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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


For more info on the state of industry financials, check out the coming Light Reading Live! event:

  • Light Reading's Telecom Investment Conference, in New York City, November 10.

  • No-tell 12/5/2012 | 1:24:13 AM
    re: Nortel: Material Margin Madness Dodo, re-read the passage carefully. What it says is that since September 30, 2003, the people on the list likely have had access to non-public material information. The fact that Pahapill and Kerr are on the list is no big news...they're the new top finance gurus at the company. Of course they have access to material information.
    dodo 12/5/2012 | 1:24:23 AM
    re: Nortel: Material Margin Madness Check the "who's who" list of those on the OSC's radar.
    reference schedule "A" from
    http://www.osc.gov.on.ca/Enfor...


    "Each of the Respondents is, or was, at some time since the end of the period covered by
    the last financial statements filed by NNC and NNL, namely September 30, 2003, a
    director, officer or insider of NNC or NNL and during that time had, or may have had,
    access to material information with respect to NNC and NNL that has not been generally
    disclosed."

    Bill Kerr and Pahapill are on the list!!!!!!!!
    inauniversefarfaraway 12/5/2012 | 1:24:24 AM
    re: Nortel: Material Margin Madness crm366x wrote:

    Finally, with regard to Ciena - I'm no analyst but there seems to be some risk- note that they are still loosing money but with a good cash position they havesome breathing room. Furthermore, without the need to implement massive jobcuts in a hurry, a whole bunch of techies got to work a few extra years. I know the market doesn't care but I, as an individual, think this is good.
    _____________________________________________

    This sounds like Ciena merely got itself a write-off. It's investment in VC capital shows up on the balance sheet as gain, and people get to work for a couple of years. Worst case it becomes a write-off.

    While it's better than being liquidated by the vc's, it still only postpones the inevitable.

    It's a wonderful world.

    Far'y
    No-tell 12/5/2012 | 1:24:26 AM
    re: Nortel: Material Margin Madness Three thoughts on Nortel and DSL...

    1. The way I understand it, Nortel's foray into the DSLAM market via the acquisition of Promatory Communications was the result of a "schism" in the Nortel access business. Some thought that DSLAM was a natural addition to the existing UE-9000 that could be added by Nortel; others thought Nortel needed a stand-alone DSLAM. I guess the stand-aloners won that battle.

    2. This acquisition occured in 2000 and was therefore approved by both John Roth and the board of directors. Why would Roth approve an access acquisition if part of his "strategy" was to get out of the access business? I don't know, but it may lead to good discussion.

    3. NT's acquisition of Promatory showed two big NT weaknesses. First, NT underestimated the power of being first to market...no matter how good Promatory was, Alcatel was just too strong already. Second, the Promatory DSLAM was an incredibly expensive product vs. Alcatel. They had (and still have) low-cost production outsourced to Asia...not so for Nortel and Promatory. No way NT could compete on price vs. Alcatel...which would've been about the only way to unseat them.
    dodo 12/5/2012 | 1:24:26 AM
    re: Nortel: Material Margin Madness "This was one of the first areas he withdrew from as he focused on optical and access was one of the first to be gutted when the bloodletting began in 2002"

    Rectification:

    As early as Spring of 2000, the dear EVP (or was he a President) of Access Networks going by the name: SS had already mentioned that he would get rid of Access.Promatory was acquired because Rob Pfeffer was still the CTO at that time, and the technology group from Access Networks who were lobbying him had his ear. Unfortunately there were some groups from the Switching div who thought that they knew access and data [putting a proprietary data port in lieu of a 10baseT on the 1Meg modem, who would have thought of that!] and who decided that everything could be done via the UE9000-DMS version (instead of the AccessNode) and Chandran with his ilk SS had the upper hand.

    Result: Rob retired in Autumn 2000 and the access BU got the axe during the first week of Jan 2001 and the access portfolio including the DSLAM was unloaded sometimes in summer 2001.

    Just have to see where Chandran is today and where SS is in the organization to realize the incompetence of the decision makers.

    crm366x 12/5/2012 | 1:24:26 AM
    re: Nortel: Material Margin Madness inauniversefarfaraway wrote

    Our positions are not that far apart. Is "crm366x" similar to a handle from your days at nt?....

    -------------------

    Yeah, I was having a bit of fun with my ID. CRM366X is similar to a real (and very old) BNR/NT mainframe computer userid, which may or may not have been mine. Maybe we know each other. :-)

    NT should have been able to make a nice business of DSL but never really got past the 1 Meg Modem. IMO, one reason for this is that Roth didn't believe in access. This was one of the first areas he withdrew from as he focused on optical and access was one of the first to be gutted when the bloodletting began in 2002. Optical was hot, growing rapidly and made the stock price rise quickly, which made a bunch of execs rich.

    Furthermore, I am convinced that the sales, marketing and PLM organizations had became so set in stone they could not comprehend anything that was not a DMS. Far easier to keep selling features on the installed base than to take the difficult and risky step of actually innovating in the access space. This drove the R&D community absolutely mad (at least at the lower levels) because it had been working on various forms of DSL since the early 80's. The need was obvious.

    Finally, with regard to Ciena - I'm no analyst but there seems to be some risk - note that hey are still loosing money but with a good cash position they have some breathing room. Furthermore, without the need to implement massive job cuts in a hurry, a whole bunch of techies got to work a few extra years. I know the market doesn't care but I, as an individual, think this is good.

    X
    Prizm 12/5/2012 | 1:24:27 AM
    re: Nortel: Material Margin Madness 'Our positions are not that far apart. Is "crm366x" similar to a handle from your days at nt?'

    I also noticed the familiar looking handle. The IT group at BNR/NT used to give out mainframe user ids that were the letters crm followed by a number. I never understood what their significance was. By the time I joined BNR (87) they were not issuing these odd handles anymore, but my first boss had one.
    inauniversefarfaraway 12/5/2012 | 1:24:29 AM
    re: Nortel: Material Margin Madness crm366x,

    Our positions are not that far apart. Is "crm366x" similar to a handle from your days at nt?

    Project resets are not endemic to Nortel, to be fair. This morning's Dilbert was spot on.

    Since many technologies were part of the roadmap at Nortel, it is curious that DSL never got as big as Optical or Wireless. It looked like Nortel was going to make major inroads with some dsl story, but things seemed to fall through. Probably management dropping the ball since they appeared to have momentum, but then lost it all when they surrendered the field to Alcatel. Why did Roth shy away from DSL, did he not nurture any projects related to DSL? Too bad the fellow isn't here to provide some insight.

    Wireless seemed to remain low-key, even when the trend was be flashy, as seemed to be the case in optical.

    From reports of the Chandran fiasco, as well as the wholesale hiring of warm bodies, combined with worthless acquisitions, luxurious renovations, and real-estate expansions, it seemed that money was going out the door like it was going out of style.
    It's a shame if none of the employees got more than a few great parties.

    The Roth "vision" was to grow Nortel into a $20B company. Regrettably, not only were those bubble dollars, but the approach seemed to be one tied with the classical model that headcount had to be "x" when revenues were "y". This is how Nortel had operated as a Bell subsidiary. Roth was still from the old guard, and didn't see the change in business dynamics. This would then lead him down the same road of creative fiscal reporting that carried through the Dunn years. All these companies actually thought that business had changed, that products didn't matter, and so forth. With everybody making a killing off stock appreciation, no-one was going to be a buzzkill.

    In regard to Ciena, your point of view comes in clearer now. Do you share analyst's view that the cash position is good, but that risk still exists given that there isn't necessarily a path to growth for it's acquisitions? There may have been hype, but SEC filings do not yet point to the expected bonanza in revenue growth. Where are the billions?

    Far'y
    crm366x 12/5/2012 | 1:24:30 AM
    re: Nortel: Material Margin Madness Inauniversefarfaraway,

    I don't think we're in disagreement. I have memories of BNR/NT that go very far back in time and I too have charted the decline in corporate culture and the increasing role of what I always called "politics" in the management structure. If you worked there, you will remember the constant project resets, the BS schedules that guaranteed failure, followed by the inevitable project cancellations. Never was so much effort by so many techies so totally wasted.

    NT/BNR was once a "great" company. It was once a great employer and once it had a very wide and deep product portfolio. It also once had a good earnings position, which funded a courageous and visionary R&D organisation. BNR was working on "data over voice" - the precursor to the various flavors of DSL --in the early 80's. BNR also worked on optical in the 80's, laying the groundwork and expertise base for NT's short-lived success during the optical bubble. There was even an entire issue of Telesis devoted to fibre optics - in 1981! Does anybody remember Chisholm talking openly about "intelligent subversion"? Would this type of talk even be understood by the shortsighted beancounters running the place today?

    Perhaps management became a victim of the DMS success and started believing it's own marketing BS. Maybe it got too big and political and complacent. Whatever the causes, I firmly believe that NT's corporate culture had lost the will to innovate by the late 1990's and as you said, it drove many talented folks away -- only to get trashed in startups - but that's yet another sad story. :-(

    I still think NT could have been turned around, had Roth & Dunn not gotten hold of the place. Those two jettisoned all sorts of profitable (but boring) lines of business, alienated employees and customers, hitched the NT wagon firmly to the optical bubble and proceeded to ride it straight into the ground. This, I suppose, was the "right angle turn". Maybe another Jean Monty would have been wiser -- I'm sure he would have.

    I mentioned Ciena, not as any kind of corporate model, but as an example of a company who, either by good fortune or good planning, exited the bubble with a decent cash position. Had NT possessed this sort of cushion it would not have needed to so completely gut itself to break even. There may even have been money, if wisely used, to lay the foundation for the next generation of products. Unfortunately, I don't think that foundation exists today.

    X
    inauniversefarfaraway 12/5/2012 | 1:24:32 AM
    re: Nortel: Material Margin Madness networkbuff,

    Thank you for providing your insights into some of the insiders. What's even crazier is that the network also includes a lot of bodies from the venture capital community, government, and much more.

    Another euphemism for not being part of the gang is sometimes called being "out of the loop".

    What can be a touch more twisted is that shareholders, management, and employees all use one another. The poor saps who actually focus on the product are the casualties because they are trading reward for achievement. They are easy to motivate, you simply threaten their ability to achieve by throwing incompetent staff at them, or delay their deliverables, or reduce their budgets, or increase their workloads. Coercion is so easy for these people, and it reduces expenses because the consequences are such that you can not only reap by brow beating them, but after they fail, you penalize them by reducing, or withholding their bonuses. Hahaha!

    Achievement from any particular individual is finite, but reward from the fountain of executive priviledge is boundless and requires only loyalty, something people have an endless supply of since it requires very little effort. Optimizing for least effort dictates that loyalty is the most successful road. Since the leaders decide where the dollars are going, who do you think gets paid last?

    It really is up to government (as in: We the people) to ensure that balance exists. When U.S. regulators have to intervene in the case of Nortel, that just tells you how far the rot goes.

    You really have to wonder what kind of old boys club exists in Canada, especially when the Ontario SEC publicly declares that it is thinking about imposing a blackout on insider transactions, but it's wondering about the timing, maybe in a couple of weeks they say.

    Anything other than immediately when making such a public statement is just plain wrong. Perhaps the U.S. should also investigate the Ontario Securities Commision for insider warning. Old boys must have called all their chips, long before the blackout took effect. Did you notice that nobody got busted in Canada?

    The real losers are the types that adhere and support such widespread corruption, since they inevitably defeat themselves. They wind up crushing the producers of the very goods that keep them fed. They perpetuate their mediocrity, and try to pass it off as success. They feed off the achievements of others, and accept the loss of others as their gain.

    "We the people" also lose. Look at outsourcing, it is the case made for executive power. In a lot of these companies, the quality of the staff went from strict requirement of engineering degrees, to underqualified foreign workers, to outsourcing the work completely. Soon, monkeys will be trained to do the job. Is it a surprise that companies like Intel are increasingly focusing on quality given a string of product failures? You get what you pay for.

    Government and engineering associations are mute because unlike civil engineering mistakes, nobody dies. This has caused the slide in staff qualification, outsourcing, and overall reduction in product quality

    Far'y
    eieio 12/5/2012 | 1:24:37 AM
    re: Nortel: Material Margin Madness <snip>
    squander the wealth of the shareholders.

    ++++++++++++++++++++++++++++++++++++++++

    Go ahead ... divest off of yours.</snip>
    networkbuff 12/5/2012 | 1:24:39 AM
    re: Nortel: Material Margin Madness inauniversefarfaraway,

    Well said! From what I have heard from insiders, this is a pretty accurate summarization. Similar to any large governmental organization, loyalty is key at Nortel, not results! Results are only a nice-to-have side effect. If you dare so much as question any decisions made by the "loyalists", you are branded as not being a team member. If one stays at the company 10, 15 or 20 years, one is considered very valuable, just because he/she knows a lot of what goes on in the company. Some of the decision makers are clueless about where the market is going. Some are very aware that they are worth jackshit outside, so they hang on to their empires at all costs, jeopardizing results and success. While this may be true at any century-old company, NT management seems to have perfected this. It is sad to see that the misguided, selfish and clueless management/decision-makers ruin the lives of so many employees and squander the wealth of the shareholders.
    inauniversefarfaraway 12/5/2012 | 1:24:40 AM
    re: Nortel: Material Margin Madness crm366x,

    It seems that Nortel is reaping what it has sown for quite some time. Like many of it's peer telecom manufacturers born of state-sponsored Bells, they have a common denominator: they reward bad behavior. Idiots were invariably promoted, because the logic went, some use had to be found for them while the productive people were left to the barrens of technical ladders. Promoted "out of the way" it might have been called. The result of this perversion is that the worst possible elements decide on the direction of the company. These companies make decisions based on loyalties, rather than technology, or hard work, or results. When clueless people decide priorities, team makeup, how people work, interact, and how credit and rewards are distributed, what other result can there be but what we are seeing unfold today? The lack of ethics in the board room, the lack of talent in the ranks, the crappy second-best products that are manifestations of a weak foundation.

    Same goes with startups. The "first wave" of startup companies were founded by hard working folks that couldn't survive in the barrens of telecom where achievement didn't count. Once these innovations hit, a mass exodus from telecom hapenned, encouraged by the flow of VC money. The major issue is that the corruption of the telecom sector poured into technology startups. VC's thought that 20/30/40 years in telecom was the greatest thing. Check out these companies and what became of them. The result has been hobbled companies barely able to get a product out the door. Many served the purpose of the old boy's club by making big money for the club, either by way of fat paychecks, or bloated acquisitions. How is this possible when all these incredible management teams came so highly recommended? This is the big news: they were all part of that club from companies that were all good friends, and were promoted from the ranks of people that weren't able to tie their shoe laces.

    Regarding Ciena, they espouse the almighty dollar. They too seem to be willing to rid themselves of talent as quickly as possible once a product has been "monetized". It must be a great place to manage from.

    Insofar as the parking lot you allude to, isn't that crown land ceded to the current tenants for free? Maybe it's next occupant will have a spinal cord.

    Great company? From what has been presented on this board and in the press, it may be suffering from corruption, incompetence, and possibly engaged in genocidal and/or desciminatory behavior. Is it any wonder it may disappear from the face of the earth?

    There is more to making a real company than having good products, money in the bank, and all the tangibles that are so easy to account for. Forgotten is the reality that companies are the instruments of society, not the other way around. Maybe this is what ails this company...

    far'y
    dodo 12/5/2012 | 1:24:43 AM
    re: Nortel: Material Margin Madness "At that time, Nortel is expected to outline plans to reduce costs, which could include job cuts and other restructuring. A number of scenarios have been outlined, such as combining optical gear with another division.

    Mr. Papageorgiou said he would not be surprised to see Nortel close its Brampton, Ont., headquarters and move its executive and financial employees to Ottawa, home to its core research and development"

    http://www.theglobeandmail.com...
    Yabba 12/5/2012 | 1:24:51 AM
    re: Nortel: Material Margin Madness Author: No-tell Number:
    1. Reduce the number of products/product lines by either shutting them down or selling them off. This would be interesting: compare the NT product catalog today vs. the product catalog from 4 years ago.

    >> They have been trying to kill off the DMS-10 for a number of years. The problem is that there are so many of them installed, and they work so well, the customers love them. NT almost drove away this very loyal customer base by eliminating the sales staff and going to an 800 number. While the glory days of new CO sales are over, there is still substantial revenue available from the ILEC base.
    crm366x 12/5/2012 | 1:24:53 AM
    re: Nortel: Material Margin Madness Quote:
    ...John Roth was right about finding new market and platforms in the 90's. He just shifted the company too fast without isolating the new guard from the old guard....
    ---------------------------------------

    I refuse to give Roth credit for anything. While, indeed in the late 90's he did recognise that telecom was changing, his response was the infamous "Right Angle Turn" by which he completely hollowed out the company to focus on just one market - optical. I am convinced that if the bubble had run a few more months he would have gotten around to trashing wireless -- one of the few bright spots in NT's present product portfolio. Furthermore, unlike Ciena (just as an example), Roth managed to exit the bubble without cash in the bank. Almost as a footnote, I'm told NT's last profitable year was 1998 (someone please correct me if I'm wrong). How on earth did Roth and Dunn manage to loose money during the height of the bubble? And then they made Dunn CEO after they bought Roth out? (As reported in SVN, Roth got a year-long leave of absence with pay when he left and furthermore, he was given a very significant raise just a few weeks prior to his leaving).

    I'm very sorry to say this, but I don't see an upside for this once-great company. No cash in the bank, no DMS cash cow to support ongoing R&D, massive talent loss, the increasing commoditization of the industry and increasing competition from offshore and lower cost suppliers. NT is simply too weak to execute a turnaround in today's market - and the mismanagement of the Dunn/Roth twosome contributed mightily to this weakness.

    It may not be much longer before someone else owns the parking lot at Carling/Moodie -- and that will be the very sad end of an era.

    X
    goundan 12/5/2012 | 1:24:58 AM
    re: Nortel: Material Margin Madness Nortel bid and won the recent $1B BSNL GSM bid in India for $75/sub for the whole kit and kaboodle from BTS to MSC to towers and diesel generators to billing systems to services. Nortel's AP business at this rate will be enough to flush their margins down the toilet in no time even after the proposed cost cuts.
    whyiswhy 12/5/2012 | 1:25:01 AM
    re: Nortel: Material Margin Madness Same old business strategy:

    How do we make money?

    Sales!

    How do we make sales?

    Cut the price!

    Price is less than cost?

    Increase sales!
    __________________________

    Look, the problem is many companies have a workable razor blade strategy: like Cisco.

    I am afraid NT does not.

    They keep killing themselves with the old "never breaks" core hardware quality paradigm.

    MSO's are used to repairing and repairing, because they design for CHEAP. That means only the minimum redundancy (if any), and the cheapest crap components on the cheapest boards in the cheapest racks they can find.

    Selling core-quality hardware in that market is a lose-your-shirt proposition.

    Better to sell the CHEAPEST piece of crap that works to the minimum specs, then make your money on replacing blades in the long run. As the blades age and burnout or just become obsolete, increase the price.

    -Why
    goli95 12/5/2012 | 1:25:02 AM
    re: Nortel: Material Margin Madness I am not surprised; the only way Nortel has been able to compete lately is by giving products away. Look at how they have competed against Nokia in Cingular. In order to win a VOD project in a major MSO, they dropped their price from $7.5M to less than $2.3M.

    So, this news doesn't surprise me.

    No-tell 12/5/2012 | 1:25:04 AM
    re: Nortel: Material Margin Madness Warning: following my advice will be neither quick nor easy, but it will result in lower costs.

    1. Reduce the number of products/product lines by either shutting them down or selling them off. This would be interesting: compare the NT product catalog today vs. the product catalog from 4 years ago. While there are new products, how many of the older products are gone? Few, I believe. Fact is that there is a certain fixed cost level needed to support any product line, regardless of product volume. So cut costs by cutting product lines. Yes, it's messy and there are obligations that will remain for a while, but it's a long-term fix. (Note that if anyone is going to be interested in acquiring a business from Nortel, that business will have to be marginally profitable or at least have a viable, believable path to profitability. No one wants to buy money-losing businesses; those businesses must be shut down.)

    2. Same goes for geographic scope. There's no virtue in being a global company, but there may be virtue in being a selectively global company. Sales in some areas surely don't justify the required administrative and legal costs of maintaining offices/employees/operations in those areas. Close them down and save the overhead.

    Bottom line: focus on where business has the greatest potential, both geographically and product-wise.
    dljvjbsl 12/5/2012 | 1:25:05 AM
    re: Nortel: Material Margin Madness From the article:

    Nortel said it is taking steps "to put into place an improved cost structure to optimize our financial performance."


    No prizes for guessing what this means - fewer cars in the parking lot at Carling and Moodie
    the_lord 12/5/2012 | 1:25:05 AM
    re: Nortel: Material Margin Madness The first few rounds of layoffs may improve the stock price because it appears that management will start to shed unprofitable businesses.

    However, this has been the same story for the last 4 years. Bob Palmer, the DEC CEO in the 90's, kept asking himself when it was going to end with DEC. Well, it ended when they got bought by Compaq.

    Owens is right about a new cost structure must be put into place. The current cost structure was based off an extremely successful hardware platform. This hardware platform not only produced sales when a switch was sold; however, it increased sales in software, services, and consulting.

    The DMS is gone.... Now, a new business strategy must be adopted. Or, a new company must be created. John Roth was right about finding new market and platforms in the 90's. He just shifted the company too fast without isolating the new guard from the old guard.




    Stevery 12/5/2012 | 1:25:05 AM
    re: Nortel: Material Margin Madness
    From the story, cost cutting often means layoffs.

    But don't layoffs usually mean a rise in stock price?
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