Nortel's Q1 Results: Understanding Deferred Revenue

By Frank Burch

The Curious Deferred Revenue Issue and Jaded Analysts

Street analysts again distinguish themselves by fixating on and misinterpreting Nortel's (NT) LG JV and deferred revenues. Many an analyst had some knucklehead comment when, in fact, NT blew out the numbers…with or without the JV. Part of the blame should go to Nortel IR for not giving some sort of quarterly guidance.

First of all, deferred revenues and joint ventures are not sneaky, bad things. Nortel owns over 50% of the JV. Nortel people are key in managing the JV and do much of the work of the JV. This is not some separate entity that just sends revenue and expenses over to Nortel. This is a real business (http://www.lg-nortel.com/). To make it easier to sell into the Korean market, Nortel has a great Korean partner who has, along with NT, invested cash in the business. What comes out of this business are real revenues, real expenses and real cash.

As reported, NT posted Revenue of $2.758 billion, Gross Margin of 41.6% and operation margin of 4.7%. Obviously, revenue was a blowout with the JV revenue coming a quarter earlier than expected. OK…so take out the JV revenue to try to get to analysts’ numbers and you get $2.508 billion. I have 14 revenue estimates for the first quarter, and the average is $2.4992. That is a beat (2.5080 > 2.4992).

Gross margin: NT reported of 41.6%. I was able to find 12 analyst estimates on Gross Margin and the average was 41.1%. OK, let’s take out the JV for people that feel it is “not real” for some reason. GM would have been even higher since the JV business has a lower than average GM. In fact, the Gross Margin would have been 42.3%…a significant outperformance compared to the analysts’ estimate of 41.1%

The best of all is operating margin, which no one really congratulates NT for blowing out …even without the JV. The 11 analyst estimates I could find for operating margin averaged -.1%. NT reported Operating Margin of 4.7%. Take out the JV, and the operating margin was 1.8%….that is a huge outperformance. Even further, Q1 2008 operating margin was reduced by $29 million due to the weak US Dollar…on an apples to apples basis this lowered the OM by 120 basis points versus Q1 2007. That leads to an operating margin of around 3%!

Comments

[Warm_Paw]

Say Whaaaa?!
Introduce the acronyms.

[Phreddy]

I read the article with interest but, other than a mention, I could not find a discussion of "Deferred Revenues". They, along with inventory methods, are always a pithy subject worthy of close scrutiny. I, for one, am not going to dig into NT's handling of deferred revenues, but I would be very interested in reading a discussion of them.

[Frank Burch]

The joint venture revenue was also deferred revenue..the gist is that people don't want to recognize joint venture revenue or deferred revenue...in this case it was joint venture deferred revenue. I guess the point is that NT HAS to recognize the revenue and earnings sometime...why not?