Nortel Networks gave an update on its plans to overhaul its business today, including how it will distribute research and development spending and how it will raise operating margins.

Nortel increased investment in three primary focus areas--IMS, WiMAX and IPTV--by $100 million last year and will add $67 million in R&D to what was originally earmarked for those areas this year. The company also announced today a new metro Ethernet “initiative” to be led by Philippe Morin (general manager of Nortel’s optical business) and backed by “an initial incremental [R&D] investment.” That group will combine four existing Nortel business groups--carrier Ethernet, carrier data, broadband access and optical--and be reported as a separate business unit starting in the third quarter.

Over the next three years, Nortel has previously said, it will seek to have at least 20% of every market in which it participates. When asked today which areas Nortel might exit, Chief Executive Officer Mike Zafirovski said he would not announce every decision the company makes.

Nortel backed away from six products last year, which freed up a combined $73 million in R&D, the company said. It significantly reduced the scope of three more programs, which will save $39 million in R&D this year. Nortel has also sold or is now selling two product businesses worth $11 million in R&D last year. And it made one acquisition this year (Tasman Networks) that will consume $11 million in R&D in 2006.

Nortel spent about 18% of its revenue on R&D in 2005 (or about $1.9 billion) and could cut about $400 million without sacrificing any of its ambitions, Zafirovski said.

One of Zafirovski’s goals for Nortel is to raise to double digits the 0.4% operating margin the company reported for 2005. Starting this year and through the next two, he wants to increase the operating margin by 300 to 500 basis points each year.

One of the ways Nortel plans to deliver those results is through what Zafirovski called a “clean sheet” approach to lower its costs. Nortel plans to examine the products it gets from suppliers and determine how much it costs to make them, then arrive at its own determination of how much the product should cost. “With that as ammunition, you have a very different discussion with your suppliers,” Zafirovski said, predicting initial savings in excess of 25% but minimal impact this year. Over the next three years, Nortel’s goal is to save $500 million this way.

When asked about plans for headcount reductions, Zafirovski said they were a “minimal driver” in his plans to improve Nortel’s profitability.

The company also predicted first-quarter revenue to be flat to slightly down and net loss to be slightly larger than it was a year earlier. But for the full year 2006, Nortel expects revenue growth in the high single digits.

“While we expect continued operating margin expansion in [2006 and 2007],” UBS Investment wrote in a research note today following Nortel’s conference call, “we remain skeptical of Nortel's ability to achieve double-digit operating margins with its current broad strategy of investing in new areas such as IMS, WiMax and IPTV, while remaining engaged in enterprise, wireless and optical.”

When asked what announcements Nortel might make at the upcoming Globalcomm trade show in June, Zafirovski --who has spent much of his first six months at Nortel meeting with hundreds of customers and thousands of employees around the globe--joked that the question seemed to involve speculation about long-term planning.