Nortel Reports 1Q08

TORONTO -- Nortel(1) Networks Corporation (Toronto:NT.TO - News)(NYSE:NT - News) announced its results for first quarter 2008, which demonstrated continued progress against the Company's turnaround strategy. Strong operational progress in margins combined with steady revenue growth kept Nortel on track to meet full year goals. Results were prepared in accordance with United States generally accepted accounting principles (GAAP) in U.S. dollars.

"Nortel had a strong first quarter, driven by the completion of a contract in our LG-Nortel joint venture and continued improvements in gross and operating margins. Nortel's operating margin, a critical measure of our plan's traction, expanded for the seventh consecutive quarter year over year, recording a 512 bps improvement to 4.7 percent," said Mike Zafirovski, Nortel president and chief executive officer. "We expect to achieve our full year guidance and we continue to make solid progress against the strategy to turn around the company. Our relentless focus on execution and our determination to deliver value to customers is strengthening the foundation upon which to build our performance over the balance of 2008 and beyond."

2008 Financial Highlights

Business Highlights

Revenue

Revenue was $2.76 billion for the first quarter of 2008 compared to $2.48 billion for the first quarter of 2007 and $3.20 billion for the fourth quarter of 2007. In the first quarter of 2008, revenue increased by 11 percent compared with the year ago quarter and decreased by 14 percent compared to the fourth quarter of 2007. The first quarter of 2008 included the release of deferred revenue associated with the completion of a large contract in the LG-Nortel joint venture.

Carrier Networks (CN) revenue in the first quarter of 2008 was $1,218 million, an increase of 21 percent compared with the year ago quarter and a decrease of 10 percent sequentially. Compared to the year ago quarter, CN revenue benefited from the LG-Nortel joint venture contract completion, partially offset by a slight decline in CDMA and lower legacy switching sales.

Enterprise Solutions (ES) revenue in the first quarter of 2008 was $641 million, an increase of 7 percent compared with the year ago quarter and a decrease of 16 percent sequentially. Compared to the year ago quarter, ES revenues were positively impacted by higher voice and applications revenues, primarily from customer migration to unified communications, partially offset by a decline in the data networking business primarily from lower sales in the North American and EMEA regions and significant contract completions in the first quarter of 2007, not repeated to the same extent in the first quarter of 2008.

Global Services (GS) revenue in the first quarter of 2008 was $516 million, an increase of 15 percent compared with the year ago quarter and a decrease of 15 percent sequentially. The first quarter showed strong growth in network implementation services and managed services, partially offset by a decline in network support services. Compared to the year ago quarter, GS revenue benefited from the LG-Nortel joint venture contract completion and other growth in implementation services primarily in the Asia region.

Metro Ethernet Networks (MEN) revenue in the first quarter of 2008 was $327 million, a decrease of 12 percent compared with the year ago quarter and a decrease of 24 percent sequentially. The year over year decrease in revenue was primarily due to decreases in optical and data revenue resulting from the completion of large contracts in the first quarter of 2007 not repeated to the same extent in the first quarter of 2008.

Deferred Revenue

Deferred revenue balances decreased by $266 million during the first quarter of 2008 compared to an increase of $32 million in the first quarter of 2007.

Gross margin

Gross margin was 41.6 percent of revenue in the first quarter of 2008. This compared to gross margin of 40.4 percent for the first quarter of 2007 and 43.7 percent for the fourth quarter of 2007. Compared to the first quarter of 2007, gross margins benefited primarily from productivity improvements partially offset by unfavourable product mix and lower margin deferred revenue releases.

Operating Expenses

Operating expenses were $1,017 million in the first quarter of 2008. This compares to operating expenses of $1,013 million for the first quarter of 2007 and $1,153 million for the fourth quarter of 2007.

Selling, general and administrative (SG&A) expenses were $597 million in the first quarter of 2008, compared to $604 million for the first quarter of 2007, and $678 million for the fourth quarter of 2007. Compared to the first quarter of 2007, SG&A was favourably impacted primarily by savings from previously announced restructuring programs, partially offset by investments in sales and marketing and negative foreign exchange impacts.

Research and development (R&D) expenses were $420 million in the first quarter of 2008, compared to $409 million for the first quarter of 2007 and $475 million for the fourth quarter of 2007. Compared to the first quarter of 2007, R&D was favourably impacted primarily by savings from previously announced restructuring programs, partially offset by negative foreign exchange impacts and investments in new technologies.

Operating Margin

Operating margin was 4.7 percent in the first quarter of 2008, compared to (0.4) percent for the first quarter of 2007 and 7.6 percent for the fourth quarter of 2007. The first quarter of 2008 operating margin increased by 512 basis points compared to the year ago quarter, marking the seventh consecutive quarter of year over year improvement. The improvement was driven by higher gross margin and lower operating expense to revenue.

Other

Special charges in the first quarter of 2008 of $88 million related to costs associated with previously announced restructuring plans.

Other income (expense) - net was $37 million of income for the first quarter of 2008, compared to income of $66 million in the first quarter of 2007 and income of $93 million in the fourth quarter of 2007. Other income included interest and dividend income of $38 million, a foreign exchange loss of $19 million and a $16 million gain on an interest rate swap.

Minority interest was an expense of $78 million in the first quarter of 2008, compared to an expense of $22 million for the first quarter of 2007 and an expense of $39 million for the fourth quarter of 2007. Minority interest expense included an expense of $11 million related to the ongoing payment of preferred shares dividends, but was primarily driven by the profitability of the LG-Nortel joint venture.

Interest expense was $80 million in the first quarter of 2008, compared to $96 million for the first quarter of 2007 and $80 million for the fourth quarter of 2007.

Income tax expense was $36 million in the first quarter of 2008, compared to an expense of $13 million for the first quarter of 2007 and an expense of $1,040 million for the fourth quarter of 2007 which included an increase to the valuation allowance against the deferred tax asset of $1,043 million.

Earnings

The Company reported a net loss in the first quarter of 2008 of $138 million, or $0.28 per common share on a basic and diluted basis, compared to net loss of $103 million, or $0.23 per common share on a basic and diluted basis, in the first quarter of 2007 and net loss of $844 million, or $1.70 per common share on a diluted basis, in the fourth quarter of 2007.

The net loss in the first quarter of 2008 of $138 million included special charges of $88 million for restructurings, a loss of $19 million due to changes in foreign exchange rates, a charge of $12 million related to a patent lawsuit settlement and a gain of $16 million primarily from mark-to-market gains on interest rate swaps. The net loss in the first quarter of 2007 of $103 million included a shareholder litigation gain of $54 million reflecting a mark-to-market adjustment of the share portion of the class action settlement and special charges of $80 million for restructuring. The net loss in the fourth quarter of 2007 of $844 million included a reduction of the deferred tax asset of $1,043 million, special charges of $38 million for restructurings, a gain of $23 million on the sale of assets, a gain of $40 million due to favourable effects of changes in foreign exchange rates and a gain due to a market value adjustment of $15 million on an interest rate swap.

Cash balance at the end of the first quarter of 2008 was $3.22 billion, down from $3.53 billion at the end of the fourth quarter of 2007. The decrease in cash was primarily driven by a cash outflow from operating activities of $260 million, cash used in investing activities of $44 million and cash used in financing activities of $14 million. The cash outflow from operating activities of $260 million included a net loss of $138 million and outflows of $264 million primarily related to the payment of 2007 bonuses and fourth quarter sales compensation, $121 million related to pension funding, $51 million cash payments related to our previously announced restructuring plans, partially offset by net cash inflows of $99 million of working capital and non-cash additions including $82 million of amortization and depreciation and $78 million of minority interest primarily related to profitability of the LG-Nortel joint venture.

Outlook(a)

Nortel reiterates its financial outlook for the full year 2008, and continues to expect:

(a) The Company's financial outlook contains forward-looking information and as such, is based on certain assumptions, and is subject to important risk factors and uncertainties (which are summarized in italics at the end of this press release) that could cause actual results or events to differ materially from this outlook.

Nortel Networks Ltd.