Alcatel-Lucent defends against price attacks

Alcatel-Lucent’s second-quarter revenue beat the expectations of Wall Street analysts but fell short of earnings expectations, leading many analysts to focus on the vendor’s margins.

Analysts wanted to know if the drop in gross margins during the quarter--from 37.7% to 32.3%--would last or to what degree it was just a temporary effect of the vendor lowering its prices to keep competitors at bay while it was distracted with merger integration issues.

Alcatel-Lucent’s leaders acknowledged that margins were lower than they would have preferred but not indicative of future expectations. However, they would not provide detailed expectations for future improvements. The margins were partly the result of the company’s investment in key strategic areas, they said, such as the migration to IP networks and emerging geographic markets, where pricing pressure is high.

“We’re managing a large, complex integration in an industry that’s not waiting for our merger to be completed,” said Pat Russo, Alcatel-Lucent’s chief executive officer. “That puts short-term pressure on the company.”

Among the temporary effects on the company, Russo said, “We’re communicating all our plans [with customers] more upfront with respect to the merger. That results in us being willing to make some concessions. Secondly, in the early days of the merger, we’ve had some attacks on our customer base with offers for swap out, et cetera. We have consciously chosen to maintain our customers. We also have not seen all the benefits of product rationalization and cost-cutting that affect margins as well.”

“Mergers and consolidation in the industry [present an] opportunity to reshuffle market share and certainly for all customers to reconsider the way they’re looking at their suppliers and major solutions,” said Jean-Pascal Beaufret, the company’s chief financial officer. “We cannot miss any major market share.”

Russo still believes the company can raise margins higher than Alcatel and Lucent did as separate companies, but she added, “The unknown around gross margins is what happens to price in the industry.”

During this morning’s earnings call, company leaders repeatedly stressed that 2007 was a transition year and that it would offer more details on its model in early 2008. With about a third of the company’s three-year post-merger headcount reductions already behind it (the company cut 1900 employees in the quarter, for a total of 3800 this year), one analyst on today’s call even suggested Alcatel-Lucent revise its three-year synergy goals upward. Company executives declined.

The company’s overall revenue was up 11% sequentially to 4.33 billion euros in the second quarter. Revenue from carriers was down 5% from a year earlier but up 11% sequentially. The company’s wireline business did better than its wireless side, with revenue up 7% from a year earlier and up 18% sequentially while wireless revenue sank 8% from a year earlier and 4% sequentially. The services business did particularly well, driven by IP migration: Revenue grew 11% from a year earlier and 26% sequentially.

Revenue from Asia grew 21% from a year earlier but declined in all other geographies.

“It's going to be a bumpy road, in our view, as Alcatel-Lucent streamlines operations, fends off competitors, rationalizes its products and reduces headcount,” RBC Capital Markets analyst Mark Sue wrote in a research note today.