By Frank Burch
The Curious Deferred Revenue Issue and Jaded Analysts
Street analysts again distinguish themselves by fixating on and misinterpreting the 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%!
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The most telling lack of analysis is that not a single analyst explained that the operating expenses related to the revenue of the JV were expensed in last year’s Q3 and Q4. So, operating margins in Q3 and Q4 of last year were better than reported if you play this game of taking out JV expenses, revenue etc. Mr. Analyst: you can’t have it both ways. If you are going take the operating earnings of the JV out of this quarter, then you must take the operating expenses out of the previous quarters. Otherwise, you are reporting expenses with no associated revenue. No one spoke of this. A corollary discussion would ask the question: Why does NT not recognize the deferred revenue with the deferred operating expenses….they do match up the cost of goods sold, but not the operating expenses.
So, NT beat on these three important metrics with or without the JV. Analysts poo poo the results by saying they will have to lower numbers for the 2nd quarter to account for the JV. The interesting thought is: What would the analysts have said if the JV revenue hadn’t occurred in the 1st quarter, but in the 2nd quarter? Would they have said, “NT meets on revenue expectations, beats handily on Gross and Operating Margins!” Logic demands that they would raise margins for Q2 based on the success NT has had this past quarter in dealing with expenses.
But since NT gives vague annual guidance, analysts have to find a way to cram possible results into their quirky models. When you beat on all metrics and not change your guidance, how does an analyst actually lower their earnings number for the year? It’s quite impossible to do logically. An analyst really has to jump through some perverted hoops to lower numbers based on Q1 results.
Typically insightful comments from analysts:
“Normalized Q1 EPS of $(0.05) would have been spot on our $(0.13) est excluding the $0.08 bottom-line boost from deferred revs.” Well, NT recognized the expenses for this in Q3 and Q4. Is it never supposed to recognize these earnings? They earned the money…what are they supposed to do…its earnings! I guess NT should just put the expenses on its income statement and never recognize the earnings….yeah, that makes sense!
“Revs/Oper margins beat on revenue pull-in and def revenues” I think not. NT beat on every metric even if you exclude the JV.
What a bunch of yo-yos.
