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|  | APRIL 4, 2005
 SPECIAL REPORT S&P's Tech Company Report Card, Pt. 1 This installment provides financial and outlook overviews on companies in communications gear, and computers, components, and peripherals Here's the first part of a sectoral company-by-company look at Standard & Poor's credit ratings for the high-technology outfits followed by its credit analysts -- along with S&P's comments on the financial strength and business outlook for each company. Additional portions of the review will be published in subsequent days (also see S&P's sector-by-sector overview of the tech industry).In this portion, S&P looks at: • Communications equipment manufacturers • Computer component manufacturers • Computer manufacturers • Computer peripherals manufacturers Communications equipment manufacturers Alcatel (ALA ) Corporate credit rating: BB; Outlook: Stable Alcatel achieved results in line with expectations for the fourth quarter of 2004, in a typically strong season for the industry. Quarterly revenues were €3.8 billion, reflecting 10.7% year-over-year growth, after restatements of assets disbursed. Sales grew in Mobile Communications and Private Communications, but fell by 1.6% in Fixed Communications as legacy PSTN continue their structural decline. Gross margins fell to 34.4%, down 330 basis points sequentially, as the group took up some early positions in growth markets such as India and Brazil. The operating profit reached €393 million for the quarter, equivalent to a 10% margin. Free cash flow was modestly positive for the first time in 2004, reflecting cost cutting and the deconsolidation of some underperforming operations. Alcatel's liquidity remained strong at Dec. 31, 2004, with net cash of €752 million. Alcatel gave guidance of low-to mid-single-digit sales growth in 2005. Andrew Corp. (ANDW ) BB/Stable In the first quarter ended Dec. 31, 2004, sales were higher than expected because of increased demand for wireless infrastructure overseas and for certain products supporting the consumer broadband satellite market. This offset some of the weakness in wireless infrastructure demand in North America because of operator consolidation. Nevertheless, growth opportunities will materialize as carriers upgrade their networks for thirdgeneration (3G), next-generation services and expand coverage. The gross margin improved sequentially to 23.3% from 22.2% in the fourth quarter of 2004 because of the relocation of certain facilities and lower startup costs associated with new products. However, further improvement in the margin will be somewhat offset by higher raw material costs. In the first fiscal quarter, total debt to EBITDA annualized and adjusted for operating leases was about 1.9x, which we believe is comfortable for the rating. Avaya Inc. (AV ) BB/Stable EBITDA profitability gradually has improved over the past eight quarters, reaching a 12% margin in the December, 2004, quarter. Acquisitions and divestitures, including Tenovis, which closed during the December quarter, may help to strenghten Avaya's business profile. Funded debt levels have been reduced to $368 million as of Dec. 31, 2004, and cash balances have increased. At $911 million as of Dec. 31, 2004, cash is down sequentially because of the Tenovis acquisition, but it remains at healthy levels. Ciena Corp. (CIEN ) B/Negative* Market conditions for the high-speed communications components industry remain weak, and Ciena remains heavily dependent on a handful of network operators. Ciena is shuttering its San Jose (Calif.) facility and cutting staff by 25%, hoping to slash costs by $60 million, after a restructuring charge of $80 million. While Ciena continues its product development and marketing programs, visibility of future sales levels is minimal. Although sales have been increasing, operating profitability remains constrained. Negative EBITDA and free cash flows are expected to continue. Still, financial flexibility is ample for operational requirements. Cash balances were $1.2 billion, and debt $861 million, as of Jan. 31, 2005. Comverse Technology (CMVT ) BB-/Stable Operating performance continued to improve in the Jan. 31, 2005, quarter, with revenues growing 28% year-over-year and EBITDA margins up sequentially to 13.1%. The improvements are underpinned by increased wireless telecom spending on enhanced service offerings. Liquidity remains strong ($2.3 billion of cash against $508 million of funded debt) and is an ongoing source of ratings support in light of a narrow, volatile business profile. Ericsson (ERICY ) BBB-/Positive Ericsson posted a strong operating performance in the fourth quarter and full year 2004. Critically, yearly turnover grew by 12% to Swedish krona (Skr) 132 billion from Skr118 billion in 2003 and the core mobile systems division -- which accounts for 74% of the group's revenues -- grew by a record 20% year-over-year. Ericsson achieved strong operating profitability of 22% for the year, reflecting strong sales momentum combined with the benefits of its aggressive cost cutting. As a result, it generated strong free cash flow of Skr17.7 billion (about €2 billion) for the year. The group also exhibited a strong and conservative financial profile at Dec. 31, 2004, with gross cash and equivalents of Skr76.5 billion against gross financial debt of only Skr23.5 billion, a conservative lease- and pensions-adjusted gross financial debt to 2004 EBITDA of 1.2x. Harris Corp. (HRS ) BBB/Stable Strength in government-related communications businesses continues to offset weaker performance in commercial telecom and broadcast businesses. Total revenues grew 22% year-over-year in the December, 2004 quarter, consistent with recent performance. Profitability in the commercial businesses, particularly microwave, has improved, turning modestly positive in recent quarters, although still below healthy levels. Debt coverage remains comfortable for the rating level, with total debt-to-EBITDA at 1.4x in the December, 2004, quarter, which provides Harris some flexibility to pursue strategic objectives, such as the recent acquisition of Encoda Systems. IPC Acquisition Corp. B+/Stable Although financial flexibility currently is constrained following a $20 million special dividend and the purchase of Orbacom Systems for up to $18 million, including deferred consideration, Standard & Poor's expects cash generated from operations over the near term to be sufficient to pay down the revolver balance, as well as to cover any operational needs. Credit protection measures remain adequate for the ratings level. Juniper Networks (JNPR ) B+/Positive Juniper retains a good share of its niche market, and revenues continue to grow as it expands its product offerings and distribution channels. The company has ample flexibility to execute its business plan, with cash ($1.7 billion at Dec. 31, 2004) well in excess of its $400 million funded debt. Juniper has generated $250 million in free cash flows over the past year. A common stock repurchase plan will not significantly affect financial flexibility. Lucent Technologies (LU ) B/Positive Sales appear to have stabilized at about $2.2 billion per quarter. Lucent's profitability has been improving, and it has brought costs down to reflect this revenue range. Still, with a narrow customer base and rapid technology evolution, overall visibility remains limited, and revenue fluctuations are likely. Cash balances were $3.7 billion at Dec. 31, 2004, sufficient to support operations over the intermediate term, and Lucent is expected to receive a $900 million tax refund in 2005. It will be compelled to address substantial postretirement health-care benefit obligations, as fund assets will be depleted by 2007. Pension-adjusted debt to EBITDA is around 7x, including postretirement benefit obligations. Motorola (MOT ) BBB/Positive A moderate level of diversification, ample cash levels ($11 billion at Dec. 31, 2004), and positive free cash flows (around $3 billion per year) have helped offset the challenges of the cell-phone market, where Motorola recently gained share. Still, cell phones essentially are commodity fashion items, possibly presenting longer-term profitability challenges. Divesting the semiconductor operations (Freescale Semiconductor Inc.) in December has yielded more stable free cash flows for Motorola. Asset turnover has improved to 9x, benefiting from an asset-light strategy. Return on capital has only recently been in double digits, while leverage is well within the rating at about 1.7x EBITDA, including the effects of unfunded postretirement benefit obligations. Nokia (NOK ) A/Negative Nokia reported satisfactory results in the seasonally strong fourth quarter of 2004. The group seems to be containing the downward trend in terms of market share (34% in the fourth quarter) on the back of its defensive cuts on prices and the update of its mobile handsets portfolio among a very aggressive competitive environment. Nokia generated healthy operating margins in mobile phones of 19%. Free cash flow generation was strong, at €3.8 billion for the past 12 months. Nokia's net cash position remains very large, at €11.3 billion at Dec. 31, 2004. The group returned €4.1 billion cash to shareholders in 2004 through dividend distribution and share buybacks, close to its annual free cash flow generation. Nortel Networks (NT ) B-/Watch Developing A number of recent positive developments are happening at Nortel Networks: The independent review of its audit committee has been completed, the restatement of fiscal 2002 and 2001 financial statements is complete, and Nortel has made all necessary regulatory filings in the U.S. and Canada for fiscal 2003 and first and second quarters of 2004. It has made significant progress toward addressing the material weaknesses in its internal controls. However, those weaknesses likely will continue for the foreseeable future. Third-quarter 2004 and full-year 2004 financial statements are expected to be filed by the end of March, 2005, and April, 2005, respectively. The ratings will remain on CreditWatch until a full review of 2004 results can be completed. SR Telecom CC /Negative SR Telecom is having difficulties obtaining all necessary commitments from various financial stakeholders for a refinancing of its debt, and it's now clearly operating under severe time constraints, with its debentures due on April 22, 2005. It will be difficult for SR Telecom to raise new equity or subordinated debt in light of recent performance. Verifone B+/Stable Privately owned Verifone has a leading position in the niche market for electronic payment devices. It has a short financial history as an independent company and a leveraged financial profile. However, Verifone recently filed a common stock registration statement with the Securities & Exchange Commission. Verifone intends to use a portion of the net proceeds from the prospective IPO to repay debt. If it successfully completes its IPO and reduces debt, we expect to revise the outlook on the company to positive. These ratings were initiated by Standard & Poor's Ratings Services. They may be based solely on publicly available information and may or may not involve the participation of the issuer's management. Standard & Poor's Ratings Services has used information from sources believed to be reliable, but does not guarantee the accuracy, adequacy, or completeness of any information used. Ratings are statements of opinion, not statements of fact or recommendations to buy, hold, or sell any securities. Other analytic services performed by Standard & Poor's may be based on information that was not available for this rating and this report.
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