Nortel Reports results For The Fourth Quarter And Full Year 2006
TORONTO - Nortel Networks** Corporation’s [NYSE/TSX: NT] continued focus on growth initiatives and organizational simplification delivered measurable operational and financial progress as the Company announced results for the fourth quarter and audited results for the year 2006. These results were prepared in accordance with United States generally accepted accounting principles in U.S. dollars.
“A relentless focus on execution in 2006 delivered solid progress on our Business Transformation plan and laid the foundations upon which Nortel will build its future. I am particularly pleased with the progress made in the fourth quarter as we grew revenues by 10 percent, grew our backlog, and improved operating margin and operating cash flow performance. In fact, the fourth quarter operating margin, was the highest in eight quarters and the operating cash flow performance for 2006 was the best since 1998,” said Mike Zafirovski, Nortel president and CEO. “We are 100% focused on the future and are taking the necessary steps to reduce costs, grow revenues faster than the market in key next-generation solutions and position the Company for profitable growth. There is a significant amount of work left to be done, but today Nortel is stronger than it has been in years.”
Fourth Quarter 2006 Results
Revenues for the fourth quarter of 2006 were $3.32 billion. Nortel achieved year over year revenue increases of 10 percent in the quarter and 14 percent sequentially as it continued to drive its core strategy and expand its business through growth in our strategic priority areas of the Transformed Enterprise, Next Generation Mobility and Convergence, and Services and Solutions.
Net loss in the fourth quarter of 2006 was $80 million, or $0.19 per common share on a diluted basis, included a gain of $164 million on the sale of assets, a shareholder litigation expense of $234 million reflecting a mark-to-market adjustment of the share portion of the global class action settlement and special charges of $29 million for restructuring. The net loss in the fourth quarter of 2005 was $2,286 million, which included a litigation expense of $2,474 million, a tax benefit of $134 million and special charges of $24 million. The net loss in the third quarter of 2006 was $63 million, which included a benefit of approximately $43 million related to the announced changes to the North American employee benefit plans, a gain of $15 million on the sale of assets, a shareholder litigation expense of $38 million and special charges of $22 million.
The fourth quarter of 2006 operating margin was impacted by two items, higher accruals for commissions and incentive plans, largely offset by increased profitability of our LG-Nortel joint venture resulting from the recognition of previously deferred revenue. Although we expect improved annual performance from the LG-Nortel joint venture in 2007, the strong performance in the fourth quarter of 2006 is not expected to be repeated to the same extent in quarters throughout 2007.
Deferred revenues decreased sequentially by $152 million from third quarter 2006 and by $187 million since the beginning of 2006. Order input for the quarter was $3.43 billion, up from $3.38 billion in the fourth quarter of 2005 and up from the $2.33 billion in the third quarter of 2006.
Mobility and Converged Core Networks (MCCN) revenues in the fourth quarter of 2006 were $1,672 million, a decrease of 5 percent compared with the year-ago quarter and an increase of 10 percent sequentially. In the fourth quarter, the strong pace of CDMA growth was offset by declines in the GSM business, primarily due to a contract in Asia not repeated in 2006 and a decrease in North American GSM revenues.
Recent MCCN highlights include:
Signed a $2 billion wireless equipment and services deal with Verizon Wireless;
Completed sale of certain assets and liabilities related to UMTS access business to Alcatel-Lucent;
Introduced mobile WiMAX portfolio to position Nortel for leadership in the emerging 4G market; signed WiMAX contract with Chunghwa Telecom in Taiwan; and conducted trials with Golden Telecom in Russia and with Toshiba Corporation for the Japanese Government.
Enterprise Solutions (ES) revenues in the fourth quarter of 2006 were $806 million, an increase of 61 percent compared with the year-ago quarter and an increase of 39 percent sequentially. The year over year strong growth was driven by the LG-Nortel joint venture (33 points) and robust growth in voice, data and applications revenues (28 points). We believe that we gained market share for the second consecutive quarter.
Recent ES highlights include:
-Signed a three-year partnership agreement with BT to drive the uptake of VoIP, multimedia, instant messaging and mobile communications by UK enterprises of all sizes;
-The Innovative Communications Alliance (ICA) formed by Nortel and Microsoft unveiled a roadmap for future development, signed agreements with dozens of customers, and has developed a pipeline of hundreds of prospects who want to realize the benefits of unified communications;
-Contracts signed with the New York Times and the Montreal Canadiens hockey team;
-Several new wins in the hospitality sector, including the Louisiana Superdome, Kernzer International Limited and the Intercontinental Jeddah Hotel in Saudi Arabia;
-A string of new municipal-wireless customer wins, including Carlsbad, New Mexico; Occoquan Wireless in Occoquan, Virginia; and Ronco Communications in Niagara County, New York;
-Momentum in the Middle East, with contracts from the American University in Cairo and the Dubai Silicon Oasis, the region’s innovations hub for high-tech industries;
-Strategic additions to the enterprise portfolio, including two data products targeted specifically at the small and medium business market, and enhancements to the municipal wireless and contact center portfolios.
Metro Ethernet Networks (MEN) revenues in the fourth quarter of 2006 were $473 million, an increase of 18 percent compared with the year-ago quarter and an increase of 9 percent sequentially. A strong performance in the optical networking business was partially offset by declines in the data networking and security space.
Recent MEN highlights include:
-MEN began 2007 with a groundbreaking win with BT, positioning Nortel as an important vendor for that company’s 21st Century project and validating our Provider Backbone Transport (PBT) technology;
-Signed contract with MTC, a leading mobile operator in the Middle East and Africa, to deliver high-speed mobile services such as mobile video, multimedia messaging and web browsing in Kuwait;
-Win with Iraq Telecommunications & Post Corporation, Iraq’s sole fixed-line operator, to build a nationwide optical backbone;
-Other contracts around the globe included Ntl Telewest, the UK’s largest cable operator; the Chinese Academy of Sciences; Joint University Computer Center in Hong Kong; and Easynet Belgium.
Global Services (GS) revenues in the fourth quarter of 2006 were $313 million, an increase of 2 percent compared with the year-ago quarter with growth across all service groups and a decrease of 5 percent sequentially.
Recent GS highlights include:
-Signed a three-year contract extension with Eastman Kodak Company for management of Kodak’s U.S. voice network;
-Opened a new customer network management center in New Delhi, India, to deliver services & solutions to enterprises, service providers and cable operators worldwide;
-Introduced a new network managed service - the industry’s first real-time, end-to-end support for IP telephony voice quality - to help enterprises speed their transition to VoIP;
-Enhanced an already broad channel partner Assurance Services portfolio for Europe, Middle East and Africa with the addition of a program for small and medium business.
Gross margin was 40 percent of revenue in the fourth quarter of 2006, reflecting a strong contribution from the LG-Nortel joint venture and CDMA solutions. This compares to gross margin of 39 percent for the fourth quarter of 2005 and 38 percent for the third quarter of 2006. Compared to the fourth quarter of 2005, there were significant improvements in MCCN gross margins due to the negative impact of certain contracts in the fourth quarter of 2005 not repeated in the fourth quarter of 2006, partially offset by a significant decline in MEN margins due to product mix and lower margins in ES and GS.
Selling, general and administrative (SG&A)
SG&A expenses were $694 million in the fourth quarter of 2006, compared to $683 million for the fourth quarter of 2005, and $585 million for the third quarter of 2006. Compared to the fourth quarter of 2005, SG&A was impacted by the consolidation of the LG-Nortel joint venture, higher accruals for commission and bonus payments, and higher costs related to our business transformation initiatives, partially offset by lower restatement related and employee benefit plan costs.
Research and development (R&D)
R&D expenses were $488 million in the fourth quarter of 2006, compared to $457 million for the fourth quarter of 2005 and $474 million for the third quarter of 2006. Compared to the fourth quarter of 2005, R&D was impacted by increased investment in targeted product areas, higher accruals for bonus payments and the impact of the consolidation of the LG-Nortel joint venture, partially offset by lower employee benefit plan costs.
Special charges in the fourth quarter of 2006 of $29 million included $13 million related to our prior restructuring plans and $17 million for the restructuring program announced June 27, 2006. As discussed in our February 7, 2007 press release, the business transformation programs to reduce operating costs and improve operating margins will result in additional restructuring costs, as the program is implemented.
Other income (expense) - net was $34 million of income for the fourth quarter of 2006, which primarily included interest and dividend income of $47 million.
Minority interest expense was $58 million in the fourth quarter of 2006, compared to $2 million for the fourth quarter of 2005 and $11 million for the third quarter of 2006. Compared to the fourth quarter of 2005, minority interest expenses were primarily driven by the profitability of the LG-Nortel joint venture in the fourth quarter of 2006 resulting from the recognition of previously deferred revenue.
Interest expense on long term debt was $84 million in the fourth quarter of 2006, compared to $54 million for the fourth quarter of 2005 and $85 million for the third quarter of 2006. Compared to the fourth quarter of 2005, interest expense on long term debt was up due to the increase in interest costs associated with the $2 billion aggregate principal amount of senior notes issued in July 2006.
Cash balance at the end of the fourth quarter of 2006 was $3.49 billion, up from $2.60 billion at the end of the third quarter of 2006. This increase was primarily driven by positive cash from operations of $520 million as well as $306 million in cash received upon the closing of the sale of certain assets and liabilities related to the UMTS Access business.
Full Year 2006 Results
For the year 2006, revenues were $11.42 billion compared to $10.51 billion for the year 2005. The Company reported net earnings for the year 2006 of $28 million, or $0.06 per common share on a diluted basis, compared to a net loss of $2,610 million, or $6.02 per common share on a diluted basis, for the year 2005.
Net earnings for the year 2006 included a shareholder litigation recovery of $219 million reflecting mark-to-market adjustments of the share portion of the global class action settlement, special charges of $105 million primarily related to restructuring activities, a benefit of approximately $43 million related to the announced changes to the North American employee benefit plans and a benefit of $206 million related to the sale of assets. The year 2005 results included a litigation expense of $2,474 million, special charges of $169 million and $47 million of costs related to the sale of businesses and assets.
The unfunded status of the Company’s pension benefit obligation was $2.1 billion as of year end 2006, as compared to $2.5 billion in 2005. The decrease of $425 million resulted from changes to our North American plans announced in the second quarter of 2006, improved return on assets, and the Company’s contributions to the plans. The full unfunded status is recorded as a liability on the balance sheet in accordance with SFAS 158.
Commenting on the Company’s financial expectations, Peter Currie, executive vice president and chief financial officer, Nortel said, “For the full year 2007, we expect revenues to be flat to down slightly compared to 2006, reflecting a decrease in revenues as a result of the UMTS Access disposition (note that 2006 UMTS Access revenues associated with the assets sold was approximately $660 million). We expect full year 2007 gross margin to be in the low 40’s, as a percentage of revenues, and operating margin (b) to be at 5 percent, or higher, of revenues. For the first quarter of 2007, we expect revenues to be approximately flat compared to the same period in 2006, reflecting a decrease in revenues as a result of the UMTS Access disposition (note that Q1 2006 UMTS Access revenues associated with the assets sold was approximately $170 million). We expect first quarter of 2007 gross margin to be in the high 30’s, as a percentage of revenues, and operating expenses to be down modestly compared to the first quarter of 2006.”
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.
(b) Operating Margin is a non-GAAP measure defined as Gross Profit less SG&A and R&D expenses divided by Revenue. The Company believes that operating margin is a meaningful measurement of operating performance.
As reported in our 2006 Annual Report on Form 10-K (“2006 Form 10-K”), management has implemented remedial measures and other actions to significantly improve Nortel’s internal control over financial reporting, which individually and in the aggregate addressed most of the internal control issues in the previously reported five material weaknesses. As at December 31, 2006, management has concluded that these measures resulted in the elimination of the five material weaknesses, with the exception of the deficiencies that comprise the revenue related material weakness as at December 31, 2006. See Item 9A in the 2006 Form 10-K for further information.
The restatement of certain prior periods announced on March 1, 2007 has been completed and is reflected in the 2006 Form 10-K. The restatement includes revisions to the Company’s previously reported 2006 nine month results resulting in increases in revenues and improvements in net earnings of approximately $15 million and $8 million, respectively, as well as revisions to its previously reported 2005 and 2004 financial results reflecting reductions in revenue of approximately $14 million and $38 million and increases in net loss of approximately $35 million and $40 million, respectively. With respect to financial results prior to 2004, the restatement includes cumulative reductions in revenues and earnings of approximately $28 million and $2 million, respectively.
Global Class Action Settlement
As previously announced, the Company signed a definitive agreement with the lead plaintiffs and Canadian plaintiffs with respect to most pending and proposed shareholder class actions commenced against the Company and certain other individuals. Also as previously announced, the settlement remains conditioned on receipt of all court, securities regulatory and stock exchange approvals. Nortel now anticipates that these conditions will be satisfied shortly, resulting in an effective date as early as March 20, 2007 for the finalization of the settlement. On or about this date, it is anticipated that approximately 4 percent of the total 62,866,775 Nortel Networks Corporation settlement shares will be issued to plaintiffs’ counsel in accordance with the terms of the settlement, and be freely tradable, with the remainder of the shares expected to be issued, and be freely tradable, in the second half of 2007.
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