For whatever reason, some people seem to be getting excited about Lucent (NYSE: LU ) again. A look at the headlines says it all: "Profit Soars!" There, of course, are some hopeful signs: The company is no longer bleeding money, for example. Also, Lucent's win of a $5 billion contract with Verizon's (NYSE: VZ ) wireless division last week reaffirms that Lucent is still the preferred provider for some of the largest spenders in the telecommunications business.
Lucent earned $0.08 per share for the third quarter, saying that its sales were bolstered by increases in demand for 3G wireless technology and voice over Internet protocol equipment. This included a bunch of non-cash items, such as a revaluation of warrants that will be issued as a result of shareholder lawsuits, recoveries of receivables that the company had written off, and a reversal of restructuring charges the company took in previous quarters. These equaled all told $0.04, or half of the company's entire profit. Instead of looking at these as part of this quarter's profits, a better way for investors to view them would be as a readjustment of losses taken in previous quarters.
For the first nine months of this year, Lucent's total revenues increased a paltry 3.1% over the same period from last year. Lucent's chief financial officer, Frank D'Amelio, anticipates that the total revenues for the year will increase at a "mid-single digits" percentage rate. This would mean that the company anticipates that its fourth quarter will be dramatically better than the fourth quarter from last year. Certainly its third quarter showed such an improvement to be possible, as revenues were 11% higher over the same quarter.
Lucent seems to have done a fantastic job in tightening up its expense base, decreasing its sales, general, and administrative expenses by $366 million, or nearly 40%. More troubling were two line items: One of the areas where Lucent has extracted cost savings seems to have been research and development, where the company dropped its expenditures by more than 21% in the first nine months of this year. As we've said repeatedly in the past, R&D is the lifeblood of technology companies, which are plagued by rapid product cycles and product replacements. A drop in R&D could have the effect of robbing a company's future in order to make its "number" today. Also highly troubling is the rapid increase of Lucent's inventories, more than 55% over a year ago, and at $982 million, a gaudy 24% increase over the previous quarter's levels. For a company that anticipates total revenue increases in the mid-single digits, such a buildup is shocking.
The Verizon contract calls for the Baby Bell to purchase equipment, software, and services from Lucent over a six-year period. This is a nice boost for Lucent, which has seen, along with the rest of the industry, flaccid demand for its wireline equipment business. Verizon intends to use the Lucent equipment appropriations to, among other things, deploy its next-generation cellular network based on Qualcomm's (Nasdaq: QCOM ) CDMA technology, which will allow data to transmit many times faster than currently available speeds. But most of the Verizon capital expenditures will go toward simply expanding the company's geographical coverage for its data network. Verizon has considerable latitude on the timing of its purchases, so Lucent needs to be careful about overestimating its revenues on a quarterly basis from the deal.
Yes, Lucent has returned a fourth consecutive quarter of profitability. Profits that don't generate cash are not nearly as powerful as those that do. Thus far this year, Lucent has reported $804 million in income, but only $201 million in free cash flow. Meanwhile, the company has, mostly because of the dilutive impact of the warrants issued as a result of its shareholder suits, seen its share count balloon by 21% over the last year to more than 5 billion.
There's not nearly as much to be completely depressed about in Lucent's results as in recent years. But this isn't the time to run out and light sparklers in celebration, either. Lucent still has a long road ahead of it.
Fool contributor Bill Mann does not own shares in any company mentioned in this article.