More from Smith Barney:
OPINION
Today's Status Update From Nortel Was Slightly More Positive Than Expected
Supporting Our Recent Upgrade And Our Buy Recommendation On The Shares
Today's status update from Nortel included estimated limited preliminary
financials for 1Q04 and 2Q04 and a set of new strategic initiatives designed to
reset the business model, including a 10% workforce reduction. The company
also reaffirmed that it expects to publish full prior period financial
restatements and the audited 1H04 results by the end of September, indicating
to us that the overhang on the shares from the accounting issues is likely soon
to be fully cleared. We upgraded Nortel shares to 1S (Buy) a couple of weeks
ago in anticipation of today's update and today's information was inline to
slightly better than our expectations. With the restructurings and business
streamlining announced, we are meaningfully raising our forward estimates and
reiterating our Buy rating on the shares.
1H04 Revenues And Cash Slightly Better Than Expected, Margins And Earnings
Inline With Our Expectations. Unaudited revenues for 1Q04 and 2Q04 were $2.5
billion and $2.6 billion versus our estimates of $2.4 billion and $2.5 billion.
We are encouraged by the solid revenue performance during the restatement
process, which indicates that Nortel's customer relationships and competitive
position remain strong. Gross margins for 1H04 were 43%, which is exactly
where we expected gross margins to come in. 1H04 operating expenses were also
inline with our forecast at about $2.1 billion. Nortel indicated that EPS for
1H04 were between $0.00 and $0.02 including a two-cent benefit from a customer
contract settlement. We had modeled slightly negative but more or less
breakeven EPS. Nortel's end of 2Q cash balance of $3.7 billion is about $100
million higher than we had estimated. We believe Nortel finished 2Q at an
approximate breakeven net cash position.
In 1H04 Wireless Revenues Appear To Have Been Stronger Than Expected And A
Greater Portion In The Mix Of Overall Sales. Nortel indicated that Wireless
revenues made up 51% of its first half sales against our expectation for
Wireless to be 44% of revenues. As a result, all three other segments came in
below our revenues contribution estimates. Enterprise was about 21.5% of 1H
sales versus our estimate of 25%. Wireline was about 17.5% against our
estimate of 20% and Optical made up 10% of sales, just short of our 11%
estimate. Management spoke optimistically about the continuing opportunities
in 3G UMTS wireless, especially in emerging markets such as China and India.
However, Nortel is seeing some pricing pressures in Wireless and this is one
factor behind the under-45% gross margins. In the Wireline segment, Nortel
noted it is seeing good traction in VoIP softswitching, but noted that revenues
have been lumpy quarter-to-quarter due to the nature of large scale carrier
rollouts of new technology.
Management Spent Most Of The Call Today Talking About Strategy And Business
Realignment To Capitalize On The Current Market Opportunity. Nortel unveiled a
number of initiatives today with the aim of growing market share, leveraging
core strengths, and improving margin performance. These steps include:
* A targeted headcount reduction of about 3,500 employees. With the 2,500
employees being transferred to Flextronics (FLEX--$11.20 rated 1H by
David Pescherine) and the 3,500 heads announced today, Nortel's employee
level will drop from about 36,000 to 30,000. The reduction should be
substantially completed by the end of the year. Nortel estimates one-
time restructuring costs of $300-$400 million and annualized cost
savings of $450-$500 million. Management indicated that U.S. employees
in the Wireline division will bear the brunt of the cutbacks. Wireless
and emerging market employees are likely to be untouched by the layoff.
* Realignment of the current business segment structure. Wireline,
Wireless and Optical will be combined into one Carrier Networks division
and Enterprise will remain its own division. Pascal Debon, the former
President of Wireless Networks will become President of Carrier
Networks.
* Increased emphasis on the Enterprise and Government markets and
Professional Services opportunities.
* The establishment on corporate-level Chief Marketing and Chief Strategy
Officer positions. Dion Joannou, who was previously President of
Central and Latin America, will assume the CSO role. Nortel is
searching for a CMO.
* Brian McFadden, currently President of Optical Networks, will become CTO
effective October 1. Greg Mumford, who is currently CTO, will retire
effective October 1.
* Seven additional finance employees were terminated for cause, including
four that had previously been placed on leave. In April, Nortel had
also terminated its previous CEO, CFO, and Controller for cause.
* Nortel will demand repayment from these ten individuals for 2003 bonus
repayments made based on incorrect financial reporting profits. Nortel
is also contemplating other actions against these individuals.
Raising Forward Earnings Estimates -- Reiterate Buy Rating. Based on today's
call we are making significant changes to our forward estimates, especially for
the out years. Our 2004 estimates remain basically unchanged with revenues
remaining at $10.4 billion, gross margins remaining at 43%, operating margins
still at 2%, and EPS remaining at $0.03.
Our 2005 numbers change as follows:
* Revenues remain at $11 billion. Gross margins remain at 44%.
* Operating margins goes to 7.8% from 4.2%.
* EPS goes to $0.14 from $0.07.
Our 2006 numbers change as follows:
* Revenues remain at $12 billion. Gross margins remain at 45%.
* Operating margins goes to 9.7% from 6.4%.
* EPS goes to $0.17 from $0.12. |
