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Nortel: Material Margin MadnessNortel: Material Margin Madness

Nothing has materially changed, says Nortel, except for the fact that its profit margins aren't hitting targets

July 27, 2004

3 Min Read
Nortel: Material Margin Madness

Nortel Networks Ltd. (NYSE/Toronto: NT) shares were shellacked this morning after the company said in a statement that it wasn't achieving its profit-margin goals (see Nortel Provides Status Update).

In morning trading, Nortel shares lost $0.59 (14.50%) to change hands at $3.48.

Today's curiously worded release could have easily set you off track – that is, unless you actually read past the second paragraph:

"The Company and NNL reported that there have been no material developments in the matters reported in their status updates of June 2, 2004, June 29, 2004, and July 13, 2004, with the exception of the matters described below," read the second paragraph of the release, part of a biweekly update that Nortel is providing the Ontario Securities Commission.

Of course, there were material developments. It was exactly the "matters described below" that caught investors' attention and gave the share price a 15 percent haircut. In the paragraph that followed, president and CEO Bill Owens had this to say:

"I remain pleased with Nortel Networks market momentum and continue to expect our revenues in 2004 to grow faster than the market (which we expect will grow in the low to mid single digits). However, as we move through 2004 and based on the work to date on our financial results, it is clear that our business model is not achieving our targeted operating cost (SG&A and R&D) performance of below 40 percent of overall revenues and our targeted gross margin percent of mid 40's."

Nortel said it is taking steps "to put into place an improved cost structure to optimize our financial performance." It also said it is working on its financial restatements and expects to "be in a position to announce" limited preliminary unaudited results for the first and second quarters of 2004 – and provide another update – in mid August.

In recent weeks, Nortel had already hinted that more cost-cutting might be needed to get the company back to healthy profit margins as it tries to move beyond the "accounting-challenged" tenure of ex-CEO Frank Dunn (see Nortel Gets Federal Subpoena, Dunn's Done With Nortel , Nortel Rattles Nerves). As highlighted in Headcount last week, Nortel's Owens provided some warning that something was up (see Headcount: Fair Warning).

What could lie ahead? When a company says "cost-cutting," it usually means layoffs. The only other options would be for Nortel to sell some assets or look for operational moves, but given its past extensive garage sales and recent restructuring deal to sell manufacturing to Flextronics Corp. (Nasdaq: FLEX), the most obvious moves have already been made (Nortel Sells Plants, Supplies Update and Nortel Sells Directory Biz). Of course, it could sell one of its four core divisions (Optical Networks, Wireline Networks, Wireless Networks, and Enterprise Networks), and there has been some chatter about this in the past. The wireless division would probably garner the most interest, but that's also what generates the most revenue for the company (about $1.4 billion per quarter).

— R. Scott Raynovich, US Editor, Light Reading

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