Nortel Moves into Profit, Despite Revenue Drop

Nortel has announced its results for the third quarter of 2007, posting a swing back into net earnings, moving from a loss of US$63 million in the third quarter a year earlier and a loss of US$37 million in the prior quarter, to a gain of US$27 million. Revenues painted a mixed picture: still sharply down 7.9% on the same period a year earlier from US$2.93 billion to US$2.70 billion, although they were up 5.5% on the second quarter and the year-earlier revenue figures are enhanced by the loss of the UMTS unit as a continuing operation. Nortel was also unable to fulfil some orders as it transferred a CDMA manufacturing centre, resulting in a deferral of US$45 million in revenues. Quarterly operating earnings moved from a gain of US$11 million a year previously and a loss of US$40 million in the second quarter of 2007 to an operating profit of US$63 million. Operating margin—gross profit minus research and development and selling, general and administrative costs—more than doubled year-on-year (y/y) from US$64 million to US$134 million, rising from 2.2% to 5.0% as gross margins rose 4.6% to 43.0%, their highest level in nine quarters.

Nortel's president and CEO Mike Zafirovski saw signs of further improvement going into the fourth quarter. "Adjusted for the UMTS sale," he said, "orders in the third quarter were up 9 percent (y/y) and up 5 percent year to date, which demonstrates Nortel's increasing relevance in the marketplace. With an ongoing focus on customers and execution, we expect to continue to deliver operational and financial improvements in the fourth quarter and beyond."

On a segmented basis, Enterprise Solutions showed the strongest growth from its portfolio of IP voice and video communications and conferencing, data networking, and security solutions targeting enterprise clients. This segment will have benefited from the continuing partnerships with Microsoft (see World: 19 January 2007: Microsoft and Nortel Team Up for Unified Messaging and World: 18 January 2007: Nortel Aims for Acquisitions, Unveils New Products with Microsoft).  

Global Services was affected by the loss of the UMTS division and lower GSM services revenue, but gained from increases in support services revenues.

The Metro Ethernet Networks division also lost revenue when compared with the prior year and quarter as long-haul optical and legacy data networking revenues fell, although some growth in metro optical and carrier ethernet revenues was seen.

Carrier networks' revenues were hit by the loss of the UMTS division and the aforementioned issues with the transfer of the CDMA manufacturing centre, as well as slower sales of legacy products. The LG joint venture, however, has seen some growth (see World: 18 August 2005: Nortel and LG to Form Joint Venture). This joint venture is likely to have been largely responsible for the growth Nortel has seen in Asian markets, the only region showing consistent growth and growing its share of Nortel's revenue from 14.8% to 19.9% between the third quarter of 2006 and 2007.

Outlook and Implications

Nortel expects the fourth-quarter 2007 to be relatively flat with the prior year, which included UMTS access revenues. Nortel has resolved outstanding issues with the Securities and Exchange Commission with the US$35.7-million settlement announced in October 2007 covered by a US$35-million accrual accounted for in the second quarter of 2007, which will therefore not have an effect going into the fourth quarter (see World: 16 October 2007: Nortel Reaches Fraud Settlement for US$35.7 mil).  

CEO Zafirovski has done well to stabilise the troubled company, but the long-term game is where Nortel currently lacks a strong strategy. Danger signs can still be seen—investment in research and development (R&D) has fallen, down by 1.7% quarter-on-quarter (q/q) and 12.2% y/y (although this latter figure is added to by the loss of the UMTS unit), while selling, general, and administrative (SG&A) expenses have risen 3.0% q/q and 4.8% y/y. The increase in SG&A was largely attributed to increases in sales commissions and unfavourable foreign-exchange effects, although the same slide in the U.S. dollar that increased foreign business costs should have favourably affected revenues as an increasing proportion of sales are generated outside of the United States. With the divestiture of the UMTS business Nortel intended to skip a generation and emerge as a strong player in the WiMAX and 4G wireless technologies—this will require significant R&D expense, and by missing the UMTS link it may lack an entry point into wireless carriers networks as they upgrade systems from other vendors. It also lacks the end-to-end product portfolios including devices that appear to have driven recent vendor decisions (see World: 28 September 2007: Nortel Launches Consumer WiMAX Products).