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Communication Networks for the Next Geration
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lucent annual report 1999 Lucent Technologies
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next generation networks
financial review
management's discussion and analysis
notes to financial statements
-  1. basis of presentation
- 2. summary of significant accounting policies
- 3. recent pronouncements
- 4. supplementary financial information
- 5. earnings per common share
- 6. comprehensive income
- 7. business restructuring and other charges
- 8. income taxes
- 9. debt obligations
- 10. employee benefit plans
- 11. stock compensation plans
- 12. operating systems
- 13. financial instruments
- 14. commitments and contingencies
- 15. subsequent events
- 16. quarterly information (unaudited)

for our investors

 
Notes to Consolidated Financial Statements

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-       1. Basis of Presentation -
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On June 24, 1999, Lucent Technologies Inc. (the "Company") merged with Ascend Communications, Inc. Each share of Ascend common stock was converted into 1.65 shares of Lucent common stock. Lucent issued approximately 371 million shares in exchange for all of the outstanding shares of Ascend. On February 26, 1999, under the terms of the Kenan Systems Corporation merger agreement, Lucent issued approximately 26 million shares (post April 1, 1999 stock split) of Lucent common stock in exchange for all the outstanding shares of Kenan. These transactions were accounted for as pooling-of-interests and, accordingly, the consolidated financial statements of Lucent were restated for all periods prior to the mergers to include the accounts and operations of Ascend and Kenan.
Before merging with Lucent, both Ascend and Kenan had December 31 fiscal year ends. Lucent financial information for fiscal 1998 and earlier years was computed by adding financial information for corresponding quarters of Ascend's and Kenan's fiscal year. Thus, the consolidated statements of income for the years ended September 30, 1998, and 1997 were derived by combining the results of operations of Lucent for the years ended September 30, 1998, and 1997, respectively, with the results of operations of Ascend and Kenan for the years ended December 31, 1998, and 1997, respectively. The consolidated balance sheet at September 30, 1998, was derived by combining the financial position of Lucent at September 30, 1998, with the financial position of Ascend and Kenan at December 31, 1998. The consolidated statements of cash flows for the years ended September 30, 1998, and 1997 were derived by combining the cash flows of Lucent for the years ended September 30, 1998, and 1997 with the cash flows of Ascend and Kenan for the years ended December 31, 1998, and 1997.
The results of operations, financial position and cash flows as of and for the three months ended December 31, 1998, for Ascend and Kenan were included in Lucent's financial statements as of and for the year ended September 30, 1998. The results of operations for the three months ended December 31, 1998, also were included in Lucent's financial statements for the year ended September 30, 1999. As a result, the consolidated balance sheet of Lucent at September 30, 1999, includes an adjustment to retained earnings to eliminate the income recognized from both Ascend and Kenan for the three months ended December 31, 1998. In addition, information from the statements of cash flows for Ascend and Kenan for the three months ended December 31, 1998, has been eliminated from the consolidated statements of cash flows for the year ended September 30, 1999, since Ascend's and Kenan's activity for this period has been included in the consolidated statements of cash flows for the year ended September 30, 1998.
On April 1, 1998, and April 1, 1999, two-for-one splits of Lucent's common stock became effective. Shareowners' equity has been restated to give retroactive recognition to the stock splits for all periods presented by reclassifying from retained earnings to common stock the par value of the additional shares issued as a result of the stock splits. In addition, all references in the financial statements and notes to number of shares, per share amounts, stock option data and market prices have been restated to reflect these stock splits.

Acquisitions
Purchase Method
The following table presents information about certain acquisitions by Lucent in the fiscal years ended September 30, 1999, 1998, and 1997. All the acquisitions were accounted for under the purchase method of accounting, and the acquired technology valuation included both existing technology and purchased in-process research and development. All charges were recorded in the quarter in which the transaction was completed.


1999   Acquisition
Date
  Purchase
Price
  Goodwill   Existing
Tech.
  Purchased
IPRD
(after-tax)
  Amortization
Period
Goodwill
(in-years)
  Amortization
Period
Existing Tech.
(in years)
Stratus(1)   10/98   $917   $0   $130   $267*   n/a   10
Other(2)   various   187   133   17   29   4-8   6-7

1998
Yurie(3)   5/98   $1,056   $ 292   $ 40   $620   7   5
Prominet(4)   1/98   199   35   23   157   5   6
Livingston(5)   12/97   610   114   69   427   5   8
Other(6)   various   453   137   67   208   5-10   5-10

1997
Octel(7)   9/97   $1,819   $ 181   $ 186   $ 945   7   5
InterCon(8)   2/97   22   0   3   18   n/a   3
Sahara(9)   1/97   219   0   0   213   n/a   n/a

(1) Stratus Computer, Inc. was a manufacturer of fault-tolerant computer systems, acquired by Ascend.

(2) Other acquisitions include the Ethernet LAN business of Enable Semiconductor ("Enable Ethernet"), Sybarus Technologies, WaveAccess Ltd., and Quadritek Systems, Inc.

(3) Yurie Systems, Inc. was a provider of ATM access technology and equipment for data, voice and video networking.

(4) Prominet Corporation was a participant in the emerging Gigabit Ethernet networking industry. The merger involved $164 of Lucent stock and options. In addition, under the terms of the agreement, Lucent had contingent obligations to pay former Prominet shareowners $35 in stock. The $35 of stock was paid by Lucent in July 1998 and recorded primarily as goodwill.

(5) Livingston Enterprises, Inc. was a global provider of equipment used by Internet service providers to connect their subscribers to the Internet.

(6) Other acquisitions include JNA Telecommunications Limited, LANNET, MassMedia Communications, Inc., SDX Business Systems plc, and Optimay GmbH. The purchase price for MassMedia has been deemed immaterial.

(7) Octel Communications Corporation was a provider of voice, fax and electronic messaging technologies.

(8) InterCon Systems Corporation was a developer of remote access client software products, acquired by Ascend.

(9) Sahara Networks, Inc. was a developer of scalable high-speed broadband access products, acquired by Ascend.
n/a Not applicable.

* $24 of purchased in-process research and development was subsequently reversed in March 1999.



Included in the purchase price for the above acquisitions was purchased in-process research and development, which was a non-cash charge to earnings as this technology had not reached technological feasibility and had no future alternative use. The remaining purchase price was allocated to tangible assets and intangible assets, including goodwill and existing technology, less liabilities assumed.
The value allocated to purchased in-process research and development was determined utilizing an income approach that included an excess earnings analysis reflecting the appropriate cost of capital for the investment. Estimates of future cash flows related to the in-process research and development were made for each project based on Lucent's estimates of revenue, operating expenses and income taxes from the project. These estimates were consistent with historical pricing, margins and expense levels for similar products.
Revenues were estimated based on relevant market size and growth factors, expected industry trends, individual product sales cycles and the estimated life of each product's underlying technology. Estimated operating expenses, income taxes, and charges for the use of contributory assets were deducted from estimated revenues to determine estimated after-tax cash flows for each project. Estimated operating expenses include cost of goods sold; selling, general and administrative expenses; and research and development expenses. The research and development expenses include estimated costs to maintain the products once they have been introduced into the market and generate revenues and costs to complete the in-process research and development.
The discount rates utilized to discount the projected cash flows were based on consideration of Lucent's weighted average cost of capital, as well as other factors including the useful life of each project, the anticipated profitability of each project, the uncertainty of technology advances that were known at the time and the stage of completion of each project.
Management is primarily responsible for estimating the fair value of the assets and liabilities acquired, and has conducted due diligence in determining the fair value. Management has made estimates and assumptions that affect the reported amounts of assets, liabilities and expenses resulting from such acquisitions. Actual results could differ from those amounts.

SpecTran Corporation
On July 21, 1999, Lucent began its cash tender offer for the outstanding shares of SpecTran Corporation, a designer and manufacturer of specialty optical fiber and fiber-optic products. The tender offer expired on August 31, 1999, and Lucent thereafter accepted and paid for shares giving it a 61% interest in SpecTran. The acquisition was accounted for under the purchase method of accounting. Lucent expects to acquire the remaining shares of SpecTran by the end of the first quarter of fiscal year 2000, resulting in a total purchase price of approximately $68.

Pooling-of-Interests Mergers

Ascend Communications
On June 24, 1999, Lucent merged with Ascend, a developer, manufacturer and seller of wide area networking solutions. As a result, the outstanding Ascend common stock was converted into approximately 371 million shares of Lucent common stock, based on an exchange ratio of 1.65 shares of Lucent common stock for each share of Ascend common stock. In addition, Lucent assumed Ascend stock options equivalent to approximately 65 million shares of Lucent common stock. The merger was accounted for as a pooling-of-interests under Accounting Principles Board Opinion No. 16, and accordingly, Lucent's consolidated financial statements have been restated for all periods prior to the merger to include the results of operations, financial position and cash flows of Ascend as though it had always been a part of Lucent. Intercompany transactions for fiscal 1999 have been eliminated. Intercompany transactions prior to 1999 were immaterial. In connection with the merger, Lucent recorded a third fiscal quarter charge to operating expenses of approximately $79 (non-tax deductible) for merger-related costs. The merger-related costs consisted primarily of fees for investment bankers, attorneys, accountants and financial printing. Certain reclassifications were made to Ascend's accounts to conform to Lucent's presentation. The results of operations for the separate companies and the combined amounts presented in the consolidated financial statements are as follows:


Nine Months
Ended
June 30,
 
Twelve Months Ended
September 30,
REVENUES 1999  1998  1997
Lucent   $26,256   $30,328   $26,444
Ascend   1,610   1,478   1,167
Eliminations   (138)   —   —
Combined   $27,728   $31,806   $ 27,611

NET INCOME (LOSS)
Lucent   $ 3,838(a)   $ 1,055(c)   $ 573(e)
Ascend   66(b)   (20)(d)   (124)(f)
Eliminations   (86)   —   —
Combined   $ 3,818   $ 1,035   $ 449
(a) Includes $108 of one-time after-tax charges related to Lucent's acquisitions of Quadritek, WaveAccess, Sybarus and Enable Ethernet and the merger-related costs for Ascend as well as $1,308 after-tax gain from the cumulative effect of the accounting change (see Note 10 ­ EMPLOYEE BENEFIT PLANS).

(b) Includes $243 of one-time after-tax charges related to Ascend's acquisition of Stratus. The original charge of $267 was reduced by $24 in the second fiscal quarter of 1999.

(c) Includes $1,412 of one-time after-tax charges related to Lucent's acquisitions of Livingston, Prominet, Optimay, Yurie, SDX, LANNET, MassMedia and JNA as well as the $95 after-tax gain on the sale of Advanced Technology Systems ("ATS") business.

(d) Includes $267 of one-time after-tax charges related to Ascend's acquisition of Stratus.

(e) Includes $966 of one-time after-tax charges related to Lucent's acquisition of Octel.

(f) Includes $335 one-time after-tax charges related to Ascend's acquisitions of Sahara and InterCon and Ascend's mergers with Whitetree, Inc. and Cascade Communications Corp.

Kenan Systems
On February 26, 1999, Lucent merged with Kenan Systems Corporation, a developer of third-party billing and customer software. Under the terms of the Kenan merger agreement, Lucent issued approximately 26 million shares (post April 1, 1999 stock split) of Lucent common stock in exchange for all the outstanding shares of Kenan.

Mosaix
On July 15, 1999, Lucent completed its merger with Mosaix, a provider of software that links companies' front and back offices and helps them deliver more responsive and efficient customer service. Under the terms of the agreement, the outstanding common stock of Mosaix was converted into the right to receive approximately 2.6 million shares of Lucent common stock. Lucent has not restated its historical financial statements to reflect its pooling-of-interests with Mosaix.

Nexabit Networks
On July 19, 1999, Lucent completed its merger with Nexabit, a developer of high-speed switching equipment and software that directs traffic along telecommunications networks. Under the terms of the agreement, the outstanding stock of Nexabit was converted into the right to receive approximately 13.7 million shares of Lucent common stock. Lucent has not restated its historical financial statements to reflect its pooling-of-interests with Nexabit.

Cascade Communications
On June 30, 1997, Ascend completed its merger with Cascade, a developer and manufacturer of wide area network switches.

Whitetree
On April 1, 1997, Ascend completed its merger with Whitetree, a developer and manufacturer of high-speed ATM switching products. Ascend did not restate its historical financial statements to reflect its pooling-of-interests with Whitetree.


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