Revenue-Recognition Problems in the Communications Equipment Industry

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9-107-025
REV: AUGUST 23, 2007

PAUL HEALY

Revenue-Recognition Problems in the Communications Equipment Industry On November 21, 2000, Lucent Technologies announced that it was revising its fourth-quarter results as a result of revenue-recognition problems discovered by its auditors during the year-end financial review. The revision lowered revenues by $125 million and earnings per share by 2 cents from 18 cents. In response, Lucent’s stock price fell by 16%, to $17.56. One month later, on December 22, Lucent announced that after a more comprehensive review, revenues for the fourth quarter would need to be adjusted downward by $679 million, to $8.7 billion, and that earnings per share would be revised from the initially predicted 18 cents to 10 cents. The stock plummeted by a further 19%, to $13.625 (see Exhibit 1 for a graph of Lucent’s stock price during 2000). Finally, on December 29, the company reported that it was increasing its provision for customer bad debts to $252 million for the fiscal year ended September 30, 2000. As he reflected on Lucent’s revisions and revenue-recognition problems, John O’Connor, a communications equipment industry analyst at Dana Katz Inc., a midtier investment bank, wondered whether other companies in the industry faced similar risks. To be sure, Lucent’s revenue-recognition issues arose partially from its own internal control and management problems. However, they also appeared to be exacerbated by industrywide challenges arising from excess capacity in the telecommunications sector and the declining fortunes of Internet businesses. O’Connor decided that it would be worth spending time examining the potential for revenue-recognition problems at Lucent’s major competitors.

Lucent’s Problems
Lucent Technologies provided communications systems and software for large wire and wireless communications network operators and service providers. More than 75% of the company’s sales were to large service providers. Its two largest customers, Verizon and AT&T, accounted for 13% and 10% of sales, respectively. Lucent provided medium- to long-term financing and financing guarantees to its customers. Many of these loans, however, were not included on its balance sheet, since they had been sold to financial institutions. By December 31, 2000, Lucent had agreed to extend credit to customers for $5.7 billion, $1.8 billion of which had been used, and was finalizing an ________________________________________________________________________________________________________________ Professor Paul Healy and Research Associate Arjuna Costa (MBA 2001) prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2006, 2007 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

Purchased by Kai Li (kai.li001@umb.edu) on September 30, 2012

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Revenue-Recognition Problems in the Communications Equipment Industry

agreement with a customer to extend an additional $1.6 billion of credit. Lucent had also made commitments to guarantee customer debt of about $1.8 billion, $740 million of which had been used. Even before the discovery of its accounting problems, the year 2000 had been a challenging one for Lucent. In product development it had failed to foresee the rapid switch to fiber-optic networks, enabling competitors such as Nortel Networks Inc. to capture market...
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