared pool of computing resources) to provide traditional telecom services and applications. Our vision is to create a network where all services reside and are updated automatically.
Everything is Video: Focused on scaling networks to support increased traffic resulting from the increased use of video.
In 2009, we took a number of initiatives to further strengthen the innovation culture within our company, as well as advance open innovation programs that engage third parties in generating and exploiting new market opportunities.
Within the company an ongoing series of Entrepreneurial Bootcamps were conducted during the course of 2009. The Entrepreneurial Boot Camp is an internal opportunity identification program designed to enable employees to develop innovative ideas into comprehensive Business Opportunity Plans. The programs goal is to stimulate innovation and enhance creativity across the organization with an eye towards injecting new ideas into the market and sharpening the companys competitive edge. Promising Bootcamp solutions are typically incubated within our Ventures unit or absorbed into one of our business groups.
Regarding open innovation, Bell Labs has adopted a new strategy that changes the scope of research from traditional co-research initiatives to one that encompasses a broader business perspective and involves, from the outset, a wider range of stakeholders, including our partners. Following this strategy, two pilot projects were initiated in 2009 that focused on growth opportunities in new, non-traditional markets.
Reliability is essential for the continuous and successful operation of todays complex communications infrastructures. In 2009, we initiated a program to improve the reliability of our products and solutions. The program stressed the early design alignment of products with:
customized reliability performance objectives;
a best-in-class planning framework for achieving these objectives; and
implementation of industry consensus best practices.
In addition, the improvement program utilizes the Eight Ingredient (8i) Framework, an advanced methodology we developed that is widely used by industry, government and academia to analyze the communications infrastructure and to achieve high levels of control for systems.
More than 500 employees were actively engaged with telecommunication standardization bodies during 2009. Our engineers have participated in approximately 100 standards organizations and more than 200 different working groups, including the 3GPP, 3GPP2, ATIS, Broadband Forum, CCSA, ETSI, IEEE, IETF, OMA, Open IPTV Forum, TIA and the WiMAX Forum. The initial direction of our efforts has been to ensure standards support for our Applications Enablement and High Leverage NetworkTM strategies, and to reinforce our position as a leading contributor in the areas of Access, IP, Optics and Wireless technologies, with a particular focus on LTE. We have also taken a very active role in initiatives around energy efficient, or Green Networks.
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5.9 INTELLECTUAL PROPERTY
In 2009, we obtained more than 2,100 patents worldwide, resulting in a portfolio of more than 27,600 active patents worldwide across a vast array of technologies. We also continued to actively pursue a strategy of licensing selected technologies to expand the reach of our technologies and to generate licensing revenues.
We rely on patent, trademark, trade secret and copyright laws both to protect our proprietary technology and to protect us against claims from others. We believe that we have direct intellectual property rights or rights under licensing arrangements covering substantially all of our material technologies.
We consider patent protection to be particularly important to our businesses due to the emphasis on Research and Development and intense competition in our markets.
5.10 SOURCES AND AVAILABILITY OF MATERIALS
We make significant purchases of electronic components and other materials from many sources. While we have experienced some shortages in components and other commodities commonly used across the industry, we have generally been able to obtain sufficient materials and components from various sources around the world to meet our needs. We continue to develop and maintain alternative sources of supply for essential materials and components.
We do not have a concentration of sources of supply of materials, labor or services that, if suddenly eliminated, could severely impact our operations, and we believe that we will be able to obtain sufficient materials and components from U.S., European and other world market sources to meet our production requirements.
The typical quarterly pattern in our revenues a weak first quarter, a strong fourth quarter and second and third quarter results that fall between those two extremes generally reflects the traditional seasonal pattern of service providers capital expenditures. In 2009, however, the typical seasonal pattern in our revenues was somewhat muted, especially in the fourth quarter when our revenues accounted for a smaller piece of full year revenue than has been the case in recent years. We expect the traditional seasonal pattern of service providers capital expenditures and in our quarterly revenues will continue in 2010.
5.12 OUR ACTIVITIES IN CERTAIN COUNTRIES
We operate in more than 130 countries, some of which have been accused of human rights violations, are subject to economic sanctions by the U.S. Treasury Departments Office of Foreign Assets Control or have been identified by the U.S. State Department as state sponsors of terrorism. Some U.S.-based pension funds and endowments have announced their intention to divest the securities of companies doing business in some of these countries and some state and local governments have adopted, or are considering adopting, legislation that would require their state and local pension funds to divest their ownership of securities of companies doing business in those countries. Our net revenues in 2009 attributable to these countries represented less than one percent of our total net revenues. Although U.S.-based pension funds and endowments own a significant amount of our outstanding stock, most of these institutions have not indicated that they intend to effect such divestment.
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5.13 ENVIRONMENTAL MATTERS
We are subject to national and local environmental and health and safety laws and regulations that affect our operations, facilities and products in each of the jurisdictions in which we operate. These laws and regulations impose limitations on the discharge of pollutants into the air and water, establish standards for the treatment, storage and disposal of solid and hazardous waste and may require us to clean up a site at significant cost. In the U.S., these laws often require parties to fund remedial action regardless of fault. We have incurred significant costs to comply with these laws and regulations and we expect to continue to incur significant compliance costs in the future.
Remedial and investigatory activities are under way at numerous current and former facilities owned or operated by the respective historical Alcatel and Lucent entities. In addition, Lucent was named a successor to AT&T as a potentially responsible party at numerous Superfund sites pursuant to the U.S. Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) or comparable state statutes in the United States. Under a Separation and Distribution Agreement with AT&T and NCR Corp. (a former subsidiary of AT&T), Lucent is responsible for all liabilities primarily resulting from or relating to its assets and the operation of its business as conducted at any time prior to or after the separation from AT&T, including related businesses discontinued or disposed of prior to its separation from AT&T. Furthermore, under that Separation and Distribution Agreement, Lucent is required to pay a portion of contingent liabilities in excess of certain amounts paid out by AT&T and NCR, including environmental liabilities. For a discussion about one such matter that involves the clean up of the Fox River in Wisconsin, USA, please refer to Section 6.7 Contractual Obligations and Off-Balance Sheet Contingent Commitments Specific commitments of former Lucent in this annual report. In Lucents separation agreements with Agere and Avaya, those companies have agreed, subject to certain exceptions, to assume all environmental liabilities related to their respective businesses.
It is our policy to comply with environmental requirements and to provide workplaces for employees that are safe and environmentally sound and that will not adversely affect the health or environment of communities in which we operate. Although we believe that we are in substantial compliance with all environmental and health and safety laws and regulations and that we have obtained all material environmental permits required for our operations and all material environmental authorizations required for our products, there is a risk that we may have to incur expenditures significantly in excess of our expectations to cover environmental liabilities, to maintain compliance with current or future environmental and health and safety laws and regulations or to undertake any necessary remediation. The future impact of environmental matters, including potential liabilities, is often difficult to estimate. Although it is not possible at this stage to predict the outcome of the remedial and investigatory activities with any degree of certainty, we believe that the ultimate financial impact of these activities, net of applicable reserves, will not have a material adverse effect on our consolidated financial position or our income (loss) from operating activities.
5.14 HUMAN RESOURCES
In 2009, our Human Resources teams played a key role in supporting our strategic transformation, encouraging diversity, promoting the development of talent and laying the groundwork for a new approach to employee recognition and engagement.
Our strategic transformation journey
In 2009, we accelerated our strategic transformation. Our transformation program is aimed at giving coherence to all the actions engaged across all functions and all regions of our company. It is based on three main components: Strategy, Systems & Structure, and Culture & Behavior. It is this last component that is entirely the responsibility of our employees, supported by our Human Resources teams. In 2009, we established a set of key performance indicators in order to measure progress on changing behavior. Each employee was asked to define at least one objective that takes into account one of our core values: put the customer first, be accountable, be a global team player, focus on innovation, lead courageously, and show respect, passion and energy.
From an organizational point of view, we have flattened the hierarchies in our management structures to become more innovative, empower our people and eliminate silos.
We have also held over 20 strategy roadshows across our three regions to help all employees better understand our transformation strategy and more clearly see the changes that have already been made.
Developing and managing our talent
Our long-term success depends in part upon our ability to manage our human capital. In this respect, our Human Resources team members provide the necessary expertise and support and beyond, besides individual actions and regional initiatives, a number of concrete global programs also exist. Our Global Performance Management Process (GPMP), for example, helps managers and employees work together to define clear, consistent goals and then document their accomplishments. It facilitates open discussion and feedback, aids in the creation of development plans, and helps to support our business objectives. In 2009, more than 84% of our managers and professionals used the GPMP for their annual review. With our yearly Organization and People Reviews (OPR), we build and develop a pipeline of future leaders with the potential to take over the most strategic positions in the company. We also define succession plans for all key positions to ensure leadership continuity. Our 360° Feedback Program is an on line-process helping leaders and managers identify their key strengths and development needs based on our defined Leadership Competencies, and then build a development plan by working with a certified coach. A dedicated Transformation 360 project was also launched in 2009, engaging all our mid-level leaders as change agents and developing their change management skills. Our Key Performer Learning Program provides timely and compelling training to our current and future leaders, helping them develop thought leadership, results leadership, personal leadership, and people leadership.
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A truly global learning community, Alcatel-Lucent University is a network of 21 accredited training centers. Last year, Alcatel-Lucent University launched its fully accredited training center in Istanbul, Turkey. In 2009, our employees averaged 17 hours of training, 40% of which was taken online (up from 33% in 2008). Overall, more than 65,000 employees received formal training in 2009 (approximately 83% of our employees). A strategic learning priority is that of Business Transformation, consisting of 15 operational learning programs designed to enhance the knowledge and efficiency of Alcatel-Lucent employees. Alcatel-Lucent University is also addressing the need for employee technology qualification programs in strategic areas, such as LTE and Applications Enablement.
Recognizing exceptional contributions
At the end of 2009, we launched a program to recognize specific people and teams who have made outstanding contributions. Among several features of this program, the CEO Excellence Award Recognizing Change will be given to an employee or a team for work that embodies the new behavior of transformation and that can be replicated across the company.
For many years now, we have actively encouraged mobility across geographical, organizational and functional borders. Mobility is a key element of our human resource policy, because we know that giving people opportunities to explore new career options and to pursue professional advancement makes our entire company stronger. Our goal is to have 80% of our high-potential employees change their assignment within the next three years. In 2009, 70.4% of these high-potential employees had been in their current role for less than three years.
DIVERSITY AND EQUAL OPPORTUNITY
With more than 78,000 employees living in 130 countries and representing more than 100 nationalities, we have employees of all ages, from all walks of life and from very different backgrounds. This is a great source of our strength and we firmly believe that it allows each of us to develop new ways of looking at issues and to contribute to our innovation and creativity. In todays global environment we believe more than ever before that it is crucial to understand the cultures, customs and needs of employees, customers and regional markets. As a global enterprise, we actively seek to ensure that our employee body reflects the diversity of our business environment. Our Statement of Business Principles, and our Human Rights policies clearly confirm our responsibility to recognizing and respecting the diversity of people and ideas, and to ensuring equal opportunities.
In 2009, we paid particular attention to the Generation Y population (individuals born between the late 1970's and the mid-1990's), and to gender diversity.
A COMPETITIVE AND HARMONIZED COMPENSATION POLICY
We are committed to providing our employees with a total compensation package that, in each country, is competitive with those of major companies in the technology sector. Our compensation structure reflects both individual and company performance. Our policy is for all employees to be fairly paid regardless of gender, ethnic origin or disability.
We also have a long-term remuneration policy involving equity ownership. In March 2009, our Board of Directors approved the allocation of 400 stock options to all employees, with an exercise price set at 2 euros. By granting every employee stock options, we sought to recognize and underline that each person plays a role in the transformation of our company.
Leveling and grading program
To properly manage human resources programs in the new company organization and structure launched in January 2009, it was necessary to evaluate the appropriate level and grade for each employee. In 2009, we undertook this Leveling & Grading program. All employees have now received their personal levels and grades from their direct supervisors. Thanks to this action, we have created a common reference point to be used to qualify future promotions and facilitate internal mobility. This new leveling and grading structure will also enable us to better benchmark ourselves versus the external market and will add further structure to compensation decisions.
Progress on our plan to reduce costs and streamline our structure
As of the fourth quarter 2009 and on an annualized exit run rate, Alcatel-Lucent has reduced its cost and expense structure by approximately 950 million at constant currency, of which approximately 40% in Cost of sales (including fixed operations, product and procurement costs), 25% in R&D and 35% in Administrative and Selling expenses (including marketing, general & administrative costs).
In 2009, the company estimates that it has reduced its break-even point defined as the amount of revenue required to achieve break-even at the adjusted1 operating level by 1.05 billion at constant currency.
In 2009, Alcatel-Lucent reduced its operating working capital by 597 million through a decrease in net inventories of 488 million or 5 days, a decrease in net receivables of 1,174 million or 16 days, partially offset by a decrease in payables, progress payments and product reserves on construction contracts of 1,065 million or 11 days. In 2009, the company reduced its cash conversion cycle by 10 days.
Maintaining a dialogue with employees
The Alcatel-Lucent European Committee for Information and Dialogue (ECID) is one way we maintain an open dialogue with employees and their representatives on the important actions and decisions that directly affect the company where they are working. ECID allows Alcatel-Lucent senior management and European employee representatives to exchange views. The committee has 30 members, including since January 2009 representatives from Romania. There is also a separate liaison committee made up of five members designated by the ECID among the main European countries that have the largest number of Alcatel-Lucent employees. In 2009, ECID decided to maintain the previous years liaison committee countries and so had representatives from Germany, Belgium, Spain, France and Italy. In 2009, ECID met three times (March, June and October) and specific meetings were also organized with the liaison committee when appropriate.
At December 31, 2009, we employed 78,373 people worldwide, compared with 77,717 at December 31, 2008 and 76,410 at December 31, 2007.
Adjusted refers to the fact that it excludes the main impacts from Lucents purchase price allocation.
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The tables below show the geographic locations and the business segments in which our employees worked on December 31, 2007 through 2009.
Total number of employees and the breakdown of this number by business segment and by geographical area is determined by taking into account all of the employees at year-end who worked for fully consolidated companies and companies in which we own 50% or more of the equity.
BREAKDOWN OF EMPLOYEES BY BUSINESS SEGMENT
BREAKDOWN OF EMPLOYEES BY GEOGRAPHICAL AREA
Movements in headcount due to Group perimeter changes during 2009 amounted to a net increase of 3,032 employees, mainly due to insourcing in India within the context of managed services contracts.
Membership of our employees in trade unions varies from country to country. In general, relations with our employees are satisfactory.
Contractors and Temporary workers
The average number of contractors (that is, individuals at third parties performing work subcontracted by us on a Time and Materials basis, when such third parties cost to us is almost exclusively a function of the time spent by their employees in performing this work), and of temporary workers (that is, in general, employees of third parties seconded to perform work at our premises due, for example, to a short-term shortfall in our employees or in the availability of a certain expertise) in 2009 was 9,624 in the aggregate.
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6 OPERATING AND FINANCIAL REVIEW AND PROSPECTS
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This Form 20-F, including the discussion of our Operating and Financial Review and Prospects, contains forward-looking statements based on beliefs of our management. We use the words anticipate, believe, expect, may, intend, should, plan, project, or similar expressions to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to risks and uncertainties. Many factors could cause the actual results to be materially different, including, among others, changes in general economic and business conditions, changes in currency exchange rates and interest rates, introduction of competing products, lack of acceptance of new products or services and changes in business strategy. Such forward-looking statements include, but are not limited to, the forecasts and targets set forth in this Form 20-F, such as the discussion in Chapter 4 Information about the Group and below in this Chapter 6 under the heading Outlook for 2010 with respect to (i) our projection that the 2010 global telecommunications equipment and related services market should experience nominal growth, defined as between 0% and 5%, at constant currency rates; (ii) our aim to reach an operating profit before restructuring costs, impairment of assets, gain/loss on disposal of consolidated entities, litigations and post-retirement benefit plan amendments (excluding the negative non-cash impacts of Lucents purchase price allocation) in the low to mid single digit range as a percent of revenues (defined as between 1% and 5% of revenues) in 2010; (iii) our aspiration to an operating profit before restructuring costs, impairment of assets, gain/loss on disposal of consolidated entities, litigations and post-retirement benefit plan amendments (excluding the negative non-cash impacts of Lucents purchase price allocation) in the mid to high single-digit range as a percent of revenues (defined as between 5% and 9% of revenues) in 2011; (iv) such forward-looking statements regarding the expected level of restructuring costs and capital expenditures in 2010 can be found under the heading Liquidity and Capital Resources; and (v) statements regarding the amount we would be required to pay in the future pursuant to our existing contractual obligations and off-balance sheet contingent commitments are also forward-looking statements and can be found under the heading Contractual obligations and off-balance sheet contingent commitments.
PRESENTATION OF FINANCIAL INFORMATION
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes presented elsewhere in this document. Our consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. IFRSs, as adopted by the European Union, differ in certain respects from the International Financial Reporting Standards issued by the International Accounting Standards Board. However, our consolidated financial statements for the years presented in this document in accordance with IFRSs would be no different if we had applied International Financial Reporting Standards issued by the International Accounting Standards Board. References to IFRSs in this Form 20-F refer to IFRSs as adopted by the European Union.
As a result of the purchase accounting treatment of the Lucent business combination required by IFRSs, our results for 2009, 2008 and 2007 included several negative, non-cash impacts of purchase accounting entries.
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CHANGES IN ACCOUNTING STANDARDS AS OF JANUARY 1, 2009
New financial reporting standards and interpretations that the Group applies but which are not yet mandatory
As of December 31, 2009, we had not applied any new International Financial Reporting Standards and Interpretations that the European Union had published and adopted but which were not yet mandatory.
New financial reporting standards or amendments applied as of January 1, 2009
IAS 1 Presentation of Financial Statements revised
The IASB published a revised IAS 1 Presentation of Financial Statements: A Revised Presentation during 2007, which were endorsed by the European Union and became effective as of January 1, 2009.
The main changes from the previous version of IAS 1 are:
the titles balance sheet and cash flow statement are now denominated statement of financial position and statement of cash flows;
all changes arising from transactions with owners in their capacity as owners are presented separately from non-owner changes in equity;
income and expenses are presented in either one statement (statement of comprehensive income) or two statements (a separate income statement and a statement of comprehensive income);
total comprehensive income is presented in the financial statements.
CRITICAL ACCOUNTING POLICIES
Our Operating and Financial Review and Prospects is based on our consolidated financial statements, which are prepared in accordance with IFRS as described in Note 1 to those consolidated financial statements. Some of the accounting methods and policies used in preparing our consolidated financial statements under IFRS are based on complex and subjective assessments by our management or on estimates based on past experience and assumptions deemed realistic and reasonable based on the circumstances concerned. The actual value of our assets, liabilities and shareholders equity and of our earnings could differ from the value derived from these estimates if conditions changed and these changes had an impact on the assumptions adopted.
We believe that the accounting methods and policies listed below are the most likely to be affected by these estimates and assessments:
Valuation allowance for inventories and work in progress
Inventories and work in progress are measured at the lower of cost or net realizable value. Valuation allowances for inventories and work in progress are calculated based on an analysis of foreseeable changes in demand, technology or the market, in order to determine obsolete or excess inventories and work in progress.
The valuation allowances are accounted for in cost of sales or in restructuring costs depending on the nature of the amounts concerned.
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Impairment of customer receivables
An impairment loss is recorded for customer receivables if the present value of the future receipts is below the nominal value. The amount of the impairment loss reflects both the customers ability to honor their debts and the age of the debts in question. A higher default rate than estimated or the deterioration of our major customers creditworthiness could have an adverse impact on our future results.
Capitalized development costs, other intangible assets and goodwill
CAPITALIZED DEVELOPMENT COSTS
The criteria for capitalizing development costs are set out in Note 1f to our consolidated financial statements included elsewhere in this annual report. Once capitalized, these costs are amortized over the estimated useful lives of the products concerned (3 to 10 years).
We must therefore evaluate the commercial and technical feasibility of these development projects and estimate the useful lives of the products resulting from the projects. Should a product fail to substantiate these assumptions, we may be required to impair or write off some of the capitalized development costs in the future.
An impairment loss of €20 million for capitalized development costs was accounted for in 2009.
Impairment losses for capitalized development costs of €135 million were accounted for in the fourth quarter of 2008 mainly related to a change in our WiMAX strategy, by focusing on supporting fixed and nomadic broadband access applications for providers. These impairment losses are presented in the line item Impairment of assets in the income statement.
During the fourth quarter of 2009, following our decision to cease any new WiMAX development on the existing hardware platform and software release, restructuring costs of €44 million were reserved.
Impairment losses for capitalized development costs of €41 million were accounted for in 2007 mainly related to the UMTS (Universal Mobile Telecommunications Systems) business.
OTHER INTANGIBLE ASSETS AND GOODWILL
Goodwill amounting to € 8,051 million and intangible assets amounting to € 4,813 million were accounted for in 2006 as a result of the Lucent business combination (as described in Note 3 to our Consolidated Financial Statements), using market-related information, estimates (primarly based on risk adjusted discounted cash flows derived from Lucents management) and judgment (in particular in determining the fair values relating to the intangible assets acquired).
No impairment loss on goodwill was accounted for during 2009.
Impairment losses of €4,545 million were accounted for in 2008 mainly related to the CDMA (€2,533 million), Optics (€1,019 million), Multicore (€300 million), and Applications (€339 million) business divisions, each of which were considered to be groups of Cash Generating Units (“CGUs”) in 2008 at which level impairment tests of goodwill are performed. Please refer to Notes 7, 12 and 13 to our consolidated financial statements for a further explanation.
An impairment loss of €2,832 million was accounted for in 2007, of which €2,657 million was charged to goodwill and €175 million was charged to other intangible assets, mainly for the CDMA and IMS Business Divisions and the UMTS business.
The recoverable value of each business division is calculated upon a five years discounted cash flow approach plus a discounted residual value, corresponding to the weighted average of the following three approaches:
capitalization to perpetuity of the normalized cash flows of year 5 (Gordon Shapiro approach) weighted 50%;
application of a Sales Multiple (Enterprise Value EV/Sales) weighted 25%;
application of an Operating Profit Multiple (Enterprise Value-EV/Earnings Before Interest, Tax, Depreciation and Amortization EBITDA) weighted 25%.
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The recoverable values of our goodwill and intangible assets, as determined for the 2009 annual impairment test performed by the Group in the second quarter 2009, were based on key assumptions which could have a significant impact on the consolidated financial statements. Some of these key assumptions are:
discount rate; and
projected cash-flows arising out of the successful implementation of the strategic plan the Group publicly announced on December 12, 2008 and on a nominal rate of growth of our revenues in 2010.
The discount rates used for the annual impairment tests of 2009, 2008 and 2007 were the Groups weighted average cost of capital (WACC) of 11%, 10% and 10% respectively. For the additional impairment tests performed during the fourth quarter of 2008 and 2007, the rates used were 12% and 10% respectively. The discount rates used for both the annual and additional impairment tests are after-tax rates applied to after-tax cash flows. The use of such rates results in recoverable values that are identical to those that would be obtained by using, as required by IAS 36, pre-tax rates applied to pre-tax cash flows. Given the absence of comparable pure player listed companies for each group of Cash Generating Units, we do not believe that the assessment of a specific WACC for each product or market is feasible. A single discount rate has therefore been used on the basis that risks specific to certain products or markets have been reflected in determining the cash flows.
Holding all other assumptions constant, a 0.5% increase or decrease in the discount rate would have decreased or increased the 2009 recoverable value of goodwill and intangible assets by €373 million and €406 million, respectively. An increase of 0.5% in the discount rate would not have impacted impairment losses as of December 31, 2009.
As indicated in Note 1g to our consolidated financial statements, in addition to the annual goodwill impairment tests, impairment tests are carried out if we have indications of a potential reduction in the value of its goodwill or intangible assets. Possible impairments are based on discounted future cash flows and/or fair values of the assets concerned. Changes in the market conditions or the cash flows initially estimated can therefore lead to a review and a change in the impairment losses previously recorded.
Due to the change in the recent economic environment and the volatile behaviour of financial markets, the Group assessed whether as of December 31, 2009 there was any indication that any business division goodwill may be impaired at that date. The Group concluded that there were no triggering events that would justify performing an additional impairment test as of December 31, 2009.
Impairment of property, plant and equipment
In accordance with IAS 36 Impairment of Assets, when events or changes in market conditions indicate that tangible or intangible assets may be impaired, such assets are reviewed in detail to determine whether their carrying value is lower than their recoverable value, which could lead to recording an impairment loss (recoverable value is the higher of value in use and fair value less costs to sell) (see Note 1g to our consolidated financial statements). Value in use is estimated by calculating the present value of the future cash flows expected to be derived from the asset. Fair value less costs to sell is based on the most reliable information available such as market statistics and recent transactions.
When determining recoverable values of property, plant and equipment, assumptions and estimates are made, based primarily on market outlooks, obsolescence and sale or liquidation disposal values. Any change in these assumptions can have a significant effect on the recoverable amount and could lead to a revision of recorded impairment losses.
The planned closing of certain facilities, additional reductions in personnel and unfavorable market conditions have been considered impairment triggering events in prior years. No impairment loss on property, plant and equipment was accounted for in 2009 (€39 million in 2008). Impairment losses of €94 million were accounted for during 2007 mainly related to the UMTS business and the planned disposal of real estate.
Provision for warranty costs and other product sales reserves
Provisions are recorded for (i) warranties given to customers for our products, (ii) expected losses at completion and (iii) penalties incurred in the event of failure to meet contractual obligations. These provisions are calculated based on historical return rates and warranty costs expensed as well as on estimates. These provisions and subsequent changes to the provisions are recorded in cost of sales either when revenue is recognized (provision for customer warranties) or, for construction contracts, when revenue and expenses are recognized by reference to the stage of completion of the contract activity. Costs and penalties ultimately paid can differ considerably from the amounts initially reserved and could therefore have a significant impact on future results.
PRODUCT SALES RESERVES
For further information on the impact on the income statement of the change in these provisions, see Notes 18 and 27.
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Deferred tax assets relate primarily to tax loss carry-forwards and to deductible temporary differences between reported amounts and the tax bases of assets and liabilities. The assets relating to the tax loss carry-forwards are recognized if it is probable that the Group will generate future taxable profits against which these tax losses can be set off.
Evaluation of the Groups capacity to utilize tax loss carry-forwards relies on significant judgment. The Group analyzes past events and the positive and negative elements of certain economic factors that may affect its business in the foreseeable future to determine the probability of its future utilization of these tax loss carry-forwards, which also consider the factors indicated in Note 1n to our consolidated financial statements. This analysis is carried out regularly in each tax jurisdiction where significant deferred tax assets are recorded. If future taxable results are considerably different from those forecast that support recording deferred tax assets, the Group will be obliged to revise downwards or upwards the amount of the deferred tax assets, which would have a significant impact on our statement of financial position and net income (loss).
As a result of the business combination with Lucent, €2,395 million of net deferred tax liabilities were recorded as of December 31, 2006, resulting from the temporary differences generated by the differences between the fair value of assets and liabilities acquired (mainly intangible assets such as acquired technologies) and their corresponding tax bases. These deferred tax liabilities will be reduced in future Group income statements as and when such differences are amortized. The remaining deferred tax liabilities related to the purchase price allocation of Lucent as of December 31, 2009 are €751 million (€957 million as of December 31, 2008 and €1,629 million as of December 31, 2007).
As prescribed by IFRSs, we had a twelve-month period to complete the purchase price allocation and to determine whether certain deferred tax assets related to the carry-forward of Lucents unused tax losses that had not been recognized in Lucents historical financial statements should be recognized in the combined company's financial statements. If any additional deferred tax assets attributed to the combined companys unrecognized tax losses existing as of the transaction date are recognized in future financial statements, the tax benefit will be included in the income statement.
Pension and retirement obligations and other employee and post-employment benefit obligations
Our results of operations include the impact of significant pension and post-retirement benefits that are measured using actuarial valuations. Inherent in these valuations are key assumptions, including assumptions about discount rates, expected return on plan assets, healthcare cost trend rates and expected participation rates in retirement healthcare plans. These assumptions are updated on an annual basis at the beginning of each fiscal year or more frequently upon the occurrence of significant events. In addition, discount rates are updated quarterly for those plans for which changes in this assumption would have a material impact on our results or shareholders equity.
The net effect of pension and post-retirement costs included in income (loss) before tax, related reduction of goodwill and discontinued operations” was a €150 million increase in pre-tax income during 2009 (€246 million increase in pre-tax income during 2008 and a €628 million increase in pre-tax income during 2007). Included in the €150 million increase in 2009 was €253 million booked as a result of certain changes to management retiree pension and healthcare benefit plans. Included in the €246 million increase in 2008 was €65 million booked as a result of certain changes to management retiree healthcare benefit plans. Included in the €628 million increase in 2007 was €258 million booked as a result of certain changes to management retiree healthcare benefit plans. Please refer to Note 25f to our consolidated financial statements for a further discussion of these changes.
Discount rates for our U.S. plans are determined using the values published in the original CitiGroup Pension Discount Curve which is based on AA-rated corporate bonds. Each future year's expected benefit payments are discounted by the discount rate for the applicable year listed in the CitiGroup Curve, and for those years beyond the last year presented in the CitiGroup Curve for which we have expected benefit payments, we apply the discount rate of the last year presented in the Curve. After applying the discount rates to all future years benefits, we calculate a single discount rate that results in the same interest cost for the next period as the application of the individual rates would have produced. Discount rates for Alcatel-Lucent's non U.S. plans are determined based on Bloomberg AA Corporate yields.
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Holding all other assumptions constant, a 0.5% increase or decrease in the discount rate would have decreased or increased the 2009 net pension and post-retirement result by approximately €(35) million and €49 million, respectively.
Expected return on plan assets
Expected return on plan assets for our U.S. plans is determined based on recommendations from our external investment advisor and our own historical returns experience. Our advisor develops its recommendations by applying the long-term return expectations it develops for each of many classes of investments, to the specific classes and values of investments held by each of our benefit plans. Expected return assumptions are long-term assumptions and are not intended to reflect expectations for the period immediately following their determination. Although these assumptions are reviewed each year, we do not update them for small changes in our advisor's recommendations. However, the pension expense or credit for our U.S. plans is updated every quarter using the fair value of assets and discount rates as of the beginning of the quarter. The 2009 fourth quarter expected return on plan assets (accounted for in other financial income (loss)) for our U.S. plans is based on September 30, 2009 plan asset fair values. However, the expected return on plan assets for our non U.S. plans is based on the fair values of plan assets at December 31, 2008.
Holding all other assumptions constant, a 0.5% increase or decrease in the expected return on plan assets would have increased or decreased the 2009 net pension and post-retirement result by approximately €122 million.
We recognized a U.S.$ 70 million increase between the third and the fourth quarters of 2009 in the net pension credit, which is accounted for in other financial income (loss). The net pension credit increased due to an increase in the expected return on plan assets for our U.S. plans resulting from the increase in the plan asset fair values and the expected change of the interest cost in relation to the change in the liability). On our U.S. plans, we expect a U.S.$ 30 million decrease in the net pension credit to be accounted for in other financial income (loss) between the 2009 fourth quarter and the 2010 first quarter. Alcatel-Lucent does not anticipate a material impact outside U.S. plans.
Healthcare inflation trends
Regarding healthcare inflation trend rates for our U.S. plans, our actuary annually reviews expected cost trends from numerous healthcare providers, recent developments in medical treatments, the utilization of medical services, and Medicare future premium rates published by the U.S. Government's Center for Medicare and Medicaid Services (CMS) as these premiums are reimbursed for some retirees. The actuary applies its findings to the specific provisions and experience of our U.S. post-retirement healthcare plans in making its recommendations. In determining our assumptions, we review our recent experience together with our actuary's recommendations.
Our U.S. post-retirement healthcare plans allow participants to opt out of coverage at each annual enrollment period, and for almost all to opt back in at any future annual enrollment. An assumption is developed for the number of eligible retirees who will elect to participate in our plans at each future enrollment period. Our actuaries develop a recommendation based on the expected increases in the cost to be paid by a retiree participating in our plans and recent participation history. We review this recommendation annually after the annual enrollment has been completed and update it if necessary.
The mortality assumption for our U.S. plans is based on actual recent experience of the participants in our management pension plan and our occupational pension plans. For the 2009 year-end valuation, we updated the mortality assumptions, again based on the actual experience of the two plans. We looked at the experience for the years of 2004 through 2008. As was the case previously, there was insufficient experience to develop assumptions for active employees and former employees who have delayed commencing their pension benefits, so we used the RP 2000 mortality table projected up to 2009.
PLAN ASSETS INVESTMENT
At its meeting in July 29, 2009, our Board of Directors approved the following modifications to the asset allocation of our pension funds: the investments in equity securities is to be reduced from 22.5% to 15% and the investments in bonds is to be increased from 62.5% to 70%, while investments in alternatives (such as real estate, private equity and hedge funds) is to remain unchanged. The reduction in equity investments in favor of fixed income securities was achieved immediately. The implementation of the asset allocation approved on July 29, 2009 was completed as of January 1, 2010. We believe that these changes should lead to a slight decrease in long-term returns from financial assets. The impact of these changes has been reflected in our expected return assumptions for 2010.
Plans assets are invested in many different asset categories (such as cash, equities, bonds, real estate and private equity). In the quarterly update of plan asset fair values, approximately 80% are based on closing date fair values and 20% have a one to three month delay as the fair value of private equity, venture capital, real estate and absolute return investments are not available in a short period. This is standard practice in the investment management industry. Assuming that the December 31, 2009 actual fair values of private equity, venture capital, real estate and absolute return investments at year end were 10% lower than the ones used for accounting purposes as of December 31, 2009, and since the Management Pension Plan has a material investment in these asset classes (and the asset ceiling described below is not applicable to this plan), equity would be negatively impacted by approximately €210 million.
According to IAS 19, the amount of prepaid pension costs that can be recognized in our financial statements is limited to the sum of (i) the cumulative unrecognized net actuarial losses and prior service cost, (ii) the present value of any available refunds from the plan and (iii) any reduction in future contributions to the plan. Since we have used and intend to use in the future eligible excess pension assets applicable to formerly union-represented retirees to fund certain retiree healthcare benefits for such retirees, such use is considered as a reimbursement from the pension plan when setting the asset ceiling.
The impact of expected future economic benefits on the pension plan asset ceiling is a complex matter. For formerly union-represented retirees, we expect to fund our current retiree healthcare obligation with Section 420 Transfers from the U.S. Occupational pension plan. Section 420 of the U.S. Internal Revenue Code provides for transfers of certain excess pension plan assets held by a defined pension plan into a retiree health benefits account established to pay retiree health benefits. We may select among numerous methods available for valuing plan assets and obligations for funding purposes and for determining the amount of excess assets available for Section 420 Transfers. The assumptions to be used for the January 1, 2010 valuation have not been chosen at this time.
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Also, asset values for private equity, real estate, and certain alternative investments, and the obligation based on January 1, 2010 census data will not be final until late in the third quarter of 2010. Prior to the Pension Protection Act of 2006 (or the PPA), Section 420 of the U.S. Internal Revenue Code allowed for a Section 420 Transfer in excess of 125% of a pension plan's funding obligation to be used to fund the healthcare costs of that plan's retired participants. The Code permitted only one transfer in a tax year with transferred amounts being fully used in the year of the transfer. It also required the company to continue providing healthcare benefits to those retirees for a period of five years beginning with the year of the transfer (cost maintenance period), at the highest per-person cost it had experienced during either of the two years immediately preceding the year of the transfer. With some limitations, benefits could be eliminated for up to 20% of the retiree population, or reduced for up to 20% of the retiree population, during the five year period. The PPA as amended by the U.S. Troop Readiness, Veterans' Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007, expanded the types of transfers to include transfers covering a period of more than one year from assets in excess of 120% of the funding obligation, with the cost maintenance period extended through the end of the fourth year following the transfer period, and the funded status being maintained at a minimum of 120% during each January 1 valuation date in the transfer period. The amendments also provided for collective bargained transfers, both single year and multi-year, wherein an enforceable labor agreement is substituted for the cost maintenance period. Using variations of the available methods, we estimate that as of December 31, 2009, the excess of assets above 120% of the plan obligations is between $ 1.7 billion and $3.2 billion, and the excess above 125% of plan obligations is between $1.2 billion and $ 2.7 billion. However, deterioration in the funded status of the U.S. occupational pension plan could negatively impact our ability to make future Section 420 Transfers.
As indicated in Note 1o to our consolidated financial statements, revenue under IAS 18 accounting is measured at the fair value of the consideration received or to be received when the Group has transferred the significant risks and rewards of ownership of a product to the buyer.
For revenues and expenses generated from construction contracts, the Group applies the percentage of completion method of accounting, provided certain specified conditions are met, based either on the achievement of contractually defined milestones or on costs incurred compared with total estimated costs. The determination of the stage of completion and the revenues to be recognized rely on numerous estimations based on costs incurred and acquired experience. Adjustments of initial estimates can, however, occur throughout the life of the contract, which can have significant impacts on future net income (loss).
Although estimates inherent in construction contracts are subject to uncertainty, certain situations exist whereby management is unable to reliably estimate the outcome of a construction contract. These situations can occur during the early stages of a contract due to a lack of historical experience or throughout the contract as significant uncertainties develop related to additional costs, claims and performance obligations, particularly with new technologies. During the fourth quarter of 2007, as a result of cost overruns and major technical problems that we experienced in implementing a large W-CDMA (Wideband Code Division Multiple Access) contract, we determined then that we could no longer estimate with sufficient reliability the final revenue and associated costs of such contract. As a result, we expensed all the contract costs incurred to that date, and we only recognized revenues to the extent that the contract costs incurred were recoverable. Consequently, revenues of €72 million and cost of sales of €298 million were recognized in 2007 in connection with this construction contract. The negative impact on income (loss) before tax, related reduction of goodwill and discontinued operations of changing from the percentage of completion method to this basis of accounting was €98 million for 2007. This basis of accounting was maintained in 2008 and for the first nine months of 2009. During that 21 month period, our operational performance on the contract steadily improved to a point where we could then estimate reliably the outcome of the contract. However, because the contract was considered complete starting on October 1, 2009, reverting back to percentage of completion accounting was no longer necessary.
Contracts that are multiple element arrangements can include hardware products, stand-alone software, installation and/or integration services, extended warranty, product roadmaps, etc. Revenue for each unit of accounting is recognized when earned based on the relative fair value of each unit of accounting as determined by internal or third-party analyses of market-based prices. If the criteria described in Note 1o are met, revenue is earned when units of accounting are delivered. If such criteria are not met, revenue for the arrangement as a whole is accounted for as a single unit of accounting. Significant judgment is required to allocate contract consideration to each unit of accounting and determine whether the arrangement is a single unit of accounting or a multiple element arrangement. Depending upon how such judgment is exercised, the timing and amount of revenue recognized could differ significantly.
For multiple element arrangements that are based principally on licensing, selling or otherwise marketing software solutions, judgment is required as to whether such arrangements are accounted for under IAS 18 or IAS 11. Software arrangements requiring significant production, modification or customization are accounted for as a construction contract under IAS 11. All other software arrangements are accounted for under IAS 18, in which case the Group requires vendor specific objective evidence (VSOE) of fair value to separate the multiple software elements. If VSOE of fair value is not available, revenue is deferred until the final element in the arrangement is delivered or revenue is recognized over the period that services are being performed if services are the last undelivered element. Significant judgment is required to determine the most appropriate accounting model to be applied in this environment and whether VSOE of fair value exists to allow separation of multiple software elements.
For product sales made through distributors, product returns that are estimated according to contractual obligations and past sales statistics are recognized as a reduction of sales. Again, if the actual product returns were considerably different from those estimated, the resulting impact on the net income (loss) could be significant.
It can be difficult to evaluate the Groups capacity to recover receivables. Such evaluation is based on the customers creditworthiness and on the Groups capacity to sell such receivables without recourse. If, subsequent to revenue recognition, the recoverability of a receivable that had been initially considered as likely becomes doubtful, a provision for an impairment loss is then recorded (see Note 2b to our consolidated financial statements).
Purchase price allocation of a business combination
In a business combination, the acquirer must allocate the cost of the business combination at the acquisition date by recognizing the acquirees identifiable assets, liabilities and contingent liabilities at fair value at that date. The allocation is based upon certain valuations and other studies performed with the assistance of outside valuation specialists. Due to the underlying assumptions made in the valuation process, the determination of those fair values requires estimations of the effects of uncertain future events at the acquisition date and the carrying amounts of some assets, such as fixed assets, acquired through a business combination could therefore differ significantly in the future.
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As prescribed by IFRS 3, if the initial accounting for a business combination can be determined only provisionally by the end of the reporting period in which the combination is effected, the acquirer must account for the business combination using those provisional values and has a twelve-month period to complete the purchase price allocation. Any adjustment of the carrying amount of an identifiable asset or liability made as a result of completing the initial accounting is accounted for as if its fair value at the acquisition date had been recognized from that date. Detailed adjustments accounted for in the allocation period are disclosed in Note 3.
Once the initial accounting of a business combination is complete, only errors may be corrected.
Accounting treatment of convertible bonds with optional redemption periods/dates before contractual maturity
Some of our convertible bonds have optional redemption periods/dates occurring before their contractual maturity, as described in Note 24 to our consolidated financial statements. All of our convertible bond issues were accounted for in accordance with IAS 32 requirements (paragraphs 28 to 32) as described in Note 1m to our consolidated financial statements. Classification of the liability and equity components of a convertible instrument is not revised when a change occurs in the likelihood that a conversion will be exercised. On the other hand, if optional redemption periods/dates occur before the contractual maturity of a debenture, a change in the likelihood of redemption before the contractual maturity can lead to a change in the estimated payments. As prescribed by IAS 39, if an issuer revises the estimates of payment due to reliable new estimates, it must adjust the carrying amount of the instrument by computing the present value of the remaining cash flows at the original effective interest rate of the financial liability to reflect the revised estimated cash flows. The adjustment is recognized as income or expense in profit or loss.
As described in Notes 8, 24 and 26 to our consolidated financial statements, such a change in estimates occurred during the second quarter of 2009 regarding Lucents 2.875% Series A convertible debenture. Similar changes in estimates could occur in the future for all convertible debentures with optional redemption periods/dates. A loss corresponding to the difference between the present value of the revised estimated cash flows and the carrying amount derived from the split accounting, as described in Note 1m to our consolidated financial statements, could impact other financial income (loss) as a result of any change in the Groups estimate of redemption triggers on all of Lucents convertible debt. An approximation of the potential negative impact on other financial income (loss) is the carrying amount of the equity component, as disclosed in Notes 24 and 26 to our consolidated financial statements.
If all or some of the holders of Lucents 2.875% Series A convertible debentures do not demand redemption on the first optional redemption date, which is June 15, 2010, the estimated cash flows related to the remaining debt will then be revised accordingly, if new estimates are considered reliable, with a corresponding potential positive impact on other financial income (loss). The initial accounting treatment could then be reapplied.
In 2008, a fire occurred in our newly-built factory containing new machinery. Non-recoverable assets having a net book value of €4 million were written off as of September 30, 2008, representing an equivalent negative impact on cost of sales in 2008. The cost of the physical damage and business interruption were insured and gave right to an indemnity claim, the amount of which was definitively settled as of September 30, 2009. We received €33 million on our business interruption insurance which was accounted for in other revenues during 2009, only when the cash was received.
In December 2009, the roof and technical floor of our headquarters in Madrid, Spain partially collapsed for unknown reasons. Our Spanish subsidiary rents this building and the lease is accounted for as an operating lease. The damaged assets were derecognized as of December 31, 2009 with a negative impact of €1 million on income (loss) from operating activities. All costs related to this incident (damaged assets, displacement and relocation costs, etc.) are insured subject to a €15 million deductible. Displacement and relocation costs below this threshold will be accounted for as incurred in 2010. As the cause of the incident is still not known, nothing has been reserved related to Alcatel-Lucent Spains potential liability to third parties. At this stage, Alcatel-Lucent Spains liability is not considered probable. However, depending upon the results of the investigation, this situation could evolve.
6.1 OVERVIEW OF 2009
2009 was a difficult year for suppliers of telecommunications equipment, and the economy posed the single largest challenge to our markets and our business. In response to the global recession, service providers worldwide reduced their spending for new equipment; they re-prioritized the makeup of that spending to speed the shift from legacy to next-generation technologies; and increased their focus on the need to grow revenues while reducing costs. The recession heightened already-intense competitive pressures as vendors from Asia, offering low-priced products and services and aggressive financing, captured a bigger share of the market. Left with a smaller share of a shrinking market, other vendors slashed costs and expenses to rebuild profitability. Led by burgeoning growth in mobile broadband data in 2009, service providers faced the growing challenge to profitably accommodate surging traffic volumes.
The global recession hit service providers in a number of ways that prompted them to aggressively reduce their spending for new equipment. In economies around the world, falling employment created businesses with fewer employees, thereby reducing the need for communications services and equipment. In addition, increased unemployment created jobless consumers who reduced spending on communications services and equipment. Mobile subscriber growth slowed, the number of wireline connections fell at an accelerated rate and the demand for new networks connecting new businesses and new homes plummeted as new construction activity tumbled. With demand for their services dropping, service providers took steps to protect cash flow and liquidity, including cuts in spending for new equipment. In many emerging markets, especially in Latin America, service provider spending cuts also reflected sharply weaker currencies that effectively raised equipment prices to prohibitive levels at the same time that financing became almost unavailable.
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Although almost all service providers reduced spending for new equipment during 2009, the magnitude of those cuts differed significantly from sector to sector with some exceptions. For example, service providers remained focused on spending for next-generation technologies that will allow them to offer new services and/or reduce operating expenses. However, spending cuts did affect next-generation gear, although the migration to new technologies accelerated and spending cuts on legacy equipment increased. Included in those legacy technologies, where spending cuts were particularly sharp, were TDM (time division multiplexing) also known as legacy switching, ATM (asynchronous transfer mode) data networking, second generation wireless (CDMA and GSM), traditional DSL-based broadband access, and most terrestrial optical networking. Our own business reflected those trends, with double-digit year-over-year declines in each of those areas. The parts of our business that held up better in 2009 included IP service routers, third generation wireless (W-CDMA), managed services (outsourcing), submarine optical networking and applications. In W-CDMA, managed services, and submarine optical, our growth in 2009 was largely a reflection of growth in those sectors, which was, in turn due to specific factors that outweighed the declining trend in overall spending. Spending for W-CDMA infrastructure was boosted by the aggressive build-out of 3G wireless in China and by service provider spending for an enhanced mobile broadband capability. Growth in the demand for managed services reflected an increased willingness by service providers to outsource network operations and cut operating expenses, as well as their desire to focus on the services they offer end users. Strong spending for submarine optical in 2009 reflected the build-out of new undersea cable systems associated with the global expansion of Internet access, and the need to add capacity on existing networks. In IP service routers, our growth in 2009 reflected an increase in market share and the growing importance of the wireless backhaul market. Growth in our Applications business reflected a very positive customer response to our new applications portfolio and our new applications enablement strategy.
Mobile broadband traffic experienced explosive growth in 2009, which may have potentially very significant implications for service providers and equipment vendors. New smartphones, like Apples iPhone, and new applications designed for those devices, have made it easier than ever to access, create and share content, and traffic volumes have surged accordingly. Strong growth in mobile data traffic is nothing new it has been the fastest growing type of traffic for some time. But data traffic had not reached the levels seen in 2009, when a few operators acknowledged quality of service issues brought about by a growing imbalance between network capacity and exploding demand for mobile broadband data. Mobile video, which uses a significant amount of bandwidth, is the fastest-growing application on mobile networks today. Since mobile video is a relatively new service with relatively few users, we believe that explosive growth in mobile data traffic will continue. The challenge of profitably accommodating this demand is one of the factors behind our development of what we call the High Leverage NetworkTM. The High Leverage NetworkTM is an architecture designed to deliver value-added services at the lowest possible cost. In addition, our High Leverage NetworkTM is driving significant activity and service provider interest in LTE, the fourth generation wireless technology designed to efficiently handle mobile data traffic.
As 2009 came to a close, the global economy had largely stabilized, and prospects for some kind of recovery were improving. However, consensus expectations called for a muted recovery, spending for telecommunications equipment remained sluggish, the market remained intensely competitive and vendors were still very much focused on cutting costs in the face of ongoing pressure on revenues and profitability.
6.2 CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2009 COMPARED TO THE YEAR ENDED DECEMBER 31, 2008
Revenues. Revenues totaled €15,157 million in 2009, a decline of 10.8% from €16,984 million in 2008. Approximately 54% of our revenues are denominated in or linked to the U.S. dollar. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. The increase in the value of the U.S. dollar relative to the euro in 2009 compared with 2008 has tempered the decline in our reported revenues. If there had been a constant euro/U.S. dollar exchange rate in 2009 as compared to 2008, our consolidated revenues would have declined by approximately 12.4% instead of the 10.8% decrease actually experienced. This is based on applying (i) to our sales made directly in U.S. dollars or currencies linked to U.S. dollars effected during 2009, the average exchange rate that applied for 2008, instead of the average exchange rate that applied for 2009, and (ii) to our exports (mainly from Europe) effected during 2009 which are denominated in U.S. dollars and for which we enter into hedging transactions, our average euro / U.S. dollar hedging rate that applied for 2008. Our management believes that providing our investors with our revenues for 2009 in constant euro / U.S. dollar exchange rates facilitates the comparison of the evolution of our revenues with that of the industry.
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The table below sets forth our revenues as reported, the conversion and hedging impact of the euro/U.S. dollar and our revenues at a constant rate:
Revenues in our Carrier business segment fell 17.3% in 2009, as recessionary pressures on carrier capital expenditures were reflected to varying degrees on revenue declines across all four businesses that comprise the Carrier segment. Spending cuts were, however, sharply focused on legacy technologies. Our wireline business, for example, reflected pronounced weakness in spending for legacy core switching and, to a lesser extent, legacy ADSL access equipment, and our overall wireline revenues dropped 25.8% in 2009. Similarly, in our wireless business, a sharp drop in spending for second-generation GSM equipment and CDMA equipment significantly outweighed increased spending for third-generation technologies, and overall wireless revenues fell 20.9% in 2009. Optics revenue declined 11.2% in 2009, as weakness in terrestrial optics offset continued strong growth in submarine optics. There was a 4.2% decline in revenues in our IP division as growth in IP/MPLS service routers was more than offset by the secular decline in spending for legacy ATM equipment. Revenues in the Applications software segment increased 8.6% in 2009, driven by strong carrier spending for applications. Activity in our Enterprise segment was also significantly impacted by global economic conditions, and revenues fell 15.3% in 2009. Revenues in our Services business segment continued to grow by 6.4% in 2009, led by very strong growth in managed and outsourcing solutions.
Revenues in 2009 and in 2008 by geographical market (calculated based upon the location of the customer) are as shown in the table below:
In 2009, 71% of our revenue was generated in the Europe and Americas regions, where the challenging economic environment pressured levels of activity across all segments and revenue declined 12.2% from 2008. The Asia Pacific and Rest of World regions accounted for a combined 29% of revenue in 2009, and had a decrease in revenue of 7.1% over 2008. The United States accounted for 28.8% of revenues, up from 28.3% in 2008 as revenues fell 9%. Weakness was widespread in the United States with just a few areas, including applications and W-CDMA, able to post increased revenues in that market. Europe accounted for 34.3% of revenues in 2009 (10.1% in France, 20.0% in Other Western Europe and 4.2% in Rest of Europe), down from 34.7% in 2008 (8.4% in France, 20.8% in Other Western Europe and 5.5% in Rest of Europe). Within Europe, revenue increased 8% year-over-year in France due, in part, to gains in GPON, but fell 14% in Other Western Europe and dropped 33% in Rest of Europe. Weakness in Europe was especially pronounced in our wireless business, which was partially offset by strength in applications. Revenues in the Asia Pacific market in 2009 decreased 7% from 2008, but increased its share of total revenue from 18.8% in 2008 to 19.6% in 2009. Within Asia Pacific, our GSM business was particularly weak due to the migration to 3G wireless technology (W-CDMA and CDMA) in China. Revenues in Other Americas in 2009 fell 23% from 2008 and its share of total revenue slipped from 9.1% to 7.8%. Rest of World increased its share of total revenue to 9.4% in 2009, up from 9.1% in 2008, and had an 8% decrease in revenue.
Gross Profit. In 2009, gross profit decreased to 33.7% of revenue, or €5,111 million, compared to 34.1% of revenue or €5,794 million in 2008. Profitability per product can vary based on a product’s maturity, the required intensity of R&D and our competitive position. In addition, profitability can be impacted by geographic area depending on the local competitive environment, our market share and the procurement policy of operators. In 2009, revenue contraction was generally more pronounced in products and in geographic areas where our profitability has historically been above average. Similarly, the products or areas where we enjoyed revenue growth in 2009 tended to generate below average margins. The shift in the product and geographic mix witnessed in 2009 therefore negatively impacted our gross profit.
We estimate that the increase in the value of the U.S. dollar versus the euro which took place in 2009 compared to 2008 had a negative impact on our gross profit as a percentage of revenue. This is due to the fact, we believe, that the weight of the U.S. dollar and of currencies linked to the U.S. dollar is higher as a percentage of the cost of goods sold than it is as a percentage of revenue. The decrease in gross profit was mainly driven by lower volumes, unfavorable shifts in product and geographic sales mix, and the recovery of the U.S. dollar relative to the euro. These negative factors more than offset margin improvements from cost reduction initiatives in fixed costs, procurement and product design. Gross profit in 2009 included the negative impacts from (i) a net charge of €139 million for write-downs of inventory and work in progress; and (ii) a net charge of €15 million of reserves on customer receivables. Gross profit in 2008 included the negative impacts of (x) a net charge of €275 million for write-downs of inventory and work in progress; (y) a net charge of €24 million of reserves on customer receivables; and (z) a €48 million provision for a contract loss. However, the negative impacts on gross profit in 2008 were somewhat offset by positive impacts of (i) a €13 million net gain from currency hedging; (ii) a €21 million gain from the sale of real estate; and (iii) €34 million from a litigation settlement.
Administrative and selling expenses. In 2009, administrative and selling expenses were €2,913 million or 19.2% of revenues compared to €3,093 million or 18.2% of revenues in 2008. The year over year increase as a percentage of revenues was due to lower revenues in 2009 as compared to 2008. Included in administrative and selling expenses are non-cash purchase accounting entries resulting from the Lucent business combination of €117 million in 2009 and €122 million in 2008. They primarily relate to the amortization of purchased intangible assets of Lucent, such as customer relationships. The 5.8% decline in administrative and selling expenses largely reflects the progress we have made executing our programs to reduce operating expenses by de-layering our organization and eliminating sales duplication between product groups and regions. Some of these gains have been offset by the unfavorable currency impact of the recovery of the U.S. dollar on our U.S. dollar denominated expenses.
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Research and development costs. Research and development costs were €2,523 million or 16.6% of revenues in 2009, after a net impact of capitalization of €4 million of development expense, a decline of 8.5% from €2,757 million or 16.2% of revenues after the net impact of capitalization of €101 million of development expense in 2008. Included in research and development costs are non-cash purchase accounting entries resulting from the Lucent business combination of €151 million in 2009 and €394 million in 2008. The 8.5% decline in research and development costs reflects the progress we have made enhancing R&D efficiency by focusing on four key areas IP, optics, mobile and fixed broadband access and applications while we accelerate the shift of our investment toward next-generation platforms, and the reduced impact from purchase accounting for the Lucent business combination. Those two factors more than offset the unfavorable effects from the sharp reduction in net impact of R&D capitalization year over year (which, by itself, would result in an increase in R&D expense in 2009), the inclusion of a one-time gain of €58 million in 2008 related to the sale of intellectual property and the unfavorable currency impact of the recovery of the U.S. dollar on our dollar denominated expenses.
Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments. We recorded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments of €(325) million in 2009 compared to a loss of €(56) million in 2008. The larger loss in 2009 reflects the unfavorable impact of the global recession on volumes and pricing, and lower gross margins, all of which more than offset the favorable impacts of our product cost and fixed cost reduction programs and a decline in the purchase accounting entries resulting from the Lucent business combination booked in 2009. The purchase accounting entries had a negative, non-cash impact of €269 million in 2009 as compared to €522 million in 2008.
In addition, changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments in 2009 by €151 million, of which €396 million were additional provisions and €244 million were reversals. Of the €396 million of additional provisions, additional product sales reserves (excluding construction contracts) were €323 million. Reversals of product sales reserves were €162 million during 2009, representing a significant portion of the total reversals of €244 million in 2009. Of the €162 million in reversals, €71 million related to reversals of reserves made in respect of warranties due to the revision of our original estimates for these reserves regarding warranty period and costs. This revision was due mainly to (i) the earlier than expected replacement of products under warranty by our customers with more recent technologies and (ii) the products actual performance leading to fewer warranty claims than anticipated and for which we had made a reserve. In addition, €20 million of the €162 million reversal of product sales reserves was mainly related to reductions in probable penalties due to contract delays or other contractual issues or in estimated amounts based upon statistical and historical evidence. The remaining reversals of €71 million were mainly related to new estimates of losses at completion. Changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of intangible assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments by €235 million in 2008, of which additional provisions were €443 million and reversals were €208 million. Additional product sales reserves created during 2008 were €354 million while reversals of product sales reserves were €135 million.
Restructuring Costs. Restructuring costs were €605 million for 2009, representing (i) €368 million of new restructuring plans and adjustments to previous plans; (ii) a valuation allowance and a write-off of assets of €88 million in the aggregate; and (iii) €149 million of other monetary costs. New restructuring plans cover costs related to the elimination of jobs and to product rationalization and facilities closing decisions. Restructuring costs were €562 million in 2008, representing (i) €489 million of new restructuring plans or adjustments to previous plans; (ii) a valuation allowance and write-off of assets of €35 million; and (iii) €38 million of other monetary costs. Our restructuring reserves of €459 million at December 31, 2009 covered (i) jobs identified for elimination and for which notice had been given in the course of 2009, (ii) jobs eliminated in previous years for which total or partial payment is still due, (iii) costs of replacing rationalized products, and (iv) other monetary costs linked to decisions to reduce the number of our facilities.
Litigations. In 2009, we booked an increase in litigation reserves of €(109) million related to: (i) the FCPA litigation for an amount of €(93) million and (ii) the Fox River litigation for an amount of €(16) million. A discussion regarding the FCPA litigation can be found in Section 6.10 “Legal Matters” and a discussion regarding the Fox River litigation can be found in Section 6.7 “Contractual Obligation and Off-Balance Sheet Contingent Commitments. In 2008, there were no litigation charges, reflecting the absence of any claims or settlements in 2008 that would warrant the booking of any litigation reserves on this line.
Impairment of Assets. In 2009, we had no asset impairment charges. In 2008, we booked an impairment of assets charge of €4,725 million related to our CDMA, Mulitcore, Applications, Mobile Access and Fixed Access business divisions within our Carrier segment that had been in place in 2008. Of the €4,725 million of charges in 2008, €3,272 million were related to goodwill, €135 million for capitalized development costs, €1,276 for other intangible assets, €39 million for property, plant and equipment and €14 million for financial assets.
Gain/(loss) on disposal of consolidated entities. In 2009, we booked a gain on disposal of consolidated entities of €99 million related to the sale of our fractional horsepower motors activity to Triton, compared to a loss of €(7) million in 2008.
Post-retirement benefit plan amendment. In 2009, we booked a €248 million net credit related to post-retirement benefit plan amendments, primarily related to a credit of €216 million (before tax) arising from the freeze by Alcatel-Lucent USA Inc. of the US defined benefit management pension plan and the US supplemental pension plan effective January 1, 2010. No additional benefits will accrue in these plans after December 31, 2009 for the 11,500 active U.S. based participants who are not union-represented employees. In 2008, we booked a €47 million net credit related to post-retirement benefit plan amendments. This net credit consisted of a €65 million credit related to a decrease in the obligations under the Lucent management retiree healthcare plan for an aggregate amount of €148 million partially offset by an €18 million reserve for ongoing litigation that concerned a previous Lucent healthcare plan amendment (see Section 6.10 “Legal Matters”). The benefit obligation decrease is a result of our adoption of a Medicare Advantage Private Fee-For-Service Plan. €83 million of the €148 million decrease is a result of a change in actuarial assumptions and is recognized in the Statement of Recognized Income and Expense, while €65 million of the decrease is a result of a plan amendment and is recognized in this specific line item of our income statement.
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Income (loss) from operating activities. Income (loss) from operating activities was a loss of €(692) million in 2009, compared to a loss of €(5,303) million in 2008. The smaller loss from operating activities in 2009 is mostly due to the absence of any impairment charge as compared with the €4,725 million of charges taken in 2008. In addition, the increase in the credit booked for post-retirement benefit plan amendments in 2009 compared to 2008 and the gain related to the sale of our fractional horsepower motors activity also positively affected the decrease in the loss from operating activities in 2009 compared to 2008.
Finance costs. Finance costs in 2009 were €254 million, an increase from €212 million in 2008. The increase is due to a reduction in interest earned, from €179 million in 2008 to €59 million in 2009, that exceeded the decline in interest paid, from €391 million in 2008 to €313 million in 2009. The 2009 reduction in interest paid is largely due to a lower level of gross financial debt because of the repayment of debt in 2009. The decrease of interest rates between 2008 and 2009 explains the decrease in interest earned between these two periods.
Other financial income (loss). Other financial income was €249 million in 2009, compared to €366 million in 2008. In 2009, other financial income consisted primarily of (i) a capital gain of €250 million related to the disposal of our Thales shares in May 2009 and, (ii) a gain of €50 million related to the partial repurchase of Lucent’s 7.75% bonds due March 2017, which more than offset a loss of €175 million related to a change in the estimated future cash flows related to Lucent’s 2.875% Series A convertible debenture. In 2008, other financial income consisted primarily of €349 million, representing the amount by which the expected financial return on the pension assets exceeded the interest cost on the obligations of the pension and post-retirement benefit plans. This difference only represented €105 million in 2009 mainly due to the decline of the fair market value of pension assets between 2008 and 2009.
Share in net income (losses) of equity affiliates. Share in net income of equity affiliates was €1 million during 2009, compared with income of €96 million during 2008. The decline is largely due to the sale of our Thales shares to Dassault Aviation in 2009.
Income (loss) before income tax, related reduction of goodwill and discontinued operations. Income (loss) before income tax and discontinued operations was a loss of €(696) million in 2009 compared to a loss of €(5,053) million in 2008.
Income tax (expense) benefit. We had an income tax benefit of €60 million in 2009, compared to an income tax expense of €(153) million in 2008. The income tax benefit for 2009 resulted from a current income tax charge of €(63) million offset by a net deferred income tax benefit of €123 million. The €123 million net deferred tax benefit includes deferred income tax benefits of €115 million related to the reversal of deferred tax liabilities accounted for in the purchase price allocation of the Lucent combination and a €65 million reversal of deferred tax liabilities related to the Lucent 2.875% Series A convertible debenture. These positive effects were slightly offset by €35 million in deferred tax charges related to Lucent’s post-retirement benefit plans and €22 million of other deferred income tax charges. The €(153) million income tax expense for 2008 resulted from a current income tax charge of €(99) million and a net deferred income tax charge of €(54) million. The €(54) million net deferred tax charge included deferred income tax benefits of €740 million (related to the reversal of deferred tax liabilities accounted for in the purchase price allocation of the Lucent combination), that were more than offset by (i) a €(476) million charge from changes in deferred tax mainly due to the reassessment of the recoverability of deferred tax assets in connection with the goodwill impairment tests performed in 2008; (ii) a €(293) million deferred tax charge related to Lucent’s post-retirement benefit plans; and (iii) a €(25) million deferred tax charge related to the post-retirement benefit plan amendment associated with our adoption of a Medicare Advantage Private Fee-For-Service Plan.
Income (loss) from continuing operations. We had a loss from continuing operations of €(636) million in 2009 compared to a loss of €(5,206) million in 2008.
Income (loss) from discontinued operations. Income from discontinued operations was €132 million in 2009 due to a positive adjustment in 2009 of the purchase price of the Space activities that were sold to Thales in 2007. Income from discontinued operations was €33 million in 2008, mainly related to positive adjustments on the initial capital gain (loss) on discontinued operations that were sold or contributed in previous periods (mainly related to activities that were contributed to Thales in 2007).
Non-controlling Interests. Non-controlling interests were €20 million in 2009, compared with €42 million in 2008. The decrease in amount year over year is due largely to the reduced results from Alcatel-Lucent Shanghai Bell Co., Ltd.
Net income (loss) attributable to equity holders of the parent. A net loss of €(524) million was attributable to equity holders of the parent in 2009, compared with a loss of €(5,215) million in 2008.
6.3 RESULTS OF OPERATIONS BY BUSINESS SEGMENT FOR THE YEAR ENDED DECEMBER 31, 2009 COMPARED TO THE YEAR ENDED DECEMBER 31, 2008
The following table shows how we organized our business during 2009. This organizational structure is the basis of the discussion for our segment results presented below, even though, for 2008, our organizational structure was different. We restated our segment results for 2008 to reflect the 2009 structure to provide you with a meaningful year to year comparison. Effective January 1, 2010, the 2009 organization structure was superseded by the new organization that is discussed in further detail in Section 5.1 Business Organization found elsewhere in this annual report.
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The following tables set forth certain financial information on a segment basis for 2009 and 2008. Segment operating income (loss) is the measure of profit or loss by segment that is used by our Chief Executive Officer to make decisions on resource allocation and to assess performance. It consists of segment (loss) from operating activities before restructuring costs, impairment of intangible assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments, excluding the main non-cash impacts of the purchase price allocation (PPA) entries relating to the Lucent business combination. Adding PPA Adjustments (excluding restructuring costs and impairment of assets) to segment operating income (loss), as shown in the table below, reconciles segment operating income (loss) with income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments, as shown in the table below and the consolidated financial statements included elsewhere in this annual report.
PPA Adjustments (excluding restructuring costs and impairment of assets). In 2009, PPA adjustments (excluding restructuring costs and impairment of assets) were €(269) million, compared with €(522) million in 2008. The decline in PPA adjustments in 2009 reflects a decrease in the amortization of purchased intangible assets of Lucent, such as acquired technologies and in-process R&D, mainly due to the impairment losses accounted for on these intangible assets in 2008.
Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments. In 2009, a segment operating loss of €(56) million for the Group, adjusted for €(269) million in PPA, yielded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments of €(325) million, as shown in the consolidated financial statements. In 2008, segment operating income of €466 million for the Group, adjusted for €(522) million in PPA, yielded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments of €(56) million, as shown in the consolidated financial statements.
Revenues in our carrier segment were €9,076 million in 2009, a decline of 17.3% from €10,980 million in 2008, using current exchange rates. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. The increase in the value of the U.S. dollar relative to the euro in 2009 as compared to 2008 tempered the decline in our reported revenues. If there had been a constant euro/U.S. dollar exchange rate in 2009 as compared to 2008, our carrier segment revenues would have declined by 19.3% instead of the 17.3% decrease actually reported.
Revenues in our IP division were €1,173 million, a decrease of 4.2% from 2008, as growth in our IP/MPLS service router business was more than offset by a material decline in ATM switching products. The decline in our ATM business reflects the continuing decline in that market for a number of years, since ATM is an older, legacy technology where service providers are cutting back in favor of newer IP-based technology. That trend was exacerbated by difficult economic conditions in 2009, which also had an impact on service provider spending for routers. The service provider router market, which has a long record of growth, also declined in 2009. Our own growth in that area reflected an increase in our share of the market.
Revenues for the Optics division were €2,854 million, an 11.2% decline from €3,215 million in 2008. The decline is indicative of how the economy affected the overall optical networking market, as many service providers decided they could forego, at least temporarily, the new network capacity they would have added under a healthy economic environment. The weakness in the optical networking market was especially pronounced in the terrestrial segment of the market, where service providers network capacity was not constrained. Our undersea optics business, however, continued to grow in 2009, reflecting the build-out of undersea cable systems in areas where none had previously existed, and the addition of needed capacity.
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Revenues in our Wireless networks division were €3,544 million in 2009, a decrease of 20.9% from €4,480 million in 2008. Our GSM business fell sharply, negatively impacted by much slower mobile subscriber growth, the shift in service provider spending from 2G to 3G technologies, and foreign exchange devaluations in many developing economies where we have a meaningful GSM business. Our CDMA business also dropped in 2009, primarily due to North America weakness, which more than offset EV-DO (the 3G variant of CDMA) rollouts in China. Our W-CDMA business increased strongly in 2009, driven largely by spending in China and North America, but that increase was insufficient to offset the declines in GSM and CDMA. Finally, although revenues in our nascent LTE (4G wireless) business were not meaningful in 2009, we continued to incur significant development expense as we moved closer to commercial deployment.
Activity in our Wireline networks division was also materially impacted by the legacy-focused cutbacks in service provider spending for new equipment. Our wireline revenues fell 25.8%, to €1,619 million in 2009, from €2,181 million in 2008, driven by pronounced weakness in spending for legacy switching equipmnt. Our fixed access business also declined in 2009, as cutbacks in service provider spending for traditional (DSL) broadband access equipment were caused by difficult economic conditions and increasingly saturated markets, particularly in the developed world. In many geographies, spending for next-generation fiber-based access equipment remained constrained by regulatory uncertainty in 2009.
The carrier segment operating loss was €(297) million in 2009 compared with segment operating income of €251 million, or 2.3% of revenue in 2008. The decrease in segment operating income is due to lower volumes and unfavorable shifts in terms of profitability in both product and geographic sales mix that more than offset cost and expense reductions.
Applications Software Segment
Revenues in our applications software segment were €1,135 million in 2009 compared to €1,045 million in 2008, an increase of 8.6% using current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in 2009 as compared to 2008, our applications software revenues would have increased by approximately 5.3% instead of the 8.6% reported increase.
Our carrier applications business was the key driver of growth in our applications software segment, as service providers responded favorably to our Applications Enablement strategy and increased their spending for applications that will allow them to offer new services. Genesys, our contact center business that has a large presence in the enterprise market, declined in 2009, reflecting the decline in overall corporate investment spending.
Applications software segment operating income was €14 million in 2009 compared with a segment operating loss of €(49) million in 2008. The increase is segment operating income was due to the rationalization of the product portfolio around higher margin products, the better absorption of fixed costs through revenue growth and cost reduction initiatives.
Revenues in our enterprise segment were €1,036 million in 2009, a decrease of 15.3% from revenues of €1,223 million in 2008, using current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in 2009 as compared to 2008 our enterprise segment revenues would have dropped by 16.1% instead of the 15.3% decrease actually reported.
The voice telephony piece of our Enterprise business was hit hard in 2009 by the global recession which had a pronounced impact on corporate spending for new equipment. Spending for data networking equipment saw slight growth in 2009, offsetting some of the weakness in the voice market. Elsewhere in our Enterprise group, the industrial components business was sharply impacted by global market conditions, underscoring the highly cyclical nature of the end-markets this business sells to, such as autos, housing and semiconductors.
Enterprise segment operating loss was €(17) million in 2009 compared with segment operating income of €84 million or 6.9% of revenue in 2008. Most of the segment’s operating loss occurred early in 2009. Profitability was materially improved throughout the year, reflecting cost reduction actions that were taken during the first half of 2009.
Revenues in our services business segment were €3,569 million in 2009, an increase of 6.4% over revenues of €3,353 million in 2008, using current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in 2009 as compared to 2008, our services segment revenues would have increased by 5.9% instead of the 6.4% increase actually reported.
Managed and Outsourcing solutions grew strongly in 2009, driven by the ongoing implementation of contracts entered into during the 2008-2009 period in both Western Europe and India. Multivendor maintenance revenue increased in 2009 as service providers increasingly made use of our capabilities to reduce their own spending on maintenance and simplify their operations. Revenues in our Network and Systems Integration business fell in 2009, reflecting weakness in the wireless infrastructure market - an important end-user market for our integration business. Our Product-Attached Services business, which includes product-attached maintenance as well as network build and implementation services, was flat in a challenging market in 2009.
Services segment operating income was €203 million or 5.7% of revenue in 2009 compared with €234 million or 7.0% of revenue in 2008, as the positive impact of higher sales on profitability was more than offset by price erosion.
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6.4 CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2008 COMPARED TO THE YEAR ENDED DECEMBER 31, 2007
Introduction. In January 2007, we contributed our transportation and security activities to Thales, and in April 2007, we completed the sale of our ownership interests in two joint ventures in the space sector to Thales. Consequently, our results for 2007 exclude the businesses transferred in January and April 2007 to Thales. For a further description of these transactions, please refer to Section 4.2 «History and Development.»
Revenues. Revenues were €16,984 million in 2008, a decline of 4.5% from €17,792 million in 2007. Approximately 52% of our revenues were denominated in or linked to the U.S. dollar. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. The value of the U.S. dollar relative to the euro increased significantly in the second half of 2008, but for the year as a whole compared with 2007, the value of the U.S. dollar declined relative to the euro. The decrease in the value of the U.S. dollar relative to the euro from 2007 to 2008 had a negative impact on our revenues. If there had been a constant euro/U.S. dollar exchange rate in 2008 as compared to 2007, our consolidated revenues would have decreased by approximately 1.1% instead of the 4.5% decrease actually experienced. This is based on applying (i) to our sales made directly in U.S. dollars or in currencies linked to U.S. dollars during 2008, the average exchange rate that applied for 2007, instead of the average exchange rate that applied in 2008, and (ii) to our exports (mainly from Europe) during 2008 which are denominated in U.S. dollars and for which we enter into hedging transactions, our average euro/U.S. dollar hedging rate that applied for 2007. Our management believes that providing our investors with our revenues for 2008 in constant euro/U.S. dollar exchange rates facilitates the comparison of the evolution of our revenues with that of the industry.
The table below sets forth our revenues as reported, the conversion and hedging impact of the euro/U.S. dollar and our revenues at a constant rate:
Revenues in 2008 and in 2007 by geographical market (calculated based upon the location of the customer) are as shown in the table below:
Revenue by geographical segment
In 2008, the United States accounted for 28.3% of revenues by geographical market, down from 30.6% in 2007 as revenues fell 11.5% in that market. The decline in the United States reflected particular weakness in CDMA and DSL revenues, which were not fully offset by increased sales in W-CDMA and Services. Europe accounted for 34.7% of revenues in 2008 (8.4% in France, 20.8% in Other Western Europe and 5.6% in Rest of Europe), up from 32.8% in 2007 (6.9% in France, 20.6% in Other Western Europe and 5.4% in Rest of Europe). Within Europe, revenue increased 16.4% year-over-year in France due in part to gains in W-CDMA, while revenue fell 3.3% in Other Western Europe and 1.0% in Rest of Europe. Revenues in the Asia Pacific market fell 5.7% in 2008, but they were little changed as a percent of total revenue (18.8% in 2008 and 19.0% in 2007). Services revenues were particularly strong in the Asia Pacific market in 2008. Revenues in Other Americas were flat in 2008 (up 0.3% from 2007) as widespread gains offset lower CDMA revenues, although share of total revenue increased slightly from 8.6% in 2007 to 9.1% in 2008. Rest of World revenues fell 3.9% from 2007 to 2008 but were little changed as a percent of total revenue (9.1% in 2008 and 9.0% in 2007). Around the world, growth in our Services business was solid in 2008. We capitalized on new opportunities for our wireless business in emerging markets in 2008. Our IP routing business developed strong momentum in North America, Europe and China in 2008. Our legacy fixed access business (DSL) was weak in North America and Europe as spending shifted to highly price competitive emerging markets.
Gross Profit. Despite the decline in revenue in 2008, gross profit increased to 34.1% of revenue, or €5,794 million, compared to 32.1% of revenue or €5,709 million in 2007. The increase in gross profit is due to enhanced pricing discipline, which improves our ability to retain the benefits of our product cost reduction programs, and which reflects our ongoing commercial selectivity as we balance our intent to grow share with our focus on profitable growth. In addition, gross profit was minimally impacted in 2008 from purchase accounting for the Lucent business combination whereas in 2007, there was a negative, non-cash impact of €253 million. Gross profit in 2008 included a €13 million net gain from currency hedging; a €21 million capital gain from the sale of real estate; and €34 million from a litigation settlement, which were more than offset by (i) a net charge of €275 million for write-downs of inventory and work in progress; (ii) a net charge of €24 million for reserves on customer receivables; and (iii) a €48 million provision for a contract loss. Gross profit in 2007 included €34 million from a litigation settlement related to business arrangements with a company in Columbia which was subsequently liquidated; and a net reversal of €10 million of reserves on customer receivables as the reversal of historical reserves exceeded the amount of new reserves, which were more than offset by (i) a negative impact of €130 million related to investments in current products and platforms that we will eventually discontinue, but that we continue to enhance in order to meet our commitment to our customers while preparing to converge them into a common platform; (ii) a €98 million one-time charge resulting from the difficulties we encountered in fulfilling a large W-CDMA contract; and (iii) a net charge of €178 million for write-downs of inventory and work in progress.
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Administrative and selling expenses. In 2008, administrative and selling expenses were €3,093 million or 18.2% of revenues compared to €3,462 million or 19.5% of revenues in 2007. The 10.7% decline in administration and selling expenses reflects the progress we have made executing on our programs to reduce operating expenses, as well as a favorable currency impact on our U.S. dollar denominated expenses. Also contributing to the decrease in administrative and selling expenses was a decline in purchase accounting entries resulting from the Lucent business combination, from €295 million in 2007 to €122 million in 2008. The purchase accounting entries have a negative, non-cash impact, and they primarily relate to the amortization of purchased intangible assets of Lucent, such as customer relationships.
Research and development costs. Research and development costs were €2,757 million or 16.2% of revenues in 2008, after the capitalization of €101 million of development expense, compared to €2,954 million or 16.6% of revenues after the capitalization of €153 million of development expense in 2007. The 6.7% decline in research and development costs is due, as was the case for administrative and selling expenses, to the progress we have made executing on our programs to reduce operating expenses, as well as a favorable currency impact on our U.S. dollar denominated expenses. The reported decline in research and development costs would have been 12.0%, except for an increase in 2008 in purchase accounting entries relating to R&D resulting from the Lucent business combination, from €269 million in 2007 to €394 million in 2008. The increase in purchase accounting entries relating to R&D in 2008 is largely due to a non-recurring adjustment for the disposal of patents and an increase in the amortization of in-progress R&D reflecting the completion and initial amortization of various development projects acquired from Lucent. The purchase accounting entries have a negative, non-cash impact, and they primarily relate to the amortization of purchased intangible assets of Lucent, such as acquired technologies and in-process research and development. Research and development costs in 2008 included €58 million in capital gains on the sale of intellectual property which was booked against our research and development expense.
Two contributors to our reduced operating expenses (including both administrative and selling expenses and research and development costs) in 2008, compared with 2007, were headcount reductions and a shift of manpower from high cost to low cost countries. Company-wide headcount reductions, net totaled 2,775 in 2008, excluding the impact of acquisitions, managed services contracts and new consolidations of previously nonfully-consolidated entities. In 2007, headcount reductions, net totaled 6,324 excluding the impact of acquisitions, managed services contracts and new consolidations of previously non-fully-consolidated entities.
Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments. We recorded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments of €56 million in 2008 compared to a loss of €707 million in 2007.
This smaller loss reflects improved pricing discipline, the benefits of our product cost and operating expense reduction programs and a decline in the purchase accounting entries booked in 2008, all of which more than offset the impact of lower revenues in 2008. The purchase accounting entries had a negative, non-cash impact of €522 million in 2008 as compared to €817 million in 2007.
Changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments in 2008 by €235 million (of which €443 million were additional provisions and €208 million were reversals). Additional product sales reserves (excluding construction contracts) created during 2008 were €354 million, while reversals of product sales reserves were €135 million during the same period. Of the €135 million in reversals, €59 million related to reversals of reserves made in respect of warranties due to the revision of our original estimates for these reserves regarding warranty period and costs. This revision was due mainly to (i) the earlier than expected replacement of products under warranty by our customers with more recent technologies and (ii) the products actual performance leading to fewer warranty claims than anticipated and for which we had made a reserve. In addition, €30 million of the €135 million reversal of product sales reserves was mainly related to reductions in probable penalties due to contract delays or other contractual issues or in estimated amounts based upon statistical and historical evidence. The remaining reversals (€46 million) were mainly related to new estimates of losses at completion. Changes in provisions adversely impacted income (loss) from operating activities before restructuring costs, impairment of intangible assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments by €429 million in 2007, of which additional provisions were €642 million and reversals were € 213 million. Additional product sales reserves created in 2007 were €500 million while reversals of product sales reserves were €145 million.
Restructuring Costs. Restructuring costs were €562 million in 2008, representing (i) an asset write-off of €35 million; (ii) €489 million of new restructuring plans, and adjustments to previous plans and (iii) €38 million of other monetary costs. New restructuring plans cover costs related to the elimination of jobs, to product rationalization and to decisions facilities to close. Restructuring costs were €856 million in 2007, representing (i) an asset write-off of €47 million, (ii) €623 million of new restructuring plans or adjustments to previous plans; and (iii) €186 million of other monetary costs. Our restructuring reserves of €595 million at December 31, 2008 covered jobs identified for elimination and notified in the course of 2008, as well as jobs eliminated in previous years for which total or partial settlement is still due, costs of replacing rationalized products, and other monetary costs linked to decisions to reduce the number of our facilities.
Impairment of Assets. In 2008, we booked an impairment of assets charge of €4,725 million, including €3,272 million for goodwill; €135 million for capitalized development costs; €1,276 million for other intangible assets; €39 million for property, plant and equipment; and €14 million for financial assets. €810 million of the €4,725 million is a charge taken at mid-year arising from our yearly impairment test related to our CDMA business, and charges of €3,910 million were booked at year-end related to the following business divisions within the Carrier segment that had been in place for 2008 - CDMA, Optics, Multicore, Applications, Mobile Access and Fixed Access. The mid-year CDMA impairment was due to the fact that in the second quarter of 2008, revenues from our CDMA business declined at a higher pace than we had planned. The unexpected, large reduction in the capital expenditures of one of our key CDMA customers in North America and the uncertainty regarding spending on CDMA in North America were the main drivers of the decline. We performed an additional impairment test during the fourth quarter of 2008 in light of the difficult financial and economic environment, the continuing material decrease in our market capitalization and the new 2009 outlook, taking into account estimated consequences of our strategic decisions disclosed in December 2008. In 2007, we took an impairment of assets charge of €2,944 million mainly related to our CDMA, W-CDMA and IMS businesses. Of the €2,944 million, €2,657 million is related to goodwill; €39 million to capitalized development costs; €174 million to other intangible assets; and €74 million to property, plant and equipment.
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Post-retirement benefit plan amendment. In 2008, we booked a €47 million net credit related to post-retirement benefit plan amendments. It consists of an €18 million reserve related to ongoing litigation that concerns a previous Lucent healthcare plan amendment (see Section 6.10 “Legal Matters – Lucent’s employment and benefits related cases,” in this annual report for more detail) and a €65 million credit related to a €148 million benefit obligation decrease for the Lucent management retiree healthcare plan. The benefit obligation decrease is a result of our adoption of a Medicare Advantage Private Fee-For-Service Plan. €83 million of the €148 million decrease is a result of a change in actuarial assumptions and is recognized in the Consolidated Statement of Comprehensive Income, while €65 million of the decrease is a result of a plan amendment and is recognized in specific line item of our income statement. In 2007, we booked a €258 million credit resulting from certain changes to Lucent management retiree healthcare benefit plans. Effective January 1, 2008, prescription drug coverage offered to former Lucent management retirees was changed to a drug plan similar to the Medicare Part D program. This change reduced the benefit obligation projected in the first half of 2007 by €258 million, net of a €205 million elimination of the previously expected Medicare Part D subsidies.
Income (loss) from operating activities. Income (loss) from operating activities was a loss of €5,303 million in 2008, compared to a loss of €4,249 million in 2007. The bigger loss in 2008 was due primarily to a significantly larger impairment charge in 2008 compared with 2007, which more than offset the combined positive impacts of our improved pricing discipline, our product cost and operating expense reduction programs, lower restructuring costs and a decline in the total purchase accounting entries booked in 2008 as compared with 2007. The bigger loss in 2008 was also partially due to a smaller credit booked for post-retirement benefit plan amendments than was the case in 2007.
Finance costs. Net finance costs in 2008 were €212 million and included €391 million of interest paid on our gross financial debt, offset by €179 million in interest earned on our cash, cash equivalents and marketable securities. In 2007, net finance costs of €173 million resulted from €403 million of interest paid on our gross financial debt, offset by €230 million in interest earned on cash, cash equivalents and marketable securities. The decline in interest paid in 2008 compared to 2007 was due largely to a lower level of gross financial debt, while the decline in interest earned was due largely to a lower level of cash, cash equivalents and marketable securities.
Other financial income (loss). Other financial income was €366 million in 2008, compared to financial income of €541 million in 2007. Other financial income consisted largely of the difference between the expected financial return on the assets and the interest cost on the obligations of the pension and post-retirement benefit plans, mainly related to the Lucent plans assets and obligations. The decline from 2007 to 2008 was due to a November 2007 re-allocation of the plans assets which reduced their exposure to equity markets, as well as the decline in the fair value of the plans assets.
Share in net income (losses) of equity affiliates. Share in net income of equity affiliates was €96 million in 2008, compared with €110 million in 2007. While our share of equity affiliates’ earnings included positive contributions from both Thales and Draka in 2007, our share in 2008 included a contribution from Thales only, since we sold our interest in Draka in the fourth quarter of 2007. In 2008, the contribution from Thales also reflected the reclassification of our Thales shares from net assets in equity affiliates to assets held for sale as of the announcement on December 19, 2008 of a definitive agreement to sell our stake in Thales to Dassault Aviation.
Income (loss) before income tax, related reduction of goodwill and discontinued operations. Income (loss) before income tax, related reduction of goodwill and discontinued operations was a loss of €5,053 million in 2008 compared to a loss of €3,771 million in 2007.
Reduction of goodwill related to deferred tax assets initially unrecognized. In 2008, there was no reduction of goodwill related to deferred tax assets that were initially unrecognized. In 2007, there was a €256 million reduction of goodwill that was due largely to the post-retirement benefit plan amendment described above.
Income tax (expense) benefit. We had an income tax expense of €153 million in 2008, compared to an income tax expense of €60 million in 2007. The income tax expense for 2008 resulted from a current income tax charge of €99 million and a net deferred income tax charge of €54 million. The €54 million net deferred tax charge included deferred income tax benefits of €740 million (related to the reversal of deferred tax liabilities accounted for in the purchase price allocation of the Lucent combination), that were more than offset by (i) a €476 million charge from changes in deferred tax mainly due to the reassessment of the recoverability of deferred tax assets in connection with the goodwill impairment tests performed in 2008; (ii) a €293 million deferred tax charge related to Lucent’s post-retirement benefit plans; and (iii) a €25 million deferred tax charge related to the post-retirement benefit plan amendment associated with our adoption of a Medicare Advantage Private Fee-For-Service Plan. The €60 million income tax expense for 2007 resulted from a current income tax charge of €111 million and a net deferred income tax benefit of €51 million. The €51 million net deferred tax benefit included deferred income tax benefits of €652 million (related to the reversal of deferred tax liabilities accounted for in the purchase price allocation of the Lucent combination and the recognition of deferred tax assets initially unrecognized at the time of the Lucent combination), that were not fully offset by a €420 million charge from changes in deferred tax mainly due to the reassessment of the recoverability of deferred tax assets in connection with the goodwill impairment and a €181 million deferred tax charge related primarily to the post-retirement benefit plan amendment.
Income (loss) from continuing operations. We had a loss from continuing operations of €5,206 million in 2008 compared to a loss of €4,087 million in 2007 due to the factors noted above.
Income (loss) from discontinued operations. There was income of €33 million from discontinued operations in 2008, mainly related to adjustments on initial capital gain (loss) on discontinued operations that were sold or contributed in previous periods (mainly related to activities that were contributed to Thales). That compares with income of €610 million in 2007, which consisted primarily of a €615 million net capital gain after tax on the contribution of our railway signaling business and our integration and services activities to Thales.
Minority Interests. Minority interests were €42 million in 2008, compared with €41 million in 2007, largely reflecting our operations in China with Alcatel-Lucent Shanghai Bell Co., Ltd.
Net income (loss) attributable to equity holders of the parent. A net loss of €5,215 million was attributable to equity holders of the parent in 2008, compared with a loss of €3,518 million attributable to equity holders of the parent in 2007.
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6.5 RESULTS OF OPERATIONS BY BUSINESS SEGMENT FOR THE YEAR ENDED DECEMBER 31, 2008 COMPARED TO THE YEAR ENDED DECEMBER 31, 2007
As mentioned earlier, in January 2007, we contributed our transportation and security activities to Thales, and in April 2007, we completed the sale of our ownership interests in two joint ventures in the space sector to Thales. The following table shows how we organized our business during 2009. This organizational structure is the basis for the discussion for our segment results presented below, even though, for 2008 and 2007, our organizational structure was different. We restated our segment results for 2008 and 2007 to reflect the 2009 structure to provide you with a meaningful year to year comparison. Effective January 1, 2010, the 2009 organization was superseded by the new organization that is discussed in further detail in Section 5.1 Business Organization found elsewhere in this annual report.
The following tables set forth certain financial information on a segment basis for 2008 and 2007. Segment operating income (loss) is the measure of profit or loss by segment that is used by our Management Comittee to make decisions on resource allocation and to assess performance. It consists of segment income (loss) from operating activities before restructuring costs, impairment of intangible assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments, excluding the main non-cash impacts of the purchase price allocation (PPA) entries relating to the Lucent business combination. Adding PPA Adjustments (excluding restructuring costs and impairment of assets) to segment operating income (loss), as shown in the table below, reconciles segment operating income (loss) with income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments, as shown in the table below and the consolidated financial statements included elsewhere in this annual report.
PPA Adjustments (excluding restructuring costs and impairment of assets). In 2008, PPA adjustments (excluding restructuring costs and impairment of assets) were €(522) million, compared with €(817) million in 2007. The decline in PPA adjustments in 2008 is due largely to the fact that PPA adjustments included €(258) million for an inventory reversal in 2007 which was not repeated in 2008.
Income (loss) from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments. In 2008, segment operating income of €466 million for the Group, adjusted for €(522) million in PPA, yielded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendment of €56 million, as shown in the consolidated financial statements. In 2007, segment operating income of €110 million for the Group adjusted for €(817) million in PPA, yielded a loss from operating activities before restructuring costs, impairment of assets, gain/(loss) on disposal of consolidated entities and post-retirement benefit plan amendments of €707 million, as shown in the consolidated financial statements.
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Revenues in our carrier segment were €10,980 million in 2008, a decline of 10.9% from €12,330 million in 2007, using current exchange rates. When we translate these sales into euros for accounting purposes, there is an exchange rate impact based on the relative value of the U.S. dollar and the euro. The decrease in the value of the U.S. dollar relative to the euro in 2008 as compared to 2007 had a significant negative impact on our revenues. If there had been a constant euro/U.S. dollar exchange rate in 2008 as compared to 2007, we believe that our carrier segment revenues would have declined less than the 10.9% decrease actually reported. However, we are unable to determine what that decline would have been at a constant euro/U.S. dollar exchange rate in 2008 due to the restatement of the segment financial information to reflect our 2009 business organization.
Our IP routing business increased in 2008, with an upgraded portfolio and increased customer diversification helping to drive record revenues in the fourth quarter. Our mature ATM (Asynchronous Transfer Mode) switching business, which is included in our IP division, continued on its structural decline path.
In Optics, the increasingly widespread availability of broadband access facilitated strong growth in bandwidth-intensive traffic like video, driving solid spending for added capacity in optical networks during 2008. That growth slowed considerably in the latter part of 2008, especially in the terrestrial segment, reflecting the new capacity that came on-line earlier in 2008 as well as the increasingly difficult economic environment. Spending on undersea optical networks for additional capacity on existing networks and for new cable systems was particularly strong in 2008.
Our Wireless networks division was paced by 50% growth in our W-CDMA business in 2008, as revenues ramped higher at several key customers. The increase in revenues, along with lower costs, helped us to reduce, by more than half, operating losses in our W-CDMA business in 2008. Elsewhere in Wireless, our growth in our GSM business was strong in the first half of 2008, driven by network expansions in China, India, the Middle East and Africa, but slowed considerably in the second half and was more in line with this mature, declining market. Our CDMA business declined sharply in 2008, reflecting particular weakness in North America that was not fully offset by shipments to a new customer in China.
Our Wireline division weakened in 2008 as we shipped 19% fewer DSL lines than in 2007. That decline reflected fewer new subscribers to carriers broadband access services, particularly in the increasingly saturated developed markets. DSL activity in North America and Western Europe was also impacted by the recession in the second-half of 2008. Initial mass deployments of GPON the next generation fixed access technology were launched in 2008, but growth was slower than expected due to regulatory uncertainty and the economy. Since GPON is a new technology, as of 2008, it had not yet scaled to the point where it can offset declines in our legacy DSL business.
The carrier segment operating income was €251 million, or 2.3% of revenues in 2008 compared with segment operating income of €72 million, or 0.6% of revenue in 2007. The increase in carrier segment operating income is due to enhanced pricing discipline and the progress we made executing on our programs to reduce operating expenses.
Applications Software Segment
Revenues in our applications software segment were €1,045 million in 2008 compared to €975 million in 2007, an increase of 7.2% at current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in 2008 as compared to 2007, we believe our applications software revenues would have increased more than the 7.2% reported increase. However, we are unable to determine what that decline would have been at a constant euro/U.S. dollar exchange rate in 2008 due to the restatement of the segment financial information to reflect our 2009 business organization. There were mixed trends in our carrier applications business in 2008, including weakness in legacy payment systems and strong growth in subscriber data management. Genesys, our contact center software activity saw growth in 2008.
Applications software segment operating loss was €(49) million in 2008 compared with a segment operating loss of €(133) million in 2007. Profitability in the segment was improved in 2008 compared to 2007, primarily reflecting the impact of higher volumes.
Revenues in our enterprise segment were €1,223 million in 2008, a decrease of 0.7% from revenues of €1,232 million in 2007, using current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in 2008 as compared to 2007, we believe our enterprise segment revenues would have declined by less than the 0.7% decrease actually experienced. However, we are unable to determine what that decline would have been at a constant euro/U.S. dollar exchange rate in 2008. However, we are unable to determine what that decline would have been at a constant euro/U.S. dollar exchange rate in 2008 due to the restatement of the segment financial information to reflect our 2009 business organization.
In 2008, we refocused our enterprise channel management and reorganized and added resources to our enterprise sales force, and those initiatives helped to drive growth in data networking and IP telephony. Growth in North America was particularly strong in 2008, although as the year progressed signs increased in North America and elsewhere that the deteriorating economy was affecting the enterprise market, particularly small-to-medium sized businesses.
Enterprise segment operating income was €84 million, or 6.9% of revenue in 2008 compared with segment operating income of €77 million or 6.3% of revenue in 2007. The ongoing investments we made in this part of our business were largely offset by the progress we made in our product cost reduction programs.
Revenues in our services business segment were €3,353 million in 2008, an increase of 6.1% over revenues of €3,159 million in the 2007, using current exchange rates. If there had been a constant euro/U.S. dollar exchange rate in 2008 as compared to 2007, we believe our services segment revenues would have increased by more than the 6.1% increase actually reported. However, we are unable to determine what that decline would have been at a constant euro/U.S. dollar exchange rate in 2008 due to the restatement of the segment financial information to reflect our 2009 business organization. Growth in services was particularly strong in network operations, network integration and multivendor maintenance.
Services segment operating income was €234 million or 7.0% of revenue in 2008 compared with €108 million or 3.4% of revenue in 2007. The increase in segment operating income was due to higher volumes, a favorable mix of services and higher margins across our services portfolio.
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6.6 LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW FOR THE YEARS ENDED DECEMBER 31, 2009 AND 2008
Cash flow overview
Cash and cash equivalents decreased by €110 million in 2009 to €3,577 million at December 31, 2009. This decrease was due to cash used by financing activities of €247 million (the cash used for repayment of short-term debt and repurchase and repayment of long-term debt more than offset the cash received from the issuance of long-term debt), to the adverse net effect of exchange rate changes of € 31 million and to net cash used by operating activities of € 5 million. The negative effects were offset, in part by cash provided from discontinued activities of €115 million (due mainly to the disposal of our fractional horsepower motors activity) and by cash provided from investing activities of €58 million.
Net cash provided (used) by operating activities. Net cash used by operating activities before changes in working capital, interest and taxes was € 215 million compared to net cash provided by operating activities before changes in working capital, interest and taxes of € 653 million for 2008. This decrease was primarily due to a higher loss from operating activities before restructuring costs, impairment of assets, gain (loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments, which was €325 million in 2009 compared to €56 million in 2008. The decrease is also explained by the lower amount of depreciation and amortization of tangible and intangible assets included in the income (loss) from operations in 2009, €969 million, compared with €1,241 million in 2008, such lower amount resulting from the fact that there was an impairment of €1,276 million related to amortizable intangible assets in the fourth quarter of 2008 that had been previously amortized during that year. The decrease was further due to the lower level of write-downs of inventories and work in progress included in the 2009 income (loss), with €139 million and €285 million in 2009 and 2008, respectively. The remaining part of this decrease is due to the higher reversal of product sales reserves in 2009 compared to 2008 and other differences in the non-cash items included in the income (loss) from operating activities before restructuring costs, impairment of assets, gain (loss) on disposal of consolidated entities, litigations and post-retirement benefit plan amendments.
Net cash used by operating activities was €5 million in 2009 compared to net cash provided by operating activities of €207 million in 2008. This amount takes into account the net cash provided (used) by operating activities before changes in working capital, interest and taxes, as explained in the preceding section, and also the net cash provided in 2009 by operating working capital, vendor financing and other current assets and liabilities, which amounted to €471 million, compared to net cash used by operating working capital, vendor financing and other current assets and liabilities of €131 million in 2008. The change between the two periods related to the increase in cash provided by working capital, representing an amount of cash provided of €490 million in 2009 compared to a net cash use of €30 million in 2008 (mainly due to the more disciplined management of our working capital), partially offset by the cash used related to other current assets and liabilities of €19 million in 2009 compared with €101 million in 2008. Net interest and taxes paid represented net cash used of €261 million in 2009 compared to €315 million in 2008. This reflects lower taxes paid in 2009 compared to 2008 and the improvement of the net cash (debt) position in 2009.
Net cash provided (used) by investing activities. Net cash provided (used) by investing activities was €58 million of net cash provided in 2009 compared to €726 million of net cash used by investing activities in 2008. Four main reasons explain the difference : although on one hand (i) the net cash used by the acquisition of marketable securities in 2009 was €1,062 million, compared to an amount of cash provided by the disposal of marketable securities in 2008 of €12 million and (ii) cash provided by the proceeds from disposal of tangible and intangible assets decreased from €188 million in 2008 (of which €61 million related to disposal of patents) to €25 million in 2009, on the other hand (iii) capital expenditures decreased in 2009 compared to 2008, being respectively €691 million and €901 million and (iv) the cash proceeds from sale of previously-consolidated and non-consolidated companies represented a net amount of cash of €1,765 million in 2009 (of which €1,566 million related to the disposal of our remaining shares in Thales and €128 million related to our disposal of our fractional horsepower motors activity) compared to €22 million in 2008.
Net cash provided (used) by financing activities. Net cash used by financing activities amounted to €247 million in 2009 compared to net cash used of €257 million in 2008. The primary changes were the increase in the amount of repayment of short-term and long-term debt with €1,299 million in 2009 (of which €777 million for redemption of the 4.375 % Alcatel bond due February 2009 and €382 million for early redemption of other bonds) to be compared with €250 million in 2008 (of which €137 million for redemption of the 5.50 % Lucent bond due November 2008 and €73 million for early redemption of other bonds) and the issuance in 2009 of a new convertible bond (Oceane 5.00% due January 2015) representing a net impact on cash provided by financing activities of €974 million.
Disposed of or discontinued operations. Disposed of or discontinued operations represented net cash provided of €115 million in 2009 compared to €21 million in 2008 (both being adjustments of the selling price of businesses sold to Thales in 2007).
Resources and cash flow outlook. Our capital resources may be derived from a variety of sources, including the generation of positive cash flow from on-going operations, the issuance of debt and equity in various forms, and banking facilities, including the revolving credit facility of €1.4 billion maturing in April 2012 (with an extension until April 5, 2013 for an amount of €837 million) and on which we have not drawn (see “Syndicated facility” below). Our ability to draw upon these resources at any time is dependent upon a variety of factors, including our customers ability to make payments on outstanding accounts receivable, the perception of our credit quality by lenders and investors, our ability to meet the financial covenant for our revolving facility and debt and equity market conditions generally. Given current conditions, we cannot rely on our ability to access the debt and equity markets at any given time.
Our short-term cash requirements are primarily related to funding our operations, including our restructuring programs, capital expenditures and short-term debt repayments. We believe that our cash, cash equivalents and marketable securities, including short-term investments, aggregating €5,570 million as of December 31, 2009, are sufficient to fund our cash requirements for the next 12 months, considering that the current portion of our long-term debt of €361 million as of December 31, 2009, which corresponds to Lucent’s 2.875 % Series A convertible debentures due 2023 that has a put option exercisable as of June 15, 2010 that we believe will be exercised. Approximately €926 million of our cash, cash equivalents and marketable securities are held in countries, primarily China, which are subject to exchange control restrictions. These restrictions can limit the use of such funds by our subsidiaries outside of their local jurisdictions. Repatriation efforts are underway to reduce that amount. We do not expect that such restrictions will have an impact on our ability to meet our cash obligations.
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During 2010, the projected amount of cash outlays pursuant to our previously-announced restructuring programs is expected to be in the same order of magnitude as for 2009, that is, approximately €600 million. We expect a stable level of capital expenditures compared to those in 2009, which amounted to €691 million including capitalization of development expenditures. Between January 1, 2010 and March 19, 2010, we repurchased an aggregate nominal value of U.S $75 million of Lucents 2.875% Series A convertible debentures due June 2023. Later in 2010, depending upon market and other conditions, we may continue our bond repurchase program in order to redeem certain of our outstanding bonds.
Based on our current view of our business and capital resources and the overall market environment, we believe we have sufficient resources to fund our operations. If, however, the business environment were to materially worsen, the credit markets were to limit our access to bid and performance bonds, or our customers were to dramatically pull back on their spending plans, our liquidity situation could deteriorate. If we cannot generate sufficient cash from operations to meet cash requirements in excess of our current expectations, we might be required to obtain extra funds through additional operating improvements or through external sources, such as capital market proceeds, asset sales or financing from third parties, the availability of which is dependent upon a variety of factors, as noted above.
At March 19, 2010, our credit ratings were as follows:
At March 19, 2010, Lucents credit ratings were as follows:
Moody's: On February 18, 2009, Moodys lowered the Alcatel-Lucent Corporate Family Rating, as well as the rating for senior debt of the Group, from Ba3 to B1. The trust preferred notes of Lucent Technologies Capital Trust were downgraded from B2 to B3. The Not-Prime rating for the short-term debt was confirmed. The negative outlook of the ratings was maintained.
On April 3, 2008, Moodys had affirmed the Alcatel-Lucent Corporate Family Rating as well as that of the debt instruments originally issued by historical Alcatel and Lucent. The outlook was changed from stable to negative.
The rating grid of Moodys ranges from AAA to C, which is the lowest rated class. Our B1 rating is in the B category, which also includes B2 and B3 ratings. Moodys gives the following definition of its B1 category: obligations rated B are considered speculative and are subject to high credit risk.
Standard & Poor's: On November 9, 2009, Standard & Poor's lowered to B from B+ its long-term corporate credit ratings and senior unsecured ratings on Alcatel-Lucent and on Alcatel-Lucent USA Inc. The B shortterm credit ratings of Alcatel-Lucent and of Alcatel-Lucent USA Inc. were affirmed. The rating on the trust prefered notes of Lucent Technologies Capital Trust was lowered from CCC+ to CCC. The outlook remains negative.
On March 3, 2009, Standard & Poors lowered to B+ from BB- its long-term corporate credit ratings and senior unsecured ratings on Alcatel-Lucent and on Lucent. The ratings on the trust preferred notes of Lucent Technologies Capital Trust were lowered to CCC+. The B short-term rating on Alcatel-Lucent was affirmed. The B 1 rating on Lucent was withdrawn. The outlook is negative.
On December 12, 2008, Standard & Poors placed on Credit Watch with negative implications the long-term corporate credit ratings of Alcatel-Lucent and Lucent, as well as all issue ratings on both companies. At the same time, the long-term credit ratings were affirmed.
On July 31, 2008, Standard & Poors revised to negative from stable its outlook on Alcatel-Lucent and Lucent long-term corporate credit ratings. At the same time, the long and short-term debt ratings of Alcatel-Lucent and of Lucent were affirmed.
On March 19, 2008, the remainder of Lucents senior unsecured debt was raised to BB-. The trust preferred notes of Lucent Technologies Capital Trust were rated B-.
The rating grid of Standard & Poors ranges from AAA (the strongest rating) to D (the weakest rating). Our B rating is in the B category, which also includes B+ and B- ratings. Standard & Poors gives the following definition to the B category: An obligation rated B is more vulnerable to non-payment than obligations rated BB but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial or economic conditions likely will impair the obligators capacity or willingness to meet its financial commitment on the obligation.
The CCC rating for the trust prefered notes of Lucent Technologies Capital Trust is in the CCC category, which also includes CCC+ and CCC- ratings. Standard & Poor's gives the following definition to the CCC category: An obligation rated CCC is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.
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We can provide no assurances that our credit ratings will not be lowered in the future by Standard & Poors, Moodys or similar rating agencies. In addition, a security rating is not a recommendation to buy, sell or hold securities, and each rating should be evaluated separately of any other rating. Our current short-term and long-term credit ratings as well as any possible future lowering of our ratings may result in higher financing costs and in reduced or no access to the capital markets.
At December 31, 2009, our total financial debt, gross amounted to €4,755 million compared to €5,095 million at December 31, 2008.
Short-term Debt. At December 31, 2009, we had €576 million of short-term financial debt outstanding, which included €361 million of Lucent’s 2.875% Series A convertible debentures due 2023 with a put option exercisable as of June 15,2010 and €107 million of accrued interest payable, with the remainder representing bank loans and lines of credit and other financial debt.
Long-term Debt. At December 31, 2009 we had €4,179 million of long-term financial debt outstanding.
Rating clauses affecting Alcatel-Lucent and Lucent debt at December 31, 2009. Alcatel-Lucents short-term debt rating allows a limited access to the French commercial paper market for short periods of time.
Alcatel-Lucents and Lucents outstanding bonds do not contain clauses that could trigger an accelerated repayment in the event of a lowering of their respective credit ratings.
Alcatel-Lucent syndicated bank credit facility. On April 5, 2007, Alcatel-Lucent obtained a €1.4 billion multi-currency syndicated five-year revolving bank credit facility (with two one-year extension options). On March 21, 2008, €837 million of availability under the facility was extended until April 5, 2013.
The availability of this syndicated credit facility of €1.4 billion is not dependent upon Alcatel-Lucent’s credit ratings. Alcatel-Lucent’s ability to draw on this facility is conditioned upon its compliance with a financial covenant linked to the capacity of Alcatel-Lucent to generate sufficient cash to repay its net debt and compliance is tested quarterly when we release our consolidated financial statements. Since the €1.4 billion facility was established, Alcatel-Lucent has complied every quarter with the financial covenant that is included in the facility. The facility was undrawn at February 9, 2010, the date of approval by Alcatel-Lucents Board of Directors of the Groups 2009 financial statements.
6.7 CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET CONTINGENT COMMITMENTS
Contractual obligations. We have certain contractual obligations that extend beyond 2010. Among these obligations, we have long-term debt and interest thereon, finance leases, operating leases, commitments to purchase fixed assets and other unconditional purchase obligations. Our total contractual cash obligations at December 31, 2009 for these items are presented below based upon the minimum payments we will have to make in the future under such contracts and firm commitments. Amounts related to financial debt, finance lease obligations and the equity component of our convertible bonds are fully reflected in our consolidated statement of financial position included in this annual report.
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Off-balance sheet commitments and contingencies. On December 31, 2009, our off-balance sheet commitments and contingencies amounted to €2,091 million, consisting primarily of €1,096 million in guarantees on long-term contracts for the supply of telecommunications equipment and services by our consolidated and non-consolidated subsidiaries. Generally, we provide these guarantees to back performance bonds issued to customers through financial institutions. These performance bonds and counter-guarantees are standard industry practice and are routinely provided in long-term supply contracts. If certain events occur subsequent to our including these commitments within our off-balance sheet contingencies, such as delays in promised delivery or claims related to an alleged failure by us to perform on our long-term contracts, or the failure by one of our customers to meet its payment obligations, we reserve the estimated risk on our consolidated statement of financial position under the line items “Provisions” or “Amounts due to/from our customers on construction contracts,” or in inventory reserves. Not included in the €2,091 million is approximately €424 million in customer financing provided by us.
With respect to guarantees given for contract performance, only those issued by us to back guarantees granted by financial institutions are presented in the table below.
Off-balance sheet contingent commitments given in the normal course of business are as follows:
The amounts of guarantees given on contracts reflected in the preceding table represent the maximum potential amounts of future payments (undiscounted) we could be required to make under current guarantees granted by us. These amounts do not reflect any amounts that may be recovered under recourse, collateralization provisions in the guarantees or guarantees given by customers for our benefit. In addition, most of the parent company guarantees and performance bonds given to our customers are insured; therefore, the estimated exposure related to the guarantees set forth in the preceding table may be reduced by insurance proceeds that we may receive in case of a claim.
Commitments related to product warranties and pension and post-retirement benefits are not included in the preceding table. These commitments are fully reflected in our 2009 consolidated financial statements included elsewhere in this document. Contingent liabilities arising out of litigation, arbitration or regulatory actions are not included in the preceding table either, with the exception of those linked to the guarantees given on our long-term contracts.
Commitments related to contracts that have been cancelled or interrupted due to the default or bankruptcy of the customer are included in the above-mentioned Guarantees given on contracts made by Group entities and by non-consolidated subsidiaries as long as the legal release of the guarantee is not obtained.
Guarantees given on third-party long-term contracts could require us to make payments to the guaranteed party based on a non-consolidated companys failure to perform under an agreement. The fair value of these contingent liabilities, corresponding to the premium to be received by the guarantor for issuing the guarantee, was €2 million as of December 31, 2009 (€2 million as of December 31, 2008).
In connection with our consent solicitation to amend the indenture pursuant to which Lucent’s 2.875% Series A convertible debentures due 2023 and 2.875% Series B convertible debentures due 2025 were issued, on December 29, 2006, we issued a full and unconditional guaranty of these debentures. The guaranty is unsecured and is subordinated to the prior payment in full of our senior debt and is pari passu with our other general unsecured obligations, other than those that expressly provide that they are senior to the guaranty obligations.
Customer financing. Based on standard industry practice, from time to time, we extend financing to our customers by granting extended payment terms, making direct loans, and providing guarantees to third-party financing sources. More generally, as part of our business, we routinely enter into long-term contracts involving significant amounts to be paid by our customers over time.
As of December 31, 2009, net of reserves, there was an exposure of approximately €334 million under drawn customer-financing arrangements, representing approximately €332 million of deferred payments and loans, and €2 million of guarantees. In addition, as of December 31, 2009, we had further commitments to provide customer financing for approximately €61 million. It is possible that these further commitments will expire without our having to actually provide the committed financing.
Outstanding customer financing and undrawn commitments are monitored by assessing, among other things, each customers short-term and long-term liquidity positions, the customers current operating performance versus plan, the execution challenges faced by the customer, changes in the competitive landscape, and the customers management experience and depth. When we detect potential problems, we take mitigating actions, which may include the cancellation of undrawn commitments. Although by taking such actions we may be able to limit the total amount of our exposure, we still may suffer losses to the extent of the drawn and guaranteed amounts.
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During 2009, Alcatel-Lucent entered into a major IT outsourcing transaction with Hewlett Packard Company (HP) and is also finalizing further outsourcing transactions with other service providers concerning payroll and certain R&D and business process activities. The IT outsourcing transaction, which has an effective date of December 1, 2009, was signed with HP on October 20, 2009, at the same time as a ten-year sales cooperation agreement with HP.
The IT outsourcing transaction provides for HP to transform and manage a large part of Alcatel-Lucents IT infrastructure. As part of an initial 18-month transition and transformation phase, HP will invest its own resources to transform Alcatel-Lucents global IT/IS platforms. As a result, Alcatel-Lucent is committed to restructuring its IT/IS operations, which is estimated to cost €200 million. These restructuring costs, which include severance costs and the costs of transferring certain legal entities and resources to HP, will be recognized as incurred, starting in 2010.
As part of the transfer of resources, Alcatel-Lucent has sold to HP IT infrastructure assets under a sale and finance leaseback arrangement, the payment obligations for which are included in “Finance lease obligations” in the contractual payments obligations table above representing a total amount of €57 million of finance lease obligation.
Also as part of the overall arrangement with HP, Alcatel-Lucent has committed to purchase €202 million of HP goods and services to be used in the context of customer networks over a four-year period until October 31, 2013. The finance lease obligations and the unconditional purchase commitments related to this agreement are included in the contractual payment obligations table presented above under the headings Finance lease obligations and Unconditional purchase obligations.
The further two following commitments were included in the HP agreement:
a minimum value commitment regarding the amount of IT managed services to be purchased or procured by Alcatel-Lucent from HP and/or any HP affilliates over ten years, for a total amount of €1,408 million (which amount includes €120 million of the €200 million restructuring costs mentioned above); and
commitment to make certain commercial efforts related to the development of sales pursuant to the sales cooperation agreement, including through the establishment of dedicated teams, representing a minimum investment of €298 million over ten years.
These two commitments are included in the contractual payment obligations table presented above under the heading “Unconditional purchase obligations.
Specific commitments of former Lucent (now Alcatel-Lucent USA Inc.)
Alcatel-Lucent USA Inc.s separation agreements. Alcatel-Lucent USA Inc. is party to various agreements that were entered into in connection with the separation of Alcatel-Lucent USA Inc. and former affiliates, including AT&T, Avaya, LSI Corporation (formerly Agere Systems, before its merger with LSI corporation in April 2007) and NCR Corporation. Pursuant to these agreements, Alcatel-Lucent USA Inc. and the former affiliates have agreed to allocate certain liabilities related to each others business, and have agreed to share liabilities based on certain allocations and thresholds. In the fourth quarter of 2009, Alcatel-Lucent USA Inc. recorded an additional provision of U.S.$ 22 million for a claim asserted by NCR Corporation relating to NCR Corporation's liabilities for the environmental clean up of the Fox River in Wisconsin, USA. Future developments in connection with the Fox River claim may warrant additional adjustments of existing provisions. We are not aware of any other material liabilities to Alcatel-Lucent USA Inc.s former affiliates as a result of the separation agreements that are not otherwise reflected in our consolidated financial statements included elsewhere in this annual report. Nevertheless, it is possible that potential liabilities for which the former affiliates bear primary responsibility may lead to contributions by Alcatel-Lucent USA Inc. beyond amounts currently reserved.
Alcatel-Lucent USA Inc.s other commitments Contract manufacturers. Alcatel-Lucent USA Inc. outsources most of its manufacturing operation to electronic manufacturing service (EMS) providers. Until 2008, two EMS providers, Celestica and Solectron (acquired by Flextronics in October 2007), had exclusive arrangements with Alcatel-Lucent USA Inc. to supply most of Alcatel-Lucent USA Inc.-designed wireless and wireline products. Although no longer exclusive suppliers, Celestica continues to manufacture most of Alcatel-Lucent USA Inc.s existing wireless products and Solectron continues to consolidate the outsourced manufacturing of Alcatel-Lucent USA Inc.s portfolio of wireline products. Alcatel-Lucent USA Inc. generally does not have minimum purchase obligations in its contract-manufacturing relationships with EMS providers and therefore the contractual payment obligations schedule, presented above under the heading Contractual Obligations, does not include any commitments related to contract manufacturers.
Alcatel-Lucent USA Inc.s guarantees and indemnification agreements. Alcatel-Lucent USA Inc. divested certain businesses and assets through sales to third-party purchasers and spin-offs to the other common shareowners of the businesses spun-off. In connection with these transactions, certain direct or indirect indemnifications were provided to the buyers or other third parties doing business with the divested entities. These indemnifications include secondary liability for certain leases of real property and equipment assigned to the divested entity and specific indemnifications for certain legal and environmental contingencies, as well as vendor supply commitments. The durations of such indemnifications vary but are standard for transactions of this nature.
Alcatel-Lucent USA Inc. remains secondarily liable for approximately U.S.$ 67 million of lease obligations as of December 31, 2009 (U.S.$ 105 million of lease obligations as of December 31, 2008), that were assigned to Avaya, LSI Corporation (formerly Agere) and purchasers of other businesses that were divested. The remaining terms of these assigned leases and the corresponding guarantees range from one month to 10 years. The primary obligor under the assigned leases may terminate or restructure the lease before its original maturity and thereby relieve Alcatel-Lucent USA Inc. of its secondary liability. Alcatel-Lucent USA Inc. generally has the right to receive indemnity or reimbursement from the assignees and we have not reserved for losses on this form of guarantee.
Alcatel-Lucent USA Inc. is party to a tax-sharing agreement to indemnify AT&T and is liable for tax adjustments that are attributable to its lines of business, as well as a portion of certain other shared tax adjustments during the years prior to its separation from AT&T. Alcatel-Lucent USA Inc. has similar agreements with Avaya and LSI Corporation. Certain proposed or assessed tax adjustments are subject to these tax-sharing agreements. We do not expect that the outcome of these other matters will have a material adverse effect on our consolidated results of operations, consolidated financial position or near-term liquidity.
Alcatel-Lucent USA Inc.'s guaranty of Alcatel-Lucent public bonds. On March 27, 2007, Lucent issued full and unconditional guaranties of Alcatel-Lucents 6.375% notes due 2014 (the principal amount of which was €462 million on December 31, 2009) and our 4.750% Convertible and/or Exchangeable Bonds due 2011 (the remaining principal amount of which was €818 million on December 31, 2009). Each guaranty is unsecured and is subordinated to the prior payment in full of Alcatel-Lucent USA Inc.s senior debt and is pari passu with Alcatel-Lucent USA Inc.s other general unsecured obligations, other than those that expressly provide that they are senior to the guaranty obligations.
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Customer credit approval process and risks
. We engage in a thorough credit approval process prior to providing financing to our customers or guarantees to financial institutions, which provide financing to our customers. Any significant undertakings have to be approved by a central Trade and Project Finance group and by a central Risk Assessment Committee, each independent from our commercial departments. We continually monitor and manage the credit we have extended to our customers, and attempt to limit credit risks by, in some cases, obtaining security interests or by securitizing or transferring to banks or export credit agencies a portion of the risk associated with this financing.
Although, as discussed above, we engage in a rigorous credit approval process and have taken actions to limit our exposure to customer credit risks, if economic conditions and conditions in the telecommunications industry in particular were to deteriorate, leading to the financial failure of our customers, we may realize losses on credit we extended and loans we made to our customers, on guarantees provided for our customers and losses relating to our commercial risk exposure under long-term contracts, as well as the loss of our customers ongoing business. In such a context, should customers fail to meet their obligations to us, we may experience reduced cash flows and losses in excess of reserves, which could materially adversely impact our results of operations and financial position.
We expect a stable amount of capital expenditures compared to those of 2009, which amounted to €691 million including capitalization of development expenses. We believe that our current cash, cash equivalents and marketable secutities and funding arrangements, provide us with adequate flexibility to meet our short-term and long-term financial obligations and to pursue our capital expenditure program as planned. To the extent that the business environment materially deteriorates or our customers reduce their spending plans, we will reevaluate our capital expenditure priorities appropriately. We may be also required to engage in additional restructuring efforts and seek additional sources of capital, which may be difficult if there is no continued improvement in the market environment and given our limited ability to access the fixed income market at this point. In addition, as mentioned in Capital Resources above, if we do not meet the financial covenant contained in our syndicated facility, we may not be able to rely on that funding arrangement to meet our cash needs.
6.8 OUTLOOK FOR 2010
In a global economic environment that appears to be stabilizing, the telecommunications equipment and related services market should recover in 2010. Given its improved product portfolio and the effectiveness of its cost reduction actions, Alcatel-Lucent feels confident in its ability to grow and increase its margins. However, in what remains a highly competitive environment, it is too early to have a firm view on the extent of margin expansion. The company has therefore widened the targeted range for its operating profit before restructuring costs, impairment of assets, gain/loss on disposal of consolidated entities, litigations, and post-retirement benefit plan amendments (excluding the negative non-cash impacts of Lucents purchase price allocation) as a percentage of revenues in 2010, while remaining committed to the 2011 goals of its three-year transformation plan:
for 2010, Alcatel-Lucent continues to expect nominal growth (defined as between 0% and 5%) for the telecommunications equipment and related services market;
for 2010, Alcatel-Lucent aims to reach an operating profit before restructuring costs, impairment of assets, gain/loss on disposal of consolidated entities, litigations, and post-retirement benefit plan amendments (excluding the negative non-cash impacts of Lucents purchase price allocation) in the low to mid single-digit range (defined as between 1% and 5%) as a percentage of revenue;
for 2011, Alcatel-Lucent continues to aspire to an operating profit before restructuring costs, impairment of assets, gain/loss on disposal of consolidated entities, litigations, and post-retirement benefit plan amendments (excluding the negative non-cash impacts of Lucents purchase price allocation) in the mid to high single-digit range (defined as between 5% to 9%) as a percentage of revenue, depending on market growth.
6.9 QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
We enter into derivative financial instruments primarily to manage our exposure to fluctuations in interest rates and foreign currency exchange rates. Our policy is not to take speculative positions. Our strategies to reduce exchange and interest rate risk have served to mitigate, but not eliminate, the positive or negative impact of exchange and interest rate fluctuations.
Derivative financial instruments held by us at December 31, 2009 were mostly hedges of existing or future financial or commercial transactions or were related to issued debt.
The largest position part of our issued debt is in euro and U.S. dollar. We use interest rate derivatives to convert a part of the fixed rate debt into floating rate in order to cover the interest rate risk.
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For our marketable securities, cash, cash equivalents and financial derivative instruments, we are exposed to credit risk if a counterparty defaults on its financial commitments to us. This risk is monitored daily, with strict limits based on the counterparties rating. All of our counterparties were classified in the investment grade category as of December 31, 2009. The exposure of each market counterparty is calculated taking into account the fair value of the underlying market instruments.
Foreign currency risk
Since we conduct commercial and industrial operations throughout the world, we are exposed to foreign currency risk. We use derivative financial instruments to protect ourselves against fluctuations of foreign currencies which have an impact on our assets, liabilities, revenues and expenses.
Future transactions mainly relate to firm commercial contracts and commercial bids. Firm commercial contracts and commercial bids are hedged by forward foreign exchange transactions or currency options. The duration of future transactions that are not firmly committed does not usually exceed 18 months.
Interest rate risk on financial debt, net
In the event of an interest rate decrease, the fair value of our fixed-rate debt would increase and it would be more costly for us to repurchase it (not taking into account that an increased credit spread reduces the value of the debt).
In the table below, the potential change in fair value for interest rate sensitive instruments is based on a hypothetical and immediate one percent fall or rise for 2009 and 2008, in interest rates across all maturities and for all currencies. Interest rate sensitive instruments are fixed-rate, long-term debt or swaps and marketable securities.
The fair value of the instruments in the table above is calculated with market standard financial software according to the market parameters prevailing on December 31, 2009.
Fair value hedge and cash flow hedge
The ineffective portion of changes in fair value hedges and cash flow hedges was a profit of €2 million at December 31, 2009, compared to a profit of €13 million at December 31, 2008 and a loss of €19 million at December 31, 2007. We did not have any amount excluded from the measure of effectiveness.
Net investment hedge
We have stopped using investment hedges in foreign subsidiaries. At December 31, 2009, 2008 and 2007, there were no derivatives that qualified as investment hedges.
We may use derivative instruments to manage the equity investments in listed companies that we hold in our portfolio. We may sell call options on shares held in our portfolio and any profit would be measured by the difference between our book value for such securities and the exercise price of the option, plus the premium received.
We may also use derivative instruments on our shares held in treasury. Such transactions are authorized as part of the stock repurchase program approved at our shareholders general meeting held on June 1, 2007.
Since April 2002, we have not had any derivative instruments in place on investments in listed companies or on our shares held in treasury.
Additional information regarding market and credit risks, including the hedging instruments used, is provided in Note 28 to our consolidated financial statements included elsewhere herein.
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6.10 LEGAL MATTERS
In addition to legal proceedings incidental to the conduct of its business (including employment-related collective actions in France and the United States) which management believes are adequately reserved against in the financial statements or will not result in any significant costs to the Group, Alcatel-Lucent is involved in the following legal proceedings.
Beginning in early October 2004, Alcatel-Lucent learned that investigations had been launched in Costa Rica by the Costa Rican prosecutors and the National Congress, regarding payments alleged to have been made by consultants on behalf of Alcatel CIT, a French subsidiary now called Alcatel-Lucent France (CIT), or other Alcatel-Lucent subsidiaries to various public officials in Costa Rica, two political parties in Costa Rica and representatives of ICE, the state-owned telephone company, in connection with the procurement by CIT of several contracts for network equipment and services from ICE. Upon learning of these allegations, Alcatel-Lucent commenced an investigation into this matter.
Alcatel-Lucent terminated the employment of the then-president of Alcatel de Costa Rica in October 2004 and of a vice president Latin America of CIT. CIT is also pursuing criminal actions in France against the latter and in Costa Rica against these two former employees and certain local consultants, based on their complicity in a bribery scheme and misappropriation of funds. The United States Securities and Exchange Commission (SEC) and the United States Department of Justice (DOJ) are aware of the allegations and Alcatel-Lucent stated it would cooperate fully in any inquiry or investigation into these matters. The SEC and the DOJ are conducting an investigation into possible violations of the Foreign Corrupt Practices Act (FCPA) and the federal securities laws. In connection with that investigation, the DOJ and the SEC also requested information regarding Alcatel-Lucents operations in other countries.
In connection with these allegations, on December 19, 2006, the DOJ indicted one of the two former employees on charges of violations of the FCPA, money laundering, and conspiracy. On March 20, 2007, a grand jury returned a superseding indictment against the same former employee and the former president of Alcatel de Costa Rica, based on the same allegations contained in the previous indictment. On June 11, 2007, the former CIT employee entered into a plea agreement in the U.S. District Court for the Southern District of Florida and pleaded guilty to violations of the FCPA. On September 23, 2008, the former CIT employee was sentenced to 30 months imprisonment, three years supervised release, the forfeiture of U.S.$ 261,500, and a U.S.$ 200 special assessment.
French authorities are also conducting an investigation of CITs payments to consultants in the Costa Rica matter.
Alcatel-Lucent is cooperating with the U.S., French and Costa Rican authorities in the respective investigations described above. Alcatel-Lucent reiterates that its policy is to conduct its business with transparency, and in compliance with all laws and regulations, both locally and internationally. Alcatel-Lucent will cooperate with all governmental authorities in connection with the investigation of any violation of those laws and regulations.
In connection with the Costa Rica allegations, on July 27, 2007, the Costa Rican Prosecutors Office indicted eleven individuals, including the former president of Alcatel de Costa Rica, on charges of aggravated corruption, unlawful enrichment, simulation, fraud and others. Three of those individuals have since pled guilty. Shortly thereafter, the Costa Rican Attorney Generals Office and ICE, acting as victims of this criminal case, each filed amended civil claims against the eleven criminal defendants, as well as five additional civil defendants (one individual and four corporations, including CIT) seeking compensation for damages in the amounts of U.S.$ 52 million (in the case of the Attorney Generals Office) and U.S.$ 20 million (in the case of ICE). The Attorney Generals claim supersedes two prior claims, of November 25, 2004 and August 31, 2006. On November 25, 2004, the Costa Rican Attorney Generals Office commenced a civil lawsuit against CIT to seek pecuniary compensation for the damage caused by the alleged payments described above to the people and the Treasury of Costa Rica, and for the loss of prestige suffered by the Nation of Costa Rica (social damages). The ICE claim, which supersedes its prior claim of February 1, 2005, seeks pecuniary compensation for the damage caused by the alleged payments described above to ICE and its customers, for the harm to the reputation of ICE resulting from these events (moral damages), and for damages resulting from an alleged overpricing it was forced to pay under its contract with CIT. During preliminary court hearings held in San José during September 2008, ICE filed a report in which the damages allegedly caused by CIT are valued at U.S.$ 71.6 million. No formal notice of a revised civil claim has so far been received by CIT.
Alcatel-Lucent recently entered into discussions with the Attorney Generals Office directed to a negotiated resolution of the Attorney Generals social damages claims and the moral damages claims of ICE. Those discussions have resulted in a signed written agreement entered into January 20, 2010 under which the Attorney Generals social damages claims would be dismissed in return for a payment by Alcatel-Lucent France (as successor to CIT) of approximately U.S.$ 10 million. That agreement was approved by the Court having jurisdiction over the Attorney Generals claims on February 24, 2010, and it is now effective. ICEs claims are not included in the agreement with the Attorney General and it has been reported in the Costa Rican press that the Board of ICE has decided not to participate in the settlement negotiated with the Attorney General at this time. To the extent that any of these claims are not resolved by agreement, Alcatel-Lucent intends to defend against them vigorously and to deny any liability or wrongdoing with respect to such claims.
Additionally, in August 2007, ICE notified CIT of the commencement of an administrative proceeding to terminate the 2001 contract for CIT to install 400,000 GSM cellular telephone lines (the 400KL GSM Contract), in connection with which ICE is claiming compensation of U.S.$ 59.8 million for damages and loss of income. By March 2008, CIT and ICE concluded negotiations of a draft settlement agreement for the implementation of a Get Well Plan, in full and final settlement of the above-mentioned claim. This settlement agreement was not approved by ICEs Board of Directors that resolved, instead, to resume the aforementioned administrative proceedings to terminate the operations and maintenance portion of the 400KL GSM Contract, claim penalties and damages in the amount of U.S.$ 59.8 million and call the performance bond. CIT was notified of this ICE resolution on June 23, 2008. ICE has made additional damages claims and penalty assessments related to the 400KL GSM Contract that bring the overall exposure under the contract to U.S.$ 78.1 million in the aggregate, of which ICE has collected U.S.$ 5.9 million.
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In June 2008, CIT filed an administrative appeal against the resolution mentioned above. ICE called the performance bond in August 2008, and on September 16, 2008 CIT was served notice of ICEs request for payment of the remainder amount of damages claimed, U.S.$ 44.7 million. On September 17, 2008, the Costa Rican Supreme Court ruled on the appeal filed by CIT stating that: (i) the U.S.$ 15.1 million performance bond amount is to be reimbursed to CIT and (ii) the U.S.$ 44.7 million claim is to remain suspended until final resolution by the competent court of the case. Following a clarification request filed by ICE, the Court finally decided that the U.S.$ 15.1 million performance bond amount is to remain deposited in an escrow account held by the Court, until final resolution of the case. On October 8, 2008, CIT filed a claim against ICE requesting the court to overrule ICEs contractual resolution regarding the 400KL GSM Contract and claiming compensation for the damages caused to CIT. In January 2009, ICE filed its response to CITs claim. At a court hearing on March 25, 2009, ICE ruled out entering into settlement discussions with CIT. On April 20, 2009, CIT filed a petition to the Court to recover the U.S.$ 15.1 million performance bond amount and offered the replacement of such bond with a new bond that will guarantee the results of the final decision of the Court. A hearing originally scheduled for June 1, 2009 was suspended due to ICEs decision not to present to the Court the complete administrative file wherein ICE decided the contractual resolution of the 400KL GSM Contract. The preliminary court hearing commenced on October 6, 2009, and is expected to conclude towards the end of March 2010.
On October 14, 2008, the Costa Rican authorities notified CIT of the commencement of an administrative proceeding to ban CIT from government procurement contracts in Costa Rica for up to 5 years. The administrative proceeding was suspended on December 8, 2009 pending the resolution of the criminal case mentioned above.
If the Costa Rican authorities conclude criminal violations have occurred, CIT may be banned from participating in government procurement contracts within Costa Rica for a certain period. Alcatel-Lucent expects to generate approximately €6 million in revenue from Costa Rican contracts in 2010. Based on the amount of revenue expected from these contracts, Alcatel-Lucent does not believe a loss of business in Costa Rica would have a material adverse effect on the Alcatel-Lucent group as a whole. However, these events may have a negative impact on the reputation of Alcatel-Lucent in Latin America.
Alcatel-Lucent has recognized a provision in connection with the various ongoing proceedings in Costa Rica when reliable estimates of the probable future outflow were available.
As previously disclosed in its public filings, Alcatel-Lucent has engaged in settlement discussions with the DOJ and the SEC with regard to the ongoing FCPA investigations. These discussions have resulted in December 2009 in agreements in principle with the staffs of each of the agencies. There can be no assurance however that final agreements will be reached with the agencies or accepted in court. If finalized, the agreements would relate to alleged violations of the FCPA involving several countries, including Costa Rica, Taiwan, and Kenya. Under the agreement in principle with the SEC, Alcatel-Lucent would enter into a consent decree under which Alcatel-Lucent would neither admit nor deny violations of the antibribery, internal controls and books and records provisions of the FCPA and would be enjoined from future violations of U.S. securities laws, pay U.S. $45.4 million in disgorgement of profits and prejudgment interest and agree to a three-year French anticorruption compliance monitor to evaluate in accordance with the provisions of the consent decree (unless any specific provision therein is expressly determined by the French Ministry of Justice to violate French law) the effectiveness of Alcatel-Lucents internal controls, record-keeping and financial reporting policies and procedures. Under the agreement in principle with the DOJ, Alcatel-Lucent would enter into a three-year deferred prosecution agreement (DPA), charging Alcatel-Lucent with violations of the internal controls and books and records provisions of the FCPA, and Alcatel-Lucent would pay a total criminal fine of U.S.$ 92 million payable in four installments over the course of three years. In addition, three Alcatel-Lucent subsidiaries Alcatel-Lucent France, Alcatel-Lucent Trade International AG and Alcatel Centroamerica would each plead guilty to violations of the FCPAs antibribery, books and records and internal accounting controls provisions. The agreement with the DOJ would also contain provisions relating to a three-year French anticorruption compliance monitor. If Alcatel-Lucent fully complies with the terms of the DPA, the DOJ would dismiss the charges upon conclusion of the three-year term.
Alcatel-Lucent has recognized a provision of €93 million in connection with these FCPA investigations, which is equivalent to the sum of U.S.$ 45.4 million as agreed upon in the agreement in principle with the SEC and U.S.$ 92 million as agreed upon in the agreement in principle with the DOJ, discounted back to net present value and converted into Euros.
Certain employees of Taisel, a Taiwanese affiliate of Alcatel-Lucent, and Siemenss Taiwanese distributor, along with a few suppliers and a legislative aide, have been the subject of an investigation by the Taipei Investigators Office of the Ministry of Justice relating to an axle counter supply contract awarded to Taisel by Taiwan Railways in 2003. It has been alleged that persons in Taisel, Alcatel-Lucent Deutschland AG (a German subsidiary of Alcatel-Lucent involved in the Taiwan Railway contract), Siemens Taiwan, and subcontractors hired by them were involved in a bid-rigging and illicit payment arrangement for the Taiwan Railways contract.
Upon learning of these allegations, Alcatel-Lucent commenced an investigation into this matter. As a result of the investigation, Alcatel-Lucent terminated the former president of Taisel. A director of international sales and marketing development of the German subsidiary resigned during the investigation.
On February 21, 2005, Taisel, the former president of Taisel, and others were indicted in Taiwan for violation of the Taiwanese Government Procurement Act.
On November 15, 2005, the Taipei criminal district court found Taisel not guilty of the alleged violation of the Government Procurement Act. The former President of Taisel was not judged because he was not present or represented at the proceedings. The court found two Taiwanese businessmen involved in the matter guilty of violations of the Business Accounting Act. The not guilty verdict for Taisel was upheld by the Taiwan High Court and is now final. On December 9, 2009, the Supreme Court denied the appeal filed by the Taiwan Prosecutor Office against the High Courts ruling with respect to the individual defendants.
Other allegations made in connection with this matter may still be under ongoing investigation by the Taiwanese authorities.
Kenya and Nigeria
The SEC and the DOJ asked Alcatel-Lucent to look into payments made in 2000 by CIT to a consultant arising out of a supply contract between CIT and a privately-owned company in Kenya. Alcatel-Lucent understands that the French authorities are also conducting an investigation to ascertain whether inappropriate payments were received by foreign public officials in connection with such project. Alcatel-Lucent is cooperating with the U.S. and French authorities and has submitted to these authorities its findings regarding those payments.
Following information voluntarily disclosed by Alcatel-Lucent to the U.S. and French authorities, the French authorities have recently requested Alcatel-Lucent to produce further documents related to payments made by its subsidiaries to certain consultants in Nigeria. Alcatel-Lucent is cooperating with the French authorities and will submit the requested documents.
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The French authorities have initiated an investigation of the submarine cable subsidiary of Alcatel-Lucent, Alcatel-Lucent Submarine Networks (ASN), and certain former or current employees, relating to a project for a submarine cable between Tahiti and Hawaii awarded to ASN in 2007 by the state-owned telecom agency of French Polynesia (OPT). On September 23, 2009, four of those employees were charged (mis en examen) with aiding and abetting favoritism in connection with the award by OPT of a public procurement project. On November 23, 2009, ASN was charged with benefitting from favoritism (recel de favoritisme) in connection with the same alleged favoritism. Alcatel-Lucent commenced, and is continuing, an investigation into this matter.
Alcatel-Lucent is unable to predict the outcome of this investigation and its effect on ASNs business. If ASN were convicted of a criminal violation, the French courts could, among other things, fine ASN and/or ban it from participating in French public procurement contracts for a certain period. ASN expects to generate approximately €20 million of revenue from French public procurement contracts in 2010. Accordingly, Alcatel-Lucent does not believe that a loss of business as a result of such a ban would have a material effect on the Alcatel-Lucent group as a whole.
Lucent’s employment and benefits related cases
In October 2005, a purported class action was filed by Peter A. Raetsch, Geraldine Raetsch and Curtis Shiflett, on behalf of themselves and all others similarly situated, in the U.S. District Court for the District of New Jersey. The plaintiffs alleged that Lucent failed to maintain health care benefits for retired management employees for each year from 2001 through 2006 as required by the Internal Revenue Code, the Employee Retirement Income Security Act, and the Lucent pension and medical plans. Upon motion by Lucent, the court remanded the claims to Lucents claims review process. A Special Committee was appointed and reviewed the claims of the plaintiffs and Lucent filed a report with the Court on December 28, 2006. The Special Committee denied the plaintiffs claims and the case returned to the court, where limited discovery was completed.
By Opinion and Order, each dated June 11, 2008, the court granted in part and denied in part plaintiffs motion for summary judgment (as to liability) and denied Lucents cross-motion for summary judgment (also as to liability). Specifically, the court found that Lucent had violated the Plans maintenance of benefits requirement with respect to the 2003 plan year but that the record before the court contained insufficient facts from which to conclude whether those provisions were violated for years prior to 2003. The court also tentatively ruled that defendants had not violated the Plans maintenance of cost provisions for the years 2004 through 2006. The court ordered the parties to engage in further discovery proceedings. Finally, the court denied, without prejudice, plaintiffs motion for class certification. On June 26, 2008, Lucent requested the court to certify the case for appeal to the Third Circuit Court of Appeals in its discretion. This request was denied.
As a result of the courts findings for 2003, Lucent established a provision for U.S.$ 27 million during the second quarter of 2008. As a result of the ongoing discovery and analysis, this reserve was adjusted from time to time, most recently to U.S.$ 28 million as of September 30, 2009. On January 21, 2010, the parties agreed to settle the lawsuit for the sum of U.S.$ 36 million. The settlement is memorialized in a binding and executed Settlement Agreement. The settlement is subject to court approval, including approval of the settlement amount and the amount of class counsels fees to be deducted therefrom, approval of a plan of allocation of the net settlement proceeds to class members, and certification of a settlement class by the court.
Lucent implemented various actions to address the rising costs of providing retiree health care benefits and the funding of Lucent pension plans. These actions led to the filing of cases against Lucent (now closed) and may lead to the filing of additional cases.
In September 2004, the Equal Employment Opportunity Commission (EEOC) had filed a purported class action lawsuit against Lucent, EEOC v. Lucent Technologies Inc., in the U.S. District Court in California, for gender discrimination with respect to the provision of service credit for purposes of a pension plan. In a case concerning a similar plan, the U.S. Supreme Court decided in May 2009 that such plan is not unlawful unless there is evidence of intentional discrimination. In light of this judgment, the EEOC voluntarily dismissed this matter, and the dismissal was approved by the District Court on July 27, 2009.
Intellectual property cases
Each of Alcatel-Lucent, Lucent and certain other entities of the Group is a defendant in various cases in which third parties claim infringement of their patents, including certain cases where infringement claims have been made against its customers in connection with products the applicable Alcatel-Lucent entity has provided to them, or challenging the validity of certain patents.
Lucent, Microsoft and Dell have been involved in a number of patent lawsuits in various jurisdictions. In the summer of 2003, certain Dell and Microsoft lawsuits in San Diego, California, were consolidated in federal court in the Southern District of California. The court scheduled a number of trials for groups of the Lucent patents, including two trials held in 2008. In one of these trials, on April 4, 2008, a jury awarded Alcatel-Lucent approximately U.S.$ 357 million in damages for Microsofts infringement of the Day patent, which relates to a computerized form entry system. On June 19, 2008, the Court entered judgment on the verdict and also awarded prejudgment interest exceeding U.S.$ 140 million. The total amount awarded Alcatel-Lucent relating to the Day patent exceeds U.S.$ 497 million.
On December 15, 2008, Microsoft and Alcatel-Lucent executed a settlement and license agreement whereby the parties agreed to settle the majority of their outstanding litigations. This settlement included dismissing all pending patent claims in which Alcatel-Lucent is a defendant and provided Alcatel-Lucent with licenses to all Microsoft patents-in-suit in these cases. Also, on May 13, 2009, Alcatel-Lucent and Dell agreed to a settlement and dismissal of the appeal issues relating to Dell from the April 2008 trial. Only the appeal relating to the Day patent against Microsoft filed by it, and the appeal filed by Lucent relating to the district courts decision to dismiss certain additional claims with respect to the Day patent, remain currently pending in the Court of Appeals for the Federal Circuit. Oral Argument was held at the Federal Circuit in Washington, D.C. on June 2, 2009.
On September 11, 2009, the Federal Circuit issued its opinion affirming that the Day patent is both a valid patent and infringed by Microsoft in Microsoft Outlook, Microsoft Money, and Windows Mobile products. However, the Federal Circuit vacated the jurys damages award and ordered a new trial in the District Court in San Diego to re-calculate the amount of damages owed to Alcatel-Lucent for Microsofts infringement. On November 23, 2009, the Federal Circuit denied Microsofts en banc petition for a rehearing on the validity of the Day patent. A date has not been set for the new trial on damages.
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In a parallel proceeding, Dell filed a re-examination of the Day patent with the United States Patent and Trademark Office (Patent Office) in May of 2007 alleging that prior art existed that was not previously considered in the original examination and the Day patent should therefore be re-examined for patentability. On June 22, 2009, the Patent Office issued its latest advisory opinion rejecting the two claims of the Day patent at issue in the April 2008 trial in view of the prior art. Alcatel-Lucent appealed that decision and, in response to Alcatel-Lucents opening Appeal Brief to the Board of Patent Appeals and Interferences, the Patent Office has withdrawn its rejection of the Day patent and has confirmed that the Day patent is a valid patent.
Effect of the various proceedings
Governmental investigations and legal proceedings are subject to uncertainties and the outcomes thereof are difficult to predict. Consequently, Alcatel-Lucent is unable to estimate the ultimate aggregate amount of monetary liability or financial impact with respect to these matters. Because of the uncertainties of government investigations and legal proceedings, one or more of these matters could ultimately result in material monetary payments by Alcatel-Lucent beyond those to be made by reason of the various settlement agreements described in this Section 6.10.
6.11 RESEARCH AND DEVELOPMENT EXPENDITURES
In 2009, in absolute value, 15.3% of revenues were spent in innovation and in supporting our various product lines. These expenditures amounted to €2.4 billion before capitalization of development expenses and capital gain (loss) on disposal of fixed assets, and excluding the impact of the purchase price allocation entries of the business combination with Lucent, as disclosed in Note 3 of the consolidated financial statements included elsewhere in this document.
In accordance with IAS 38 Intangible Assets, research and development expenses are recorded as expenses in the year in which they are incurred, except for development costs, which are capitalized as an intangible asset when the following criteria are met:
the project is clearly defined, and the costs are separately identified and reliably measured;
the technical feasibility of the project is demonstrated;
the ability to use or sell the products created during the project;
the intention exists to finish the project and use or sell the products created during the project;
a potential market for the products created during the project exists or their usefulness, in case of internal use, is demonstrated, leading one to believe that the project will generate probable future economic benefits; and
adequate resources are available to complete the project.
These development costs are amortized over the estimated useful life of the projects or the products they are incorporated within. The amortization of capitalized development costs begins as soon as the related product is released.
Specifically for software, useful life is determined as follows:
in case of internal use: over its probable service lifetime;
in case of external use: according to prospects for sale, rental or other forms of distribution.
Capitalized software development costs are those incurred during the programming, codification and testing phases. Costs incurred during the design and planning, product definition and product specification stages are accounted for as expenses.
The amortization of capitalized software costs during a reporting period is the greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product and (b) the straight-line method over the remaining estimated economic life of the software or the product they are incorporated within.
The amortization of internal use software capitalized development costs is accounted for by function depending on the beneficiary function.
Customer design engineering costs (recoverable amounts disbursed under the terms of contracts with customers), are included in work in progress on construction contracts.
With regard to business combinations, we allocate a portion of the purchase price to in-process research and development projects that may be significant. As part of the process of analyzing these business combinations, we may make the decision to buy technology that has not yet been commercialized rather than develop the technology internally. Decisions of this nature consider existing opportunities for us to stay at the forefront of rapid technological advances in the telecommunications-data networking industry.
The fair value of in-process research and development acquired in business combinations is usually based on present value calculations of income, an analysis of the projects accomplishments and an evaluation of the overall contribution of the project, and the projects risks.
The revenue projection used to value in-process research and development is based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by us and our competitors. Future net cash flows from such projects are based on managements estimates of such projects cost of sales, operating expenses and income taxes.
The value assigned to purchased in-process research and development is also adjusted to reflect the stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.
Such value is determined by discounting the net cash flows to their present value. The selection of the discount rate is based on our weighted average cost of capital, adjusted upward to reflect additional risks inherent in the development life cycle.
Capitalized development costs considered as assets (either generated internally and capitalized or reflected in the purchase price of a business combination) are generally amortized over three to ten years.
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In accordance with IAS 36 Impairment of Assets, whenever events or changes in market conditions indicate a risk of impairment of intangible assets, a detailed review is carried out in order to determine whether the net carrying amount of such assets remains lower than their recoverable amount, which is defined as the greater of fair value (less costs to sell) and value in use. Value in use is measured by discounting the expected future cash flows from continuing use of the asset and its ultimate disposal.
If the recoverable value is lower than the net carrying value, the difference between the two amounts is recorded as an impairment loss. Impairment losses for intangible assets with finite useful lives can be reversed if the recoverable value becomes higher than the net carrying value (but not exceeding the loss initially recorded).
During the year ended December 31, 2009, no impairment loss was accounted for related to acquired technologies. In 2008, impairment losses of €1,125 million were accounted for related to acquired technologies coming from the business combination with Lucent completed in December 2006, and are mainly related to the CDMA business.
Impairment losses for capitalized development costs of €20 million were accounted for in 2009. In 2008, impairment losses of €135 million were recorded, mainly related to the adaptation of our WiMAX strategy, by focusing our WiMAX efforts on supporting fixed and nomadic broadband access applications for providers. In the fourth quarter of 2009, management decided to cease any new WiMAX development on the Groups existing hardware platform and software release.
Application of accounting policies to certain significant acquisitions
In accounting for our business combination with Lucent and our acquisition of the UMTS business of Nortel in 2006, we allocated a significant portion of the purchase price of each transaction to in-process research and development projects and to acquired technologies.
Set forth below is a description of our methodology for estimating the fair value of the in-process research and development of the UMTS business of Nortel at the time of its acquisition, and of Lucent at the time of the business combination. We cannot give assurances that the underlying assumptions used to estimate expected project revenues, development costs or profitability, or the events associated with such projects, as described below, will take place as estimated.
Lucent. At the date of the business combination, Lucent was conducting design, development, engineering and testing activities associated with the completion of numerous projects aimed at developing next-generation technologies for the telecommunications equipment market. The nature of the additional efforts required to develop these technologies into commercially viable products consists primarily of planning, designing, experimenting, and further testing activities necessary to determine whether the technologies can meet market expectations, including functionality and technical requirements.
The methodology we used to allocate the purchase price to in-process research and development involved established valuation techniques. The income approach was the primary valuation method employed. This approach discounts expected future cash flows related to the projects to present value. The discount rates used in the present value calculations are typically based on a weighted-average cost of capital analysis, venture capital surveys and other sources, where appropriate. We made adjustments to reflect the inherent risk of the developmental assets. We also employed the cost approach in certain cases, which entails estimating the cost to recreate the asset. We consider the pricing models related to the combination to be standard within the telecommunications industry.
The key assumptions employed in both approaches consist primarily of an expected completion date for the in-process projects, estimated costs to complete the projects, revenue and expense projections, and discount rates based on the risks associated with such development of the in-process technology acquired. We cannot give assurances that the underlying assumptions used to estimate expected project revenues, development costs or profitability, or the events associated with such projects, as described below, will take place as estimated.
In the context of the combination with Lucent, we allocated approximately U.S.$ 581 million of the purchase price to in-process research and development. An impairment charge of U.S.$ 123 million was accounted for as restructuring costs in December 2006 in connection with the discontinuance of certain product lines. An additional impairment loss of U.S.$ 50 milllion was accounted for in the context of the 2008 impairment tests of goodwill mainly in CDMA.
UMTS business of Nortel. Nortel had spent over U.S.$ 1.0 billion in the five years immediately prior to our acquisition of the UMTS business on the development of the UMTS technology assets. The technology is based on current standards and architectures and is designed to allow for future enhancements. In order to proceed with the valuation of this technology asset upon the acquisition of the UMTS business, we reviewed royalty rate data for contemporary transactions in the telecommunications transmission technology market and wireless-related protocol market. The relevant range of royalty rate was 4.0% to 6.0%.
We considered it appropriate to use a royalty rate of 6.0%, to reflect the specific characteristics of the acquired UMTS technology. Certain of the comparable transactions reviewed involved restricted licensing arrangements (limited geography, markets, etc.), which, if treated as fully comparable to our acquisition, would result in underestimating the value of our unrestricted ownership for UMTS. Additionally, we and Nortels management both considered the Nortel UMTS technology as more mature and superior to our existing products. The majority of our UMTS technology platform going forward will be comprised of Nortel UMTS assets. The acquired UMTS-developed technology was expected to contribute meaningfully to revenue generation for approximately seven years. The technology may contribute to the forthcoming long-term evolution (4G) products beyond seven years, but it was unclear at the valuation date what role, if any, the acquired assets will play. The resulting cash flows were discounted to present value using a rate of 18.0% based on the UMTS technologys relative risk profile and position in its technology cycle. The present value associated with UMTS technology assets (including in-process research and development) was €127 million.
In order to allocate this aggregate value to developed technology and in-process research and development, the expected contribution to cash flows for the in-process research and development was estimated and used as a factor for determining its share of the total UMTS value. The remaining value was ascribed to the acquired developed technology and know-how. The contribution of in-process research and development was estimated based on the relative research and development costs incurred on the identified projects to the total research and development spent on the overall UMTS platform while in development at Nortel. UA 5.0 and UA 6.0 UMTS projects were identified as in-process at the valuation date. Nortel had spent approximately U.S.$ 130 million on these projects until our acquisition of the UMTS business. In 2005, Nortel incurred U.S.$ 24.4 million and U.S.$ 0.2 million in development expenses for the UA 5.0 and the UA 6.0 in-process research and development projects, respectively, and U.S.$ 102.7 million and U.S.$ 2.1 million in 2006. Expense incurred by Alcatel-Lucent in 2007 was €45 million for UA 5.0 and €106 million for UA 6.0.
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UMTS development efforts from 2001 through 2006 can be characterized by a period of three years of development of base UMTS technology, followed by two years of higher value, differentiating product technology (including UA 5.0 and UA 6.0 technologies). Consequently, UA 5.0 and UA 6.0 development expenses were adjusted upwards in value to reflect their higher contribution to the overall technology platform than the base technology components. The combined value-adjusted research and development amount spent as of the valuation date was estimated at approximately U.S.$ 188 million. Given an estimate of U.S.$ 1.0 billion incurred on the UMTS technology platform since its inception through 2006, the in-process research and development represented 18.8% of the total amount spent. In-process research and development has therefore been valued at €24 million (representing 18.8% of the €127 million of the UMTS technology assets’ present value mentioned above).
During the second quarter of 2007, we accounted for impairment losses on tangible assets for an amount of €81 million, on capitalized development costs and other intangible assets for an amount of €208 million and on goodwill for an amount of €137 million.
These impairment losses of €426 million were related to the group of cash generating units (CGUs) corresponding to the business division UMTS/W-CDMA. The impairment charge was due to the delay in revenue generation from this division’s solutions versus its initial expectations, and to a reduction in margin estimates for this business.
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7 CORPORATE GOVERNANCE
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7.1 GOVERNANCE CODE
Alcatel-Lucent is compliant with the AFEP-MEDEF Code of corporate governance for listed corporations (sometimes referred to as the Code see the MEDEF website: www.medef.fr). The Code is the result of the consolidation of the AFEP and MEDEF report of October 2003 and their Recommendations of October 2008 regarding the compensation of executive directors of companies whose shares are admitted to trading on a regulated market. At its meetings on October 29 and December 11, 2008, our Board of Directors confirmed and then published its adherence to the AFEP and MEDEF recommendations. The principles of the Code govern, among other things, the operating rules of our Board of Directors and its Committees, as described in the Board of Directors Operating Rules.
In addition, since our securities are listed on the New York Stock Exchange (hereinafter referred to as NYSE), we make every effort to reconcile the above-mentioned principles with the applicable NYSE rules on corporate governance, as well as with the provisions of the U.S. Sarbanes-Oxley Act, which came into force in 2002. Where relevant, we have specified throughout Chapter 7 the main ways in which our corporate governance practices comply with, or differ from, the NYSEs corporate governance rules applicable to U.S. domestic issuers listed on that exchange.
The Code is based on specific principles which also largely underpin our corporate governance policy, as outlined in Chapter 7 insofar as those principles are in line with the organization, the status and the means of the company, unless otherwise mentioned. Section 7.1 highlights the areas in which our approach is in line with the Code and, where applicable, the specific position of our company in this regard.
7.1.1 Board of Directors
Our company operates according to the monist system (meaning that it has a Board of Directors, as opposed to a Supervisory Board and a Management Board).
The duties of the Chairman of the Board of Directors, performed by Mr. Philippe Camus since October 1, 2008, and those of the CEO, performed by Mr. Ben Verwaayen since September 15, 2008, are separated.
The removal and replacement of either the Chairman or the CEO may be decided by a simple majority vote of the directors present or represented at the meeting. The Board has a set of Operating Rules which set forth, among other things, the distribution of powers between the Board of Directors and the CEO in the context of the general principles defined by law. These Operating Rules, which can be found in full in Section 7.1.3 Operating Rules of the Board of Directors, define broadly the powers of the Board and the circumstances in which the CEO must obtain prior approval from the Board of Directors.
The Board of Directors has also granted Mr. Philippe Camus a delegation of authority enabling the Chairman to represent the Group at high-level meetings, in particular with government representatives.
MEMBERSHIP AND OPERATION OF THE BOARD
Our Board of Directors has 10 directors whose term of office is four years, as stipulated in our Articles of Association. The term of office of the members of our Board usually ends simultaneously. A proposal will be submitted at the Shareholders Meeting called for June 1, 2010, at which some of the Directors terms of office will be renewed. The proposal will involve amending the Articles of Association to stagger the directors terms of office and ensure compliance with the Code on this matter.
According to our Articles of Association, our Board of Directors must also include two observers (in French, Censeurs). The nomination of the observers must be proposed at a Shareholders Meeting and the two observers must, at the time of their appointment, be both salaried employees of Alcatel-Lucent or of an affiliate and members of an Alcatel-Lucent mutual fund (in French, fonds commun de placement).
At December 31, 2009, the Board consisted of directors representing five different nationalities and the average age of its members was 62.
Under the Articles of Association, each director must own at least 500 shares in the company and undertake to comply with the ethics rules of the Directors Charter which was updated on March 28, 2007 pursuant to a decision of the Board of Directors. Information concerning the Directors and observers can be found in Section 7.2 Management.
SELECTION CRITERIA AND INDEPENDENCE OF THE DIRECTORS
The appointment of new directors must comply with selection rules which are applied by our Corporate Governance and Nominating Committee. Members of the Board must be competent in the Groups high-technology businesses, have sufficient financial expertise to make informed and independent decisions about financial statements and compliance with accounting standards, and be entirely independent of the companys management as per the criteria set out below.
At its meeting of March 17, 2010, the Board of Directors reviewed the directors independence according to the criteria selected by our Company which are based on the recommendations of the AFEP-MEDEF Code: A director is independent when he or she has no relationship of any kind whatsoever with the corporation, its group or the management of either that is such as to colour his or her judgement. Accordingly, an independent director is to be understood not only as a non executive director, i.e. one not performing management duties in the corporation or its group, but also as one devoid of any particular bonds of interest (significant shareholder, employee, other) with them.
The criteria selected are based on both the recommendations of the AFEP-MEDEF Code and the requirements of the New York Stock Exchange (NYSE). The independence criteria defined by the Board of Directors comply with the criteria mentioned in the AFEP-MEDEF Code, except for the criteria that a directors total term of office should not exceed 12 years.
The Board of directors thus favored the directors competence and experience as well as good knowledge of the Group, assets which do not represent a potential conflict of interest between Directors and management. Moreover, this AFEP-MEDEF criteria is not included in the requirement of the New York Stock Exchange.
The company also complies with the rules of the NYSE and the provisions of the Sarbanes-Oxley Act on this issue. These rules stipulate that the majority of members of the Board of Directors in a U.S. listed company must be independent and that the Board must determine whether the independence criteria are met. Our Board made this determination at its meeting of March 17, 2010.
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Board of Directors independence
Our Board of Directors also includes at least one independent director who has financial expertise, as recommended in Article 5 of its Operating Rules.
In March 2010, our Board of Directors reexamined the situation of each Director with respect to the independence criteria of the AFEP-MEDEF Code. Based on all of these criteria, the Board determined that Lady Jay, Mr. Bernard, Mr. Blount, Mr. Eizenstat, Mr. Hughes, Mr. Monty, Mr. Piou and Mr. Spinetta, that is, eight of its 10 members, are independent.
Since at least half of the Board members are independent directors, the number of the Boards independent directors complies with the recommendations of the AFEP-MEDEF Code.
At its meeting of March 17, 2010, the Board of Directors acknowledged the independence of all of the directors who are members of the Audit and Finance Committee, of the Corporate Governance and Nominating Committee and of the Compensation Committee, in compliance with its Operating Rules. The number of independent directors within each committee complies with the recommendations of the AFEP-MEDEF Code.
COMMITTEES OF THE BOARD OF DIRECTORS
Our Board of Directors has four committees which are as follows: the Audit and Finance Committee, the Corporate Governance and Nominating Committee, the Compensation Committee and the Technology Committee. Their role and operating procedures are described in Section 7.4 Committees of the Board.
Each Committee has its own operating rules approved by the Board.
DIRECTORS CHARTER AND ETHICS
Before accepting office, each director must consider the Directors Charter and the obligations resulting from his or her office. The Charter stipulates that each director must attend meetings and dedicate the time and care required by the office, respect confidentiality, contribute to setting our companys strategic direction and monitor implementation of the strategy. The Directors Charter also encourages the directors to own a significant number of shares, and stipulates that each director must comply with applicable securities laws concerning trading as well as with the rules of our Alcatel-Lucent Insider Trading Policy designed to prevent insider trading. Directors are also reminded that under French regulatory requirements, a director must notify the Autorité des Marchés Financiers (the French securities regulator) of any personal transactions involving Alcatel-Lucent shares.
CONFLICTS OF INTEREST
To our knowledge, there are no potential conflicts of interest between the directors fiduciary duties and their private interests. In accordance with the Directors Charter, a director must notify the Board of any actual or potential conflict of interest.
There are no family relationships between the members of our Board of Directors and our companys senior management.
To our knowledge, there is no arrangement or agreement with a shareholder, client, supplier or any third party which has led to the appointment of our CEO or a member of our Board of Directors or of our Management Committee.
To our knowledge, no member of the Board of Directors or any executive officer of our company has been convicted of fraud during the last five years; has been charged and/or received an official public sanction pronounced by a statutory or regulatory authority; or has been banned by a court from holding office as a member of an administrative, management or supervisory body of an issuer, or from being involved in the management or conduct of the business of an issuer in the last five years.
To our knowledge, no member of the Board of Directors of our company has been a director or executive officer of a company involved in a bankruptcy, court escrow or liquidation in the last five years, with the exception of Mr. Hughes, in his capacity as non-executive chairman of the American company Outperformance Inc., which was wound up voluntarily (Chapter 7 of the U.S. Bankruptcy Code) in November 2008; and Mr. Monty, in his capacity as director of the Canadian company Teleglobe Inc., which was liquidated in 2002, with respect to which liquidation there are legal proceedings still in progress.
The Directors receive directors fees for performing their duties on the Board of Directors and, where relevant, on one of the Boards committees. The amount of these fees is dependent in part on their attendance at the various meetings, as described in Section 7.5.5 Remuneration of Directors and observers. However, in accordance with the provisions of Article 6 of the Board of Directors Operating Rules (see Section 7.1.3 Operating Rules of the Board of Directors), the Chairman and the Chief Executive Officer do not receive any attendance fees.
7.1.2 Compensation policy for the Executive Directors of the Company
The Board of Directors ensures a balance between the various components of the Executive Directors compensation (fixed and variable compensation, stock options and Performance share awards, and additional pension benefits if any). It also ensures that these components are set in accordance with the general principles of comprehensiveness, balance, benchmarking, consistency, clarity of the rules and reasonableness set forth in the AFEP-MEDEF Code.
As per the Code, none of the Executive Directors has an employment contract with our company.
Executive Directors are not entitled to severance payments when they leave the company.
The Board elected to target the efforts and competencies of the Chairman and CEO on both short-term and medium to long-term goals. The performance criteria were also set in such a manner as to allow the Board of Directors to assess the medium and long-term measures taken by the new Executive Directors in areas where such measures were most likely to have a delayed impact on the Groups financial performance. (See Sections 7.5 Compensation and 7.6 Interest of employees and senior management in Alcatel-Lucents capital.)
The Board of Directors therefore opted to most of the CEOs and Chairmans compensation to quantitative criteria based on the evolution of the Groups financial position and, if applicable, to qualitative criteria which measure the improvement in our governance.
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The Board of Directors elected to split the Chairmans compensation between a fixed cash amount and Performance shares. The fixed portion was only 2.3 times higher than the average remuneration of the companys directors. The Chairmans compensation does not include a variable portion (see Section 7.5.2 Chairman of the Board of Directors).
As the above awards of Performance shares are conditioned by performance criteria, over half of the Chairmans overall remuneration is dependent on the achievement of performance objectives. The performance criteria underpinning the performance shares correspond to the quantitative and qualitative targets set for the Chairman. These targets will be assessed by the Board of Directors.
In accordance with the recommendations of the Code, the Board of Directors also set the holding and purchase obligation conditions for the Performance share awards. Under these conditions, the Chairman is required to retain a number of Alcatel-Lucent shares equal in value to 100% of his annual compensation until the end of his term of office. In addition, he is required to purchase a number of company shares equivalent to 40% of the fully vested Performance shares awarded to him. (See Section 184.108.40.206 Performance shares grants to the Executive Directors).
Chief Executive Officers Compensation
The CEOs compensation was set by the Board of Directors based on the same resolute approach and ambitious targets. The targets were intended as an incentive for the CEO to address the challenges involved in turning the company around. Each component of the CEOs compensation (variable remuneration, pension benefits, stock options (in all or in part) and performance shares) is dependent on the satisfaction of one or more performance criteria.
The performance targets which condition the CEOs variable compensation were particularly challenging in view of the issues at stake and the companys financial situation. The Board of Directors reviews the targets annually based on proposals by the Compensation Committee. The targets were set against a backdrop of unfavorable conditions both worldwide and in the Telecom sector. Unlike the Groups other executives (including executive officers), the CEOs performance criteria were all quantitative. (See Section 7.5.3 Chief Executive Officer, Section 220.127.116.11 Performance share grants to the Executive Directors and Section 18.104.22.168 Stock option grants to the Executive Directors).
The CEOs total annual compensation was consistent with the compensation of other members of the Groups senior management.
ADDITIONAL PENSION BENEFITS
As a Director of Alcatel-Lucent, the CEO participates in a private retirement pension plan open to a group of beneficiaries mainly comprising French executive officers from the Group. The plan has around 400 beneficiaries. The Board of Directors guaranteed the CEO a pension equal to 40% of his compensation based on the average of the two best paid years of the five-year term within the Company taking into account all retirement rights acquired.
The Pension entitlement awarded to the CEO is not expressly conditioned upon the termination of the beneficiarys career in our company. The Board of Directors therefore laid down performance conditions to be assessed during his term of office, thus rendering the pension benefit contingent on the achievement of performance criteria (see Section 7.5.3 Chief Executive Officer).
STOCK OPTIONS AND PERFORMANCE SHARES
The stock option and Performance share plans decided in 2009 and 2010 reflect a balanced distribution policy that does not favor a particular type of beneficiary - in particular the Companys Executive Directors - as per the recommendations of the AFEP-MEDEF Code.
In 2009, the number of Performance shares, awarded to the Chairman amounted to 2.9% of total Performance shares awarded in March 2009, and 0.01% of share capital as at December 31, 2009. This grant of Performance shares is subject to the satisfaction of presence and holding conditions, and of performance conditions based on quantitative and qualitative criteria set at the time of the grant. The Board of Directors has determined individual conditions pertaining to the holding of shares vested at the end of the vesting period, until the termination of his office within the company in accordance with Article L. 225-197-1 of the French Commercial Code, and to the obligation to purchase shares of the company further to the recommendations of the AFEP-MEDEF Code. (See section 22.214.171.124 Performance share grants to the Executive Directors).
The number of stock options awarded in 2009 to the CEO amounted to 1.9% of total stock options awarded in March 2009 (4.6% of the 2009 Annual plan), and 0.04% of share capital as at December 31, 2009. The stock options awarded to the CEO are tied to two performance conditions, one related to the CEOs presence in the Group and, the other one related to our companys share price performance compared with a representative selection of solutions and services providers in the sector of telecommunications equipment, as evaluated annually by a consulting firm (see Section 126.96.36.199 Stock option grants to the Executive Directors). This grant is subject to individual conditions pertaining to the holding of shares resulting from the exercise of stock options, until the termination of his office within the company, in accordance with Article L. 225-185 of the French Commercial Code. (See Section 188.8.131.52 Stock option grants to the Executive Directors).
In connection with the renewal by the shareholders at the Shareholders Meeting to be held on June 1, 2010 of the authorizations to award stock options and Performance shares to group employees and senior management, the Board of Directors set a maximum percentage of stock options and Performance shares that can be awarded to Executive Directors out of the total amount authorized, as per the recommendations of the Code.
7.1.3 Operating Rules of the Board of Directors
There follows a full transcription of the Operating Rules of our Board of Directors.
The directors of Alcatel-Lucent (hereafter the Company) have enacted the following rules which constitute the internal regulation of the Board of Directors, in order to define its operating procedures and its role according to the rules of corporate governance in force.
These rules, approved at the board of directors meeting held on October 29, 2008, are primarily intended to:
define the role of the board vis-à-vis the shareholders meeting on the one hand, and of the Chief Executive Officer (Directeur Général) on the other hand, by clarifying the existing provisions of the law and of the Companys bylaws and the position of its members;
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maximize the efficiency of meetings and debates, in particular by specifying the role of the Chairman, and develop the proper procedures of the bodies that oversee the administration of the Company, in the spirit of the Companys corporate governance policy.
These rules are purely internal and are not intended to be a substitute for the applicable provisions of the law and the Companys bylaws, but, rather, are intended to implement the bylaws in a practical manner, and consequently may not be held against the Company, third parties and against the shareholders.
SECTION I THE BOARDS ROLE
Article 1 Deliberations of the Board
In addition to matters related to its legal or regulatory function, the Board shall regularly decide upon the Groups strategic orientations and the main decisions affecting its activities. This relates in particular to the projects of important investments of organic growth and the operations of internal reorganizations, major acquisitions and divestitures of shares and assets, transactions or commitments that may significantly affect the financial results of the group or considerably modify the structure of its balance sheet and the strategic alliances and financial cooperation agreements.
Article 2 Decisions subject to the prior approval of the Board
The Chief Executive Officer must submit the following decisions to the prior approval of the Board:
the update of the groups annual strategic plans, and any significant strategic operation not envisaged by these plans;
the groups annual budget and annual capital expenditure plan;
acquisitions or divestitures in an amount higher than €300 million (enterprise value);
capital expenditures in an amount higher than €300 million;
offers and commercial contracts of strategic importance in an amount higher than €1 billion;
any significant strategic alliances and industrial and financial cooperation agreements with annual projected revenues in excess of €200 million, in particular if they imply a significant shareholding by a third party in the capital of the Company;
financial transactions having a significant impact on the accounts of the group, in particular the issuance of debt securities in amounts greater than €400 million (1);
amendments to the National Security Agreement (“NSA“) between Alcatel, Lucent Technologies, Inc. and certain United States Government parties.
Article 3 Information of the Board
The Board of directors shall be regularly informed, either directly or through its committees, of any significant occurrence in the Companys operations.
The Board is also entitled at all times, including between meetings focused on the review of the financial statements, to become acquainted with any significant change affecting the Companys financial condition, cash position and commitments.
SECTION II THE MEMBERS
Article 4 Independence
The Board of directors shall define the criteria that a director must meet in order to be deemed independent, in accordance with the principles of corporate governance applicable to the Company. The Board of directors shall ensure that the proportion of independent directors is at all times greater than half the members of the Board and shall take action as soon as possible to replace directors, if necessary.
By definition, an independent director has no direct or indirect relationships of any nature whatsoever with the Company, its group or its management of a nature that could compromise the free exercise of his or her judgement.
Article 5 Expertise
Board members will be selected so as to bring a diversity of competencies, especially with respect to technology, finance, human resources, emerging markets, as well as a connection with academia and the government agencies community (in view of the Companys highly classified work). At least one of the independent members of the Board of directors shall have financial expertise.
The members of the Board will participate in training programs regarding the specificities of the Company, its activities and its industry sector, that may be arranged by the Company from time to time.
In order for the directors to have and dedicate the time and attention necessary to carry out their responsibilities, the Board of directors shall ensure that none of its members violates the legal restrictions regarding the holding of multiple offices. The number of additional directorships that a director of the Company may hold in limited liability companies which are part of different groups, in any countries, may not exceed four.
Article 6 Compensation
The directors receive attendance fees the annual amount of which is determined by the Shareholders Meeting. Such fees will be divided into two equal portions.
The first portion will be a fixed amount and will be divided among all of the directors according to the following rules:
the President of the Audit & Finance Committee will receive an annual amount of € 25,000;
each other member of the Audit & Finance Committee will receive an annual amount of € 15,000;
the President of each of the other three committees will receive an annual amount of € 15,000;
each other member of the other three committees will receive an annual amount of € 10,000.
the remainder of this first portion will be divided equally among the directors.
The second portion will be a variable amount and will be divided among the directors in accordance with their attendance at Board meetings and at any meetings of the committees of which they are members.
Attendance fees will be paid in two installments. The first installment will be paid after the annual shareholders meeting and the second will be paid at the end of the year.
The Chairman, the Chief Executive Officer and any directors who are executive officers of the Company will not receive any attendance fees.
A specific delegation of power exists in favor of the CEO, concerning the issuance of debt securities, for up to € 1 billion (which is a temporary exception to € 400 million level concerning financial transaction).
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The Board observers will receive a compensation as determined by the Shareholders Meeting, to be divided between them and paid according to the same rules as applicable to the directors fees.
SECTION III THE CHAIRMAN
Article 7 Role of the Chairman
The Chairman of the Board (hereafter the Chairman) shall organize and manage the tasks of the Board and announce the outcome thereof at the Shareholders Meeting. He shall watch over the correct operations of the corporate bodies of the Company and especially those of the Boards committees.
He shall ensure that the directors are able to perform their assignments, in particular those that stem from the committees to which they belong.
He shall take care that the formulation and implementation of the principles of the corporate governance of Company are of the highest standard.
The Chairman is the only person who can act and speak on behalf of the Board of directors.
With the approval of the Chief Executive Officer, he may represent the group in high level relationships, in particular with the authorities, in national and international arenas.
Article 8 Information of the Chairman - Office of the Chairman
The Chairman shall be regularly informed by the Chief Executive Officer of the significant events and positions regarding the activities of the group he shall receive all useful information for the performance of the Board and the committees tasks and those necessary for the establishment of the internal audit report.
The Chairman may meet with the auditors.
The Chairman may attend as advisor the meetings of the committees of the Board in which he is not member, and may seek their advice on any question that falls within their jurisdiction.
The General Counsel, in his Board Secretary mission, will report to the Chairman. He or she will assist the Chairman in organizing Board meetings, shareholders meetings and discharging any other duties associated with governance items linked to the legal incorporation of the Company.
SECTION IV OPERATING PROCEDURES OF THE BOARD
Article 9 Meetings
The Board of directors shall meet on notice of the Chairman, at least once during each quarter, at the registered office of the Company or at any other place, in France or abroad, as shall be set forth in the applicable notice of meeting, in order to consider collectively the matters that are submitted to it.
In principle, there will be six board meetings, four of them primarily dedicated to the review of financial statements, one to strategy matters and one to the yearly budget. On a regular basis, the Board will meet in executive sessions attended by non-executive directors only.
Article 10 Participation
The directors may participate in the meetings of the Board by means of telecommunication as authorized by the bylaws. In such event, they will be considered to be present for the purpose of calculating the applicable quorum and majority requirements except with respect to votes regarding the Companys statutory financial statements, the yearly consolidated financial statements and the annual report.
As prescribed by the applicable legal requirements, board meetings that are held by video-conference or other telecommunication media must be carried through technical means that ensure the proper identification of the parties, the confidentiality of the discussions and the real-time effective participation of all the directors present at any such meetings of the Board, and the transmission of the discussions shall be done in a continuous manner.
The secretary of the Board of directors shall initial the attendance sheet on behalf of the directors who attend meetings of the Board via video-conference or other telecommunication media (as well as for the directors for whom they act as proxy).
Article 11 Evaluation of the Board
The Board shall meet once a year to discuss its operating procedures, after each Board member having answered an evaluation questionnaire. It shall also meet once a year to consider the performance of the executive officers of the Company, and no directors who are either officers or employees of the Company shall attend such meetings.
The Board of directors may, at any time, and at least once every two years, engage an outside consultant to evaluate its performance.
Article 12 Expenses
The members of the Board shall be reimbursed, upon presentation of receipts, for travel expenses as well as for other expenses incurred by them in the interests of the Company, after signature of the receipts by the Chief Financial Officer.
SECTION V INFORMATION OF THE BOARD
Article 13 The Committees
In the course of carrying out its various responsibilities, the Board of directors may create specialized committees, composed of directors appointed by the Board, that review matters within the scope of the Boards responsibilities and submit to the Board their opinions and proposals, in accordance with the internal rules governing such committees. The Board of directors shall have the following standing committees: the corporate governance and nominating committee, the compensation committee, the audit and finance committee and the technology committee.
Each committee shall have no less than three directors, and shall be chaired by such director among the members of the committee as shall be appointed by the Board of directors.
Each committee shall submit reports regarding the matters reviewed by it to the Board of directors, which is the only body that can make any decision regarding such matters.
The Chief Executive Officer may attend as advisor the meetings of the committees of the Board in which he or she is not member (except meetings of the Compensation committee dealing with his or her compensation).
Article 14 Right to information from the Executive Officers
In order to efficiently oversee the management of the Company, the members of the Board may, through the Chairman or after having informed him, request the opinion of the executive officers of the group on any matter they deem appropriate. They may, under the same conditions, meet such officers without the presence of any directors who are executive officers.
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The members of the Board shall have the right to require the Chief Executive Officer, through the Chairman or after having informed him, to provide them, within a reasonable period of time, with such information as shall be necessary to permit such members to comply with their assignment.
In order to assist them in the fulfillment of their duties, the members of the Board shall receive all relevant information regarding the Company, including press articles and reports by financial analysts.
Article 15 Transparency
The Board of directors shall ensure the openness of its activities to the shareholders of the Company by presenting each year, in the annual report, a statement regarding its activities during the fiscal year just ended, and regarding the operation of the Board and its committees.
SECTION VI ROLE AND ACTIONS OF THE COMMITTEES
Article 16 Corporate governance and nominating Committee
The mission of the Corporate Governance and Nominating Committee shall be to review matters relating to the composition, organization and operation of the Board of directors and its committees, to identify and make proposals to the Board regarding individuals qualified to serve as directors of the Company and on committees of the Board of directors; to develop and recommend to the Board of directors a set of corporate governance principles applicable to the Company; and to oversee the evaluations of the Board of directors and committees thereof.
The Corporate Governance and Nominating Committee will also review succession plans for the Chi