Nortel's Numbers Disappoint

For Nortel Networks Ltd. (NYSE/Toronto: NT), this looks like the beginning of the end of its accounting nightmare.

But that doesn't mean its troubles are over.

Having struggled to put its financial house in order for nearly a year, the Canadian vendor finally released some financial results for the first three quarters of 2004 and for the years 2001, 2002, and 2003, albeit "limited estimated unaudited" numbers (see Nortel Provides Estimates).

As previously stated, Nortel expects to start filing complete reports on January 10 (see Jan 10 Is Nortel's F-Day).

The estimated revenues for the third quarter are $2.27 billion, with gross margins of 37 percent, and an estimated loss per share of 6 cents. That's less than the $2.47 billion in revenues and EPS of 0 cents, or break-even, expected by analysts.

But the outlook is a bit brighter for the current three-month period. In the fourth quarter, Nortel expects revenues of between $2.8 billion and $2.9 billion. That's ahead of the $2.69 billion expected by analysts, who have been predicting a fourth-quarter EPS of 2 cents.

The tables below show Nortel's latest estimates, though the vendor stresses that these figures are still subject to change, even though the date for filing audited results with the Securities and Exchange Commission (SEC) is only a matter of weeks away.

Table 1: Current estimates for 2004's quarters
Q4 2004 estimates Q3 2004 Q2 2004 Q1 2004
Revenues $2.8-$2.9 billion $2.27 billion $2.59 billion $2.46 billion
EPS NA ($0.06) $0.00 $0.00
Gross margins NA 37% 41% 43%
Cash at period end NA $3.4 billion $3.7 billion $3.6 billion
Source: Nortel
EPS = earnings per share
Figures in brackets denote negative sums

Table 2: Current estimates for full years 2001-2004
2004 2003 2002 2001
Revenues $10.1-$10.2 billion $10.27 billion $10.83 billion $18.94 billion
EPS NA 12 cents ($0.83) ($8.06)
Cash at year end NA $4 billion $3.8 billion $3.5 billion
Source: Nortel
EPS = earnings per share
Figures in brackets denote negative sums

The news, released late Tuesday, took its toll on the company's share price today. It's currently down 12 cents, more than 3 percent, at $3.57, and has been as low as $3.41 in this morning's trading.

Analysts rushed out revised forecasts and research notes following Nortel's news. Pat Chiefalo at Merrill Lynch & Co. Inc. now expects 2004 and 2005 revenues to be $10.2 billion and $10.8 billion, respectively, from $10.3 billion and $10.9 billion. "We now have revenue declining 1 percent in 2004 and then growing 6 percent in 2005," notes Chiefalo.

The analyst has also reduced his 2005 EPS estimate to 15 cents from 19 cents and cut his gross margin forecast for next year from 43.4 percent to 42 percent. "We remain neutral on the stock," he says.

The team at UBS AG, meanwhile, is worried about Nortel's wireless business. The vendor had noted that half of the 6 cents per share loss in the third quarter was due to "investment costs associated with a wireless contract in India," referring to a recent contract award by Bharat Sanchar Nigam Ltd. (BSNL) (see BSNL Selects Nortel).

"We would observe that Nortel appears to have bid too aggressively to win that contract. Combined with the loss of the Cingular Wireless deal, these may be signs of management distraction while the restatement effort continues." (See Cingular Confirms 3G Trio.)

And wireless revenues are slipping. They fell to just more than $1 billion in the third quarter from $1.27 billion in the second quarter. "We observe that the company has missed out on key wireless contracts recently, a trend that cannot continue for a firm that counts wireless revenue as around 50 percent of its business," notes the UBS team.

And they reckon Nortel is chasing too many low-value deals. "Nortel’s recent success in winning low-priced contracts appears to be having a detrimental impact on the company’s margins. We would expect that Nortel might rethink its bids on these types of contracts in the future."

Indeed, Nortel's gross margin estimates have shown a steady decline during 2004, as seen in the table above. This, note the UBS analysts, means Nortel needs to achieve gross margins of 43.2 percent in the fourth quarter "if the company is to maintain its reiterated target of 40 percent to 44 percent," and the vendor hasn't achieved that margin level before this year.

UBS is maintaining its Neutral rating on Nortel's stock and a target price of $3.60.

— Ray Le Maistre, International News Editor, Light Reading

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