12 November 2007

NT: Financial Analysis through September 2007

We have analyzed Nortel Networks (NT) financial statements for the September 2007 quarter as filed with the SEC in a 10-Q. This post reports the results of our evaluation.

Nortel is the Canadian-based supplier of products and services to telecom carriers, other networking enterprises, and businesses. Nortel has defied the worst-case predictions and managed to stay in business and even independent, unlike fellow fallen telecom Lucent. Losses have been the norm at Nortel for most of this decade, resulting in an unfathomable accumulated earnings deficit of $35 billion (U.S.).

Tougher times also revealed shortfalls in the company's internal financial controls, resulting in numerous restatements, and allegations of fraud. The restatements complicate any financial analysis of Nortel.

When we analyzed Nortel after the June quarter, the Overall score was a still-disappointing 25 points. Of the four individual gauges that fed into this composite result, Cash Management was (surprisingly) the strongest at 14 points. Growth was weakest at 0 points.

Now, with the available data from the September 2007 quarter, our gauges display the following scores:
Before we examine the factors that affected each gauge, let's compare the Income Statements for the recent and year-earlier quarters. We didn't issue a forecast for the September quarter, so all figures below are actuals. Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.


September 2007
September 2006
Revenue (1)

Op expenses

CGS (1542)

R&D (416)

SG&A (613)

Other (2) (68)
Operating Income
66 34
Other income

Investments (3)

Asset sales

Interest, etc. (4)
56 (47)
Pretax income

77 (10)
Income tax

Net Income
27 (25)

Extraordinary items (5)

1. Total revenues includes products and services.
2. Amortization of intangible assets + Special charges.
3. Minority interests + Equity in net income of associated companies. Both figures are net of tax.
4. Other income - Interest expense
5. Shareholder litigation settlement expense.

Revenue was 7.6 percent less than in the year-earlier quarter. On a year-over-year basis, Revenue was down 0.5 percent. On a more positive note, Gross Margin increased as Cost of Goods Sold dropped from 61.6 to 57.0 percent of Revenue. Similarly, Research and Development (R&D) expense declined from 16.2 to 15.4 percent of Revenue. The cost control was less successful with Sales, General, and Administrative (SG&A) expenses, which increased from 20.0 to 22.7 percent of revenue.

The lower levels of CGS and R&D outweighed the higher SG&A and greater "special" charges, leading to a near doubling of Operating Income.

Net non-operating income was a substantial $55 million more in the Sept 2007 quarter than the Sept 2006 quarter. The income tax rate is hard to understand in both quarters: 65 percent in the recent quarter and incalculable (pre-tax income was negative) in the year-earlier quarter.

It has been unusual in recent years for Nortel to have a positive Net Income, but they managed to eke out earnings in the last quarter.

Cash Management. This gauge decreased from 14 points in June to 6 points now.

The following measures pushed the score up the most:
The following measures held the score down:
Growth. This gauge increased from 0 points in June to 2 points now.

The following measure was the one small positive contributor:
The following measures held the score down:
Profitability. This gauge decreased from 5 points in June to 4 points now.

The following measures pushed the score up the most:
The following measures held the score down:

Value. Nortel's stock price dropped over the course of the quarter from $24.05 to $16.98. Based on the latter price, the Value gauge increased from 5 points in June to 9 points.

The following measures pushed the score up the most:
The following measures held the score down:
The average P/E for the Communication Equipment industry is currently 26. The average Price/Revenue for the industry is currently 4.6.

Now at 26 out of 100 possible points, the best we can say about the Overall gauge score for Nortel is that has been worse. The positive Net Income in the last quarter could be viewed favorably, but the amount is insignificantly low and CFO remains negative. More than 6 years after the high-tech bubble burst, we don't yet see any firm signs that Nortel has turned the corner towards sustained profitability. Over the years, there have been a couple of encouraging moments. But, they proved evanescent. We need to see more.

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