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AUGUST 20, 2004
By Olga Kharif and Steve Rosenbush Nortel Turns a Tiny Corner The Canadian telecom equipment maker has issued its first post-accounting-scandal financial update. So far, so good For almost any other company, it would have been a routine financial report. But for Nortel Networks (NT ), it was more like a coming-out party. Investors cheered on Aug. 19 as the scandal-scarred telecom equipment maker issued its first quarterly numbers since the beginning of the year (see BW Online, 8/18/04, "Nortel's Day of Reckoning"). And even though it cautioned that the data, for the first and second quarters, were "estimated, unaudited, preliminary," the beaten-down stock jumped 6.6%, to $3.84 a share. Wall Street was relieved that the Canadian telecom-equipment maker didn't blindside them with more bad news and seemed to agree that the worst of the accounting scandal was over. "A new day is dawning for Nortel, although not all the fog has lifted," Lehman Brothers analyst Steve Levy wrote in a report. Indeed, one portfolio manager says the results were "better than feared." Chief Executive Bill Owens said Nortel appeared to have broken even or earned 2 cents a share over the course of the last two quarters. He isn't sure because it's still in the process of restating its results going back to 2001. Nortel overstated profits for 2003, leading to higher bonuses for executives and many workers. As a result, it's under criminal investigation by the Royal Canadian Mounted Police and the U.S. attorneys office in Dallas, and it faces civil probes by the U.S. Securities & Exchange Commission and the Ontario Securities Commission. "CLOSER TO THE END." Owens also announced a several-step restructuring in the neighborhood of $400 million, including the dismissal of seven more executives. Nortel had previously showed former CEO Frank Dunn and other senior executives the door. And to contain costs, Owens says he'll cut staff by 3,500, bringing headcount to about 30,000. During its heyday, Nortel had 100,000 workers. Owens told BusinessWeek Online that the restructuring is far from over, as Nortel attempts to lower its costs to the levels of competitors. Perhaps most important of all, Nortel promised to release fully restated financial results back to 2001 in September. "We did get a sense that we're getting closer to the end of this story," says Duncan Stewart, partner at Tera Capital in Toronto, which hold Nortel shares. But while Nortel has turned a page, it has an encyclopedia's worth left to leaf through, and troubles could plague it for months. For starters, continued profitability isn't a given. In the first half of 2004, Nortel reaped a 2-cent earnings-per-share benefit from settling a contract, leaving operating earnings still a question mark. And while analysts polled by financial service Thomson Financial expect Nortel to earn 11 cents this year, they've reduced their EPS estimates by 34% in the past month alone. DOUBLY DIFFICULT. Nortel's future earnings could also fall victim to dozens of lawsuits sparked by the accounting problems. The suits could reduce earnings by as much as 22 cents a share, estimates Robert McWhirter, who manages $31 million for Selective Asset Management in Toronto, Canada. Nortel hasn't said yet whether it has made any provision for such a settlement. So, the lawsuits could potentially wipe out its 11 cents in earnings for 2004 -- and then some. If the SEC, or any other organization investigating Nortel, does find it guilty of wrongdoing, countering these lawsuits will be doubly difficult. "The right thing for us to do is to get on with our business," says Owens. "I feel confident that we're on the right path. And if the business is good, it'll be to no one's advantage to not allow this business to continue on a successful path." Still, Nortel's year-over-year performance will remain unclear until it restates its 2003 results. What's known today is that Nortel booked about $5.1 billion in sales in the first half of this year. Some analysts suspect that's down from last year. So Owens has good reason for his management-heavy layoffs. "MORE WITH LESS." Nortel's gross margin, now 43%, leave much to be desired as well. Rival Ericsson (ERICY ), which has gone through its own massive restructuring in the past several years, boasts a much better 47.8% gross margin. However, Nortel might find it difficult to prop up its margins because of increased price competition, particularly from Chinese manufacturers like Huawei. In wireless infrastructure, which contributes better than half of Nortel's sales, prices are falling by 20% a year, according to telecom consultancy Dell'Oro Group. And Nortel might have to cut them even deeper to prevent customers spooked by its accounting troubles from fleeing. It's not all grim news, though. Analysts report that Nortel hasn't lost market share in the past year in important growth areas such as wireless, where a recovery in the infrastructure market will also help Nortel. Worldwide spending in this segment in 2004 should rise 14%, to $33 billion, estimates Dell'Oro analyst Greg Collins. And Nortel plans to beef up its salesforce and add a chief marketing officer. "Nortel is doing more with less, not doing less with less," says Mark Bruneau, founder and chairman of telecom consultancy Adventis in Boston. "NEXT STEP." Chastened by the scandal, new management is taking the need for financial accountability to heart. It plans to provide incentives to managers to ensure accurate numbers. It also will install database software from Germany's SAP (SAP ) that will improve financial reporting. "This is an important next step in the return of Nortel," Owen said during the Aug. 19 conference call. Yes, Nortel's latest news is a sign of progress. But it will take years to get beyond this catastrophic episode.  Kharif is a reporter for BusinessWeek Online in Portland, Ore., and Rosenbush is a senior writer in New York
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