Solved by verified expert:For the Downgrade Warnings, it’s two different documents. One is the case study and the other is the questions.For the J.P. Morgan Downgrade Warnings, the questions are found on page 3, which is under section “REQUIRED”
lucent_tech_2014.pdf
j.p._morgan_tells_analysts__to_warn_of_a_downgrade.docx
questions_for_downgrades_warning_.docx
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LUCENT TECHNOLOGIES
AT&T spun off its research and development division (the former Bell
Laboratories) in April of 1996, and the newly independent company – renamed Lucent
Technologies – was an instant hit with investors. The company’s stock became the most
widely held in the United States, and over the following 3 years and 9 months its price
increased 892%.1
This remarkable price appreciation tracked a series of steadily
increasing earnings that exceeded analyst expectations. Lucent, in fact, had beaten those
expectations in each of its 15 quarters of operations (Zacks, 2000).
Lucent Technologies manufactures, sells and services voice and data
communications systems and software. By the end of its fiscal-year 1999, Lucent
generated over thirty-eight billion dollars in annual revenues, employed over 150,000
people, and had offices in more than ninety countries worldwide.
On October 26, 1999, Lucent issued a press release describing record earnings for
both the quarter and the fiscal year ended September 30, 1999 (Lucent, 1999a). Lucent’s
revenues were up 23 percent, and earnings were up 50 percent from the fourth quarter of
the previous year. For the fiscal year, Lucent’s revenues and earnings were up 20 and 46
percent respectively. Lucent’s chairman and CEO, Richard McGinn, described the results
saying: “Lucent enters the new millennium with momentum. This was the strongest
quarter and the strongest year in Lucent’s history.”
The report of these record results was accompanied by another press release. This
second announcement outlined a realignment of Lucent into “four core businesses.” This
realignment was, in the words of McGinn, “…intended to mirror the way we are
1
Lucent’s beta as reported by Yahoo Finance was 1.6 on January 6, 2000.
approaching customers today – with converged network solutions. We are sharpening our
focus on high-growth areas – such as data networking, optical networking, wireless
semiconductors, e-business and professional services – while speeding our growth in
international markets.
And, we will also be aligning our management structure to
increase productivity and accelerate our response to customer needs” (Lucent, 1999b).
Over the ensuing days and weeks, Lucent’s share price soared. Climbing steadily
from $59 7/8 on October 25, 1999, it traded at prices over $82 during December 1999,
and closed at $72 3/8 on January 5, 2000.
On January 6, however, Lucent filed a Form 8-K with the U.S. Securities and
Exchange Commission. Form 8-Ks are used to report “material events,” and Lucent’s
“event” was that first quarter earnings for the quarter ended December 31, 1999 would be
significantly below expectations. Lucent reported that its revenue from Service Provider
Networks was down 2%. A result, company executives said, that was caused by the
domino effect of unanticipated customer shifts to new optical systems and the
manufacturing deployment and capacity problems that ensued. Indeed, analysts estimated
that Lucent lost up to $1 billion in sales because of production delays, delivery problems
and cancelled orders during the quarter (Dow Jones, 1/20/00).
Although Richard McGinn, said the company expected its problems to be
resolved by the end of the second quarter, and Lucent’s Chief Financial Officer, Don
Peterson described the shortfall as a “bump in the road,” (Burns, 1/27/00) the response of
investors was harsh. The company’s stock price fell from $72 3/8 to $52. The decline in
stock price erased, in a single day, more than $80 billion in market capitalization and a
year’s worth of gains. Furthermore, a number of class action lawsuits were filed on behalf
of investors who had purchased Lucent’s stock between October 27, 1999 and January 6,
2000 (PRNewswire, 1/20/00). The suits claimed that Lucent violated Sections 10(b) and
20(a) of the Securities Act of 1934 by issuing a series of materially false and misleading
statements that failed to disclose the weaker-than-expected performance in a timely
fashion.
REQUIRED
1. Conduct a DuPont decomposition of Lucent’s ROE for each quarter of 1998,
1999 and 2000 (December 1999 is fiscal year 2000’s first quarter).
What factors
contributed to the differences in Lucent’s performance between those quarters?
2. Evaluate the seasonally adjusted change (i.e., quarter i in year t to quarter i in
year t-1) in Lucent’s: Sales, Accounts Receivable, Inventory and Gross Margin for the
five quarterly periods: December 1998 through December 1999. Be sure to include an
evaluation of the Footnote disclosures regarding Lucent’s inventories in your
examination. Does the explanation for the earnings shortfall provided by Lucent’s
managers make sense in light of your analysis?
3. Based on your analysis:
a) When might you have determined that Lucent would be unable to maintain its
streak of record earnings?
b) Do you think the class-action lawsuits have merit?
c) Would you expect Lucent’s earnings to ‘recover’ by the second quarter of 2000?
d) What obstacles are there to Lucent’s recovery?
EXHIBIT 1
LUCENT TECHNOLOGIES
Selected Earnings Per Share Data
For the Quarters Ended:
Earnings Per Share
Analyst Expected Earnings Per Share
Difference
% Surprise
Dec-99
0.36
0.43
(0.07)
-16.28%
Sep-99
0.31
0.29
0.02
6.90%
Jun-99
0.26
0.23
0.03
13.04%
Mar-99
0.17
0.15
0.02
13.33%
Dec-98
0.52
0.50
0.02
5.00%
EXHIBIT 2
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
——————————————FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
January 6, 2000
————————————————————Lucent Technologies Inc.
———————————-
Item 5.
Other Events.
On January 6, 2000, Lucent Technologies Inc. announced that, based on
preliminary estimates for its first fiscal quarter of 2000 ended December 31,
1999, the company expects to report revenues in the range of $9.8 to $9.9
billion for the quarter, flat with the prior year period.(1) The company expects
earnings per share for the quarter to be in the range of 36 to 39 cents compared
to 48 cents for the year-ago quarter.(2)
The company attributed the lower than expected revenue and earnings for the
first fiscal quarter to several factors, including:
—
faster than anticipated shifts in customers’ purchases to
Lucent’s newest 80-channel DWDM optical product line and
greater than expected demand for OC-192 capability on the
80-channel systems, which resulted in near-term manufacturing
capacity and deployment constraints;
—
changes in implementation plans by a number of customers
inside and outside the United States, which led to delays in
network deployments by enterprises and service providers;
—
lower software revenues, reflecting an acceleration in the
continuing trend by service providers to acquire software more
evenly throughout the year. In the past, these purchases
occurred primarily in the quarter ending December 31; and
—
preliminary results show lower than anticipated gross margins
this quarter from ramp-up costs associated with introducing
and implementing new products and lower software revenues.
The information provided in this Form 8-K is based on preliminary financial
results, which are subject to further review and adjustment, and contains
forward-looking statements based on current expectations, forecasts and
assumptions that involve risks and uncertainties that could cause actual
outcomes and results to differ materially. These risks and uncertainties include
price and product competition, dependence on new product development, reliance
on major customers, customer demand for our products and services, the ability
to successfully integrate acquired companies, control of costs and expenses,
international growth, general industry and market conditions, growth rates and
general domestic and international economic conditions, including interest rate
and currency exchange rate fluctuations. For a further list and description of
such risks and uncertainties, see the discussion in Lucent’s Form 10-K for the
fiscal year ended September 30, 1999 in Item 1 in the section entitled “X.
OUTLOOK, A. Forward Looking Statements” and the remainder of the X. OUTLOOK
section.
——–(1) All items in both the 1999 and 2000 periods include the results of recent
mergers with International Network Services and Excel Switching.
(2) All earnings per share amounts reported in this Form 8-K are diluted EPS
figures.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
LUCENT TECHNOLOGIES INC.
By:
/s/ JAMES S. LUSK
Name: James S. Lusk
Senior Vice President and Controller
Date:
January 7, 2000
EXHIBIT 3
LUCENT TECHNOLOGIES
Consolidated Balance Sheets
For the Quarters Ended:
Dec-99
Assets
Cash
Receivables
Less Allowance
Inventory
Contracts in Process, net
Deferred Taxes, net
Other Current Assets
Total Current Assets
Property & Equipment (net)
Accumulated Depreciation
Pre-paid Pension Costs
Deferred Taxes, net
Capitalized Software Development Costs
Other Assets
Total Assets
Liabilities and Shareholders’ Equity
Accounts Payable
Payroll and Benefit Liabilities
Post-retirement and Post-employment Benefit Liabilities
Debt Maturing within One Year
Other Current Liabilities
Total Current Liabilities
Post-retirement and Post-employment Benefit Liabilities
Long Term Debt
Other Liabilities
Total Liabilities
Common Stock
Additional Paid-in Capital
Guaranteed ESOP Obligations
Retained Earnings
Accumulated Other Comprehensive Income or Loss
Total Shareholders Equity
Total Liabilities and Shareholders’ Equity
$
$
$
$
$
$
$
2,219
10,143
381
5,380
1,164
1,504
1,168
$ 21,578
6,986
7,693
6,078
506
3,486
$ 38,634
2,162
1,321
103
2,672
3,659
9,917
6,013
3,832
2,793
22,555
32
9,032
(30)
7,296
(251)
16,079
38,634
Sep-99
$
$
$
$
$
$
$
$
$
1,816
10,438
362
5,048
1,103
1,583
1,943
21,931
6,847
7,445
6,485
470
3,002
38,735
$
2,878
2,300
137
2,864
3,599
11,778
6,615
3,812
2,908
25,113
31
7,763
(33)
6,105
(244)
13,622
38,735
$
$
$
$
$
$
$
$
Jun-99
Mar-99
1,495 $
9,486
393
5,179
1,338
1,784
1,528
20,810 $
6,257
7,274
6337
412
3,340
37,156 $
792
8,752
349
4,332
1,106
1,632
1,160
17,774
5,751
6,935
6,210
346
2,759
32,840
$
2,705
2,001
169
3,080
4,001
11,956
6,533
3,712
2,552
24,753
30
7,339
(34)
5,240
(172)
12,403
37,156
2,410
1,724
184
3,185
4,059
11,562
6,471
3,716
2,040
23,789
27
4,996
(34)
4,384
(322)
9,051
32,840
$
$
$
$
$
$
$
Dec-98
$
$
$
$
$
$
$
Sep-98
940
9,185
346
3,778
1,060
1,620
768
17,351
5,645
6,886
6,068
306
2,271
31,641
$
2,468
1,857
186
3,763
4,167
12,441
6,413
2,404
1,946
23,204
13
4,706
(49)
3,565
(198)
8,437
31,641
$
$
$
$
$
$
$
$
Jun-98
685
6,939
390
3,081
1,259
1,623
491
14,078
5,403
6,382
3,754
750
298
2,437
26,720
$
2,040
2,511
187
2,231
3,459
10,428
6,380
2,409
1,969
21,186
13
4,468
(49)
1,364
(262)
5,534
26,720
$
$
$
$
$
$
$
$
Mar-98
Dec-97
1,099
5,792
374
2,973
1,405
1,554
482
13,305
4,957
6,253
3,597
832
289
2,299
25,279
$
969
5,576
369
2,874
1,332
1,477
481
$ 12,709
4,805
6,132
3,462
1,002
279
2,407
$ 24,664
$
1,727
2,354
194
2,423
3,498
10,196
6,286
1,899
1,976
20,357
13
4,251
(63)
1,028
(307)
4,922
25,279
$ 1,659
2,048
195
1,898
3,618
$ 9,418
6,249
1,918
2,043
$ 19,628
$
13
4,076
(63)
1,314
(304)
$ 5,036
$ 24,664
$
$
$
$
$
$
$
$
Sep-97
1,225
6,295
344
2,604
1,214
1,469
449
13,256
4,729
6,121
3,322
1,120
246
2,079
24,752
$
1,496
2,178
221
1,757
4,310
9,962
6,136
1,945
2,038
20,081
6
3,717
(77)
1,298
(273)
4,671
24,752
$
$
$
$
$
$
$
$
1,350
5,373
352
2,926
1,046
1,333
473
12,501
5,147
6,407
3,172
1,262
293
1,436
23,811
1,931
2,178
239
2,538
3,852
10,738
6,073
1,665
1,948
20,424
6
3,047
(77)
602
(191)
3,387
23,811
EXHIBIT 4
LUCENT TECHNOLOGIES
Consolidated Statements of Income*
For the Quarters Ended:
Total Revenues
Cost of Sales
Gross Margin
Selling, General and Administrative Expenses
Research and Development
Total Operating Expenses
Operating Income
Other Income (Expense), net
Interest Expense
Income Before Taxes
Income Tax Expense
Net Income
$
$
Dec-99
9,905 $
5,259
4,646
1,908
978
2,886
1,760
66
98
1,728
553
1,175 $
Sep-99
10,575 $
5,706
4,869
2,251
1,131
3,382
1,487
92
114
1,465
493
972 $
* Excludes one-time events and the cumulative effect of accounting changes
Jun-99
9,315 $
4,834
4,481
1,984
1,141
3,125
1,356
19
119
1,256
427
829 $
Mar-99
8,220 $
4,327
3,893
1,902
1,139
3,041
852
(65)
95
692
235
457 $
Dec-98
9,842 $
4,630
5,212
1,937
1,013
2,950
2,262
116
78
2,300
777
1,523 $
Sep-98
8,574 $
4,443
4,131
1,972
1,050
3,022
1,109
(43)
71
995
348
647 $
Jun-98
7,642 $
4,087
3,555
1,673
1,002
2,675
880
(17)
63
800
282
518 $
Mar-98
6,184 $
3,436
2,748
1,501
932
2,433
315
31
58
288
102
186 $
Dec-97
Sep-97
8,724 $ 6,933
4,519
3,873
4,205
3,060
1,555
1,608
829
835
2,384
2,443
1,821
617
14
51
79
72
1,756
596
632
227
1,124 $
369
EXHIBIT 5
Notes to Consolidated Financial Statements
Supplementary Balance Sheet Information
Dec-99
Inventories
Finished Goods
Work in Process
Total Inventories
3062.00
2318.00
5380.00
Sep-99
2946.00
2102.00
5048.00
Jun-99
2917.00
2262.00
5179.00
Mar-99
2281.00
2051.00
4332.00
Dec-98
1777.00
2001.00
3778.00
Sep-98
1578.00
1503.00
3081.00
Jun-98
1594.00
1379.00
2973.00
Mar-98
1463.00
1411.00
2874.00
Dec-97
1291.00
1313.00
2604.00
Sep-97
1611.00
1315.00
2926.00
4/
1/
9
7/ 6
1/
10 96
/1
/9
1/ 6
1/
9
4/ 7
1/
9
7/ 7
1/
10 97
/1
/9
1/ 7
1/
9
4/ 8
1/
9
7/ 8
1/
10 98
/1
/9
1/ 8
1/
9
4/ 9
1/
9
7/ 9
1/
10 99
/1
/9
1/ 9
1/
00
$ Price per Share
EXHIBIT 6
LUCENT TECHNOLOGIES
Common Stock Price
(Adjusted for Splits)
90
80
70
60
50
40
30
20
10
0
April 1996 through January 2000
By WADE LAMBERT and JATHON SAPSFORD
Staff Reporters of THE WALL STREET JOURNAL
J.P. Morgan Tells Analysts To Warn of a Downgrade
J.P. Morgan Chase & Co.’s head of European research told his team of analysts they
must run all changes in European stock recommendations past both the company in
question and J.P. Morgan’s investment-banking department.
“Both the company and the client banker need to be notified, in advance, of the
recommendation change that we plan to make,” said the memo, written by Peter
Houghton, head of equity research in Europe. “If the company requests changes to the
research note, the analyst has a responsibility to either incorporate the changes
requested or communicate clearly why the changes cannot be made.”
The memo, which a company spokesman described as a global policy for the bank
and which was previously reported by the Times of London, represents a rare written
edict on a practice that raises questions about analysts’ independence.
Wall Street analysts long have been pressured by corporate clients and their own
bankers to shun negative research. Some companies penalize analysts or their firms
for “sell” recommendations. Investment bankers pressure analysts because they fear
any negative research will hamper their chances of winning lucrative underwriting or
advisory business from the same corporate client. Thus, many savvy investors ignore
much of the research that comes from securities firms.
“It defeats the purpose of research,” says Frank Barkocy, director of research at hedge
fund Keefe Managers. Mr. Barkocy represents the “buy side,” or those who are
potential customers for the research of analysts at Wall Street securities firms who are
known as the “sell side.”
By showing the report first to the company in question, “the way an analyst uses
some words might very well be minimized,” Mr. Barkocy says. “It’s a disservice to the
analyst and a disservice to the buy side.”
J.P. Morgan Chase maintains the memo merely reiterates a policy it has long
followed, and that it reflects practices that are common in the industry. The company
says it sent the memo to ensure that several new analysts who came from other firms
know the policy. The company maintains that analysts aren’t under pressure to change
recommendations, but only to make factual changes.
“The point of the memo was to ensure that there’s clear communication between
analysts and bankers and companies,” says Nick O’Donohoe, head of European
equities at J.P. Morgan. It is “a normal, common courtesy” to warn a company that an
analyst was about to downgrade its stock. Nothing in the memo “compromises the
honesty or objectivity or independence of our analysts,” he says.
Analysts’ practices are coming under increased scrutiny after the Securities and
Exchange Commission last October began enforcing Regulation FD, for fair
disclosure, a rule that seeks to rein in the flow of privileged information between
corporations and the Wall Street analysts who cover them. Wall Street analysts also
have been criticized for maintaining “buy” recommendations on once-highflying tech
stocks, despite their lack of profits, and long after their stocks had fallen.
The issue came to a head for many European investors in December over the initial
public offering for France Telecom’s Orange PLC unit. Analysts were barred from a
briefing by Orange officials unless they agreed to let the lead banks “fact-check” their
reports on the share offering.
Some question whether research can ever be considered objective if the other arm of
the firm publishing it is advising the same company on a merger or selling shares.
Sebastian Virchow, a fund manager at Deutsche Bank AG’s asset-management unit
DWS Group in Frankfurt, says his team confirms the earnings and scientific
developments of the companies it invests in, rather than taking analysts’ reports at face
value. “We read the analyst reports and gather information, but we do our own due
diligence and would never just use the reports on their own,” he says. “We talk to the
companies ourselves and make our own earnings estimates.”
QUESTIONS:
1.) What is meant by “analysts’ independence”? When and how might analysts’
independence be compromised? What pressures do analysts face that might reduce
their independence? Is maintaining a “buy” recommendation on a stock after its
price has fallen evidence that an analysts’ independence is compromised? Do
analysts who currently recommend investing in tech stocks and the broader stock
market lack independence?
2.) What exactly does Peter Houghton’s memo say? Does the memo say that
analysts should compromise their independence? How does the memo raise
questions about analysts’ independence? Does it make any difference whether
“analysts aren’t pressured to change recommendations, but only to make factual
changes”?
3.) What are the “buy side” and “sell side”? Why might the “sell side” be
unwilling to make “sell” recommendations on stocks? If the “buy side” has its
own analysts, would the “buy side” ever look at “sell side” analysts’ reports?
4.) Why might “sell side” companies extend the “normal, common courtesy” of
warning firms before they downgrade their stocks? Would you consider this good
business practice? What is Mr. Barkocy’s “buy side” criticism of such
practices? Why might the “sell side” ignore such criticism?
5.) Former SEC chairman, Arthur Levitt, criticized analysts in January this
year in a speech in Philadelphia. Read the speech at:
http://www.sec.gov/news/speech/spch457.htm. Levitt comments that a “sell”
recommendation from an analyst is as common as a Philly steak sandwich without
the cheese. If analysts don’t issue “sell” recommendations, how do they advise
investors that they should sell certain stocks?
…
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