UPDATE 3-Concerns over U.S. business overshadow Alcatel-Lucent results

Thu Jul 31, 2014 8:26am EDT

* Confirms positive free cash flow goal by end 2015

* Q2 sales up 0.7 pct to 3.28 bln euro, in-line w consensus

* Q2 operating margin 4.1 pct vs 1.3 pct last year

* Sales of IP products - usually growth driver - slip 10 pct

* Plans to IPO submarine unit in H1 2015

* Shares down 6 pct, biggest loser on French index (Recasts, adds analyst, share trend reversal)

By Leila Abboud and Gwénaëlle Barzic

PARIS, July 31 (Reuters) - Progress in Alcatel-Lucent's efforts to end years of losses was eclipsed on Thursday by concerns over weaker demand for the telecom equipment maker's core networking products and a potential slowdown in its vital U.S. market.

Alcatel posted quarterly sales largely in line with expectations and its operating margin improved. But its main listed competitors, Sweden's Ericsson and Finland's Nokia, both beat forecasts in the same period and forecast higher sales in the second half.

Alcatel shares had risen about 6 percent in the past two weeks in the expectation that its results would mirror its rivals. They gave back that gain on Thursday.

Investors were also unnerved by a 10 percent drop in sales of so-called IP products - seen as a growth driver for Alcatel - which telecom operators install to carry heavy traffic generated by people surfing the web on the go.

Alcatel's shares were down 6.4 percent at 1210 GMT at 2.65 euros, the biggest loser on the French CAC 40 index

In the United States, where the company makes a third of its revenue, the biggest mobile carriers Verizon and AT&T have said they front-loaded network investments in the first half as they compete for customers on service quality.

Third-place Sprint cut its 2014 guidance for network spending and could freeze its rollout plans if it buys T-Mobile later this year as mooted.

This has sparked concerns that the third and fourth quarters, when telecom equipment makers tend to make a large chunk of their business, could bring disappointment.

BNP Exane Paribas Alexandre Peterc said Alcatel's results were in line with forecasts at first blush, but closer inspection revealed grounds for concern.

"It seems investors are fearing that the U.S. will slow down and that will derail Alcatel despite the good execution of its turnaround," said Peterc, who has a neutral rating on the stock.

Alcatel's North America sales were down 2.6 percent to 1.49 billion in the second quarter, while Asia jumped 25 percent to 667 million because of massive rollouts of 4G in China.

The U.S. has been a very profitable market in recent years for Alcatel and Ericsson because operators have rapidly built 4G networks and low-cost Chinese rivals have been kept out because of the government's concern over the security of key national infrastructure.

ALCATEL CONFIRMS CASHFLOW GOAL

Alcatel-Lucent has not posted regular profits since it was created in a transatlantic merger in 2006, because of its smaller size in mobile than competitors and tough competition with rising Chinese vendors Huawei and ZTE.

Chief Executive Michel Combes has promised 10,000 job cuts, 1 billion euros of asset sales and 1 billion euros in cost cuts, while streamlining Alcatel's product line to focus on cloud computing and IP networking, which help operators carry booming mobile traffic.

On Thursday, he focused on the progress Alcatel had made since the beginning of his turnaround plan, dubbed Shift, in June 2013.

He confirmed Alcatel's aim to reach positive free cash flow by the end of 2015 and underlined the improvement to the operating margin, which reached 4.1 percent in the second quarter from 1.3 percent last year.

The company consumed 205 million euros in cash in the second quarter, a small improvement from the 247 million last year.

Operating profit tripled to 136 million, while revenue rose 0.7 percent to 3.28 billion euros compared with a year ago.

Wireless revenue rose 28 percent to 1.3 billion euros on U.S. and China strength, while IP networking products fell 10 percent to 1.37 billion euros.

The result compares with a 5 percent rise in quarterly network equipment sales for Ericsson, and a 8 percent decline in Nokia's top line, which has shrunk because of asset sales.

"This fourth consecutive quarter of consistent execution has enabled us to close the first chapter of the Shift turnaround plan," said Combes.

Investors have backed the CEO, causing the shares to more than quadrupled in 2013, but they fell 19 percent this year, compared to Ericsson's 9 percent rise and Nokia' 7.5 percent.

Progress on cleaning up Alcatel's balance sheet has been made, so it will pay back a 1.6 billion euro loan next month that was secured with the group's patents.

Combes said the company planned to float its submarine network division in the first half of next year, while keeping a majority stake so as to help the unit develop in a new area of delivering telecom services to the oil and gas services market.

The business - valued by analysts at between 350 million and 1 billion euros - lays underseas cables for telecom companies via a fleet of seven ships and has about 1,000 employees and a factory in the northern French port of Calais. (Editing by Tom Pfeiffer)

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