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Lucent CEO walks tightrope as stock stumbles

As the company's stock founders, a growing chorus of investors, analysts, and current and former employees say it may be time for Rich McGinn to step aside.

Standing before his sales force more than a year ago, Lucent CEO Rich McGinn tried to rally the troops to increase revenue for the struggling telecommunications giant.

"If you guys don't do it for me this quarter, I'm out of a job," recalled a source who recounted the plea. "(McGinn's) talk was meant to be motivational, but he wasn't joking."

It's not likely McGinn is doing much joking these days. The CEO, known for his sense of humor and avant-garde ways, is on the hot seat again. But this time, the temperature may be too hot to handle, as a growing chorus of investors, analysts, and current and former employees say it may be time for him to step aside.

The struggling Lucent is searching for a chief operating officer--and prospective candidates are being told the CEO post may become available in the near future, said a source familiar with those efforts. However, prospective candidates have not been given any guarantees of when, or if, such a transition will occur.

During the past 12 months, McGinn has faced increasing pressure to improve the network equipment maker's sagging fortunes. The company has issued three earnings warnings this year, the stock has plummeted 75 percent from its 52-week high of $84, and a series of restructuring efforts have failed to halt the slide.

McGinn, in an effort to counter the concerns about his performance and speculation over his resignation, told 400 Lucent executives via a conference call this week that he had no plans to resign, said Bill Price, a company spokesman. And one source familiar with the board of directors' thinking said no discussions have been held to move McGinn into a chairman-only role.

The confident tone belies a rough week for the company. Lucent said its fourth-quarter results will fall short of Wall Street's expectations--the second such warning it has issued regarding the quarter. Lucent's stock lost a third of its value after the announcement; it will report fourth-quarter results Oct. 24.

"The company has lost credibility with investors," said Dave Heger, an analyst with A.G. Edwards. "I would imagine that the markets would react favorably to a new CEO search. The pressure is certainly on."

McGinn's reign in question
Jack Holden, co-portfolio manager with the Touchstone Utility A fund, also noted it may be time for a new CEO. "We got nervous when things blew up last year. We felt that some of the issues it was dealing with after the first quarter weren't going to go away anytime soon. It's like the cockroach theory: There's usually never just one," Holden said.

Last January, the company warned its first-quarter earnings would fall short of analysts' estimates because of its inability to meet demand for optical networking equipment, lower software sales, and delays in purchases by other service providers.

Current and former employees also are questioning McGinn's reign these days. Said one source: "How many strikes does a CEO get to have before it's time for a change?"

As analysts and others pick through the debris of Lucent's latest problems, they note that many of the troubles can be traced to McGinn's history with AT&T, a lack of leadership in removing Lucent's so-called pocket veto, and an inability to spot trends in some key market segments.

Lucent falls
Under Lucent CEO Rich McGinn, stock performance has declined. Stock price from October 1997 to present.  
 Source: Prophet Finance
Lehman Brothers analyst Steve Levy said reorganizing the company is less important than changing Lucent's culture. The company, a spinoff of AT&T, is still hindered by its heritage with the slow-moving telecom giant.

"Lucent's reorganizations didn't seem to have worked, but reorganization isn't what was needed," Levy said. "What was needed was a change in culture and business processes. Lucent and (research arm) BellLabs are incredibly productive when it comes to inventing things, but they are not a good company for getting those inventions and commercializing them in a timely basis.

"This is not about who reports to whom," Levy added. "When you don't have a culture with a sense of urgency, you can't pull yourself out."

McGinn, a veteran AT&T executive who was part of the telecom giant's Lucent spinoff in 1996, was brought up the ranks at AT&T and Lucent. McGinn was named senior vice president of AT&T Network Systems Group in 1991 and eventually worked his way up to CEO of that division three years later.

When he joined Lucent in 1996, he was appointed president and chief operating officer. A year later he was named CEO, and he later added the chairman's title to his resume.

"Things tend to take a lot of time to do at Lucent. It's a consensus culture that comes from AT&T, and McGinn is a creation of that culture," one source said.

Flawed execution
And then there's the issue of the "pocket veto."

"McGinn would announce a decision and all the executives would nod in agreement, but then some people who didn't like the decision would just pocket it and not take action," the source said.

As a result, some analysts and others question McGinn's leadership, as well as his ability to move quickly and with a sense of urgency.

Lucent's optical systems business is one example. When the company issued its first-quarter warning, one of the problems it cited was its inability to meet demand for optical networking equipment. In essence, Lucent was slow to pick up on the trend that demand for a 10-gigabit equipment would be hot and adjust its operations accordingly. Optical equipment allows service providers to send a larger volume of Net traffic through their networks at faster speeds.

Lucent annual results
Lucent's earnings are expected to fall in fiscal 2000, marking a first for McGinn's reign as CEO.
  Revenues Earnings / share*
Fiscal 1998 $31.8 billion 86 cents
Fiscal 1999 $38.3 billion $1.22
Fiscal 2000 $34.3 billion** $1.02**
* Excluding charges
** First Call/Thomson Financial estimates

Source: Lucent and First Call
Lucent's flawed execution in the optical systems market was also an issue in the fourth-quarter warning. Although production was in place, customers apparently were still kicking the tires. Revenue and gross margins from that business would come in less than expected in the fourth quarter, the company said.

"Lucent's optical business is the biggest concern, since it should be the company's strong growth area," analyst Heger said. "They introduced their (high-speed) product in February, while their competitor Nortel has had a product in this space for four years."

Lehman's Levy believes the company's woes began when Lucent's senior executives predicted the company would see 20 percent revenue growth in fiscal 1999, after 13 percent growth in 1997 and 14 percent growth in 1998.

Under pressure to meet revenue goals, Lucent in 1999 began giving large discounts to meet its numbers and began giving more loans to service providers to win their business, Levy said.

"They began doing these unnatural acts and the balance sheet kept getting worse and worse, and one year later, it broke--they came up short in revenue and earnings…They ended up training their customers to wait for the end of the quarter" to get the big discounts.

Lucent has also been victimized by bad loans to start-up service providers who have fallen on hard times.

Price, however, contends the company has moved rapidly to take action. During the past three months, Lucent has reorganized its optical business into two units, initiated a COO search, and is consolidating the services divisions into one unit, he said.

Last April, McGinn hired Deborah Hopkins, Boeing's former chief financial officer, to serve as Lucent's CFO.

"She was brought in to search for (business improvements) from a CFO perspective," Price said. He noted the company has been able to have a CFO perform this function only since it began paring down its sprawling operations.

"As we become a smaller, leaner business, we have been able to better identify ways to address business reviews and controls," he said.

The shrinking company
Lucent in recent months has chosen to shrink itself, focusing on the fast-growing service provider market. The company recently spun off Avaya, its slow-growing corporate networking business, and is in the middle of a similar move with its lucrative chipmaking and fiber-optic component business.

In addition, it has decided to rework its remaining businesses, dividing its optical networking division into core and metropolitan networking units to create more rapid growth across the entire optical networking business.

Several senior executives have left as part of the restructuring, including Patricia Russo, executive vice president and chief executive of Lucent's service provider business and Harry Bosco, head of its optical equipment unit.

see story: Lucent's loans gone bad And more shuffling is in the works: When the company issued its fourth-quarter warning this week, McGinn told analysts, "It is clear there must be a major retooling of the Lucent business."

Meanwhile, with all the restructuring under way, some company observers wonder whether Lucent will be able to maintain its service to its old customers while attracting new ones. And they wonder whether the company will be able to execute on improved operations.

"(McGinn) is a smart guy," said a source. "So he's aware of the consequences."

News.com's Ben Heskett contributed to this report.