No Accounting for Nortel's Woes

Earnings are being restated once again. Those dubious financials make it hard to get excited about a nascent turnaround

Nortel Networks (NT) was supposed to have its accounting problems licked. At least that's what the company proclaimed more than a year ago, when it finished restating three years of earnings.

It's no wonder then that when Nortel announced Mar. 10 it would once again restate results to fix bookkeeping snafus, its stock price lost more than 7% on the Toronto Stock Exchange, plunging to $3.34. "You would have expected that everything would have been done," says Claude Lamoureux, president of the Ontario Teachers' Pension Plan. His fund is watching the stock, rather than being a big holder right now. "Here we go again."


  CEO Mike Zafirovski says Nortel will restate financial results for 2003, 2004, and the first nine months of 2005. It will also have to make adjustments to periods prior to 2003, retracing some of the same ground the company said it had so painstakingly reviewed under previous CEO Bill Owens. The restatement will also delay the company's 2005 annual reports.

The restatements cover some $866 million in revenue. Zafirovski says the revenue was incorrectly recognized in prior periods that should have been deferred to future periods. According to Nortel, its adjustments were the result of an extensive contract review undertaken as part of efforts ordered by the board to compensate for previously reported internal control deficiencies.

"We cannot give assurances that a restatement will never happen again," Zafirovski told reporters in a conference call. "We feel we are minimizing further financial restatements."

Nortel also posted a preliminary fourth-quarter net loss of $2.2 billion, on revenue of $2.9 billion, largely from paying $2.5 billion to settle two shareholder class actions. The suits are connected to its earlier bout of accounting troubles that sliced a large chunk of shareholder value. The company, which expects to file its 2005 annual report by next month, says for the full year it recorded a net loss of $2.4 billion, on revenue of $10.8 billion.


  Some Wall Street analysts wonder if the recurring accounting issues have something to do with Nortel's merry-go-round of chief executives. After firing CEO Frank Dunn in April, 2004, the company hired former Navy Admiral Owens to oversee an extensive cleansing of the books. Owens stayed on until mid-November, 2005.

Other execs haven't lingered even that long. Ex-Cisco exec Gary Daichendt, hired as Nortel's COO, left last June, after just three months, due to an apparent clash with Owens and the board over ideology and management style.

Enter Zafirovski in October, 2005. The former Motorola (MOT) COO is known to be an intensely thorough executive with a keen eye for boosting margins. Some investors assume the current dustup is a result of Zafirovski's determination to scrub the books with his own meticulous brush. "This is a company that nearly went bankrupt," says one investor, who doesn't currently hold any Nortel shares. "Mike Z probably wants to scrub the books as clean as possible."


  Plenty of investors remain bullish about Zafirovski's leadership. Moreover, he reassured Wall Street by emphasizing that the current restatements are not the result of malfeasance. He stressed his commitment to returning the company to profitable growth within three to five years.

Many industry analysts also point out that Nortel's product portfolio is strong, with the company gaining share in markets like next-generation networking gear. "Nortel has very strong fundamentals," says Susan Eustis, president of consultancy WinterGreen Reseach. "This [the restatements] doesn't diminish their products portfolio. Customers care about whether the products work, and if they are going to receive good service. Nortel has always been strong in both."

But the restatement raises questions about the future. According to Albert Lin of American Technology Research, deferring $866 million in revenue would create a 43% deferred net margin. More revenue and fatter margins are certainly welcome news, but the average net margin for the industry is about 8%, Lin says.


  Such a large discrepancy "implies there could be some sort of accounting gimmickry going on," Lin says. "I'm not saying this is some explosive Enron situation, but there has to be more explanation other than, 'this is all we have for now, we'll get back to you later.'" (See BW Online, 2/24/06, "Nortel's Long, Hard Slog".)

Some Wall Street analysts are particularly disheartened because some of the restatement involved revenue as recent as 2005. "What bothers me is that's not that long ago," says Michael Mahoney, portfolio manager with EGM Capital hedge funds in San Francisco. "It just leaves me saying, I'm not interested in being in this stock at this time. I can't trust their financials."