18 May 2009

NT: Financial Analysis through March 2009

Nortel Networks (OTC:NRTLQ), a Toronto-based supplier of telecom and other networking products and services with a long history of achievement, soared during the dot-com era, stumbled repeatedly in the years since, and succumbed to bankruptcy in January 2009.

The company is now subject to creditor protection proceedings.  In February, Nortel announced additional workforce reductions involving approximately 3000 positions.  There is speculation that the company will be carved up and sold in pieces.

Nortel shares were delisted from the New York Stock Exchange because of the bankruptcy.  Delisting was already likely because the price per share was persistently under $1.00.  (In late 2006, Nortel implemented a 1-for-10 reverse stock split in an ultimately unsuccessful attempt to boost the share price.)  The shares now trade for pocket change on the pink sheets.

Nortel lost $1.02 per share in the three months that ended 31 March 2009, according to this press release and this 10-Q report.  Nortel lost $0.28 per share in the first quarter of 2008.

We have watched Nortel deteriorate for the last nine years, and we couldn't resist another, very limited, look.  The difficult times revealed shortfalls in the company's internal financial controls, which resulted in numerous restatements and allegations of misdeeds over the years.  Restatements and massive charges bedeviled our attempts to interpret the company's condition throughout this period.  In retrospect, we were not up to the challenge.  However, we have since toughed up our gauge score calculations to penalize companies that show similarities to Nortel during its fall.

Nortel's financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) and are expressed in U.S. dollars.  Please note that the tabular 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.


Revenue in the recent quarter was 37 percent less than in the March 2008 period.  The 10-Q suggests that the economic conditions and the uncertainty caused by the bankruptcy filing affected sales. Revenues were lower in all regions.

The Cost of Goods Sold was 63.9 percent of Revenue in the quarter, which translates into a Gross Margin of 36.1 percent.  The Gross Margin was 41.6 percent in March 2008.  Nortel attributed the lower margin to many factors, including currency exchange rates, changes in the product mix, price erosion, and restructuring costs.

Research and Development (R&D) expenses were reduced almost 19 percent, but still represented about 20 percent of Revenue.  Nortel has fewer employees working on R&D, and the company has cancelled some R&D projects.  Abandoning the WiMAX business also resulted in less R&D spending.

Sales, General, and Administrative expenses were also reduced, but only by 11.6 percent.  The 10-Q mentions "headcount reductions" and limited marketing efforts.  Expenses associated with personnel cutbacks kept the cost reductions from being more substantial.

Other operating expenses, totaling $46 million, included charges for Amortization of intangible assets and Goodwill impairment, offset by Other operating income.

Operating Income, by our definition that excludes asset sale, fell to a $290 million loss.  Operating Income was gain of $16 million in the March 2008 quarter.

Non-operating items summed to a net expense of $184 million. This included reorganization expenses of $52 million.

Despite the loss, Nortel still had to make a $7 million provision for Income Taxes.  A  subtraction of $26 million for Minority Interests was also required.  The bottom line was Net Income of minus $507 million (-$1.02 per share).  In the year-earlier quarter, the loss was $138 million (-$0.28 per share).

Computing gauge scores would be a futile exercise because many of the required metrics are not applicable to Nortel in its current state.  Income, Cash Flow, Equity, and Invested Capital are all negative.  The common shares are close to worthless.  In the table below, we list values for metrics that might still be relevant.
March 2009
3 months prior12 months prior
Current Ratio1.9
105 days104 days109 days
Finished Goods/Inventory
Days of Sales Outstanding (DSO)78.3 days
83.0 days
76.4 days
Cash Conversion Cycle Time131 days
115 days
123 days
Revenue growth (trailing year)
Revenue/Assets 77.2%
Operating Expenses/Revenue 98.0%

Full disclosure: No position in Nortel at time of writing.

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