Credit analyst sees little hope for Lucent improvement soon

By Ronda Fears

Nashville, Tenn., April 23 - Lucent Technologies, Inc. was celebrated for performing within expectations, albeit at lower levels, but Carol Levenson, director of research at Gimme Credit, said there is little hope that credit quality at Lucent will improve anytime soon.

"In the telecom sector, the markets have become conditioned to expect disaster, so small victories such as Lucent Technologies (B2/B+) meeting the low end of the range of revenue guidance it shared with investors two weeks before its fiscal second quarter was over was cause for celebration," Levenson said in a report Tuesday.

"Apparently these two weeks weren't so great in the revenue department but were gangbusters in the EBITDA department, at least EBITDA defined in a way only Lucent and its bankers know for sure. Thus the company, which had warned in mid-March it wouldn't be meeting the requirements imposed by its banks for spinning off Agere in the March quarter, yesterday reported it had met them after all."

The company also lost slightly less money than it did in the prior quarter, and much less than it lost in the comparable quarter last year.

"Clearly in these trying times visibility on the upside isn't much better than visibility on the downside," the analyst said.

"By our calculations, traditional EBITDA was negative $200 million in the quarter, a big sequential improvement but still most decidedly negative. Yet what people have begun to call 'bank EBITDA' was positive."

By how much was not readily visible, however.

"Coy management preferred not to say. 'Positive,' 'above zero,' and 'north of $1 dollar,' the CFO responded to direct questions in a Bloomberg interview," Levenson said.

"We do not find this pussyfooting at all cute, especially since this measure is very strictly monitored under Lucent's bank agreements, which in addition to its cash on hand comprise the company's only source of liquidity at the moment. Furthermore, we question just how sustainable this surprising improvement in EBITDA might be."

Unquestionably, the company saw a nice increase in gross margin in the quarter, an 800 basis point improvement over the prior year and a 900 basis point sequential improvement, she said, which was attributed to product and geographic mix and cost cutting.

However, she added that below the gross margin line, three-quarters of the sequential improvement in Lucent's SG&A expense was the result of a substantially lower provision for uncollectibles, which was down 60% sequentially and nearly 75% year-over-year - the lowest it's been in seven quarters.

"We note the company made no attempt to hide this fact, but neither did it proffer an explanation for this dramatic improvement in bad debt expense," Levenson said, pointing out that she is not inferring anything suspicious.

"However, it bears mentioning that both EBITDA and the net loss would have been considerably worse if this provision had been more normal in size. Furthermore, reaching positive 'bank EBITDA' in the quarter did save Lucent the trouble of having to get another extension from the IRS in order for the Agere spinoff to be tax-free."

Despite continuing but much improved negative free cash flow, excluding certain cash expenses, net debt didn't change appreciably in the quarter, thanks to additional asset sales, the analyst noted.

There was no cash flow detail, she said, but it appears working capital elements were a big help, as was a substantial tax refund with an even bigger one already received this quarter.

"One thing we'll be watching for is any contingent liabilities from the Agere spinoff, in addition to the existing purchase commitment and bank loan cross-default provisions," she said, along with results from Lucent's latest cost-cutting program aimed at achieving a lower breakeven revenue level.

"We see little hope of imminent credit quality improvement."

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