Nortel's plan to cut products doesn't worry customers

Nortel Networks customers aren't too concerned about the six product cancellations described earlier this week by CEO Mike Zafirovski, according to two user group officials. But some industry and Wall Street analysts were more critical of the news and of Nortel's general direction.

"To the average end user, none of the discontinuances will be terribly major," said David Dooley, treasurer of the 6,000-member International Nortel Networks User Association (INNUA) in Chicago. "I can assure you that if they were major products that people are clamoring for, they wouldn't be discontinuing them."

Dooley did not have details about which products have been discontinued, although a spokeswoman for Nortel said one of the six, the Multiservice Provider Edge router for the service provider market, will no longer be sold as a stand-alone product. Neither the spokeswoman nor Zafirovski would name any of the others.

Zafirovski's comments came during a wide-ranging discussion of changes he's implemented in his first six months as CEO, after the company survived two years of financial restatements and investor class action lawsuits that will cost it US$2.5 billion.

Dooley and Victor Bohnert, executive director of INNUA, said they want more information about the affected products and Nortel's direction from Zafirovski when he meets INNUA members at their annual conference in San Diego on June 11.

"It's not like Zafirovski keeps a secret. He's been speaking quite often to customers," Dooley said. "In June, I want to hear a reaffirmation from him that the end users who have been longtime Nortel customers are important to Nortel ... and I fully expect he'll say that."

Dooley has been a Nortel customer for a dozen years and has found that the company has a good "evergreen" philosophy with products put out to pasture. "What keeps you as a user is that they always find a way to take care of you even when they go to end-of-lifing a product," Dooley said. He is director of telecommunications and special projects for the Plano, Texas, Independent School District, which serves 51,000 students and 8,000 teachers with Nortel telecommunications equipment at 78 sites. The equipment runs over a fiber link between sites and was considered the Cadillac of networking gear when it was installed, he said.

Absent details about the discontinued products and three others put on a "scope reduction" list, Bohnert said that in general "there is optimism in the Nortel customer base. Customers finally feel Nortel is taking control of its sales channels and that Nortel leaders are concerned about aggressively defending their market share.

"Nortel customers are very loyal and feel Nortel flat out makes the best products, even though Nortel has stumbled with its financial challenges," he said. "Mike [Zafirovski] is playing to win."

In addition to the cuts, Zafirovski also announced a new Metro Ethernet Networks unit, as well as US$167 million more in research and development for three product areas: IP Multimedia Subsystems, WiMax and IPTV.

The six programs or products Nortel is exiting cost Nortel US$73 million in R&D last year; the three on the scope reduction list will cut an $80 million R&D investment last year to about US$40 million this year, Zafirovski said. The sale of Nortel's blade server unit and the proposed sale of another unnamed unit will also trim another US$11 million in R&D spending. That savings, however, will be offset by the acquisition earlier this year of Tasman Networks, he said.

It is not clear how the cuts will affect Nortel's R&D budget, which totalled nearly US$1.9 billion in 2005, representing about 18 percent of all revenues. A spokeswoman said Zafirovski has not stated the R&D spending goal for 2006, although the changes he described would cut about US$10 million in that category.

In his presentation to analysts on Tuesday, Zafirovski also said he is trying to reduce US$1.5 billion in spending over three years, with more than US$600 million of that total derived from services, enterprise and R&D efforts. Those funds will be a "significant driver for targeted operating margin expansion," he said.

In general, Zafirovski said he is focusing on product areas that can bring Nortel to 20 percent market share within three years, which he said means the products need to be "truly relevant" and can make Nortel first or second in the market with some exceptions. Nortel will be emphasizing software and services, with less emphasis on hardware and products, he said.

Nortel will report its first-quarter 2006 financials on June 5, but expects revenues to be flat to slightly down, with the rest of 2006 resulting in high single-digit growth compared with 2005, he said. In response to a question, Zafirovski also said the remainder of the year will yield "good performance" in sales of optical networking gear, with "continued strong performance in enterprise, particularly on the voice side."

The harshest criticism of the company came from analysts. "What he says sounds good, but Nortel has announced things that sounded good in the past and they are still digging out," said Jeff Kagan, an independent analyst in Atlanta. "So at this point, we'll have to wait and then reward them after they are successful."

Zeus Kerravala, an analyst at Yankee Group Research, said the reluctance to name all the discontinued products "means that customers will speculate that they might get out of the enterprise routing, switching or security areas." Customers should not buy Nortel products that have a low market share "until you find out what they are discontinuing," he said.

Zafirovski's optimism about enterprise sales is surprising, Kerravala added, since enterprise sales have declined year over year at Nortel. "What is he basing enterprise increases on, especially with increased efforts by competitors?" he said. Even if Nortel is committed to its installed base and its INNUA-type customers, "how does that help you grow?"

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