UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
![]() |
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended June 30, 2002 |
OR
![]() |
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period From to |
Commission file number 001-07260
Nortel Networks Corporation
(Exact name of registrant as specified in its charter)
Canada (State or other jurisdiction of incorporation or organization) |
Not Applicable (I.R.S. Employer Identification No.) |
|
8200 Dixie Road, Suite 100 Brampton, Ontario, Canada (Address of principal executive offices) |
L6T 5P6 (Zip Code) |
Registrants telephone number including area code (905) 863-0000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.
Yes ![]() |
No |
Indicate the number of shares outstanding of each of the issuers classes of common stock, as at July 31, 2002
3,838,842,211 without nominal or par value
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
PAGE | ||||||||
ITEM 1. |
Consolidated Financial Statements (unaudited) | 3 | ||||||
ITEM 2. |
Management's Discussion and Analysis of Financial | |||||||
Condition and Results of Operations | 33 | |||||||
ITEM 3. |
Quantitative and Qualitative Disclosures About | |||||||
Market Risk | 65 | |||||||
PART II | ||||||||
OTHER INFORMATION | ||||||||
ITEM 1. |
Legal Proceedings | 66 | ||||||
ITEM 2. |
Changes in Securities and Use of Proceeds | 66 | ||||||
ITEM 4. |
Submissions of Matters to a Vote of Security Holders | 66 | ||||||
ITEM 6. |
Exhibits and Reports on Form 8-K | 67 | ||||||
Signatures |
70 |
All dollar amounts in this document are in United States dollars unless otherwise stated.
ALTEON is a trademark of Alteon Websystems, Inc.
BAY NETWORKS is a trademark of Nortel Networks.
CLARIFY is a trademark of Amdocs Software Systems Limited.
NORTEL NETWORKS, NT are trademarks of Nortel Networks.
QTERA is a trademark of Qtera Corporation.
S&P 500 is a trademark of The McGraw-Hill Companies, Inc.
XROS is a trademark of Xros, Inc.
2
PART I
FINANCIAL INFORMATION
ITEM 1. | Consolidated Financial Statements (unaudited) | |||||||
Contents of Consolidated Financial Statements | ||||||||
PAGE | ||||||||
Consolidated Statements of Operations | 4 | |||||||
Consolidated Balance Sheets | 5 | |||||||
Consolidated Statements of Cash Flows | 6 | |||||||
Notes to Consolidated Financial Statements | 7 |
3
NORTEL NETWORKS CORPORATION
Consolidated Statements of Operations (unaudited)
(millions of U.S. dollars, except per share amounts)
Three months ended | Six months ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
Revenues |
$ | 2,773 | $ | 4,610 | $ | 5,685 | $ | 10,361 | |||||||||
Cost of revenues |
1,815 | 4,184 | 3,969 | 8,077 | |||||||||||||
Gross profit |
958 | 426 | 1,716 | 2,284 | |||||||||||||
Selling,
general and administrative expense (excluding stock option compensation) |
767 | 1,642 | 1,511 | 2,983 | |||||||||||||
Research and development expense |
579 | 910 | 1,174 | 1,853 | |||||||||||||
In-process research and development expense |
| | | 15 | |||||||||||||
Amortization of intangibles |
|||||||||||||||||
Acquired technology |
41 | 285 | 84 | 559 | |||||||||||||
Goodwill |
| 1,639 | | 3,231 | |||||||||||||
Stock option compensation |
21 | 25 | 46 | 59 | |||||||||||||
Special charges |
403 | 13,570 | 890 | 13,925 | |||||||||||||
Gain on sale of businesses |
| | (14 | ) | | ||||||||||||
Operating loss |
(853 | ) | (17,645 | ) | (1,975 | ) | (20,341 | ) | |||||||||
Equity in net loss of associated companies |
(10 | ) | (116 | ) | (14 | ) | (132 | ) | |||||||||
Other income (expense) net |
1 | (47 | ) | (18 | ) | 50 | |||||||||||
Interest expense |
|||||||||||||||||
Long-term debt |
(55 | ) | (45 | ) | (113 | ) | (84 | ) | |||||||||
Other |
(9 | ) | (43 | ) | (21 | ) | (59 | ) | |||||||||
Loss from continuing operations before income taxes |
(926 | ) | (17,896 | ) | (2,141 | ) | (20,566 | ) | |||||||||
Income tax benefit |
229 | 1,252 | 603 | 1,553 | |||||||||||||
Net loss from continuing operations |
(697 | ) | (16,644 | ) | (1,538 | ) | (19,013 | ) | |||||||||
Net loss from discontinued operations net of tax |
| (2,784 | ) | | (3,010 | ) | |||||||||||
Net loss before cumulative effect of accounting change |
(697 | ) | (19,428 | ) | (1,538 | ) | (22,023 | ) | |||||||||
Cumulative effect of accounting change net of tax of $9 |
| | | 15 | |||||||||||||
Net loss |
$ | (697 | ) | $ | (19,428 | ) | $ | (1,538 | ) | $ | (22,008 | ) | |||||
Basic and diluted loss per common share |
|||||||||||||||||
- from continuing operations |
$ | (0.20 | ) | $ | (5.21 | ) | $ | (0.46 | ) | $ | (6.00 | ) | |||||
- from discontinued operations |
| (0.87 | ) | | (0.94 | ) | |||||||||||
Basic and diluted loss per common share |
$ | (0.20 | ) | $ | (6.08 | ) | $ | (0.46 | ) | $ | (6.94 | ) | |||||
Dividends declared per common share |
$ | | $ | 0.01875 | $ | | $ | 0.03750 |
See notes to unaudited consolidated financial statements.
4
NORTEL NETWORKS CORPORATION
Consolidated Balance Sheets (unaudited)
(millions of U.S. dollars)
June 30, | December 31, | ||||||||
2002 | 2001 | ||||||||
ASSETS |
|||||||||
Current assets |
|||||||||
Cash and cash equivalents |
$ | 4,869 | $ | 3,513 | |||||
Accounts receivable (less provisions of $574 at June 30, 2002; $655 at December 31, 2001) |
2,338 | 2,923 | |||||||
Inventories net |
1,453 | 1,579 | |||||||
Income taxes recoverable |
55 | 796 | |||||||
Deferred income taxes net |
1,246 | 1,386 | |||||||
Other current assets |
855 | 857 | |||||||
Current assets of discontinued operations |
336 | 708 | |||||||
Total current assets |
11,152 | 11,762 | |||||||
Long-term receivables (less provisions of $841 at June 30, 2002; $828 at December 31, 2001) |
254 | 203 | |||||||
Investments at cost and associated companies at equity |
223 | 253 | |||||||
Plant and equipment net |
2,001 | 2,571 | |||||||
Goodwill |
2,795 | 2,810 | |||||||
Intangible assets net |
171 | 285 | |||||||
Deferred income taxes net |
2,448 | 2,077 | |||||||
Other assets |
937 | 893 | |||||||
Long-term assets of discontinued operations |
105 | 283 | |||||||
Total assets |
$ | 20,086 | $ | 21,137 | |||||
LIABILITIES AND SHAREHOLDERS EQUITY |
|||||||||
Current liabilities |
|||||||||
Notes payable |
$ | 340 | $ | 426 | |||||
Trade and other accounts payable |
1,600 | 1,988 | |||||||
Payroll and benefit-related liabilities |
562 | 636 | |||||||
Other accrued liabilities |
5,196 | 5,459 | |||||||
Income taxes payable |
108 | 143 | |||||||
Long-term debt due within one year |
325 | 384 | |||||||
Current liabilities of discontinued operations |
171 | 421 | |||||||
Total current liabilities |
8,302 | 9,457 | |||||||
Deferred income |
123 | 154 | |||||||
Long-term debt |
4,125 | 4,094 | |||||||
Deferred income taxes net |
523 | 518 | |||||||
Other liabilities |
1,498 | 1,453 | |||||||
Minority interest in subsidiary companies |
604 | 637 | |||||||
15,175 | 16,313 | ||||||||
Commitments and contingencies (notes 13 and 14) |
|||||||||
SHAREHOLDERS EQUITY |
|||||||||
Common
shares, without par value Authorized shares: unlimited; Issued and outstanding shares: 3,849,075,583 at June 30, 2002 and 3,213,742,169 at December 31, 2001 |
33,860 | 32,899 | |||||||
Additional paid-in capital |
3,766 | 3,257 | |||||||
Deferred stock option compensation |
(139 | ) | (205 | ) | |||||
Deficit |
(31,689 | ) | (30,151 | ) | |||||
Accumulated other comprehensive loss |
(887 | ) | (976 | ) | |||||
Total shareholders equity |
4,911 | 4,824 | |||||||
Total liabilities and shareholders equity |
$ | 20,086 | $ | 21,137 | |||||
See notes to unaudited consolidated financial statements.
5
NORTEL NETWORKS CORPORATION
Consolidated Statements of Cash Flows (unaudited)
(millions of U.S. dollars)
Six months ended | |||||||||||
June 30, | |||||||||||
2002 | 2001 | ||||||||||
Cash flows from (used in) operating activities |
|||||||||||
Net loss from continuing operations |
$ | (1,538 | ) | $ | (19,013 | ) | |||||
Adjustments
to reconcile net loss from continuing operations to net cash used in operating activities, net of effects from acquisitions and divestitures of businesses: |
|||||||||||
Amortization and depreciation |
384 | 4,133 | |||||||||
In-process research and development expense |
| 15 | |||||||||
Non-cash portion of special charges and related asset write downs |
382 | 12,901 | |||||||||
Equity in net loss of associated companies |
14 | 132 | |||||||||
Stock option compensation |
46 | 59 | |||||||||
Tax benefit from stock options |
| 34 | |||||||||
Deferred income taxes |
(225 | ) | (1,090 | ) | |||||||
Other liabilities |
(30 | ) | (17 | ) | |||||||
Gain on sale of investments and businesses |
(26 | ) | (26 | ) | |||||||
Other net |
206 | (166 | ) | ||||||||
Change in operating assets and liabilities: |
|||||||||||
Accounts receivable |
544 | 2,359 | |||||||||
Inventories |
126 | 1,184 | |||||||||
Income taxes |
706 | (882 | ) | ||||||||
Accounts payable and accrued liabilities |
(755 | ) | (490 | ) | |||||||
Other operating assets and liabilities |
(52 | ) | 352 | ||||||||
Net cash used in operating activities of continuing operations |
(218 | ) | (515 | ) | |||||||
Cash flows from (used in) investing activities |
|||||||||||
Expenditures for plant and equipment |
(208 | ) | (854 | ) | |||||||
Proceeds on disposals of plant and equipment |
76 | 20 | |||||||||
Increase in long-term receivables |
(210 | ) | (502 | ) | |||||||
Decrease in long-term receivables |
105 | 93 | |||||||||
Acquisitions of investments and businesses net of cash acquired |
(25 | ) | (73 | ) | |||||||
Proceeds on sale of investments and businesses |
73 | 66 | |||||||||
Net cash used in investing activities of continuing operations |
(189 | ) | (1,250 | ) | |||||||
Cash flows from (used in) financing activities |
|||||||||||
Dividends on common shares |
| (123 | ) | ||||||||
Increase (decrease) in notes payable net |
(77 | ) | 1,421 | ||||||||
Proceeds from long-term debt |
31 | 1,505 | |||||||||
Repayments of long-term debt |
(6 | ) | (412 | ) | |||||||
Decrease in capital leases payable |
(5 | ) | (24 | ) | |||||||
Issuance of common shares |
862 | 133 | |||||||||
Issuance of prepaid forward purchase contracts |
623 | | |||||||||
Net cash from financing activities of continuing operations |
1,428 | 2,500 | |||||||||
Effect of foreign exchange rate changes on cash and cash equivalents |
46 | (17 | ) | ||||||||
Net cash from continuing operations |
1,067 | 718 | |||||||||
Net cash from (used in) discontinued operations |
289 | (433 | ) | ||||||||
Net increase in cash and cash equivalents |
1,356 | 285 | |||||||||
Cash and cash equivalents at beginning of period net |
3,513 | 1,644 | |||||||||
Cash and cash equivalents at end of period net |
$ | 4,869 | $ | 1,929 | |||||||
See notes to unaudited consolidated financial statements.
6
NORTEL NETWORKS CORPORATION
Notes to Consolidated Financial Statements (unaudited)
(millions of U.S. dollars, except per share amounts, unless otherwise stated)
1. | Nortel Networks Corporation | |
Effective May 1, 2000, a newly formed Canadian corporation (New Nortel) and the corporation previously known as Nortel Networks Corporation (Old Nortel) participated in a Canadian court-approved plan of arrangement (the Arrangement) with BCE Inc. As a result of the Arrangement: Old Nortel and its subsidiaries became direct and indirect subsidiaries, respectively, of New Nortel; New Nortel assumed the name Nortel Networks Corporation; New Nortels common shares began to trade publicly on the New York and Toronto stock exchanges under the symbol NT; Old Nortel was renamed Nortel Networks Limited (NNL); and 100 percent of Old Nortels common shares were acquired by New Nortel and ceased to be publicly traded. The preferred shares and debt securities of Old Nortel outstanding immediately prior to the Arrangement remained outstanding and continued to be obligations of Old Nortel immediately after the Arrangement. All of the business and operations conducted by Old Nortel and its subsidiaries immediately prior to the effective date of the Arrangement continued to be conducted by Old Nortel and its subsidiaries as subsidiaries of New Nortel immediately after the Arrangement. | ||
2. | Basis of presentation | |
The accompanying unaudited Consolidated Financial Statements of Nortel Networks Corporation (Nortel Networks) include all majority owned subsidiaries over which Nortel Networks exercises control, and have been prepared in accordance with the rules and regulations of the United States Securities and Exchange Commission (the SEC) for the preparation of interim financial information. Accordingly, they do not include all information and notes as required by United States generally accepted accounting principles (GAAP) in the preparation of annual consolidated financial statements. The accounting policies used in the preparation of the accompanying unaudited Consolidated Financial Statements are the same as those described in Nortel Networks audited Consolidated Financial Statements prepared in accordance with GAAP for the three years ended December 31, 2001, except as described in note 3. Although Nortel Networks is headquartered in Canada, the accompanying unaudited Consolidated Financial Statements are expressed in United States dollars as the greater part of Nortel Networks financial results and net assets are denominated in United States dollars. | ||
In the opinion of management, all adjustments necessary to effect a fair statement of the results for the periods presented have been made and all such adjustments are of a normal recurring nature. The financial results for the three months and six months ended June 30, 2002, are not necessarily indicative of financial results for the full year. The accompanying unaudited Consolidated Financial Statements should be read in conjunction with Nortel Networks Annual Report on Form 10-K for the year ended December 31, 2001 (the 2001 10-K) and Current Report on Form 8-K dated May 13, 2002, which includes certain supplemental financial disclosure and disclosure related to certain events that occurred subsequent to the filing of the original historical audited consolidated financial statements. | ||
The preparation of Nortel Networks Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates are used when accounting for items and matters such as long-term contracts, allowance for uncollectible accounts receivable and customer financings, inventory obsolescence, product warranty, amortization, asset valuations, employee benefits, taxes, restructuring and other provisions, in-process research and development (IPR&D), and contingencies. | ||
Certain 2001 figures in the accompanying unaudited Consolidated Financial Statements have been reclassified to conform to the 2002 presentation. |
7
3. | Accounting changes |
(a) | Accounting for goodwill and other intangible assets | ||
In July 2001, the Financial Accounting Standards Board (the FASB) issued Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS 142), effective for fiscal years beginning after December 15, 2001. SFAS 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Thus, amortization of goodwill, including goodwill recorded in past business combinations, and amortization of intangibles with an indefinite life, ceased upon adoption of this Statement. For any acquisitions completed after June 30, 2001, goodwill and intangible assets with an indefinite life are not amortized. | |||
Nortel Networks adopted the provisions of SFAS 142 effective January 1, 2002. Nortel Networks completed the first of the required SFAS 142 transitional impairment tests during the second quarter of 2002 and concluded that there was no impairment of recorded goodwill, as the fair value of its reporting units exceeded their carrying amount as of January 1, 2002. Therefore the second step of the transitional impairment test under SFAS 142 was not required to be performed. There can be no assurance that future goodwill impairment tests will not result in a charge to net earnings (loss). | |||
Acquired technology will continue to be amortized and carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally two to three years. | |||
The following tables present the impact on net loss and on basic and diluted loss per common share from both continuing and discontinued operations for the three months and six months ended June 30, 2002 and 2001, and for the years ended December 31, 2001, 2000, and 1999, of the SFAS 142 requirement to cease the amortization of goodwill as if the standard had been in effect beginning January 1, 1999: |
Three months ended | Six months ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
Reported results: |
|||||||||||||||||
Net loss from continuing operations |
$ | (697 | ) | $ | (16,644 | ) | $ | (1,538 | ) | $ | (19,013 | ) | |||||
Net loss from discontinued operations net of tax |
| (2,784 | ) | | (3,010 | ) | |||||||||||
Cumulative effect of accounting change net of tax of $9 |
| | | 15 | |||||||||||||
Net loss reported |
$ | (697 | ) | $ | (19,428 | ) | $ | (1,538 | ) | $ | (22,008 | ) | |||||
Adjustments: |
|||||||||||||||||
Amortization of goodwill from continuing operations net of tax(a) |
$ | | $ | 1,644 | $ | | $ | 3,240 | |||||||||
Amortization of goodwill from discontinued operations |
| 94 | | 190 | |||||||||||||
Total net adjustments |
$ | | $ | 1,738 | $ | | $ | 3,430 | |||||||||
Adjusted results: |
|||||||||||||||||
Net loss from continuing operations |
$ | (697 | ) | $ | (15,000 | ) | $ | (1,538 | ) | $ | (15,773 | ) | |||||
Net loss from discontinued operations net of tax |
| (2,690 | ) | | (2,820 | ) | |||||||||||
Cumulative effect of accounting change net of tax of $9 |
| | | 15 | |||||||||||||
Net loss adjusted |
$ | (697 | ) | $ | (17,690 | ) | $ | (1,538 | ) | $ | (18,578 | ) | |||||
Reported basic and diluted loss per common share: |
|||||||||||||||||
- from continuing operations |
$ | (0.20 | ) | $ | (5.21 | ) | $ | (0.46 | ) | $ | (6.00 | ) | |||||
- from discontinued operations |
| (0.87 | ) | | (0.94 | ) | |||||||||||
Basic and diluted loss per common share reported |
$ | (0.20 | ) | $ | (6.08 | ) | $ | (0.46 | ) | $ | (6.94 | ) | |||||
Adjusted basic and diluted loss per common share: |
|||||||||||||||||
- from continuing operations |
$ | (0.20 | ) | $ | (4.70 | ) | $ | (0.46 | ) | $ | (4.97 | ) | |||||
- from discontinued operations |
| (0.84 | ) | | (0.89 | ) | |||||||||||
Basic and diluted loss per common share adjusted |
$ | (0.20 | ) | $ | (5.54 | ) | $ | (0.46 | ) | $ | (5.86 | ) | |||||
(a) | Includes goodwill amortization of equity accounted investments, net of tax of $2 and $5 for the three months and six months ended June 30, 2001, respectively. |
8
The following historical financial information is provided in accordance with the SECs June 2002 announcement on SFAS 142 transition disclosures: |
Year ended December 31, | |||||||||||||
2001 | 2000 | 1999 | |||||||||||
Reported results: |
|||||||||||||
Net loss from continuing operations |
$ | (24,307 | ) | $ | (2,995 | ) | $ | (257 | ) | ||||
Net loss from discontinued operations net of tax |
(3,010 | ) | (475 | ) | (94 | ) | |||||||
Cumulative effect of accounting change net of tax of $9 |
15 | | | ||||||||||
Net loss reported |
$ | (27,302 | ) | $ | (3,470 | ) | $ | (351 | ) | ||||
Adjustments: |
|||||||||||||
Amortization of goodwill from continuing operations net of tax (a) |
$ | 4,157 | $ | 3,735 | $ | 1,178 | |||||||
Amortization of goodwill from discontinued operations |
190 | 224 | 29 | ||||||||||
Total net adjustments |
$ | 4,347 | $ | 3,959 | $ | 1,207 | |||||||
Adjusted results: |
|||||||||||||
Net earnings (loss) from continuing operations |
$ | (20,150 | ) | $ | 740 | $ | 921 | ||||||
Net loss from discontinued operations net of tax |
(2,820 | ) | (251 | ) | (65 | ) | |||||||
Cumulative effect of accounting change net of tax of $9 |
15 | | | ||||||||||
Net earnings (loss) adjusted |
$ | (22,955 | ) | $ | 489 | $ | 856 | ||||||
Reported basic and diluted loss per common share: |
|||||||||||||
- from continuing operations |
$ | (7.62 | ) | $ | (1.01 | ) | $ | (0.10 | ) | ||||
- from discontinued operations |
(0.94 | ) | (0.16 | ) | (0.03 | ) | |||||||
Basic and diluted loss per common share reported |
$ | (8.56 | ) | $ | (1.17 | ) | $ | (0.13 | ) | ||||
Adjusted basic earnings (loss) per common share: |
|||||||||||||
- from continuing operations |
$ | (6.31 | ) | $ | 0.25 | $ | 0.34 | ||||||
- from discontinued operations |
(0.89 | ) | (0.08 | ) | (0.02 | ) | |||||||
Basic earnings (loss) per common share adjusted |
$ | (7.20 | ) | $ | 0.17 | $ | 0.32 | ||||||
Adjusted diluted earnings (loss) per common share: |
|||||||||||||
- from continuing operations |
$ | (6.31 | ) | $ | 0.24 | $ | 0.33 | ||||||
- from discontinued operations |
(0.89 | ) | (0.08 | ) | (0.02 | ) | |||||||
Diluted earnings (loss) per common share adjusted |
$ | (7.20 | ) | $ | 0.16 | $ | 0.31 | ||||||
(a) | Includes goodwill amortization of equity accounted investments, net of tax of $5, $7 and nil for the years ended December 31, 2001, 2000 and 1999, respectively. |
(b) | Impairment or disposal of long-lived assets | ||
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 applies to certain long-lived assets, including discontinued operations, and develops one accounting model for long-lived assets to be disposed of by sale. This Statement supersedes SFAS No. 121, Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board Opinion (APB) No. 30, Reporting the Results of Operations Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB 30), for the disposal of a segment of a business. | |||
SFAS 144 requires that long-lived assets to be disposed of by sale be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet been incurred. SFAS 144 also broadens the reporting of discontinued operations to include the disposal of a component of an entity provided that the operations and cash flows of the component will be eliminated from the ongoing operations of the entity and the entity will not have any significant continuing involvement in the operations of the component. |
9
Nortel Networks adopted the provisions of SFAS 144 effective January 1, 2002. The adoption of SFAS 144 did not have a material effect on the business, results of operations, and financial condition of Nortel Networks. |
4. | Discontinued operations | |
On June 14, 2001, Nortel Networks Board of Directors approved a plan to discontinue Nortel Networks access solutions operations consisting of all of Nortel Networks narrowband and broadband solutions, including copper, cable, and fixed wireless solutions, as well as Nortel Networks then current consolidated membership interest in Arris Interactive LLC (Arris) and equity investment in Elastic Networks Inc. (Elastic Networks). Also affected by the decision were Nortel Networks prior acquisitions of Sonoma Systems (Sonoma), Promatory Communications, Inc. (Promatory), Aptis Communications, Inc. (Aptis), and Broadband Networks Inc. | ||
Pursuant to APB 30, the revenues, costs and expenses, assets and liabilities, and cash flows of Nortel Networks access solutions operations have been segregated in the accompanying unaudited Consolidated Statements of Operations, unaudited Consolidated Balance Sheets, and unaudited Consolidated Statements of Cash Flows, and are reported as discontinued operations. | ||
The results of discontinued operations for the three months and six months ended June 30, presented in the accompanying unaudited Consolidated Statements of Operations, were as follows: |
Three months ended | Six months ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
Revenues |
$ | 70 | $ | 287 | $ | 138 | $ | 713 | |||||||||
Loss from discontinued operations net of tax(a) |
$ | | $ | (216 | ) | $ | | $ | (442 | ) | |||||||
Loss on disposal of operations net of tax(b) |
| (2,568 | ) | | (2,568 | ) | |||||||||||
Net loss from discontinued operations net of tax |
$ | | $ | (2,784 | ) | $ | | $ | (3,010 | ) | |||||||
(a) | Loss from discontinued operations was net of applicable income tax recovery of nil and $54 for the three months ended June 30, 2002 and 2001, respectively, and an income tax recovery of nil and $119 for the six months ended June 30, 2002 and 2001, respectively. | ||
(b) | Loss on disposal of operations was net of applicable income tax recovery of $604 for the three months and six months ended June 30, 2001. |
During the three months ended June 30, 2002, Arris Group Inc. (Arris Group) completed a secondary public offering of 15 million common shares held by Nortel Networks. Following the closing of the offering on June 25, 2002, Nortel Networks owned 22 million shares, or approximately 27 percent of Arris Groups common shares. The cash proceeds received were $67 and a gain of approximately $15 was recorded as a result of this transaction, which is included in the estimated remaining provisions required for discontinued operations. During the three months ended March 31, 2002, Nortel Networks recorded a gain of approximately $13 due to the reduction of Nortel Networks ownership interest in Arris Group, received for Nortel Networks original interest in Arris, from approximately 49 percent to approximately 46 percent as a result of Arris Groups issuance of common shares in connection with its acquisition of another company, which is included in the estimated remaining provisions required for discontinued operations. | ||
On April 21, 2002, Nortel Networks entered into an agreement with Aastra Technologies Limited to sell certain assets which were included in discontinued operations, associated with Nortel Networks prior acquisition of Aptis. The transaction was completed during the three months ended June 30, 2002. The consideration primarily consisted of approximately $16 in cash, as well as contingent cash consideration of up to $60 over four years based on the achievement of certain revenue targets by the business. Nortel Networks recorded a loss of approximately $43 on the transaction, which reduced the estimated provisions required for discontinued operations. |
10
On March 5, 2002, Nortel Networks divested its approximately 46 percent ownership interest in Elastic Networks to Paradyne Networks, Inc. (Paradyne) in exchange for an approximately 8 percent ownership interest in Paradyne. Nortel Networks recorded a gain of approximately $7 on the transaction, which is included in the estimated remaining provisions required for discontinued operations. | ||
In connection with the decision to discontinue the access solutions operations on June 14, 2001, Nortel Networks recorded a pre-tax loss on disposal of the access solutions operations of $3,172 in the second quarter of 2001, which reflected the estimated costs directly associated with Nortel Networks plan of disposition. The loss reflected: the write-off of goodwill associated with the acquisitions of Sonoma and Promatory in the amount of $755; provisions for both short-term and long-term receivables of $601; a provision for inventories of $379; other asset write-offs totaling $156; future contractual obligations and estimated liabilities of $1,104; and estimated operating losses during the planned period of disposition of $177. | ||
During the six months ended June 30, 2002, Nortel Networks has continued to actively wind down the access solutions operations and there has been no change to the initial disposal strategy or intent to exit the business since June 14, 2001. However, the continued deterioration in industry and market conditions has delayed certain disposal activities beyond the original planned timeframe of one year. In particular, actions involving negotiations with customers, who have also been affected by industry conditions, are taking longer than expected. Therefore, although disposal activities continue beyond the one-year period generally contemplated under APB 30, Nortel Networks continues to present the access solutions operations as discontinued operations in the Consolidated Financial Statements. Nortel Networks has disposed of or transitioned the ownership of certain operations, and operations not disposed of or so transitioned are expected to be closed. Nortel Networks now expects to complete this plan by the end of 2002 or early 2003, subject to the closing of specific transactions, the timing of which may continue to be impacted by customer issues, any applicable regulatory requirements, and business issues. | ||
At June 30, 2002, the remaining accruals of $164 related to the above-noted future contractual obligations and estimated liabilities, and estimated operating losses during the planned period of disposition were included in current liabilities of discontinued operations. The remaining accruals are expected to be substantially drawn down by cash payments over the period of disposition, the impact of which is expected to be offset by proceeds from the sale of certain remaining assets to be disposed of. | ||
The assets and liabilities of discontinued operations presented in the accompanying unaudited Consolidated Balance Sheets were as follows: |
June 30, | December 31, | |||||||
2002 | 2001 | |||||||
Accounts receivable net |
$ | 25 | $ | 109 | ||||
Inventories net |
| 66 | ||||||
Deferred income taxes |
212 | 358 | ||||||
Other current assets |
99 | 175 | ||||||
Total current assets of discontinued operations |
336 | 708 | ||||||
Intangible assets net |
| 17 | ||||||
Other long-term assets |
105 | 266 | ||||||
Total assets of discontinued operations |
$ | 441 | $ | 991 | ||||
Current liabilities |
$ | 171 | $ | 421 | ||||
Long-term liabilities (included in Other liabilities) |
2 | 11 | ||||||
Total liabilities of discontinued operations |
$ | 173 | $ | 432 | ||||
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The net cash from (used in) discontinued operations for the six months ended June 30, 2002 and 2001, presented in the accompanying unaudited Consolidated Statements of Cash Flows, was as follows: |
2002 | 2001 | ||||||||
Cash flows from (used in) discontinued operations |
|||||||||
Operating activities |
$ | 209 | $ | (330 | ) | ||||
Investing activities |
80 | (103 | ) | ||||||
Net cash from (used in) discontinued operations |
$ | 289 | $ | (433 | ) | ||||
5. | Consolidated financial statement details | |
Consolidated balance sheets | ||
The following tables provide details as at: | ||
Inventories net: |
June 30, | December 31, | |||||||
2002 | 2001 | |||||||
Raw materials |
$ | 577 | $ | 759 | ||||
Work in process |
461 | 586 | ||||||
Finished goods |
415 | 234 | ||||||
Inventories net(a) |
$ | 1,453 | $ | 1,579 | ||||
(a) | Net of inventory provisions of $1,057 and $933 as at June 30, 2002 and December 31, 2001, respectively. Nortel Networks has also accrued in other accrued liabilities $268 and $565 at June 30, 2002 and December 31, 2001, respectively, for cancellation charges, for inventory in excess of future demand, and for the settlement of certain other claims related to its contract manufacturers or suppliers. |
Goodwill: | ||
The changes in the carrying amount of goodwill by reportable segment for the six months ended June 30, 2002 are as follows: |
Metro and | ||||||||||||||||||||
Optical | Wireless | Enterprise | ||||||||||||||||||
Networks | Networks | Networks | Other | Total | ||||||||||||||||
Balance as at January 1, 2002 |
$ | 590 | $ | 21 | $ | 2,184 | $ | 15 | $ | 2,810 | ||||||||||
Change: |
||||||||||||||||||||
Disposal |
| | | (15 | ) | (15 | ) | |||||||||||||
Other |
3 | | (3 | ) | | | ||||||||||||||
Balance as at June 30, 2002 |
$ | 593 | $ | 21 | $ | 2,181 | $ | | $ | 2,795 | ||||||||||
Intangible assets net: |
June 30, | December 31, | |||||||
2002 | 2001 | |||||||
Acquired technology |
$ | 5,732 | $ | 5,762 | ||||
Less: accumulated amortization |
(5,561 | ) | (5,477 | ) | ||||
Intangible assets net |
$ | 171 | $ | 285 | ||||
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The estimated future amortization expense of acquired technology for the fiscal years ending December 31 is as follows: |
2002 (remaining 6 months) |
$ | 73 | ||
2003 |
98 | |||
Total |
$ | 171 | ||
Consolidated statements of cash flows | ||
The following table provides details for the six months ended June 30: | ||
Interest and income taxes paid (received): |
2002 | 2001 | |||||||
Interest paid |
$ | 147 | $ | 111 | ||||
Income taxes paid (received) |
$ | (1,236 | ) | $ | 387 | |||
6. | Special charges | |
Special charges were as follows: |
Provision | Special Charges | 2002 | Provision | |||||||||||||||||||||||||||
Balance as at | Three months ended | Cumulative drawdowns | Balance as at | |||||||||||||||||||||||||||
December 31, | March 31, | June 30, | June 30, | |||||||||||||||||||||||||||
2001 | 2002 | 2002 | Subtotal | Cash | Non-cash | 2002 | ||||||||||||||||||||||||
Workforce reduction |
$ | 400 | $ | 327 | $ | 117 | $ | 844 | $ | (445 | ) | $ | | $ | 399 | |||||||||||||||
Contract settlement and lease costs |
773 | 63 | 1 | 837 | (186 | ) | | 651 | ||||||||||||||||||||||
Plant and equipment write downs |
| 85 | 270 | 355 | | (355 | ) | | ||||||||||||||||||||||
Other |
31 | 12 | 15 | 58 | (9 | ) | (27 | ) | 22 | |||||||||||||||||||||
Total |
$ | 1,204 | $ | 487 | $ | 403 | $ | 2,094 | $ | (640 | ) | $ | (382 | ) | $ | 1,072 | ||||||||||||||
Three months and six months ended June 30, 2002 | ||
For the three months and six months ended June 30, 2002, Nortel Networks recorded special charges of $403 and $890, respectively, related to restructuring costs associated with its work plan, which it began implementing in 2001 and continued into the second quarter of 2002, to streamline its operations and activities around its core markets and leadership strategies. | ||
Workforce reduction charges of $117 and $444 for the three months and six months ended June 30, 2002, respectively, were related to the cost of severance and benefits associated with approximately 1,900 and 6,300 employees notified of termination, respectively, across all of Nortel Networks segments. | ||
Contract settlement costs included negotiated settlements of approximately $1 and $64 for the three months and six months ended June 30, 2002, respectively, to either cancel contracts or renegotiate existing contracts across all of Nortel Networks segments. | ||
As part of its review of financial results during the six months ended June 30, 2002, Nortel Networks performed assessments of certain plant and equipment assets, primarily in the Optical Networks segment, due to the current market conditions and the delay in the anticipated recovery of that segment. The conclusion of these assessments resulted in a write down of certain plant and equipment assets within the Optical Networks segment of approximately $270 during the three months ended June 30, 2002. These plant and equipment assets continue to be held and used, and were written down to estimated fair value based on market assessments. During the three months ended March |
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31, 2002, the plant and equipment write down included assets within the Optical Networks segment and within global operations, a function that supports all of Nortel Networks segments, totaling approximately $85. | ||
In addition, during the three months ended June 30, 2002, Nortel Networks reassessed the market conditions for certain acquired technology in the Optical Networks segment, and concluded that the associated fair value had declined. As a result, a $15 write off of the remaining book value of this acquired technology was recorded. | ||
During the three months ended March 31, 2002, Nortel Networks concluded that the Xros, Inc. X-1000 IPR&D project did not meet short-term market requirements. Nortel Networks will continue to assess the timing to commercialize this technology and will manage Nortel Networks development program accordingly. In connection with this decision, Nortel Networks recorded a $12 write off of the acquired technology associated with this project. | ||
Year ended December 31, 2001 | ||
For the year ended December 31, 2001, Nortel Networks recorded restructuring charges of $3,359, related to workforce reduction costs of $1,361, contract settlement and lease costs of $883, plant and equipment write downs of $970, and other costs of $145. During the year ended December 31, 2001, there were cumulative cash and non-cash drawdowns against the provision of $1,093 and $1,062, respectively, resulting in an ending provision balance at December 31, 2001 of $1,204. The cash drawdowns related primarily to workforce reduction payments, and the non-cash drawdowns related primarily to the plant and equipment write downs. | ||
Period from January 1, 2001 to June 30, 2002 | ||
Of the approximately 42,400 employees notified during the period from January 1, 2001 to June 30, 2002, approximately 15,400 were direct employees performing manufacturing, assembly, test and inspection activities associated with the production of Nortel Networks products, and approximately 27,000 were indirect sales, marketing, research and development, and administrative employees, and manufacturing managers. The workforce reduction was primarily in North America and the United Kingdom and extended across all of Nortel Networks segments. As at June 30, 2002, the workforce reduction provision balance has been drawn down by cumulative cash payments of $1,420, resulting in an ending provision balance for workforce reduction of $399. The remaining provision is expected to be substantially drawn down by the second quarter of 2003. | ||
In conjunction with the above noted workforce reduction, Nortel Networks identified a number of leased and owned facilities comprised of office, warehouse and manufacturing space, as well as leased manufacturing equipment, that were no longer required. As a result, Nortel Networks recorded net lease costs of approximately $757. The costs primarily related to Nortel Networks future contractual obligations under operating leases. Offsetting the total lease charge is approximately $479 in expected sublease revenue on leases that Nortel Networks cannot terminate. The reduction in expected sublease revenue of $27 in the three months ended June 30, 2002 was as a result of Nortel Networks ability to terminate certain leases early and at a discount to the originally anticipated lease costs associated with these leases. Nortel Networks expects to have subleased substantially all of these properties by the end of 2004. In addition, Nortel Networks wrote down the net carrying value of specific owned facilities across all segments within North America and the United Kingdom. The write down of approximately $95, which is included in plant and equipment write downs, reflected the net realizable value based on market assessments for general purpose facilities. | ||
Contract settlement costs included negotiated settlements of approximately $190, to either cancel contracts or renegotiate existing contracts across all of Nortel Networks segments. As at June 30, 2002, the provision balance for contract settlement and lease costs has been drawn down by cumulative cash payments of $296, resulting in an ending provision balance of $651. The remaining provision is now expected to be substantially drawn down by the end of 2006. | ||
Plant and equipment write downs of approximately $459 consisted of the write down of leasehold improvements and certain information technology equipment associated with the exiting of the above noted leased and owned facilities. |
14
In addition, as a result of the significant negative industry and economic trends impacting Nortel Networks operations and expected future growth rates, Nortel Networks has performed assessments of certain plant and equipment assets as part of its review of financial results during 2001 and the first six months of 2002. The conclusion of these assessments resulted in write downs of certain plant and equipment assets totaling approximately $771, as summarized below. | ||
Within the Optical Networks segment, it was determined that there was excess manufacturing equipment at a number of facilities that would no longer be required, or the carrying value of which was not recoverable from future cash flows, as a result of the industry and economic environment. As a result, Nortel Networks recorded charges totaling approximately $592 to write down the value of this equipment to its net realizable value based on the current fair market value for this type of specialized equipment. Nortel Networks expects to dispose of this equipment, other than equipment that it continues to hold and use, by the end of 2002. In 2001, Nortel Networks also wrote down the net carrying value of a specialized manufacturing facility within the Optical Networks segment for the production of optical components within North America. The write down of approximately $91 reflects the net realizable value based on market assessments for a general purpose facility. | ||
Within global operations, it was determined that there was excess test equipment at a number of system houses that would no longer be required as a result of the industry and economic environment. As a result, Nortel Networks recorded charges totaling approximately $88 to write down the value of this equipment to its net realizable value based on the current fair value for this type of specialized equipment. Nortel Networks expects to dispose of this equipment by the end of 2002. | ||
7. | Income taxes | |
Nortel Networks effective tax benefit rate fluctuates from period to period primarily as a result of the impact of IPR&D expense, stock option compensation, goodwill write downs, certain non-tax deductible restructuring charges, and non-tax deductible goodwill amortization prior to January 1, 2002. Excluding these impacts as applicable, Nortel Networks effective tax benefit rate was 30.3 percent and 32.0 percent for the three months ended June 30, 2002 and 2001, respectively, and was 31.0 percent and 32.0 percent for the six months ended June 30, 2002 and 2001, respectively, and reflected changes in the geographic earnings (loss) mix. | ||
Recently approved tax legislation in the United States extended the net operating loss carry-back period from two years to five years. As a result, during the three months ended March 31, 2002, Nortel Networks carried back available United States losses from 2001 and utilized approximately $700 of previously recognized deferred income tax assets. | ||
Global investment tax credits of $29 and $11 for the three months ended June 30, 2002 and 2001, respectively, and $54 and $47 for the six months ended June 30, 2002 and 2001, respectively, have been incorporated into the income tax benefit. | ||
8. | Common shares and prepaid forward purchase contracts | |
On June 12, 2002, Nortel Networks issued 632,500,000 common shares for net proceeds of approximately $856. Concurrent with the common share offering, 28,750 equity units were offered, each initially evidencing its holders ownership of a prepaid forward purchase contract (purchase contract), entitling the holder to receive Nortel Networks common shares and specified zero-coupon U.S. treasury securities (U.S. treasury strips). Net proceeds to Nortel Networks from the purchase contracts were $623. |
15
The settlement date for each purchase contract will be August 15, 2005, subject to acceleration or early settlement in certain cases. The aggregate number of Nortel Networks common shares issuable on the settlement date will be between approximately 485 million and 583 million, subject to some anti-dilution adjustments. On the settlement date (or earlier if an acceleration event occurs prior to the settlement date or if the holder has elected an early settlement option), Nortel Networks will issue and deliver to the holder of each purchase contract after February 15, 2003 between 16,885.93 and 20,263.12 of its common shares (depending on the applicable market value), subject to some anti-dilution adjustments. The applicable market value will be the average of the closing prices of Nortel Networks common shares on the New York Stock Exchange during a period shortly before the settlement date. If the applicable market value of Nortel Networks common shares is: |
| greater than $1.692 per share, 16,885.93 common shares will be issued and delivered for each purchase contract; | ||
| less than or equal to $1.692 per share but greater than $1.410 per share, the number of common shares to be issued and delivered for each purchase contract will be equal to $28,571.00 divided by the applicable market value; and | ||
| less than or equal to $1.410 per share, 20,263.12 common shares will be issued and delivered for each purchase contract. |
Commencing August 15, 2002, a holder of purchase contracts may elect to accelerate the settlement date in respect of some or all of its purchase contracts. Upon an early settlement on or after August 15, 2002 and prior to February 15, 2003, the holder will receive 16,011.04 Nortel Networks common shares per purchase contract (regardless of the market price of Nortel Networks common shares at that time), subject to some anti-dilution adjustments. Upon an early settlement on or after February 15, 2003, the holder will receive 16,885.93 Nortel Networks common shares per purchase contract (regardless of the market price of Nortel Networks common shares at that time), subject to some anti-dilution adjustments. | ||
Commencing August 15, 2002, if Nortel Networks Corporation is involved in a merger, amalgamation, arrangement, consolidation or other reorganization event (other than with or into Nortel Networks Limited or certain other subsidiaries) in which all of its common shares are exchanged for consideration of at least 30 percent of the value of which consists of cash or cash equivalents, then a holder of purchase contracts may elect to accelerate and settle some or all of its purchase contracts, for Nortel Networks common shares. | ||
Commencing August 15, 2002, the settlement date under each purchase contract will automatically accelerate upon occurrence of specified events of bankruptcy, insolvency or reorganization with respect to Nortel Networks Corporation. Upon acceleration of the settlement date, holders will be entitled to receive 20,263.12 Nortel Networks common shares per purchase contract (regardless of the market price of Nortel Networks common shares at that time), subject to some anti-dilution adjustments. | ||
The purchase contracts are classified in shareholders equity as part of additional paid-in capital. | ||
The U.S. treasury strips were purchased directly by a representative of the underwriters from the gross proceeds of the equity unit offering and were delivered to a third party acting as a custodian on behalf of the equity unit holders. Nortel Networks has no obligations with respect to or interest in the U.S. treasury strips. | ||
9. | Loss per common share | |
Basic earnings (loss) per common share is calculated by dividing the net earnings (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share is calculated by dividing the applicable net earnings (loss) by the sum of the weighted average number of common shares outstanding and all additional common shares that would have been outstanding if potentially dilutive common shares had been issued during the period. |
16
The following table details the weighted average number of common shares outstanding: |
Three months ended | Six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(in millions of shares) | 2002 | 2001 | 2002 | 2001 | ||||||||||||
Weighted average number of common shares outstanding basic and diluted(a) |
3,450 | 3,193 | 3,333 | 3,170 |
(a) | The basic weighted average number of common shares outstanding includes the minimum number of common shares to be issued upon settlement of the purchase contracts of 485, assuming no early acceleration by holders (see note 8). The impact of these 485 shares on a weighted basis is 101 and 51 for the three months and six months ended June 30, 2002, respectively. |
As a result of the net losses for the three months and six months ended June 30, 2002 and 2001, the following potentially dilutive securities have not been included in the calculation of diluted loss per common share because to do so would have been anti-dilutive: |
Three months ended | Six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(in millions of shares) | 2002 | 2001 | 2002 | 2001 | ||||||||||||
Stock options |
2 | 35 | 3 | 60 | ||||||||||||
4.25 percent convertible senior notes due on September 1, 2008 |
180 | | 180 | | ||||||||||||
Purchase contracts (note 8) |
17 | | 9 | | ||||||||||||
Total |
199 | 35 | 192 | 60 | ||||||||||||
10. | Comprehensive loss | |
The components of comprehensive loss, net of tax, were as follows: |
Three months ended | Six months ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
Net loss |
$ | (697 | ) | $ | (19,428 | ) | $ | (1,538 | ) | $ | (22,008 | ) | |||||
Other comprehensive income (loss): |
|||||||||||||||||
Change in foreign currency translation adjustment(a) |
150 | 46 | 77 | (246 | ) | ||||||||||||
Unrealized gain (loss) on investments net(b) |
(19 | ) | 14 | (3 | ) | (73 | ) | ||||||||||
Unrealized derivative gains (losses) on cash flow hedges net(c) |
14 | 17 | 15 | (6 | ) | ||||||||||||
Comprehensive loss |
$ | (552 | ) | $ | (19,351 | ) | $ | (1,449 | ) | $ | (22,333 | ) | |||||
(a) | The change in the foreign currency translation adjustment is not adjusted for income taxes as it relates to indefinite investments in non-United States subsidiaries. | ||
(b) | Certain securities deemed available-for-sale by Nortel Networks are measured at fair value. Unrealized holding gains and losses related to these securities are excluded from net loss and are included in comprehensive loss until they are realized. | ||
(c) | Net derivative losses reclassified to selling, general and administrative expense were $8 and $14, respectively, during the three months and six months ended June 30, 2002, and nil and $5, respectively, during the three months and six months ended June 30, 2001. Nortel Networks estimates that $2 of net derivative losses included in other comprehensive loss will be reclassified into net earnings (loss) within the next twelve months. |
17
11. | Stock-based compensation plans | |
On June 20, 2001, Nortel Networks commenced a voluntary stock option exchange program (the Exchange Program) for Nortel Networks employees, whereby employees could exchange certain then outstanding stock options for new stock options, based on a prescribed formula. Terms of the Exchange Program were such that new grants would take place at least six months and a day from the stock option cancellation date, which was July 27, 2001. Approximately 93,416,000 stock options were accepted and cancelled. Nortel Networks then Board of Directors and its then board appointed officers were not eligible to participate in the Exchange Program. | ||
On January 29, 2002, Nortel Networks granted approximately 52,700,000 new stock options in connection with the Exchange Program with exercise prices of $7.16 in United States dollars and $11.39 in Canadian dollars per common share, which was the fair market value of Nortel Networks common shares on the date of the grant. | ||
Nortel Networks, as permitted under SFAS No. 123, Accounting for Stock-based Compensation (SFAS 123), applies APB No. 25, Accounting for Stock Issued to Employees and related interpretations in accounting for its plans. SFAS 123 requires disclosure of pro forma amounts to reflect the impact if Nortel Networks had elected to adopt the optional recognition provisions of SFAS 123 for its stock option plans and employee stock purchase plans. Accordingly, Nortel Networks net loss and loss per common share would have been increased to the pro forma amounts as indicated below for the three months and six months ended June 30, and the years ended December 31: |
Three months ended | Six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||
Net loss: |
||||||||||||||||
Basic and diluted loss per- reported(a) |
$ | (697 | ) | $ | (17,690 | ) | $ | (1,538 | ) | $ | (18,578 | ) | ||||
Basic and diluted loss per- pro forma |
$ | (1,026 | ) | $ | (18,036 | ) | $ | (2,196 | ) | $ | (19,408 | ) | ||||
Basic and diluted loss per common share: |
||||||||||||||||
Basic and diluted loss per- reported(a) |
$ | (0.20 | ) | $ | (5.54 | ) | $ | (0.46 | ) | $ | (5.86 | ) | ||||
Basic and diluted loss per- pro forma |
$ | (0.30 | ) | $ | (5.65 | ) | $ | (0.66 | ) | $ | (6.12 | ) | ||||
Year ended December 31, | ||||||||||||
2001 | 2000 | 1999 | ||||||||||
Net earnings (loss): |
||||||||||||
Basic and diluted loss per- reported(a) |
$ | (22,955 | ) | $ | 489 | $ | 856 | |||||
Basic and diluted loss per- pro forma |
$ | (24,601 | ) | $ | (915 | ) | $ | 368 | ||||
Basic earnings (loss) per common share: |
||||||||||||
Basic and diluted loss per- reported(a) |
$ | (7.20 | ) | $ | 0.17 | $ | 0.32 | |||||
Basic and diluted loss per- pro forma |
$ | (7.72 | ) | $ | (0.31 | ) | $ | 0.14 | ||||
Diluted earnings (loss) per common share: |
||||||||||||
Basic and diluted loss per- reported(a) |
$ | (7.20 | ) | $ | 0.16 | $ | 0.31 | |||||
Basic and diluted loss per- pro forma |
$ | (7.72 | ) | $ | (0.31 | ) | $ | 0.13 | ||||
(a) | The reported amounts for the three months and six months ended June 30, 2001, and the years ended December 2001, 2000 and 1999 have been adjusted to reflect the impact of the SFAS 142 requirement to cease the amortization of goodwill on net loss and basic and diluted loss per common share as if the standard had been in effect beginning January 1, 1999 (see note 3). |
18
The fair value of stock options used to compute pro forma net earnings (loss) and earnings (loss) per common share disclosures is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following weighted average assumptions: |
Three months ended | Six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Weighted-average assumptions | 2002 | 2001 | 2002 | 2001 | ||||||||||||
Expected dividend |
0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | ||||||||
Expected volatility |
74.27 | % | 85.29 | % | 71.24 | % | 70.69 | % | ||||||||
Risk-free interest rate |
4.26 | % | 4.70 | % | 4.50 | % | 4.76 | % | ||||||||
Expected option life in years |
4 | 4 | 4 | 4 | ||||||||||||
Year ended December 31, | ||||||||||||
Weighted-average assumptions | 2001 | 2000 | 1999 | |||||||||
Dividend yield |
0.00 | % | 0.13 | % | 0.22 | % | ||||||
Expected volatility |
70.36 | % | 54.01 | % | 56.44 | % | ||||||
Risk-free interest rate |
4.49 | % | 4.94 | % | 6.21 | % | ||||||
Expected option life in years |
4 | 4 | 4 | |||||||||
The weighted average fair values of Nortel Networks stock options, calculated using the Black-Scholes option-pricing model, granted during the three months ended June 30, 2002 and 2001 were $1.45 and $7.35 per share, respectively, during the six months ended June 30, 2002 and 2001 were $3.51 and $16.00 per share, respectively, and during the three years ended December 31, 2001, 2000 and 1999 were $8.38, $27.25 and $24.14 per share, respectively. | ||
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected price volatility. Nortel Networks uses expected volatility rates, which are based on historical volatility rates trended into future years. Changes in the subjective input assumptions can materially affect the fair value estimate, and therefore the existing models do not necessarily provide a reliable single measure of the fair value of Nortel Networks stock options. | ||
12. | Segmented information | |
General description | ||
Nortel Networks operations are organized around three reportable segments; Metro and Enterprise Networks (Metro and Enterprise), Wireless Networks (Wireless), and Optical Networks (Optical, formerly named Optical Long-Haul Networks). Nortel Networks reportable segments are focused on providing seamless networking products and service capabilities across Metro and Enterprise, Wireless, and Optical. These product and service solutions are used by service provider and enterprise customers, including incumbent and competitive local exchange carriers, interexchange carriers, service providers with global businesses, wireless service providers, Internet service providers, application service providers, hosting service providers, resellers, cable television companies, other communication service providers, large businesses and their branch offices, small businesses, and home offices, as well as government, education, and utility organizations. Metro and Enterprise includes data switching systems, routers, and aggregation products to deliver services via Internet Protocol (IP) and other protocol standards across local and wide area networks, voice over IP solutions for both greenfield and circuit to packet network transitions, and traditional voice circuit switching. Wireless includes wireless mobility switching and access products for voice and data communications that span most major global mobility standards. Optical includes long-haul optical transmission products designed to provide long-distance, high capacity dense wavelength division multiplexing transport, metro optical transmission products, traditional optical transmission systems that support most global transmission standards, optical switch platforms, and optical components for long distance optical networks. |
19
Other represents miscellaneous business activities and corporate functions. None of these activities meet the quantitative criteria to be disclosed as reportable segments. | ||
As described in note 4, Nortel Networks access solutions operations were discontinued during the year ended December 31, 2001. These operations were previously included as a separate segment within Other. The data included below excludes amounts related to the operations of the access solutions segment. | ||
Nortel Networks President and Chief Executive Officer (CEO) has been identified as the chief operating decision maker in assessing the performance of the segments and the allocation of resources to the segments. Each reportable segment is managed separately with each segment manager reporting directly to the CEO. The CEO relies on the information derived directly from Nortel Networks management reporting system. Contribution margin represents the primary financial measure used by the CEO in assessing performance and allocating resources, and includes the cost of revenues, and selling, general and administrative expense, for which the segment managers are held accountable. Costs associated with shared services, and other corporate costs, are allocated to the segments based on usage determined by headcount. Costs not allocated are primarily related to Nortel Networks corporate compliance and other non-operational activities and are included in Other. In addition, the CEO does not review asset information on a segmented basis. The accounting policies of the reportable segments are the same as those described in Nortel Networks audited Consolidated Financial Statements for the year ended December 31, 2001 to the extent that the related items are included within contribution margin. | ||
Segments | ||
During the three months ended June 30, 2002, management shifted the accountability for the metro optical portion of Metro and Enterprise to Optical. Consequently, financial information for these two segments has been reported on the new basis commencing in the three months ended June 30, 2002 and historical comparative financial information has been restated. The following tables set forth information by segments: |
Three months ended | Six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||
Revenues |
||||||||||||||||
Metro and Enterprise |
$ | 1,223 | $ | 1,994 | $ | 2,577 | $ | 4,422 | ||||||||
Wireless |
1,123 | 1,616 | 2,259 | 3,161 | ||||||||||||
Optical |
406 | 757 | 812 | 2,326 | ||||||||||||
Other |
21 | 243 | 37 | 452 | ||||||||||||
Total |
$ | 2,773 | $ | 4,610 | $ | 5,685 | $ | 10,361 | ||||||||
Contribution margin |
||||||||||||||||
Metro and Enterprise |
$ | 172 | $ | 214 | $ | 351 | $ | 739 | ||||||||
Wireless |
241 | (6 | ) | 485 | 173 | |||||||||||
Optical |
(204 | ) | (993 | ) | (496 | ) | (1,015 | ) | ||||||||
Other |
(18 | ) | (431 | ) | (135 | ) | (596 | ) | ||||||||
Total |
191 | (1,216 | ) | 205 | (699 | ) | ||||||||||
Research and development expense |
(579 | ) | (910 | ) | (1,174 | ) | (1,853 | ) | ||||||||
In-process research and development expense |
| | | (15 | ) | |||||||||||
Amortization of acquired technology |
(41 | ) | (285 | ) | (84 | ) | (559 | ) | ||||||||
Amortization of goodwill |
| (1,639 | ) | | (3,231 | ) | ||||||||||
Stock option compensation |
(21 | ) | (25 | ) | (46 | ) | (59 | ) | ||||||||
Special charges |
(403 | ) | (13,570 | ) | (890 | ) | (13,925 | ) | ||||||||
Gain on sale of businesses |
| | 14 | | ||||||||||||
Consolidated operating loss |
$ | (853 | ) | $ | (17,645 | ) | $ | (1,975 | ) | $ | (20,341 | ) | ||||
20
13. | Commitments | |
Nortel Networks enters into bid and performance bonds related to various contracts, which generally have terms of less than two years. Potential payments due under these bonds are related to performance under the applicable contract. The total commercial commitments representing amounts available and undrawn was $1,250 at June 30, 2002. Due to the current general economic and industry environment, and NNLs current credit ratings, the basis under which performance bonds are obtained has changed, resulting in (but not limited to) increased cash collateral requirements and/or increased fees in connection with obtaining new performance bonds. As at June 30, 2002, approximately $32 of cash and cash equivalents was restricted as cash collateral for certain performance bonds. | ||
14. | Contingencies | |
Subsequent to the February 15, 2001 announcement in which Nortel Networks provided revised guidance for financial performance for the 2001 fiscal year and the first quarter of 2001, Nortel Networks and certain of its then current officers and directors were named as defendants in more than twenty-five purported class action lawsuits. These lawsuits in the United States District Courts for the Eastern District of New York, for the Southern District of New York and for the District of New Jersey, and in the provinces of Ontario, Quebec, and British Columbia in Canada, on behalf of shareholders who acquired Nortel Networks securities as early as October 24, 2000 and as late as February 15, 2001, allege, among other things, violations of United States federal and Canadian provincial securities laws. Securities regulatory authorities in Canada and the United States are also reviewing these matters. See note 17 for further information regarding lawsuits in the province of Ontario. On May 11, 2001, Nortel Networks filed motions to dismiss and/or stay in connection with the three proceedings in Quebec primarily based on the factual allegations lacking substantial connection to Quebec and the inclusion of shareholders resident in Quebec in the class claimed in the Ontario lawsuit. The plaintiffs in two of these proceedings in Quebec obtained court approval for discontinuances of their proceedings on January 17, 2002. The motion to dismiss and/or stay the third proceeding was heard on November 6, 2001 and the court deferred any determination on the motion to the judge who will hear the application for authorization to commence a class proceeding. On December 6, 2001, Nortel Networks filed a motion seeking leave to appeal that decision. The motion for leave to appeal was dismissed on March 11, 2002. On October 16, 2001, an order in the Southern District of New York was filed consolidating twenty-five of the related United States class action lawsuits into a single case, appointing class plaintiffs and counsel for such plaintiffs. The plaintiffs served a consolidated amended complaint on January 18, 2002. On December 17, 2001, the defendants in the British Columbia action served notice of a motion requesting the court to decline jurisdiction and to stay all proceedings on the ground that British Columbia is an inappropriate forum. | ||
A class action lawsuit was also filed in the United States District Court for the Southern District of New York on behalf of shareholders who acquired the securities of JDS Uniphase Corporation (JDS) between January 18, 2001 and February 15, 2001, alleging violations of the same United States federal securities laws as the above-noted lawsuits. | ||
On April 1, 2002, Nortel Networks filed a motion to dismiss both the above consolidated United States shareholder class action and the above JDS shareholder class action complaints on the grounds that they failed to state a cause of action under United States federal securities laws. With respect to the JDS shareholder class action complaint, Nortel Networks also moved to dismiss on the separate basis that JDS shareholders lacked standing to sue Nortel Networks. | ||
A purported class action lawsuit was filed in the United States District Court for the Middle District of Tennessee on December 21, 2001, on behalf of participants and beneficiaries of the Nortel Networks Long-Term Investment Plan (the Plan) at any time during the period of March 7, 2000 through the filing date and who made or maintained Plan investments in Nortel Networks common shares, under the Employee Retirement Income Security Act for Plan-wide relief and alleging, among other things, material misrepresentations and omissions to induce Plan participants to continue to invest in and maintain investments in Nortel Networks common shares in the Plan. A second purported class action lawsuit, on behalf of the Plan and Plan participants for whose individual accounts the Plan purchased Nortel Networks common shares during the period from October 27, 2000 to February 15, 2001, and making similar allegations, was filed in the same court on March 12, 2002. A third purported class action lawsuit, on behalf of persons who are or were Plan participants or beneficiaries at any time since March 1, 1999 to the filing date, and making similar allegations, was filed in the same court on March 21, 2002. The first and second purported class action lawsuits were consolidated by a new purported class action complaint, filed on May 15, 2002 in the same court and |
21
making similar allegations, on behalf of Plan participants and beneficiaries who directed the Plan to purchase or hold shares of certain funds, which held primarily Nortel Networks common shares, during the period of March 7, 2000 through December 21, 2000. | ||
On February 12, 2001, Nortel Networks Inc. (NNI), an indirect subsidiary of Nortel Networks, was served with a consolidated amended class action complaint (the First Complaint) that purported to add Nortel Networks as a defendant to a lawsuit commenced in July 2000 against Entrust, Inc. (formerly Entrust Technologies, Inc.) (Entrust) and two of its then current officers in the United States District Court for the Eastern District of Texas (Marshall Division) (the District Court). The First Complaint alleges that Entrust, two officers of Entrust, and Nortel Networks violated the Securities Exchange Act of 1934 with respect to certain statements made by Entrust. Nortel Networks is alleged to be a controlling person of Entrust. On April 6, 2001, Nortel Networks filed a motion to dismiss the First Complaint. On July 31, 2001, the First Complaint was dismissed without prejudice. On August 31, 2001, the plaintiffs filed a second amended class action complaint (the Second Complaint) against the same defendants asserting claims substantively similar to those in the First Complaint. On September 21, 2001, Nortel Networks filed a motion to dismiss the Second Complaint. The motion is currently under consideration by the District Court. | ||
On March 4, 1997, Bay Networks, Inc. (Bay Networks), a company acquired on August 31, 1998, announced that shareholders had filed two separate lawsuits in the United States District Court for the Northern District of California (the Federal Court) and the California Superior Court, County of Santa Clara (the California Court), against Bay Networks and ten of Bay Networks then current and former officers and directors, purportedly on behalf of a class of shareholders who purchased Bay Networks common shares during the period of May 1, 1995 through October 14, 1996. On August 17, 2000, the Federal Court granted the defendants motion to dismiss the federal complaint. On August 1, 2001, the United States Court of Appeals for the Ninth Circuit denied the plaintiffs appeal of that decision. On April 18, 1997, a second lawsuit was filed in the California Court, purportedly on behalf of a class of shareholders who acquired Bay Networks common shares pursuant to the registration statement and prospectus that became effective on November 15, 1995. The two actions in the California Court were consolidated in April 1998; however, the California Court denied the plaintiffs motion for class certification. In January 2000, the California Court of Appeal rejected the plaintiffs appeal of the decision. A petition for review was filed with the California Supreme Court by the plaintiffs and was denied. In February 2000, new plaintiffs who allege to have been shareholders of Bay Networks during the relevant periods, filed a motion for intervention in the California Court seeking to become the representatives of a class of shareholders. The motion was granted on June 8, 2001 and the new plaintiffs filed their complaint-in-intervention on an individual and purported class representative basis alleging misrepresentations made in connection with the purchase and sale of securities of Bay Networks in violation of California statutory and common law. On March 11, 2002, the California Court granted the defendants motion to strike the class allegations. The plaintiffs were permitted to proceed on their individual claims. The plaintiffs are appealing the dismissal of their class allegations. | ||
Except as otherwise described herein or in note 17, in each of the matters described above, plaintiffs are seeking an unspecified amount of money damages. | ||
Nortel Networks is also a defendant in various other suits, claims, proceedings and investigations which arise in the normal course of business. | ||
Nortel Networks is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact of the above matters which seek damages of material or indeterminate amounts, and therefore cannot determine whether these actions, suits, claims, proceedings and investigations will, individually or collectively, have a material adverse effect on the business, results of operations, and financial condition of Nortel Networks. Nortel Networks and any named directors and officers of Nortel Networks intend to vigorously defend these actions, suits, claims, proceedings and investigations. |
22
15. | Credit facilities | |
Effective April 8, 2002, NNL and NNI amended and extended the 364-day revolving syndicated credit agreements originally entered into on April 12, 2000 and subsequently amended on April 11, 2001. The April 8, 2002 amendments reduced the size of the 364-day committed revolving facilities to $1,175 from $1,750, extended the term to April 7, 2003 with no additional term-out period thereafter, maintained the financial covenant in the April 2001 facilities requiring NNLs minimum consolidated tangible net worth to be not less than $1,888, and included higher pricing reflecting the then current credit and bank environment. | ||
On June 27, 2002, Nortel Networks sold certain real estate in the United Kingdom, which resulted in a reduction, effective July 2, 2002, in the available commitments under the December 20, 2001 $1,575 credit facilities by approximately $57. | ||
16. | Recent pronouncements | |
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations (SFAS 143), which is effective for financial statements issued for fiscal years beginning after June 15, 2002. SFAS 143 addresses the recognition and remeasurement of obligations associated with the retirement of a tangible long-lived asset. Nortel Networks has not yet determined the effect that the adoption of SFAS 143 will have on the business, results of operations, and financial condition of Nortel Networks. | ||
17. | Subsequent events | |
On July 17, 2002, a purported class action lawsuit (the Ontario Claim) was filed in the Ontario Superior Court of Justice, Commercial List, naming Nortel Networks, certain of its current and former officers and directors, and its auditor as defendants. The factual allegations in the Ontario Claim are substantially similar to the allegations in the consolidated amended complaint filed in the United States District Court described in the first paragraph of note 14. The Ontario Claim is on behalf of all Canadian residents who purchased Nortel Networks securities (including options on Nortel Networks securities) between October 24, 2000 and February 15, 2001. The plaintiffs claim damages of Cdn.$5,000, plus punitive damages in the amount of Cdn.$1,000, prejudgment and postjudgment interest, and costs of the action. Nortel Networks and the named directors and officers of Nortel Networks intend to vigorously defend the Ontario Claim. | ||
18. | Supplemental consolidating financial information | |
As a result of NNLs current credit ratings, various liens, pledges, and guarantees are effective under certain credit and security agreements entered into by NNL and various of its subsidiaries. In addition, in accordance with the covenants in the trust indentures for all of Nortel Networks current consolidated public debt securities, which represent primarily all of Nortel Networks consolidated long-term debt at June 30, 2002, all such public debt securities are also secured equally and ratably with the obligations under all of NNL and NNIs credit agreements by liens on substantially all of the assets of NNL and those of most of its United States and Canadian subsidiaries, and by pledges of shares in certain of NNLs other subsidiaries. In addition, certain of NNLs wholly owned subsidiaries have guaranteed NNLs obligations under the credit agreements and outstanding public debt securities (the Guarantor Subsidiaries). Non-guarantor subsidiaries (the Non-Guarantor Subsidiaries) represent either wholly owned subsidiaries of Nortel Networks whose shares have been pledged, or are the remaining subsidiaries of Nortel Networks which are not providing liens, pledges, or guarantees. | ||
The following supplemental consolidating financial data illustrates, in separate columns, the composition of Nortel Networks Corporation, NNL, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries, eliminations, and the consolidated total as at June 30, 2002 and December 31, 2001, and for the three months and six months ended June 30, 2002 and 2001. |
23
Investments in subsidiaries are accounted for by the equity method for purposes of the supplemental consolidating financial data. Net earnings (loss) of subsidiaries are, therefore, reflected in the investment accounts and net loss. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. The financial data may not necessarily be indicative of the results of operations or financial position had the subsidiaries been operated as independent entities. |
24
Supplemental Consolidating Statements of Operations for the three months ended June 30, 2002:
Nortel | Nortel | Non- | ||||||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | |||||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||||
Revenues |
$ | | $ | 848 | $ | 2,153 | $ | 660 | $ | (888 | ) | $ | 2,773 | |||||||||||||||
Cost of revenues |
| 769 | 1,396 | 538 | (888 | ) | 1,815 | |||||||||||||||||||||
Gross profit |
| 79 | 757 | 122 | | 958 | ||||||||||||||||||||||
Selling, general and administrative expense
(excluding stock option compensation) |
| 101 | 499 | 167 | | 767 | ||||||||||||||||||||||
Research and development expense |
| 241 | 248 | 90 | | 579 | ||||||||||||||||||||||
Amortization of acquired technology |
| | 6 | 35 | | 41 | ||||||||||||||||||||||
Stock option compensation |
| | | 21 | | 21 | ||||||||||||||||||||||
Special charges |
| 185 | 108 | 110 | | 403 | ||||||||||||||||||||||
Operating loss |
| (448 | ) | (104 | ) | (301 | ) | | (853 | ) | ||||||||||||||||||
Equity in net loss of associated companies |
(678 | ) | (355 | ) | (134 | ) | (7 | ) | 1,164 | (10 | ) | |||||||||||||||||
Other income (expense) net |
| 34 | (35 | ) | 7 | (5 | ) | 1 | ||||||||||||||||||||
Interest expense |
||||||||||||||||||||||||||||
Long-term debt |
(21 | ) | (27 | ) | | (7 | ) | | (55 | ) | ||||||||||||||||||
Other |
| (3 | ) | (4 | ) | (2 | ) | | (9 | ) | ||||||||||||||||||
Loss from continuing operations before income taxes |
(699 | ) | (799 | ) | (277 | ) | (310 | ) | 1,159 | (926 | ) | |||||||||||||||||
Income tax benefit |
2 | 230 | (16 | ) | 13 | | 229 | |||||||||||||||||||||
Net loss from continuing operations |
(697 | ) | (569 | ) | (293 | ) | (297 | ) | 1,159 | (697 | ) | |||||||||||||||||
Net loss from discontinued operations - - net of tax |
| | | | | | ||||||||||||||||||||||
Net loss |
$ | (697 | ) | $ | (569 | ) | $ | (293 | ) | $ | (297 | ) | $ | 1,159 | $ | (697 | ) | |||||||||||
25
Supplemental Consolidating Statements of Operations for the three months ended June 30, 2001:
Nortel | Nortel | Non- | ||||||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | |||||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||||
Revenues |
$ | | $ | 1,198 | $ | 3,273 | $ | 1,554 | $ | (1,415 | ) | $ | 4,610 | |||||||||||||||
Cost of revenues |
| 1,287 | 2,848 | 1,464 | (1,415 | ) | 4,184 | |||||||||||||||||||||
Gross profit (loss) |
| (89 | ) | 425 | 90 | | 426 | |||||||||||||||||||||
Selling, general and administrative expense
(excluding stock option compensation) |
| 93 | 1,246 | 303 | | 1,642 | ||||||||||||||||||||||
Research and development expense |
| 339 | 429 | 142 | | 910 | ||||||||||||||||||||||
Amortization of intangibles |
||||||||||||||||||||||||||||
Acquired technology |
| | 203 | 82 | | 285 | ||||||||||||||||||||||
Goodwill |
| 4 | 458 | 1,177 | | 1,639 | ||||||||||||||||||||||
Stock option compensation |
| | | 25 | | 25 | ||||||||||||||||||||||
Special charges |
| 159 | 1,597 | 11,814 | | 13,570 | ||||||||||||||||||||||
Gain on sale of businesses |
| | (13 | ) | 13 | | | |||||||||||||||||||||
Operating loss |
| (684 | ) | (3,495 | ) | (13,466 | ) | | (17,645 | ) | ||||||||||||||||||
Equity in net earnings (loss) of associated companies |
(16,637 | ) | (5,158 | ) | (1,068 | ) | 1 | 22,746 | (116 | ) | ||||||||||||||||||
Other income (expense) net |
2 | 14 | (106 | ) | 50 | (7 | ) | (47 | ) | |||||||||||||||||||
Interest expense |
||||||||||||||||||||||||||||
Long-term debt |
| (39 | ) | 1 | (7 | ) | | (45 | ) | |||||||||||||||||||
Other |
| (9 | ) | (32 | ) | (2 | ) | | (43 | ) | ||||||||||||||||||
Loss from continuing operations before income taxes |
(16,635 | ) | (5,876 | ) | (4,700 | ) | (13,424 | ) | 22,739 | (17,896 | ) | |||||||||||||||||
Income tax benefit (provision) |
(9 | ) | 495 | 392 | 374 | | 1,252 | |||||||||||||||||||||
Net loss from continuing operations |
(16,644 | ) | (5,381 | ) | (4,308 | ) | (13,050 | ) | 22,739 | (16,644 | ) | |||||||||||||||||
Net loss from discontinued operations - - net of tax |
(2,784 | ) | (2,351 | ) | (1,528 | ) | (433 | ) | 4,312 | (2,784 | ) | |||||||||||||||||
Net loss |
$ | (19,428 | ) | $ | (7,732 | ) | $ | (5,836 | ) | $ | (13,483 | ) | $ | 27,051 | $ | (19,428 | ) | |||||||||||
26
Supplemental Consolidating Statements of Operations for the six months ended June 30, 2002:
Nortel | Nortel | Non- | ||||||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | |||||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||||
Revenues |
$ | | $ | 1,604 | $ | 4,191 | $ | 1,458 | $ | (1,568 | ) | $ | 5,685 | |||||||||||||||
Cost of revenues |
| 1,462 | 2,935 | 1,140 | (1,568 | ) | 3,969 | |||||||||||||||||||||
Gross profit |
| 142 | 1,256 | 318 | | 1,716 | ||||||||||||||||||||||
Selling, general and administrative expense
(excluding stock option compensation) |
| 235 | 1,042 | 234 | | 1,511 | ||||||||||||||||||||||
Research and development expense |
| 438 | 551 | 185 | | 1,174 | ||||||||||||||||||||||
Amortization of acquired technology |
| | 11 | 73 | | 84 | ||||||||||||||||||||||
Stock option compensation |
| | | 46 | | 46 | ||||||||||||||||||||||
Special charges |
| 263 | 334 | 293 | | 890 | ||||||||||||||||||||||
Gain on sale of businesses |
| (1 | ) | (3 | ) | (10 | ) | | (14 | ) | ||||||||||||||||||
Operating loss |
| (793 | ) | (679 | ) | (503 | ) | | (1,975 | ) | ||||||||||||||||||
Equity in net loss of associated companies |
(1,495 | ) | (887 | ) | (248 | ) | (7 | ) | 2,623 | (14 | ) | |||||||||||||||||
Other income (expense) net |
(7 | ) | 34 | (57 | ) | 22 | (10 | ) | (18 | ) | ||||||||||||||||||
Interest expense |
||||||||||||||||||||||||||||
Long-term debt |
(43 | ) | (56 | ) | | (14 | ) | | (113 | ) | ||||||||||||||||||
Other |
| (3 | ) | (16 | ) | (2 | ) | | (21 | ) | ||||||||||||||||||
Loss from continuing operations before income taxes |
(1,545 | ) | (1,705 | ) | (1,000 | ) | (504 | ) | 2,613 | (2,141 | ) | |||||||||||||||||
Income tax benefit |
7 | 351 | 135 | 110 | | 603 | ||||||||||||||||||||||
Net loss from continuing operations |
(1,538 | ) | (1,354 | ) | (865 | ) | (394 | ) | 2,613 | (1,538 | ) | |||||||||||||||||
Net loss from discontinued operations - - net of tax |
| | | | | | ||||||||||||||||||||||
Net loss |
$ | (1,538 | ) | $ | (1,354 | ) | $ | (865 | ) | $ | (394 | ) | $ | 2,613 | $ | (1,538 | ) | |||||||||||
27
Supplemental Consolidating Statements of Operations for the six months ended June 30, 2001:
Nortel | Nortel | Non- | ||||||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | |||||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||||
Revenues |
$ | | $ | 2,775 | $ | 7,783 | $ | 2,937 | $ | (3,134 | ) | $ | 10,361 | |||||||||||||||
Cost of revenues |
| 2,586 | 5,957 | 2,668 | (3,134 | ) | 8,077 | |||||||||||||||||||||
Gross profit |
| 189 | 1,826 | 269 | | 2,284 | ||||||||||||||||||||||
Selling, general and administrative expense
(excluding stock option compensation) |
| 425 | 2,066 | 492 | | 2,983 | ||||||||||||||||||||||
Research and development expense |
| (93 | ) | 1,692 | 254 | | 1,853 | |||||||||||||||||||||
In-process research and development expense |
| | | 15 | | 15 | ||||||||||||||||||||||
Amortization of intangibles |
||||||||||||||||||||||||||||
Acquired technology |
| | 406 | 153 | | 559 | ||||||||||||||||||||||
Goodwill |
| 9 | 917 | 2,305 | | 3,231 | ||||||||||||||||||||||
Stock option compensation |
| | | 59 | | 59 | ||||||||||||||||||||||
Special charges |
| 245 | 1,847 | 11,833 | | 13,925 | ||||||||||||||||||||||
Gain on sale of businesses |
| | (13 | ) | 13 | | | |||||||||||||||||||||
Operating loss |
| (397 | ) | (5,089 | ) | (14,855 | ) | | (20,341 | ) | ||||||||||||||||||
Equity in net earnings (loss) of associated companies |
(18,986 | ) | (6,693 | ) | (1,290 | ) | 1 | 26,836 | (132 | ) | ||||||||||||||||||
Other income (expense) net |
2 | 40 | (31 | ) | 54 | (15 | ) | 50 | ||||||||||||||||||||
Interest expense |
||||||||||||||||||||||||||||
Long-term debt |
| (70 | ) | 1 | (15 | ) | | (84 | ) | |||||||||||||||||||
Other |
| (19 | ) | (36 | ) | (4 | ) | | (59 | ) | ||||||||||||||||||
Loss from continuing operations before income taxes |
(18,984 | ) | (7,139 | ) | (6,445 | ) | (14,819 | ) | 26,821 | (20,566 | ) | |||||||||||||||||
Income tax benefit (provision) |
(14 | ) | 407 | 688 | 472 | | 1,553 | |||||||||||||||||||||
Net loss from continuing operations |
(18,998 | ) | (6,732 | ) | (5,757 | ) | (14,347 | ) | 26,821 | (19,013 | ) | |||||||||||||||||
Net loss from discontinued operations - - net of tax |
(3,010 | ) | (2,538 | ) | (1,650 | ) | (472 | ) | 4,660 | (3,010 | ) | |||||||||||||||||
Net loss before cumulative effect of accounting change |
(22,008 | ) | (9,270 | ) | (7,407 | ) | (14,819 | ) | 31,481 | (22,023 | ) | |||||||||||||||||
Cumulative effect of accounting change - - net of tax of $9 |
| 15 | | | | 15 | ||||||||||||||||||||||
Net loss |
$ | (22,008 | ) | $ | (9,255 | ) | $ | (7,407 | ) | $ | (14,819 | ) | $ | 31,481 | $ | (22,008 | ) | |||||||||||
28
Supplemental Consolidating Balance Sheets as at June 30, 2002:
Nortel | Nortel | Non- | ||||||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | |||||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||||
ASSETS |
||||||||||||||||||||||||||||
Current assets |
||||||||||||||||||||||||||||
Cash and cash equivalents |
$ | 707 | $ | 681 | $ | 2,514 | $ | 967 | $ | | $ | 4,869 | ||||||||||||||||
Accounts receivable net |
| 412 | 1,372 | 552 | | 2,336 | ||||||||||||||||||||||
Intercompany accounts receivable |
| 4,144 | 1,008 | 521 | (5,671 | ) | 2 | |||||||||||||||||||||
Inventories net |
| 742 | 449 | 262 | | 1,453 | ||||||||||||||||||||||
Income taxes recoverable |
| | 55 | | | 55 | ||||||||||||||||||||||
Deferred income taxes net |
12 | 593 | 502 | 139 | | 1,246 | ||||||||||||||||||||||
Other current assets |
| 170 | 532 | 153 | | 855 | ||||||||||||||||||||||
Current assets of discontinued operations |
| 115 | 214 | 7 | | 336 | ||||||||||||||||||||||
Total current assets |
719 | 6,857 | 6,646 | 2,601 | (5,671 | ) | 11,152 | |||||||||||||||||||||
Long-term receivables net |
112 | 190 | 1,665 | 448 | (2,161 | ) | 254 | |||||||||||||||||||||
Investments at cost and associated companies at equity |
5,927 | 2,071 | (8,219 | ) | 148 | 296 | 223 | |||||||||||||||||||||
Plant and equipment net |
| 473 | 1,197 | 331 | | 2,001 | ||||||||||||||||||||||
Goodwill |
| 33 | 2,131 | 631 | | 2,795 | ||||||||||||||||||||||
Intangible assets net |
| | 8 | 163 | | 171 | ||||||||||||||||||||||
Deferred income taxes net |
(12 | ) | 640 | 1,745 | 75 | | 2,448 | |||||||||||||||||||||
Other assets |
42 | 224 | 181 | 490 | | 937 | ||||||||||||||||||||||
Long-term assets of discontinued operations |
| 37 | 68 | | | 105 | ||||||||||||||||||||||
Total assets |
$ | 6,788 | $ | 10,525 | $ | 5,422 | $ | 4,887 | $ | (7,536 | ) | $ | 20,086 | |||||||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||||||||||||||||||
Current liabilities |
||||||||||||||||||||||||||||
Notes payable |
$ | | $ | 2 | $ | 163 | $ | 175 | $ | | 340 | |||||||||||||||||
Trade and other accounts payable |
10 | 464 | 994 | 126 | | 1,594 | ||||||||||||||||||||||
Intercompany accounts payable |
39 | 112 | 3,572 | 1,954 | (5,671 | ) | 6 | |||||||||||||||||||||
Payroll and benefit-related liabilities |
| 31 | 432 | 99 | | 562 | ||||||||||||||||||||||
Other accrued liabilities |
33 | 1,102 | 3,018 | 1,043 | | 5,196 | ||||||||||||||||||||||
Income taxes payable |
| 16 | 10 | 82 | | 108 | ||||||||||||||||||||||
Long-term debt due within one year |
| 311 | 11 | 3 | | 325 | ||||||||||||||||||||||
Current liabilities of discontinued operations |
| 47 | 88 | 36 | | 171 | ||||||||||||||||||||||
Total current liabilities |
82 | 2,085 | 8,288 | 3,518 | (5,671 | ) | 8,302 | |||||||||||||||||||||
Deferred income |
| 1 | 119 | 3 | | 123 | ||||||||||||||||||||||
Long-term debt |
1,800 | 1,949 | 6 | 370 | | 4,125 | ||||||||||||||||||||||
Deferred income taxes net |
(5 | ) | 350 | 158 | 20 | | 523 | |||||||||||||||||||||
Other liabilities |
| 619 | 1,110 | 1,930 | (2,161 | ) | 1,498 | |||||||||||||||||||||
Minority interest in subsidiary companies |
| | | 68 | 536 | 604 | ||||||||||||||||||||||
1,877 | 5,004 | 9,681 | 5,909 | (7,296 | ) | 15,175 | ||||||||||||||||||||||
SHAREHOLDERS EQUITY |
||||||||||||||||||||||||||||
Preferred shares |
| 536 | 365 | 46 | (947 | ) | | |||||||||||||||||||||
Common shares |
33,860 | 2,111 | 5,391 | 1,535 | (9,037 | ) | 33,860 | |||||||||||||||||||||
Additional paid-in capital |
3,766 | 19,606 | 1,545 | 19,814 | (40,965 | ) | 3,766 | |||||||||||||||||||||
Deferred stock option compensation |
(139 | ) | | | (148 | ) | 148 | (139 | ) | |||||||||||||||||||
Deficit |
(31,689 | ) | (15,871 | ) | (12,517 | ) | (22,118 | ) | 50,506 | (31,689 | ) | |||||||||||||||||
Accumulated other comprehensive income (loss) |
(887 | ) | (861 | ) | 957 | (151 | ) | 55 | (887 | ) | ||||||||||||||||||
Total shareholders equity |
4,911 | 5,521 | (4,259 | ) | (1,022 | ) | (240 | ) | 4,911 | |||||||||||||||||||
Total liabilities and shareholders equity |
$ | 6,788 | $ | 10,525 | $ | 5,422 | $ | 4,887 | $ | (7,536 | ) | $ | 20,086 | |||||||||||||||
29
Supplemental Consolidating Balance Sheets as at December 31, 2001:
Nortel | Nortel | Non- | |||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | ||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | ||||||||||||||||||||
ASSETS |
|||||||||||||||||||||||||
Current assets |
|||||||||||||||||||||||||
Cash and cash equivalents |
$ | 18 | $ | (41 | ) | $ | 2,340 | $ | 1,196 | $ | | $ | 3,513 | ||||||||||||
Accounts receivable net |
| 409 | 2,032 | 482 | | 2,923 | |||||||||||||||||||
Intercompany accounts receivable |
| 4,952 | 1,054 | 637 | (6,643 | ) | | ||||||||||||||||||
Inventories net |
| 810 | 511 | 258 | | 1,579 | |||||||||||||||||||
Income taxes recoverable |
| 343 | 442 | 11 | | 796 | |||||||||||||||||||
Deferred income taxes net |
| 287 | 1,080 | 19 | | 1,386 | |||||||||||||||||||
Other current assets |
| 107 | 563 | 187 | | 857 | |||||||||||||||||||
Current assets of discontinued operations |
| 244 | 454 | 10 | | 708 | |||||||||||||||||||
Total current assets |
18 | 7,111 | 8,476 | 2,800 | (6,643 | ) | 11,762 | ||||||||||||||||||
Long-term receivables net |
168 | 225 | 1,078 | 361 | (1,629 | ) | 203 | ||||||||||||||||||
Investments at cost and associated companies at equity |
6,479 | 2,543 | (8,097 | ) | 516 | (1,188 | ) | 253 | |||||||||||||||||
Plant and equipment net |
| 705 | 1,353 | 513 | | 2,571 | |||||||||||||||||||
Goodwill net |
| 31 | 2,117 | 662 | | 2,810 | |||||||||||||||||||
Intangible assets net |
| | 20 | 265 | | 285 | |||||||||||||||||||
Deferred income taxes net |
5 | 436 | 1,578 | 58 | | 2,077 | |||||||||||||||||||
Other assets |
44 | 132 | 313 | 404 | | 893 | |||||||||||||||||||
Long-term assets of discontinued operations |
| 99 | 184 | | | 283 | |||||||||||||||||||
Total assets |
$ | 6,714 | $ | 11,282 | $ | 7,022 | $ | 5,579 | $ | (9,460 | ) | $ | 21,137 | ||||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
|||||||||||||||||||||||||
Current liabilities |
|||||||||||||||||||||||||
Notes payable |
$ | | $ | 2 | $ | 168 | $ | 256 | $ | | $ | 426 | |||||||||||||
Trade and other accounts payable |
6 | 372 | 1,288 | 322 | | 1,988 | |||||||||||||||||||
Intercompany accounts payable |
54 | 163 | 3,471 | 2,955 | (6,643 | ) | | ||||||||||||||||||
Payroll and benefit-related liabilities |
| 63 | 449 | 124 | | 636 | |||||||||||||||||||
Other accrued liabilities |
30 | 1,355 | 3,240 | 834 | | 5,459 | |||||||||||||||||||
Income taxes payable |
| | 45 | 98 | | 143 | |||||||||||||||||||
Long-term debt due within one year |
| 313 | 63 | 8 | | 384 | |||||||||||||||||||
Current liabilities of discontinued operations |
| 134 | 250 | 37 | | 421 | |||||||||||||||||||
Total current liabilities |
90 | 2,402 | 8,974 | 4,634 | (6,643 | ) | 9,457 | ||||||||||||||||||
Deferred income |
| 3 | 143 | 8 | | 154 | |||||||||||||||||||
Long-term debt |
1,800 | 1,928 | 8 | 358 | | 4,094 | |||||||||||||||||||
Deferred income taxes net |
| 360 | 100 | 58 | | 518 | |||||||||||||||||||
Other liabilities |
| 616 | 1,092 | 1,374 | (1,629 | ) | 1,453 | ||||||||||||||||||
Minority interest in subsidiary companies |
| | | 101 | 536 | 637 | |||||||||||||||||||
1,890 | 5,309 | 10,317 | 6,533 | (7,736 | ) | 16,313 | |||||||||||||||||||
SHAREHOLDERS EQUITY |
|||||||||||||||||||||||||
Preferred shares |
| 536 | 365 | 47 | (948 | ) | | ||||||||||||||||||
Common shares |
32,899 | 2,111 | 950 | 1,149 | (4,210 | ) | 32,899 | ||||||||||||||||||
Additional paid-in capital |
3,257 | 18,797 | 6,043 | 20,167 | (45,007 | ) | 3,257 | ||||||||||||||||||
Deferred stock option compensation |
(205 | ) | | | (214 | ) | 214 | (205 | ) | ||||||||||||||||
Deficit |
(30,151 | ) | (14,507 | ) | (11,605 | ) | (22,012 | ) | 48,124 | (30,151 | ) | ||||||||||||||
Accumulated other comprehensive income (loss) |
(976 | ) | (964 | ) | 952 | (91 | ) | 103 | (976 | ) | |||||||||||||||
Total shareholders equity |
4,824 | 5,973 | (3,295 | ) | (954 | ) | (1,724 | ) | 4,824 | ||||||||||||||||
Total liabilities and shareholders equity |
$ | 6,714 | $ | 11,282 | $ | 7,022 | $ | 5,579 | $ | (9,460 | ) | $ | 21,137 | ||||||||||||
30
Supplemental Consolidating Statements of Cash Flows for the six months ended June 30, 2002:
Nortel | Nortel | Non- | ||||||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | |||||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||||
Cash flows from (used in) operating activities |
||||||||||||||||||||||||||||
Net loss from continuing operations |
$ | (1,538 | ) | $ | (1,354 | ) | $ | (865 | ) | $ | (394 | ) | $ | 2,613 | $ | (1,538 | ) | |||||||||||
Adjustments to reconcile net loss from continuing operations
to net cash from (used in) operating activities, net of
effects from acquisitions and divestitures of businesses: |
||||||||||||||||||||||||||||
Amortization and depreciation |
| 47 | 238 | 99 | | 384 | ||||||||||||||||||||||
Non-cash
portion of special charges and related asset write downs |
| 155 | 101 | 126 | | 382 | ||||||||||||||||||||||
Equity in net loss of associated companies |
1,495 | 887 | 248 | 7 | (2,623 | ) | 14 | |||||||||||||||||||||
Stock option compensation |
| | | 46 | | 46 | ||||||||||||||||||||||
Deferred income taxes |
| (518 | ) | 470 | (177 | ) | | (225 | ) | |||||||||||||||||||
Other liabilities |
| (14 | ) | (33 | ) | 17 | | (30 | ) | |||||||||||||||||||
Gain on sale of investments and businesses |
| (10 | ) | (5 | ) | (11 | ) | | (26 | ) | ||||||||||||||||||
Other net |
| 25 | 153 | 28 | | 206 | ||||||||||||||||||||||
Change in operating assets and liabilities: |
||||||||||||||||||||||||||||
Accounts receivable |
| (65 | ) | 606 | 3 | | 544 | |||||||||||||||||||||
Inventories |
| 68 | 62 | (4 | ) | | 126 | |||||||||||||||||||||
Income taxes |
| 359 | 352 | (5 | ) | | 706 | |||||||||||||||||||||
Accounts payable and accrued liabilities |
7 | (198 | ) | (562 | ) | (2 | ) | | (755 | ) | ||||||||||||||||||
Other operating assets and liabilities |
| 11 | (24 | ) | (39 | ) | | (52 | ) | |||||||||||||||||||
Intercompany activity |
40 | 348 | (606 | ) | 218 | | | |||||||||||||||||||||
Net cash from (used in) operating activities |
4 | (259 | ) | 135 | (88 | ) | (10 | ) | (218 | ) | ||||||||||||||||||
Cash flows from (used in) investing activities |
||||||||||||||||||||||||||||
Expenditures for plant and equipment |
| (15 | ) | (174 | ) | (19 | ) | | (208 | ) | ||||||||||||||||||
Proceeds on disposals of plant and equipment |
| | 76 | | | 76 | ||||||||||||||||||||||
Increase in long-term receivables |
| 64 | (152 | ) | (122 | ) | | (210 | ) | |||||||||||||||||||
Decrease in long-term receivables |
| 18 | 83 | 4 | | 105 | ||||||||||||||||||||||
Acquisitions of investments and businesses net of cash acquired |
| (3 | ) | (22 | ) | | | (25 | ) | |||||||||||||||||||
Investment in subsidiaries |
(800 | ) | | | | 800 | | |||||||||||||||||||||
Proceeds on sale of investments and businesses |
| 20 | 18 | 35 | | 73 | ||||||||||||||||||||||
Net cash from (used in) investing activities |
(800 | ) | 84 | (171 | ) | (102 | ) | 800 | (189 | ) | ||||||||||||||||||
Cash flows from (used in) financing activities |
||||||||||||||||||||||||||||
Dividends on preferred shares |
| (10 | ) | | | 10 | | |||||||||||||||||||||
Increase (decrease) in notes payable net |
| | 1 | (78 | ) | | (77 | ) | ||||||||||||||||||||
Proceeds from long-term debt |
| | | 31 | | 31 | ||||||||||||||||||||||
Repayments of long-term debt |
| | (3 | ) | (3 | ) | | (6 | ) | |||||||||||||||||||
Decrease in capital leases payable |
| (1 | ) | (3 | ) | (1 | ) | | (5 | ) | ||||||||||||||||||
Issuance of common shares |
862 | 800 | | | (800 | ) | 862 | |||||||||||||||||||||
Issuance of prepaid forward purchase contracts |
623 | | | | | 623 | ||||||||||||||||||||||
Net cash from (used in) financing activities |
1,485 | 789 | (5 | ) | (51 | ) | (790 | ) | 1,428 | |||||||||||||||||||
Effect
of foreign exchange rate changes on cash and cash equivalents |
| 8 | 28 | 10 | | 46 | ||||||||||||||||||||||
Net cash from (used in) continuing operations |
689 | 622 | (13 | ) | (231 | ) | | 1,067 | ||||||||||||||||||||
Net cash from discontinued operations |
| 100 | 187 | 2 | | 289 | ||||||||||||||||||||||
Net increase (decrease) in cash and cash equivalents |
689 | 722 | 174 | (229 | ) | | 1,356 | |||||||||||||||||||||
Cash and cash equivalents at beginning of period net |
18 | (41 | ) | 2,340 | 1,196 | | 3,513 | |||||||||||||||||||||
Cash and cash equivalents at end of period net |
$ | 707 | $ | 681 | $ | 2,514 | $ | 967 | $ | | $ | 4,869 | ||||||||||||||||
31
Supplemental Consolidating Statements of Cash Flows for the six months ended June 30, 2001:
Nortel | Nortel | Non- | ||||||||||||||||||||||||||
Networks | Networks | Guarantor | Guarantor | |||||||||||||||||||||||||
Corporation | Limited | Subsidiaries | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||||
Cash flows from (used in) operating activities |
||||||||||||||||||||||||||||
Net loss from continuing operations |
$ | (18,998 | ) | $ | (6,732 | ) | $ | (5,757 | ) | $ | (14,347 | ) | $ | 26,821 | $ | (19,013 | ) | |||||||||||
Adjustments to reconcile net loss from continuing operations
to net cash from (used in) operating activities, net of effects
from acquisitions and divestitures of businesses: |
||||||||||||||||||||||||||||
Amortization and depreciation |
| 108 | 1,516 | 2,509 | | 4,133 | ||||||||||||||||||||||
In-process research and development expense |
| | | 15 | | 15 | ||||||||||||||||||||||
Non-cash
portion of special charges and related asset write downs |
| 42 | 1,136 | 11,723 | | 12,901 | ||||||||||||||||||||||
Equity in net earnings (loss) of associated companies |
18,986 | 6,693 | 1,290 | (1 | ) | (26,836 | ) | 132 | ||||||||||||||||||||
Stock option compensation |
| | | 59 | | 59 | ||||||||||||||||||||||
Tax benefit from stock options |
| 34 | | | | 34 | ||||||||||||||||||||||
Deferred income taxes |
12 | (798 | ) | (200 | ) | (104 | ) | | (1,090 | ) | ||||||||||||||||||
Other liabilities |
| (52 | ) | 60 | (25 | ) | | (17 | ) | |||||||||||||||||||
Gain on sale of investments and businesses |
| | (24 | ) | (2 | ) | | (26 | ) | |||||||||||||||||||
Other net |
| 78 | 272 | (516 | ) | | (166 | ) | ||||||||||||||||||||
Change in operating assets and liabilities: |
||||||||||||||||||||||||||||
Accounts receivable |
| 183 | 2,045 | 131 | | 2,359 | ||||||||||||||||||||||
Inventories |
| 239 | 785 | 160 | | 1,184 | ||||||||||||||||||||||
Income taxes |
| (63 | ) | (708 | ) | (111 | ) | | (882 | ) | ||||||||||||||||||
Accounts payable and accrued liabilities |
(150 | ) | (556 | ) | 9 | 207 | | (490 | ) | |||||||||||||||||||
Other operating assets and liabilities |
| 232 | (19 | ) | 139 | | 352 | |||||||||||||||||||||
Intercompany activity |
131 | (434 | ) | (75 | ) | 378 | | | ||||||||||||||||||||
Net cash from (used in) operating activities |
(19 | ) | (1,026 | ) | 330 | 215 | (15 | ) | (515 | ) | ||||||||||||||||||
Cash flows from (used in) investing activities |
||||||||||||||||||||||||||||
Expenditures for plant and equipment |
| (260 | ) | (494 | ) | (100 | ) | | (854 | ) | ||||||||||||||||||
Proceeds on disposal of plant and equipment |
| 20 | | | | 20 | ||||||||||||||||||||||
Increase in long-term receivables |
| (169 | ) | (402 | ) | 69 | | (502 | ) | |||||||||||||||||||
Decrease in long-term receivables |
| 57 | 24 | 12 | | 93 | ||||||||||||||||||||||
Acquisitions of investments and businesses net of cash acquired |
| (12 | ) | (62 | ) | 1 | | (73 | ) | |||||||||||||||||||
Proceeds on sale of investments and businesses |
| | 31 | 35 | | 66 | ||||||||||||||||||||||
Net cash from (used in) investing activities |
| (364 | ) | (903 | ) | 17 | | (1,250 | ) | |||||||||||||||||||
Cash flows from (used in) financing activities |
||||||||||||||||||||||||||||
Dividends on common and preferred shares |
(123 | ) | (15 | ) | | | 15 | (123 | ) | |||||||||||||||||||
Increase (decrease) in notes payable net |
| 294 | 1,053 | 74 | | 1,421 | ||||||||||||||||||||||
Proceeds from long-term debt |
| 1,500 | 5 | | | 1,505 | ||||||||||||||||||||||
Repayments of long-term debt |
| (250 | ) | (5 | ) | (157 | ) | | (412 | ) | ||||||||||||||||||
Decrease in capital leases payable |
| (3 | ) | (14 | ) | (7 | ) | | (24 | ) | ||||||||||||||||||
Issuance of common shares |
133 | | | | | 133 | ||||||||||||||||||||||
Net cash from (used in) financing activities |
10 | 1,526 | 1,039 | (90 | ) | 15 | 2,500 | |||||||||||||||||||||
Effect of foreign exchange rate changes on cash
and cash equivalents |
| 1 | (11 | ) | (7 | ) | | (17 | ) | |||||||||||||||||||
Net cash from (used in) continuing operations |
(9 | ) | 137 | 455 | 135 | | 718 | |||||||||||||||||||||
Net cash used in discontinued operations |
| (149 | ) | (272 | ) | (12 | ) | | (433 | ) | ||||||||||||||||||
Net increase (decrease) in cash and cash equivalents |
(9 | ) | (12 | ) | 183 | 123 | | 285 | ||||||||||||||||||||
Cash and cash equivalents at beginning of period net |
20 | (73 | ) | 1,020 | 677 | | 1,644 | |||||||||||||||||||||
Cash and cash equivalents at end of period net |
$ | 11 | $ | (85 | ) | $ | 1,203 | $ | 800 | $ | | $ | 1,929 | |||||||||||||||
32
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
You should read this section in conjunction with the accompanying unaudited consolidated financial statements prepared in accordance with United States generally accepted accounting principles. This section provides additional analysis of our operations and current financial condition and also contains forward-looking statements and should be read in conjunction with the factors set forth below under Forward-looking statements. All dollar amounts in this Managements Discussion and Analysis of Financial Condition and Results of Operations are in millions of United States dollars unless otherwise stated.
Where we say we, us, our, or Nortel Networks, we mean Nortel Networks Corporation and its subsidiaries.
Business overview
We are a leading global supplier of products and services that support the Internet and other public and private data, voice, and multimedia communications networks, using terrestrial and wireless technologies, which we refer to as networking solutions. With our networking solutions, we are focused on providing the infrastructure and applications for high performance networks, as technology transforms the way we communicate and conduct business. We have a technology focus, with a substantial portion of Nortel Networks dedicated to research and development, forming a core strength and a factor differentiating us from our competitors. Our research and development efforts are focused on delivering carrier-grade infrastructure, enabling valuable services for our customers, reducing network costs, and transforming traditional voice-communications networks into cost-effective networks supporting data, voice, and multimedia communications.
Our operations are focused on providing seamless networking products and service capabilities across three core business areas and three segments: Metro and Enterprise Networks; Wireless Networks; and Optical Networks (formerly named Optical Long-Haul Networks). These products and service solutions are used by service provider and enterprise customers, including incumbent and competitive local exchange carriers, interexchange carriers, service providers with global businesses, wireless service providers, Internet service providers, application service providers, hosting service providers, resellers, cable television companies, other communications service providers, large businesses and their branch offices, small businesses, and home offices, as well as government, education, and utility organizations.
Our Metro and Enterprise Networks segment includes a range of Optical Ethernet solutions, Ethernet switching solutions, packet switching and routing solutions, such as data switching systems, aggregation products, virtual private network gateways, and routers, and circuit to packet network solutions, such as enterprise telephone systems, digital switching systems, business solutions and applications, and network management software, together with related professional services. Our Wireless Networks segment solutions support the Time Division Multiple Access, or TDMA, Code Division Multiple Access, or CDMA, Global System for Mobile communications, or GSM, General Packet Radio Standard, or GPRS, and Universal Mobile Telecommunications Systems, or UMTS, standards, to enable end users to be mobile while they send and receive voice and data communications using a wireless device, and include radio access network equipment, key network elements of which are base station transceivers and base station controllers, core network equipment, key network elements of which are mobile switching centers and home location registers, and related professional services. Our Optical Networks segment includes optical long-haul networking solutions as well as metro optical solutions. Optical long-haul networking solutions are designed to provide long-distance, high-capacity transport and switching of data, voice, and multimedia communications signals for operators of land-based and submarine communications networks, including Dense Wave Division Multiplexing, or DWDM, solutions, synchronous optical transmission systems that support most global transmission standards, optical switching solutions, and network management software, optical components for long-distance optical networks, and related engineering, installation, and support services. The metro optical portion of the segment includes solutions designed to transport data, voice, and multimedia communications between locations within a city or between cities of close range by transmitting communication signals in the form of light particles/waves through fiber optic cables.
Nortel Networks Corporations common shares are publicly-traded on the New York and Toronto stock exchanges under the symbol NT. Nortel Networks Limited is our principal direct operating subsidiary. Nortel Networks Corporation holds all of Nortel Networks Limiteds outstanding common shares but none of its outstanding preferred shares.
33
Developments in 2002
Equity offerings under shelf registration statement and base shelf prospectus
On June 12, 2002, we issued 632,500,000 common shares in connection with the closing of our common share offering. Concurrent with the common share offering, 28,750 equity units were offered, each initially evidencing its holders ownership of: (i) a prepaid forward purchase contract, entitling the holder to receive Nortel Networks Corporation common shares; and (ii) specified zero-coupon U.S. treasury securities. The settlement date for each purchase contract will be August 15, 2005, subject to acceleration or early settlement in certain cases. The aggregate number of Nortel Networks Corporation common shares issuable on the settlement date of the purchase contracts will be between approximately 485 million and 583 million, subject to some anti-dilution adjustments, and is dependent on the average of the closing prices of Nortel Networks Corporation common shares on the New York Stock Exchange during a period shortly before the settlement date. The two offerings resulted in net proceeds to us of approximately $1,479, which will be used for general corporate purposes.
For additional information, see Common shares and prepaid forward purchase contracts in note 8 to the accompanying unaudited consolidated financial statements.
The equity offerings utilized approximately $1,700 of the $2,500 available under our shelf registration statement filed with the United States Securities and Exchange Commission and our base shelf prospectus filed with the applicable securities regulatory authorities in Canada during the three months ended June 30, 2002, for the potential sale of various types of securities by either Nortel Networks Corporation or Nortel Networks Limited.
See Liquidity and capital resources for additional information.
Optical Networks
On May 29, 2002, we announced plans to further realign our Optical Networks business, including optical components, due to the current market conditions given that we do not expect a meaningful recovery in the long-haul optical market before late 2003 or early 2004. The plan includes the potential sale and/or resizing of the optical components business.
Restructuring
In the three months ended June 30, 2002, we recorded special charges of $403, primarily comprised of a $270 charge related to plant and equipment write downs and a $117 charge related to workforce reduction. The approximately $270 write down of plant and equipment within the Optical Networks segment resulted from our assessment of certain plant and equipment assets as part of our review of financial results during the three months ended June 30, 2002. The workforce reduction charges of $117 for the three months ended June 30, 2002, were related to the cost of severance and benefits associated with approximately 1,900 employees notified of termination during the period.
In the three months ended March 31, 2002, we recorded special charges of $487, primarily related to the cost of severance and benefits associated with the approximately 4,400 employees notified of termination during the period.
As of June 30, 2002, our workforce numbered approximately 44,700. Following the completion of remaining reductions, primarily related to the realignment of the Optical Networks segment, and previously announced European work council activities, we expect to have a workforce of approximately 42,000. We will continue to actively review our cost structure to reduce or redirect costs that are not warranted. Additional charges will be required in 2002 related to remaining announced workforce reductions and related charges, and the restructuring of the Optical Networks segment.
See Special charges for additional information.
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Credit facilities
On April 10, 2002, Nortel Networks announced that, effective April 8, 2002, Nortel Networks Limited and Nortel Networks Inc. amended and extended their April 2001 364-day revolving syndicated credit facilities to April 7, 2003 with no additional term-out period thereafter. The amendment reduced the size of the 364-day committed revolving facilities to $1,175 from $1,750. The amended facilities maintained the financial covenant in the April 2001 facilities requiring Nortel Networks Limiteds minimum consolidated tangible net worth to be not less than $1,888 and included higher pricing reflecting the then current credit and bank environment. As a result, total borrowings permitted under the syndicated April 2002 364-day credit agreements and the existing April 2000 five-year credit agreements are $1,925.
On June 27, 2002, we sold certain real estate in the United Kingdom, which resulted in a reduction, effective July 2, 2002, in available commitments under Nortel Networks Limiteds and Nortel Networks Inc.s December 20, 2001 credit facilities from $1,575 to $1,518.
See Liquidity and capital resources for additional details on our credit agreements.
Debt rating downgrades
On April 4, 2002, Moodys Investors Services, Inc. lowered Nortel Networks Limiteds United States senior long-term debt rating below investment grade to Ba3. On April 9, 2002, Standard & Poors Ratings Service also lowered their credit rating for Nortel Networks Limited below investment grade to BB-. As a result, various liens, pledges, and guarantees became effective under certain credit and security agreements entered into by Nortel Networks Limited and various of its subsidiaries. In accordance with the covenants in the trust indentures for all of our current consolidated public debt securities, which represent substantially all of our consolidated long-term debt at June 30, 2002, all such public debt securities are also secured equally and ratably with the obligations under all of Nortel Networks Limited and Nortel Networks Inc.s credit agreements by liens on substantially all of the assets of Nortel Networks Limited and those of most of its United States and Canadian subsidiaries, and by pledges of shares in certain of Nortel Networks Limiteds other subsidiaries. In addition, certain of Nortel Networks Limiteds wholly owned subsidiaries have guaranteed Nortel Networks Limiteds obligations under the credit agreements and outstanding public debt securities.
For additional financial information related to those subsidiaries providing guarantees, see Supplemental consolidating financial information in note 18 of the accompanying unaudited consolidated financial statements. For additional financial information related to the three years ended December 31, 2001, see our Current Report on Form 8-K dated May 13, 2002.
In addition, see Liquidity and capital resources for additional details on our credit ratings and the granting of security under our credit agreements.
Results of operations continuing operations
Revenues
Segment revenues
During the three months ended June 30, 2002, we shifted the accountability for the metro optical portion of the Metro and Enterprise Networks segment into the Optical Networks segment (formerly named the Optical Long-haul Networks segment). All reported and historical information has been restated to reflect this realignment.
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The following table sets forth revenues by segment for the three months and six months ended June 30:
Three months ended June 30, | Six months ended June 30, | |||||||||||||||||||||||||||||||
2001 | 2002 | $ Change | % Change | 2001 | 2002 | $ Change | % Change | |||||||||||||||||||||||||
Metro and Enterprise |
$ | 1,994 | $ | 1,223 | $ | (771 | ) | (38.7 | ) | $ | 4,422 | $ | 2,577 | $ | (1,845 | ) | (41.7 | ) | ||||||||||||||
Wireless |
1,616 | 1,123 | (493 | ) | (30.5 | ) | 3,161 | 2,259 | (902 | ) | (28.5 | ) | ||||||||||||||||||||
Optical |
757 | 406 | (351 | ) | (46.4 | ) | 2,326 | 812 | (1,514 | ) | (65.1 | ) | ||||||||||||||||||||
Other(a) |
243 | 21 | (222 | ) | (91.4 | ) | 452 | 37 | (415 | ) | (91.8 | ) | ||||||||||||||||||||
Consolidated |
$ | 4,610 | $ | 2,773 | $ | (1,837 | ) | (39.8 | ) | $ | 10,361 | $ | 5,685 | $ | (4,676 | ) | (45.1 | ) | ||||||||||||||
(a) | Other represents miscellaneous business activities and corporate functions. |
Geographic revenues
The following table sets forth revenues by geographic region for the three months and six months ended June 30:
Three months ended June 30, | Six months ended June 30, | |||||||||||||||||||||||||||||||
2001 | 2002 | $ Change | % Change | 2001 | 2002 | $ Change | % Change | |||||||||||||||||||||||||
External revenues(a) |
||||||||||||||||||||||||||||||||
United States |
$ | 2,244 | $ | 1,515 | $ | (729 | ) | (32.5 | ) | $ | 5,089 | $ | 2,949 | $ | (2,140 | ) | (42.1 | ) | ||||||||||||||
Canada |
209 | 176 | (33 | ) | (15.8 | ) | 516 | 367 | (149 | ) | (28.9 | ) | ||||||||||||||||||||
Other countries |
2,157 | 1,082 | (1,075 | ) | (49.8 | ) | 4,756 | 2,369 | (2,387 | ) | (50.2 | ) | ||||||||||||||||||||
Consolidated |
$ | 4,610 | $ | 2,773 | $ | (1,837 | ) | (39.8 | ) | $ | 10,361 | $ | 5,685 | $ | (4,676 | ) | (45.1 | ) | ||||||||||||||
(a) | Revenues are attributable to geographic areas based on the location of the customer. |
Consolidated
In 2001, the telecommunications industry, or the industry, underwent a significant adjustment, particularly in the United States. Following a period of rapid infrastructure build-out and strong economic growth in 1999 and 2000, we saw a continued tightening in the capital markets and slowdown in the industry throughout 2001. This resulted in lower capital spending by industry participants and substantially less demand for our products and services as service providers focused on maximizing their return on invested capital and, as a result, our revenues declined sequentially during 2001. In the first six months of 2002, we have continued to see constraints on capital expenditures by industry participants. As a result, for the three months and six months ended June 30, 2002, our consolidated revenues declined substantially compared to the same periods in 2001. The substantial declines were due to a change in our customers focus from building new networks to conserving capital and/or increasing the capacity utilization rates and efficiency of existing networks, and reducing costs. Our consolidated revenues for the three months ended June 30, 2002 were down slightly compared to the three months ended March 31, 2002. We expect that the severe lack of available funding from the capital markets, high debt levels of many service providers, bankruptcies and financial difficulties of certain service providers, excess network assets, excess and shared bandwidth capacity, and the compounding impact of economic concerns will continue to constrain capital spending by service providers in 2003. As a result, we expect that overall capital expenditures in the industry during 2003 will decline compared to the expected amount for the full year 2002. However, it is difficult to predict the duration or severity of this industry adjustment, as growth in industry spending is not expected to occur until economic and financial concerns have subsided and the anticipated rationalization of the industry is well underway. Market visibility remains limited and we do not expect that results of operations for any quarter will necessarily be consistent with our quarterly historical profile or indicative of results to be expected for future quarters.
The substantial decline in revenues for the three months and six months ended June 30, 2002 compared to the same periods in 2001 was the result of considerable declines across all segments. The modest decline in revenues in the three months ended June 30, 2002 compared to the three months ended March 31, 2002 was primarily due to a decline in Metro and Enterprise Networks and flat revenues in both our Wireless Networks and Optical Networks segments.
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The substantial decline in revenues in the three months ended June 30, 2002 compared to the same period in 2001 was due to considerable declines in the United States, Europe, the Asia Pacific region, and the Caribbean and Latin America region, and a significant decline in Canada. The substantial decline in revenues in the six months ended June 30, 2002 compared to the same period in 2001 was due to considerable declines across all geographic regions. Compared to the three months ended March 31, 2002, revenues declined significantly in Europe, substantially in the Caribbean and Latin America region, and declined in the Asia Pacific region and Canada, partially offset by an increase in the United States.
Metro and Enterprise Networks
The following chart sets forth quarterly revenues for the Metro and Enterprise Networks segment:
The Metro and Enterprise Networks segment serves both service provider customers as well as enterprise customers. Our service provider customers include local and long-distance telephone companies, Internet service providers, and other communications service providers. Our enterprise customers include large businesses and their branch offices, small businesses, and home offices, as well as government, education, and utility organizations.
The substantial decline in revenues in the three months and six months ended June 30, 2002 compared to the same periods in 2001 was due to substantial declines in all portions of this segment. The substantial decrease in sales of the circuit to packet voice networks portion of this segment was primarily the result of continued reduced demand in the local exchange and interexchange carrier markets due to the significant adjustment in the industry, continued industry consolidation, continued tightened capital markets, and the decline in traditional circuit switching. The considerable decline in sales of the packet switching and routing portion of this segment was primarily due to a decline in demand for mature products in this portion of the segment, compounded by the ongoing industry adjustment as our service provider customers continue to reduce capital expenditures and our enterprise customers continue to delay the purchase of next generation products due to overall economic and technology evolution uncertainty. Circuit network voice solutions continue to form a majority of the overall sales for the circuit to packet voice networks portion of this segment. As data, voice, and multimedia communications technologies continue to converge, and service providers, as well as enterprises, look for ways to maximize the effectiveness of their existing networks while reducing ongoing capital expenditures and operating costs, we anticipate that communications networks will use packet-based technologies. However, the timing of this progression in the short term is unclear as a result of the continuing industry adjustment. The substantial decline in overall segment revenues in the three months and six months ended June 30, 2002 compared to the same periods in 2001 was due to considerable declines across all geographic regions.
Overall Metro and Enterprise Networks segment revenues for the three months ended June 30, 2002 declined compared to the three months ended March 31, 2002, primarily due to a decrease in demand for traditional circuit switching and a significant decline in demand for the packet switching and routing portion of this segment. A substantial decline in the Caribbean and Latin America region, a significant decline in Europe, and modest decreases in the United States and Canada were partially offset by a substantial increase in the Asia Pacific region.
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Wireless Networks
The following chart sets forth quarterly revenues for the Wireless Networks segment:
The substantial decline in revenues in the three months and six months ended June 30, 2002 compared to the same periods in 2001 was primarily due to strong revenues in the first half of 2001 driven by growth in the United States and the Asia Pacific region, as major customers completed the network expansion programs they began in 2000. Wireless Networks segment revenues began to decline in the second half of 2001, and have continued to decline into 2002, as a result of deterioration in wireless service providers financial condition, slowing subscriber growth and competition for end user customers by service providers which has resulted in the decision of many wireless service providers to delay capital expenditures. The substantial decrease in overall segment revenues during the three months ended June 30, 2002 compared to the same period in 2001 was primarily due to substantial decreases in the Asia Pacific region and Europe, and a significant decline in the United States, partially offset by a substantial increase in Canada. The substantial decrease in overall segment revenues during the six months ended June 30, 2002 compared to the same period in 2001 was due to substantial decreases in the Asia Pacific region, the United States, Europe, and the Caribbean and Latin American region, partially offset by a considerable increase in Canada.
Overall Wireless Networks segment revenues for the three months ended June 30, 2002 continue to be primarily generated by sales of Code Division Multiple Access, or CDMA, and Global System for Mobile communications, or GSM, technologies. Compared to the three months ended June 30, 2001, CDMA revenues have increased as a percentage of total revenues, Universal Mobile Telecommunications System, or UMTS, revenues have increased significantly as a percentage of revenues, and GSM revenues have remained relatively flat, offset by a substantial decrease in Time Division Multiple Access, or TDMA, revenues as a percentage of total revenues. CDMA and UMTS technology sales are expected to continue to represent a larger proportion of our total Wireless Networks segment revenues as third generation, or 3G, technologies gain a greater foothold in the market due to increased wireless data traffic and requirements for greater wireless spectrum efficiency. GSM sales will slow and are expected to transition to GPRS and EDGE 2.5G technologies and TDMA sales are expected to decline.
As with the rest of the industry, our wireless customers are experiencing significant pressure and are adapting to a new, more stringent spending environment. We anticipate a slight decline in global capital expenditures for wireless operators in 2003, compared to 2002, but cannot predict the complete impact. We also expect there may be consolidation in this marketplace, including a reduction in the number of service providers in certain regions due to competition and/or adjustments in deployment plans and schedules. In addition, the timing of changes in revenues from the different wireless technologies has become increasingly difficult to predict as a result of the complexities and potential for delays in the implementation of 3G network deployments. All of these factors could affect Wireless Networks segment revenues.
Overall Wireless Networks segment revenues for the three months ended June 30, 2002 were essentially flat compared to the three months ended March 31, 2002, primarily due to a substantial decline in the Asia Pacific region and a significant decline in Canada, partially offset by a significant increase in the United States and an increase in the Caribbean and Latin America region.
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Optical Networks
The following chart sets forth quarterly revenues for the Optical Networks segment:
The substantial decline in revenues in three months and six months ended June 30, 2002 compared to the same periods in 2001 was primarily the result of substantial reductions in capital spending, mainly by our major United States and European customers.
The optical long-haul networks portion of our Optical Networks segment revenues in the first quarter of 2001 reflected the then in-process network build-outs that had begun in 2000. However, when the industry began experiencing the significant adjustment and the capital markets tightened, our customers reduced their purchases sharply as they focused on reducing existing inventory levels to complete existing network build-outs and on improving the efficiency of existing networks. Our major customers in this portion of the segment are focused on maximizing return on invested capital by increasing the capacity utilization rates and efficiency of existing networks, and we expect that any additional capital spending by those customers will be increasingly directed to opportunities that enhance customer performance, revenue generation, and cost reduction in the near term. We expect that customers in this portion of the segment will continue to focus on route by route activities, adding channels to existing networks, and interconnect and bandwidth issues in the short term, while building out networks for increased bandwidth will remain longer term projects. Sales in this portion of the segment are primarily based on network build-outs and, as such, generally include a number of long-haul products packaged together in an end-to-end solution. As a result, volatility in this portion of the segment typically results in a corresponding increase or decline in overall optical long-haul networks sales as almost all products within this portion of the segment are generally affected in the same manner. Industry consolidation also contributed to the reduction in service provider capital spending during 2001 and the first half of 2002. The considerable decline in the optical long-haul networks portion of the segment during the three months and six months ended June 30, 2002, compared to the same periods in 2001, is due to continued capital spending constraints and, to a lesser extent, the large redeployment of assets that has occurred in this segment of the industry in 2001 primarily due to significant excess inventories, which has resulted in significant pricing pressures throughout 2001 and the first half of 2002.
Sales in the metro optical portion of the segment are primarily driven by demand for enterprise connectivity and storage solutions. The substantial decline in sales of the metro optical portion of the segment for the three months and six months ended June 30, 2002, compared to the same periods in 2001, was primarily due to a decline in demand for mature products in this portion of the segment, compounded by the ongoing industry adjustment as customers continue to focus on optimizing existing networks, which has delayed the deployment of next generation products. Sales in the metro optical portion of the segment increased as a percentage of total Optical Networks segment sales for the six months ended June 30, 2002, compared to the same period in 2001.
Due to the severe reduction, in number and size, of new long-haul network build-outs during 2001 and the first half of 2002 and due to the nature of the long-haul portion of this segment, we do not expect a meaningful recovery in the optical long-haul market before late 2003 or early 2004 and we expect that it will be one of the last to recover from the significant adjustment in the industry. However, we do anticipate that revenues of the metro optical portion of the segment will continue to increase as a percentage of total Optical Networks segment sales.
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The substantial decline in Optical Networks segment revenues for the three months ended June 30, 2002, compared to the same period in 2001, was due to substantial declines in Europe, the Asia Pacific region, the Caribbean and Latin America region, and the United States, partially offset by a substantial increase in Canada. The substantial decline in Optical Networks segment revenues for the six months ended June 30, 2002, compared to the same period in 2001, was due to considerable declines in the United States, Europe, the Asia Pacific region, and the Caribbean and Latin America region, and a significant decline in Canada.
Overall Optical Networks segment revenues were flat for the three months ended June 30, 2002 compared to the three months ended March 31, 2002, primarily due to a decline in demand for the optical long-haul networks portion of the segment, offset by a significant increase in demand for the metro optical portion of the segment. The flat revenues were primarily due to substantial increases in the United States and Canada, and a modest increase in the Asia Pacific region, offset by considerable decreases in Europe and the Caribbean and Latin America region.
Gross profit and gross margin
The following table sets forth gross profit and gross margin for the three months and six months ended June 30:
Three months ended June 30, | Six months ended June 30, | |||||||||||||||||||||||||||||||
2001 | 2002 | Change | % Change | 2001 | 2002 | Change | % Change | |||||||||||||||||||||||||
Gross profit |
$ | 426 | $ | 958 | $ | 532 | 124.9 | $ | 2,284 | $ | 1,716 | $ | (568 | ) | (24.9 | ) | ||||||||||||||||
Gross margin |
9.2% | 34.5% | 25.3 | 275.0 | 22.0% | 30.2% | 8.2 | 37.3 | ||||||||||||||||||||||||
The considerable increase in gross margin for the three months ended June 30, 2002 compared to the same period in 2001 was primarily due to approximately $750 of incremental charges related to increased inventory provisions and contract and customer settlements in the three months ended June 30, 2001. Excluding these incremental charges, gross margin would have been approximately 25.5 percent for the three months ended June 30, 2001, which is also considerably lower than the gross margin for the three months ended June 30, 2002, due to our now lower cost structure in relation to our revenue volume and more favourable supplier pricing in 2002, offset by continuing pricing pressures throughout the industry.
The substantial increase in gross margin for the six months ended June 30, 2002 compared to the same period in 2001 was primarily due to approximately $750 of incremental charges related to increased inventory provisions and contract and customer settlements in the three months ended June 30, 2001, partially offset by $200 of incremental inventory provisions primarily related to negotiations with all of our major suppliers in the three months ended March 31, 2002. Excluding these incremental charges, gross margin for the six months ended June 30, 2002 and 2001 would have been approximately 33.7 percent and 29.3 percent, respectively, which represents a significant increase in gross margin for the period, due to the sequential improvements in our cost structure as we have reduced capacity in relation to our revenue volume during the six months ended June 30, 2002.
While we cannot predict to what extent changes in product mix and pricing pressures will have on our gross margin, we have begun to see the affects of our work plan to create a cost structure that is more reflective of the current industry and economic environment. We expect that gross margin will continue to trend in the mid to high thirty percent range for the remainder of 2002 and will be substantially higher for the full year 2002 compared to the full year 2001.
See Forward-looking statements for factors that may affect our gross margins.
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Operating expenses
Selling, general and administrative expense
The following table sets forth selling, general and administrative, or SG&A, expense and SG&A expense as a percentage of revenues for the three months and six months ended June 30:
Three months ended June 30, | Six months ended June 30, | ||||||||||||||||||||||||||||||||
2001 | 2002 | $ Change | % Change | 2001 | 2002 | $ Change | % Change | ||||||||||||||||||||||||||
SG&A expense |
$ | 1,642 | $ | 767 | $ | (875 | ) | (53.3 | ) | $ | 2,983 | $ | 1,511 | $ | (1,472 | ) | (49.3 | ) | |||||||||||||||
As a % of revenues |
35.6% | 27.7% | N/A | N/A | 28.8% | 26.6% | N/A | N/A | |||||||||||||||||||||||||
SG&A expense declined substantially in the three months and six months ended June 30, 2002 compared to the same periods in 2001, reflecting the impact of our work plan which began in 2001. SG&A expense increased slightly compared to the three months ended March 31, 2002, primarily due to an incremental charge of approximately $100 in the three months ended June 30, 2002 for potentially uncollectable trade receivables, partially offset by decreases reflecting our lower cost structure. Excluding the incremental charge of approximately $100, SG&A was approximately $667, resulting in a sequential improvement of $77, which primarily reflects the impact of workforce reductions, which in turn has also resulted in a reduction in other related costs such as information services and real estate. We expect that quarterly SG&A expense will decline to a level below $650 over the next few quarters.
Research and development expense
The following table sets forth research and development, or R&D, expense and R&D expense as a percentage of revenues for the three months and six months ended June 30:
Three months ended June 30, | Six months ended June 30, | ||||||||||||||||||||||||||||||||
2001 | 2002 | $ Change | % Change | 2001 | 2002 | $ Change | % Change | ||||||||||||||||||||||||||
R&D expense |
$ | 910 | $ | 579 | $ | (331 | ) | (36.4 | ) | $ | 1,853 | $ | 1,174 | $ | (679 | ) | (36.6 | ) | |||||||||||||||
As a % of revenues |
19.7% | 20.9% | N/A | N/A | 17.9% | 20.7% | N/A | N/A | |||||||||||||||||||||||||
R&D expense decreased substantially in the three months and six months ended June 30, 2002 compared to the same periods in 2001, reflecting the impact of initiatives undertaken by us to focus our spending on key potential growth areas. R&D expense represented our planned investment in our next generation core products across all segments. R&D expense, in absolute dollars, will decline substantially for the full year 2002, compared to the full year 2001, as we improve process efficiencies. R&D expense decreased slightly in the three months ended June 30, 2002 compared to the three months ended March 31, 2002. We expect quarterly R&D expense to continue below $600 for the remainder of 2002. Our continuing strategic investments in R&D are aligned to maintain our technology leadership in anticipated growth areas, consistent with the current and future needs of our customers, while targeting a level of R&D expense that is representative of our overall cost structure.
In-process research and development expense and amortization of intangibles
The following table sets forth in-process research and development, or IPR&D, expense and amortization of intangibles for the three months and six months ended June 30:
Three months ended June 30, | Six months ended June 30, | ||||||||||||||||||||||||||||||||
2001 | 2002 | $ Change | % Change | 2001 | 2002 | $ Change | % Change | ||||||||||||||||||||||||||
IPR&D expense |
$ | | $ | | $ | | N/A | $ | 15 | $ | | $ | (15 | ) | (100.0 | ) | |||||||||||||||||
Amortization of
intangibles |
|||||||||||||||||||||||||||||||||
Acquired technology |
$ | 285 | $ | 41 | $ | (244 | ) | (85.6 | ) | $ | 559 | $ | 84 | $ | (475 | ) | (85.0 | ) | |||||||||||||||
Goodwill |
$ | 1,639 | $ | | $ | (1,639 | ) | (100.0 | ) | $ | 3,231 | $ | | $ | (3,231 | ) | (100.0 | ) | |||||||||||||||
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IPR&D expense
In the six months ended June 30, 2001, IPR&D expense reflected the acquisition of JDS Uniphase Corporations Zurich, Switzerland-based subsidiary, and related assets in Poughkeepsie, New York, or the 980 NPLC Business.
Amortization of intangibles
Acquired technology
The amortization of acquired technology for the three months and six months ended June 30, 2002 primarily reflected the charge related to the acquisition of Alteon WebSystems, Inc. The amortization of acquired technology for the same periods in 2001 primarily reflected the charge related to the acquisitions of Bay Networks, Inc., Alteon, the 980 NPLC Business, and Clarify Inc. As at June 30, 2002 and December 31, 2001, the remaining carrying value of acquired technology net was $171 and $285, respectively.
Goodwill
In the three months ended March 31, 2002, we adopted the provisions of Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, or SFAS 142. Thus, amortization of goodwill, including goodwill recorded in past business combinations, and amortization of intangibles with an indefinite life ceased upon adoption of this Statement. We completed the first of the required SFAS 142 transitional impairment tests during the three months ended June 30, 2002 and concluded that there was no impairment of recorded goodwill, as the fair values of our reporting units exceeded their carrying amount as at January 1, 2002. Therefore, the second step of the transitional impairment test under SFAS 142 was not required to be performed. There can be no assurance that future goodwill impairment tests will not result in a charge to net earnings (loss).
The amortization of goodwill for the three months and six months ended June 30, 2001 primarily reflected the charges related to the acquisitions of Alteon, Bay Networks, Xros, Inc., Qtera Corporation, Clarify, and the 980 NPLC Business.
As at June 30, 2002 and December 31, 2001, the carrying value of goodwill was $2,795 and $2,810, respectively.
Special charges
Three months and six months June 30, 2002
For the three months and six months ended June 30, 2002, we recorded special charges of $403 and $890, respectively, related to restructuring costs associated with our work plan, which we began implementing in 2001 and continued into the second quarter of 2002, to streamline our operations and activities around our core markets and leadership strategies.
Workforce reduction charges of $117 and $444 for the three months and six months ended June 30, 2002, respectively, were related to the cost of severance and benefits associated with approximately 1,900 and 6,300 employees notified of termination, respectively, across all of our segments.
Contract settlement costs included negotiated settlements of approximately $1 and $64 for the three months and six months ended June 30, 2002, respectively, to either cancel contracts or renegotiate existing contracts across all of our segments.
As part of our review of financial results during the six months ended June 30, 2002, we performed assessments of certain plant and equipment assets, primarily in the Optical Networks segment, due to the current market conditions and the delay in the anticipated recovery of that segment. The conclusion of these assessments resulted in a write down of certain plant and equipment assets within the Optical Networks segment of approximately $270 during the three months ended June 30, 2002. These plant and equipment assets continue to be held and used, and were written down to estimated fair value based on market assessments. During the three months ended March 31, 2002 the plant and equipment write down included
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assets within the Optical Networks segment and within global operations, a function that supports all of our segments, totaling approximately $85.
In addition, during the three months ended June 30, 2002, we reassessed the market conditions for certain acquired technology in the Optical Networks segment, and concluded that the associated fair value had declined. As a result, a $15 write off of the remaining book value of this acquired technology was recorded.
During the three months ended March 31, 2002, we concluded that the Xros, Inc. X-1000 IPR&D project did not meet short-term market requirements. We will continue to assess the timing to commercialize this technology and will manage our development program accordingly. In connection with this decision, we recorded a $12 write off of acquired technology associated with this project.
The ending provision balance of $1,072 at June 30, 2002 consists of workforce reduction provisions of $399, contract settlement and lease costs of $651 and other provisions of $22.
As of June 30, 2002, our workforce numbered approximately 44,700. Following the completion of remaining reductions, primarily related to the realignment of the Optical Networks segment, and previously announced European work council activities, we expect to have a workforce of approximately 42,000. We will continue to actively review our cost structure to reduce or redirect costs that are not warranted. Additional charges will be required in 2002 related to remaining announced workforce reductions and related charges, and the restructuring of the Optical Networks segment.
Year ended December 31, 2001
For the year ended December 31, 2001, we recorded restructuring charges of $3,359, related to workforce reduction costs of $1,361, contract settlement and lease costs of $883, plant and equipment write downs of $970, and other costs of $145. During the year ended December 31, 2001, there were cumulative cash and non-cash drawdowns against the provision of $1,093 and $1,062, respectively, resulting in an ending provision balance at December 31, 2001 of $1,204. The cash drawdowns related primarily to workforce reduction payments, and the non-cash drawdowns related primarily to the plant and equipment write downs.
Period from January 1, 2001 to June 30, 2002
Of the approximately 42,400 employees notified during the period from January 1, 2001 to June 30, 2002, approximately 15,400 were direct employees performing manufacturing, assembly, test and inspection activities associated with the production of our products, and approximately 27,000 were indirect sales, marketing, research and development, and administrative employees, and manufacturing managers. The workforce reduction was primarily in North America and the United Kingdom and extended across all of our segments. As at June 30, 2002, the workforce reduction provision balance has been drawn down by cumulative cash payments of $1,420, resulting in an ending provision balance for workforce reduction of $399. The remaining provision is expected to be substantially drawn down by the second quarter of 2003.
In conjunction with the above noted workforce reduction, we identified a number of leased and owned facilities comprised of office, warehouse and manufacturing space, as well as leased manufacturing equipment, that were no longer required. As a result, we recorded net lease costs of approximately $757. The costs primarily related to our future contractual obligations under operating leases. Offsetting the total lease charge is approximately $479 in expected sublease revenue on leases that we cannot terminate. The reduction in expected sublease revenue of $27 in the three months ended June 30, 2002 was as a result of our ability to terminate certain leases early and at a discount to the originally anticipated lease costs associated with these leases. We expect to have subleased substantially all of these properties by the end of 2004. In addition, we wrote down the net carrying value of specific owned facilities across all segments within North America and the United Kingdom. The write down of approximately $95, which is included in plant and equipment write downs, reflected the net realizable value based on market assessments for general purpose facilities.
Contract settlement costs included negotiated settlements of approximately $190, to either cancel contracts or renegotiate existing contracts across all of our segments. As at June 30, 2002, the provision balance for contract settlement and lease costs has been drawn down by cumulative cash payments of $296, resulting in an ending provision balance of $651. The remaining provision is now expected to be substantially drawn down by the end of 2006.
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Plant and equipment write downs of approximately $459 consisted of the write down of leasehold improvements and certain information technology equipment associated with the exiting of the above noted leased and owned facilities.
In addition, as a result of the significant negative industry and economic trends impacting our operations and expected future growth rates, we have performed assessments of certain plant and equipment assets as part of our review of financial results during 2001 and the first six months of 2002. The conclusion of these assessments resulted in write downs of certain plant and equipment assets totaling approximately $771, as summarized below.
Within the Optical Networks segment, it was determined that there was excess manufacturing equipment at a number of facilities that would no longer be required, or the carrying value of which was not recoverable from future cash flows, as a result of the industry and economic environment. As a result, we recorded charges totaling approximately $592 to write down the value of this equipment to its net realizable value based on the current fair market value for this type of specialized equipment. We expect to dispose of this equipment, other than equipment that we continue to hold and use, by the end of 2002. In 2001, we also wrote down the net carrying value of a specialized manufacturing facility within the Optical Networks segment for the production of optical components within North America. The write down of approximately $91 reflects the net realizable value based on market assessments for a general purpose facility.
Within global operations, it was determined that there was excess test equipment at a number of system houses that would no longer be required as a result of the industry and economic environment. As a result, we recorded charges totaling approximately $88 to write down the value of this equipment to its net realizable value based on the current fair value for this type of specialized equipment. We expect to dispose of this equipment by the end of 2002.
In the course of reviewing our financial results for the three months ended June 30, 2001, we determined that the carrying values of intangible assets significantly exceeded their estimated fair value. Given this assessment, we determined that intangible assets, primarily composed of goodwill from various acquisitions, exceeded their fair value by $12,422. The write down was primarily associated with the acquisition of Alteon within the Metro and Enterprise Networks segment and the acquisitions of the Xros, Qtera, and the 980 NPLC Business within the Optical Networks segment.
For additional information related to these restructuring activities, see Special charges in note 6 to the accompanying unaudited consolidated financial statements.
Interest expense
The decrease in interest expense of $24 during the three months ended June 30, 2002 compared to the same period in 2001, was primarily related to a lower level of short-term notes payable in 2002 partially offset by additional interest expense due to long-term debt offerings during 2001.
The decrease in interest expense of $9 during the six months ended June 30, 2002 compared to the same period in 2001, was primarily related to a lower level of short-term notes payable in 2002, partially offset by additional interest expense due to long-term debt offerings during 2001.
Income tax benefit
Our effective tax benefit rates fluctuate from period to period primarily as a result of the impact of IPR&D expense, stock option compensation, goodwill write downs, certain non-tax deductible restructuring charges, and non-tax deductible goodwill amortization prior to January 1, 2002. Excluding these impacts, as applicable, our effective tax benefit rates were 30.3 percent and 31.0 percent for the three months and six months ended June 30, 2002, respectively, compared to 32.0 percent for the same periods in 2001, and reflected changes in the geographic earnings (loss) mix.
Recently approved tax legislation in the United States extended the net operating loss carry-back period from two years to five years. As a result, during the three months ended March 31, 2002 we carried back available United States losses from 2001 and utilized approximately $700 of previously recognized deferred income tax assets.
See Liquidity and capital resources for additional information.
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Net loss from continuing operations
Three months ended June 30, | Six months ended June 30, | |||||||||||||||||||||||
2001 | 2002 | $ Change | 2001 | 2002 | $ Change | |||||||||||||||||||
Reported results: |
||||||||||||||||||||||||
Net loss from continuing operations |
$ | (16,644 | ) | $ | (697 | ) | $ | 15,947 | $ | (19,013 | ) | $ | (1,538 | ) | $ | 17,475 | ||||||||
Basic and diluted loss per common share - - continuing operations |
$ | (5.21 | ) | $ | (0.20 | ) | $ | 5.01 | $ | (6.00 | ) | $ | (0.46 | ) | $ | 5.54 | ||||||||
Adjusted results:(a) |
||||||||||||||||||||||||
Net loss from continuing operations |
$ | (15,000 | ) | $ | (697 | ) | $ | 14,303 | $ | (15,773 | ) | $ | (1,538 | ) | $ | 14,235 | ||||||||
Basic and diluted loss per common share - - continuing operations |
$ | (4.70 | ) | $ | (0.20 | ) | $ | 4.50 | $ | (4.97 | ) | $ | (0.46 | ) | $ | 4.51 | ||||||||
(a) | Reflects the implementation of Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets, or SFAS 142, had the Statement been effective January 1, 2001. |
As a result principally of the foregoing factors, our reported net loss from continuing operations improved by $15,947 and $17,475 in the three months and six months ended June 30, 2002, respectively, compared to the same periods in 2001.
For additional information related to results adjusted for the implementation of SFAS 142, see Accounting changes in note 3 to the accompanying unaudited consolidated financial statements.
Results of operations discontinued operations
Revenues for our access solutions operations were $70 for the three months ended June 30, 2002 and $138 for the six months ended June 30, 2002, compared to $287 and $713, respectively, for the same periods in 2001. Access solutions operations also generated net cash of $237 and $289 during the three months and six months ended June 30, 2002, respectively.
During the three months ended June 30, 2002, Arris Group Inc., or Arris Group, completed a secondary public offering of 15 million common shares held by us. Following the closing of the offering on June 25, 2002, we owned 22 million shares, or approximately 27 percent of Arris Groups common shares. The cash proceeds received were $67 and a gain of approximately $15 was recorded as a result of this transaction, which is included in the estimated remaining provisions required for discontinued operations. During the three months ended March 31, 2002, we recorded a gain of approximately $13 due to the reduction of our ownership interest in Arris Group, received for our original interest in Arris Interactive LLC, from approximately 49 percent to approximately 46 percent as a result of Arris Groups issuance of common shares in connection with its acquisition of another company, which is included in the estimated remaining provisions required for discontinued operations.
On April 21, 2002, we entered into an agreement with Aastra Technologies Limited to sell certain assets, which were included in discontinued operations, associated with our prior acquisition of Aptis Communications, Inc. The transaction was completed during the three months ended June 30, 2002. The consideration primarily consisted of approximately $16 in cash, as well as contingent cash consideration of up to $60 over four years based on the achievement of certain revenue targets by the business. We recorded a loss of approximately $43 on the transaction, which reduced the estimated remaining provisions required for discontinued operations.
On March 5, 2002, we divested our approximately 46 percent ownership interest in Elastic Networks Inc. to Paradyne Networks, Inc., in exchange for an approximately 8 percent ownership interest in Paradyne. We recorded a gain of approximately $7 on the transaction, which is included in the estimated remaining provision required for discontinued operations.
During the six months ended June 30, 2002, we have continued to actively wind down the access solutions operations and there has been no change to the initial disposal strategy or intent to exit the business since June 14, 2001. However, the continued deterioration in industry and market conditions has delayed certain disposal activities beyond the
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original planned timeframe of one year. In particular, actions involving negotiations with customers, who have also been affected by industry conditions, are taking longer than expected. Therefore, although disposal activities continue beyond the one-year period generally contemplated under APB 30, we continue to present the access solutions operations as discontinued operations in the consolidated financial statements. We have disposed of or transitioned the ownership of certain operations, and operations not disposed of or so transitioned are expected to be closed. We now expect to complete this plan by the end of 2002 or early 2003, subject to the closing of specific transactions, the timing of which may continue to be impacted by customer issues, any applicable regulatory requirements, and business issues.
For additional information, see Discontinued operations in note 4 to the accompanying unaudited consolidated financial statements.
Critical accounting policies
Revenue recognition
Nortel Networks revenue recognition accounting policies are determined in accordance with the standards and guidance provided by United States generally accepted accounting principles. Our revenue streams are the result of a wide range of activities, from custom design and installation over a long period of time to out of the box solutions, with numerous variations in between. Our solutions also cover a broad range of technologies and are offered on a global basis. As a result, if we are selling products based on more established technologies, our revenue recognition policies can differ between regions depending on the level of knowledgeable installers within the region and whether we are installing the equipment. Newer technologies within a segment may also have different revenue recognition policies, depending on, among other factors, the specific performance and acceptance criteria within the applicable contract. Therefore, management must use judgment in determining how to apply the current standards and interpretations, not only based on solution, but also within solutions based on technology development and geographic region. As a result, Nortel Networks revenues may fluctuate from period to period based on the mix of solutions sold and in which geographic region they are sold. We refer you to note 2(d) of our audited consolidated financial statements and notes thereto for the three years ended December 31, 2001 in our Current Report on Form 8-K dated May 13, 2002 for a detailed discussion of our revenue recognition policies related to our material revenue streams.
Provisions for long-term receivables
In establishing the appropriate provisions for long-term receivables, management must regularly review the financial stability of individual customers. This analysis involves a judgment of a counterpartys ability to meet and sustain its financial commitments, and takes into account a counterpartys current and projected financial condition and the positive or negative effects of the current and projected industry outlook, as well as that of the economy in general. When all of these factors are fully considered, a determination is made as to the probability of default. An appropriate provision is then made, taking into account the severity of loss likely on the receivable balance in recovery. A misinterpretation or misunderstanding of these conditions, or other failure to estimate the counterpartys projected financial condition, or uncertainty in the future outlook of our industry or the economy could result in bad debts in excess of the provisions determined to be appropriate as at the balance sheet date.
Provisions for inventory
In establishing the appropriate provisions for inventory, management must make estimates about the future customer demand for our products, taking into account both general economic conditions and growth prospects within our customers ultimate marketplace, and the market acceptance of our current and pending products. These judgments must be made in the context of our customers shifting technology needs and changes in the geographic mix of our customers. A misinterpretation or misunderstanding of these conditions or uncertainty in the future outlook of our industry or the economy, or other failure to estimate correctly, could result in inventory losses in excess of the provisions determined to be appropriate as at the balance sheet date.
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Tax asset valuation
As at June 30, 2002, we had net deferred tax assets of $3,171, comprised of tax credit carryforwards, net operating loss carryforwards and other deductible temporary differences, which can be utilized to reduce either taxable income or taxes otherwise payable in future years. We assess realization of these net deferred tax assets quarterly, and based on all available evidence, both positive and negative, we have concluded that it is more likely than not that these net deferred tax assets will be realized. However, realization is not assured. If market conditions deteriorate further or our results of operations do not continue to improve, future assessments may result in a determination that these net deferred tax assets are not realizable. As a result, we may need to establish additional valuation allowances for all or a portion of the net deferred tax assets, which may have a material adverse effect on our business, results of operations, and financial condition.
Liquidity and capital resources
Cash flows
Cash and cash equivalents, or cash, were $4,869 at June 30, 2002, an increase of $1,356 (including net cash from the access solutions operations of $289) from December 31, 2001. The increase in cash was primarily the result of the June 12, 2002 equity offerings, which generated net proceeds to us of approximately $1,479.
Cash flows used in operating activities were $218 for the six months ended June 30, 2002, due to a net loss of $787, adjusted for non-cash items. This was partially offset by a net change in operating assets and liabilities due to reductions in income tax, accounts receivable, and inventory balances, partially offset by a reduction in accounts payable and accrued liabilities, and changes in other operating assets and liabilities. The reduction in income tax is due to the collection of income tax refunds during the period. The reduction in the remaining operating assets and liabilities is due to the decline in revenue volumes and the associated size of the business for the six months ended June 30, 2002, and the utilization of certain contract manufacturer and supplier provisions and restructuring provisions.
During the six months ended June 30, 2002, we received approximately $1,273 in tax refunds. This represents primarily all of the income tax refunds that we expect to receive for the remainder of 2002. Any future income tax payments are expected to be minimal versus historical levels until we utilize our available income tax loss carryforwards and tax credits.
Cash flows used in investing activities were $189 for the six months ended June 30, 2002, and were primarily due to expenditures for plant and equipment of $208 and an increase of $105 in net long-term receivables, partially offset by net proceeds on the sale/acquisition of investments and businesses of $73, primarily related to the sale of certain assets of our service commerce operation support system business, and the proceeds on disposal of certain plant and equipment of $76, primarily related to the sale of certain real estate in the United Kingdom.
Cash flows generated from financing activities were $1,428 for the six months ended June 30, 2002, primarily due to approximately $1,479 of net proceeds generated by the equity offerings, offset partially by a net decrease in notes payable of $77.
Uses of liquidity
Our cash requirements for the next 12 months are primarily to fund operations, research and development, capital expenditures, workforce reduction and restructuring activities, debt service, and customer financings. The following provides additional information related to our uses of liquidity.
Special charges
The remaining cash outlays of $399 related to workforce reduction initiatives are expected to be substantially completed by the second quarter of 2003, and the remaining cash payments of $651 related to contract settlement and lease costs are expected to be substantially completed by the end of 2006. Additional charges will be required in 2002 related to remaining announced workforce reductions and related charges, and the restructuring of the Optical Networks segment.
See Special charges for additional information.
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Cash obligations
Our contractual cash obligations for long-term debt, outsourcing contracts and operating leases as at June 30, 2002 remain substantially unchanged from the amounts disclosed as at December 31, 2001 in our Annual Report on Form 10-K for the year then ended.
Commitments and guarantees
We enter into bid and performance bonds related to various contracts, which generally have terms of less than two years. Potential payments due under these bonds are related to performance under the applicable contract. Historically, we have not had to make material payments under these types of bonds and we currently do not anticipate that we will be required to make material payments under the current bonds. The total commercial commitments representing amounts available and undrawn were $1,250 and $1,177 at June 30, 2002 and December 31, 2001, respectively. Due to the current general economic and industry environment, and our current credit ratings, the basis under which performance bonds are obtained has changed, resulting in (but not limited to) increased cash collateral requirements and/or increased fees in connection with obtaining new performance bonds. However, we currently do not expect that the requirements and/or fees to obtain performance bonds will have a material adverse effect on our ability to win contracts from potential customers. As at June 30, 2002, approximately $32 of cash was restricted as cash collateral for certain performance bonds. We expect the amount of cash we restrict as a result of cash collateral requirements for new performance bonds will increase during the second half of 2002.
We have also entered into supply contracts with customers for products and services, which in some cases involve new technologies currently being developed, or which we have not yet commercially deployed, or which require us to build and operate networks on a turnkey basis. We have also entered into network outsourcing contracts with customers to operate their networks. Some of these supply and network outsourcing contracts contain delivery and installation timetables, performance criteria and other contractual obligations which, if not met, could result in our having to pay substantial penalties or liquidated damages, the termination of the related supply or network outsourcing contract, and/or the reduction of shared revenues under a turnkey arrangement, in certain circumstances. As is customary for the industry, these supply and networking outsourcing contracts are highly customized to address each customers particular needs and concerns and, therefore, the nature of the events triggering, as well as the actual amounts of the penalties, vary greatly and are based on a variety of complex, interrelated factors, and may vary significantly in amount over the life of the contract. We have not experienced material penalty payments in any recent reporting period.
Further, certain of our supply arrangements with our contract manufacturers were negotiated prior to the current industry and economic downturn and, depending upon the extent and duration of this downturn, the terms of these arrangements may not be achievable. To the extent that we fail to meet any of these arrangements, and if we are unable to successfully renegotiate the applicable arrangement, we may be obligated to indemnify the contract manufacturer for certain direct costs attributable to our failure to so perform. The actual amount of any such indemnification, which could be substantial, would be based on a variety of complex, interrelated factors. The failure to reach a satisfactory resolution of any such matter could have a material adverse effect on our business, results of operations, financial condition, and supply relationships.
Customer financing
The following table provides information related to customer financing commitments as at:
June 30, | December 31, | |||||||
2002 | 2001 | |||||||
Drawn and outstanding(a) |
$ | 481 | $ | 464 | ||||
Undrawn commitments |
1,636 | 1,611 | ||||||
Total customer financing |
$ | 2,117 | $ | 2,075 | ||||
(a) | Net of provisions of $875 and $887 as at June 30, 2002, and December 31, 2001, respectively. |
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We currently have customer financing commitments and balances outstanding in connection with the turnkey construction of new networks, particularly third generation, or 3G, wireless networks, and we may commit to provide additional funding in the future if such financings are strategic to our core business activities. Generally, customer financing arrangements may include financing in connection with the sale of our products and services, as well as funding for certain non-product and service costs associated with network installation and integration of our products and services, and financing for working capital purposes and equity financing.
We continue to regularly assess the levels of our customer financing provisions based on a loan-by-loan review to evaluate whether they reflect current market conditions, as well as the ability of our customers to meet their repayment obligations and determine our provisions accordingly. Any misinterpretation or misunderstanding of these factors could result in losses in excess of our provisions. We also continue to restructure financings in an effort to minimize losses and reduce undrawn commitments where possible. In addition to being highly selective in providing customer financing, we have various programs in place to monitor and mitigate customer credit risk, including performance milestones and other conditions of funding. Management is focused on the strategic use of our customer financing capacity, on revolving that capacity as quickly and efficiently as possible, and on managing the absolute dollar amount of our customer financing exposure.
Our ability to place customer financing with third-party lenders has been significantly reduced due to, among other factors, reduced demand for telecommunications financings in capital and bank markets as a result of bankruptcies and financial difficulties in the industry, our recent credit ratings downgrade, adverse changes in the credit ratings of our customers, and recent economic downturns in various countries. As a result, we are currently directly supporting, and expect to be required to support in the future, more of such commitments and outstanding balances of such customer financings. We will continue to seek to arrange for third-party lenders to assume our customer financing obligations and to fund customer financings from working capital and conventional sources of external financing in the normal course. However, our customer financing commitments and balances outstanding may increase substantially as a result of us continuing to hold such customer financings.
See Forward-looking statements for additional factors that may impact our customer financing arrangements.
Discontinued operations
At June 30, 2002, the remaining accruals totalled $164 and were related to certain future contractual obligations and estimated liabilities of the discontinued access solutions operations, and estimated operating losses during the planned period of disposition. The remaining accruals are expected to be substantially drawn down by cash payments over the period of disposition, the impact of which is expected to be offset by proceeds from the sale of certain remaining assets to be disposed of. During the six months ended June 30, 2002 we generated cash of approximately $80 on the disposition of various assets from the access solutions operations.
For additional information related to discontinued operations, see Discontinued operations in note 4 to the accompanying unaudited consolidated financial statements.
Sources of liquidity
On April 12, 2000, Nortel Networks Limited and Nortel Networks Inc. entered into five-year syndicated credit agreements, which permit borrowings in an aggregate amount of up to $750. Effective April 8, 2002, Nortel Networks Limited and Nortel Networks Inc. amended and extended the 364-day revolving syndicated credit agreements originally entered into on April 12, 2000 and subsequently amended on April 11, 2001. The April 8, 2002 amendments reduced the size of the 364-day committed revolving facilities to $1,175 from $1,750 and extended the term to April 7, 2003 with no additional term-out period thereafter. As a result, total borrowings currently permitted under these syndicated five-year and 364-day credit agreements are $1,925. The amended 364-day facilities maintain the financial covenant in the April 2001 facilities requiring Nortel Networks Limiteds consolidated tangible net worth at any time to be not less than $1,888 and include higher pricing reflecting the then current credit and bank environment. These credit facilities can be used for borrowings for general corporate purposes.
Nortel Networks Limited and Nortel Networks Inc. also have 364-day credit agreements with certain banks which permit borrowing in an aggregate amount of up to $1,518 to December 13, 2002, with a one-year term out option to convert
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outstanding amounts under the credit agreements into term loans on the termination date of the credit agreements. On June 27, 2002, we sold certain real estate in the United Kingdom, which resulted in a reduction, effective July 2, 2002, in available commitments under these credit agreements by $57 to $1,518.
The credit agreements for the $1,518 committed facilities noted above contain financial covenants that require (i) the maintenance of a minimum consolidated tangible net worth at the consolidated Nortel Networks Limited level, and (ii) the achievement of certain minimum consolidated earnings before interest, taxes, depreciation and amortization, or EBITDA, thresholds at the Nortel Networks level, which began in the first quarter of 2002. The consolidated tangible net worth of Nortel Networks Limited may not be less than $1,880. The consolidated EBITDA covenant requires that we achieve a cumulative EBITDA of negative $700 or better for the nine months ended September 30, 2002 and negative $350 or better for the full year ended December 31, 2002. In addition, there are minimum EBITDA covenants in place for the first three quarters of 2003, tested in quarterly increments during the period. Compliance with this covenant will require EBITDA improvements during the third and fourth quarters of 2002, and further improvements in the year thereafter. Certain business restructuring charges and other incremental charges and gains as publicly disclosed are excluded from the calculation of EBITDA. In addition, these credit agreements contain covenants restricting additional debt, the payment of dividends, corporate events, liens, sale and leasebacks, and investments, among others. Payments of dividends on the outstanding preferred shares of Nortel Networks Limited is permitted provided that compliance with certain covenants of the credit agreements is maintained. The credit agreements contain covenants restricting the transfer of funds by way of loans or dividends to Nortel Networks Corporation and its other wholly owned subsidiaries from Nortel Networks Limited, which as at June 30, 2002 had consolidated net assets of $5,521. These restrictions have not had, and are not expected to have an effect on Nortel Networks Corporations ability to meet its primary cash obligations associated with the $1,800 4.25 percent convertible senior notes due September 1, 2008.
Any amounts subsequently drawn under all of Nortel Networks Limiteds and Nortel Networks Inc.s existing credit agreements will be secured equally and ratably with all of our current outstanding public debt securities pursuant to the security documents which became effective following Moodys Investors Services, Inc.s downgrade of Nortel Networks Limiteds United States senior long-term debt rating below investment grade on April 4, 2002. The security is comprised of liens on substantially all of the assets of Nortel Networks Limited and those of most of its United States and Canadian subsidiaries, and pledges of shares in certain of Nortel Networks Limiteds other subsidiaries. In addition, certain of Nortel Networks Limiteds wholly owned subsidiaries have provided guarantees of Nortel Networks Limiteds obligations under these credit agreements. The security would be released when Nortel Networks Limiteds United States senior long-term debt ratings return to Baa2 (with a stable outlook) and BBB (with a stable outlook), as determined by Moodys Investors Services, Inc. and Standard & Poors Ratings Service, respectively.
For additional financial information related to those subsidiaries providing guarantees, see Supplemental consolidating financial information in note 18 of the accompanying unaudited consolidated financial statements.
As at June 30, 2002, we were in compliance with the covenants of our credit agreements and had no amounts outstanding under any of the above-noted credit agreements. Refer to the discussion below regarding our debt ratings and see Forward-looking statements for factors that may affect our ability to comply with covenants and conditions in our credit agreements in the future. The above-noted 364-day credit agreements are scheduled to expire in December 2002 and April 2003. If we are unable to renew, extend, and/or replace such facilities, or to do so on terms or at commitment levels equivalent to our current facilities, the liquidity available to us could be reduced.
During the three months ended June 30, 2002, Nortel Networks Corporation and Nortel Networks Limited filed a shelf registration statement with the United States Securities and Exchange Commission and a base shelf prospectus with the applicable securities regulatory authorities in Canada, for the purpose of qualifying the potential sale by Nortel Networks Corporation or Nortel Networks Limited from time to time in the United States and/or Canada of up to an aggregate of $2,500 of various types of securities, including common shares, preferred shares, debt securities, warrants to purchase equity or debt securities, share purchase contracts, and share purchase or equity units (subject to certain approvals). As at June 30, 2002, we have utilized approximately $1,700 of the $2,500 available under our shelf registration statement and our base shelf prospectus. Concurrently with the filing of the above shelf registration statement and base shelf prospectus, Nortel Networks Limited and its financing subsidiary withdrew an existing shelf registration statement filed with the United States Securities and Exchange Commission under which they were previously eligible to issue up to an aggregate of $1,000 of debt securities and warrants to purchase debt securities.
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The total debt to total capitalization ratio of Nortel Networks was 47 percent at June 30, 2002, compared to 47 percent at December 31, 2001. The ratio reflects the increase in our deficit, offset by the equity offerings on June 12, 2002.
Credit ratings
Rating on long-term debt issued or | Rating on preferred | |||||||||||
guaranteed by Nortel Networks Limited/ | shares issued by Nortel | |||||||||||
Rating agency | Nortel Networks Corporation | Networks Limited | Last update | |||||||||
Standard & Poors Ratings Service |
BB- | Global scale B | April 9, 2002 | |||||||||
Moodys Investor Services, Inc. |
Ba3 | B3 | April 4, 2002 | |||||||||
The ratings remain on negative outlook by Moodys and Standard & Poors. There can be no assurance that our credit ratings will not be lowered further or that such ratings agencies will not issue adverse commentaries, resulting in higher financing costs under our credit facilities and for other financings generally, and reduced access to the capital markets or our credit agreements. Our credit ratings also affect our ability, and the cost, to securitize receivables and to obtain performance bonds.
See Forward-looking statements for effects of changes in respect of our debt ratings.
During 2001 and the first six months of 2002, we took actions to strengthen our cash and liquidity positions and as of June 30, 2002, our primary source of liquidity is our current cash and cash equivalents. We believe this cash will be sufficient to meet our working capital, restructuring, capital expenditure, and investment requirements through the next 12 months. If our revenues and cash flows are materially lower than we expect, we may be required to further reduce capital expenditures and investments in order to meet our cash requirements. We may seek additional funds from liquidity-generating transactions and other conventional sources of external financing (which may include a variety of debt, convertible debt, and/or equity financings). We cannot provide any assurance that our net cash requirements will be as we currently expect, that we will continue to have access to our credit facilities when and as needed, or that liquidity-generating transactions or financings will be available to us on acceptable terms or at all.
See Forward-looking statements for factors that may affect our revenues, cash flows and debt levels.
Legal proceedings
Subsequent to the February 15, 2001 announcement in which Nortel Networks Corporation provided revised guidance for financial performance for the 2001 fiscal year and the first quarter of 2001, Nortel Networks Corporation and certain of its then current officers and directors were named as defendants in more than twenty-five purported class action lawsuits. These lawsuits in the United States District Courts for the Eastern District of New York, for the Southern District of New York and for the District of New Jersey, and in the provinces of Ontario, Quebec, and British Columbia in Canada, on behalf of shareholders who acquired Nortel Networks Corporations securities as early as October 24, 2000 and as late as February 15, 2001, allege, among other things, violations of United States federal and Canadian provincial securities laws. Securities regulatory authorities in Canada and the United States are also reviewing these matters. On May 11, 2001, Nortel Networks Corporation filed motions to dismiss and/or stay in connection with the three proceedings in Quebec primarily based on the factual allegations lacking substantial connection to Quebec and the inclusion of shareholders resident in Quebec in the class claimed in the Ontario lawsuit. The plaintiffs in two of these proceedings in Quebec obtained court approval for discontinuances of their proceedings on January 17, 2002. The motion to dismiss and/or stay the third proceeding was heard on November 6, 2001 and the court deferred any determination on the motion to the judge who will hear the application for authorization to commence a class proceeding. On December 6, 2001, Nortel Networks Corporation filed a motion seeking leave to appeal that decision. The motion for leave to appeal was dismissed on March 11, 2002. On October 16, 2001, an order in the Southern District of New York was filed consolidating twenty-five of the related United States class action lawsuits into a single case, appointing class plaintiffs and counsel for such plaintiffs. The plaintiffs served a consolidated amended complaint on January 18, 2002. On December 17, 2001, the defendants in the British Columbia action served notice of a motion requesting the court to decline jurisdiction and to stay all proceedings on the ground that
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British Columbia is an inappropriate forum. On July 17, 2002, a purported class action lawsuit was filed in the Ontario Superior Court of Justice, Commercial List, naming Nortel Networks Corporation, certain of its current and former officers and directors, and its auditors as defendants. The factual allegations in this Ontario claim are substantially similar to the allegations in the consolidated amended complaint filed in the United States District Court described above. This Ontario claim is on behalf of all Canadian residents who purchased Nortel Networks Corporations securities (including options on Nortel Networks Corporations securities) between October 24, 2000 and February 15, 2001. The plaintiffs claim damages of Cdn. $5,000, plus punitive damages in the amount of Cdn. $1,000, prejudgment and postjudgment interest, and costs of the action. Nortel Networks Corporation and the named directors and officers of Nortel Networks Corporation intend to vigorously defend this Ontario claim.
A class action lawsuit was also filed in the United States District Court for the Southern District of New York on behalf of shareholders who acquired the securities of JDS Uniphase Corporation between January 18, 2001 and February 15, 2001, alleging violations of the same United States federal securities laws as the above-noted lawsuits.
On April 1, 2002, Nortel Networks Corporation filed a motion to dismiss both the above consolidated United States shareholder class action and the above JDS Uniphase shareholder class action complaints on the grounds that they failed to state a cause of action under United States federal securities laws. With respect to the JDS Uniphase shareholder class action complaint, Nortel Networks Corporation also moved to dismiss on the separate basis that JDS Uniphase shareholders lacked standing to sue Nortel Networks Corporation.
A purported class action lawsuit was filed in the United States District Court for the Middle District of Tennessee on December 21, 2001, on behalf of participants and beneficiaries of the Nortel Networks Long-Term Investment Plan, or the Plan, at any time during the period of March 7, 2000 through the filing date and who made or maintained Plan investments in Nortel Networks Corporations common shares, under the Employee Retirement Income Security Act for Plan-wide relief and alleging, among other things, material misrepresentations and omissions to induce Plan participants to continue to invest in and maintain investments in Nortel Networks Corporations common shares in the Plan. A second purported class action lawsuit, on behalf of the Plan and Plan participants for whose individual accounts the Plan purchased Nortel Networks Corporations common shares during the period from October 27, 2000 to February 15, 2001, and making similar allegations, was filed in the same court on March 12, 2002. A third purported class action lawsuit, on behalf of persons who are or were Plan participants or beneficiaries at any time since March 1, 1999 to the filing date, and making similar allegations, was filed in the same court on March 21, 2002. The first and second purported class action lawsuits were consolidated by a new purported class action complaint, filed on May 15, 2002 in the same court and making similar allegations, on behalf of Plan participants and beneficiaries who directed the Plan to purchase or hold shares of certain funds, which held primarily Nortel Networks Corporation common shares, during the period of March 7, 2000 through December 31, 2000.
On February 12, 2001, Nortel Networks Inc., an indirect subsidiary of Nortel Networks Corporation, was served with a consolidated amended class action complaint that purported to add Nortel Networks Corporation as a defendant to a lawsuit commenced in July 2000 against Entrust, Inc. (formerly Entrust Technologies, Inc.) and two of its then current officers in the United States District Court for the Eastern District of Texas (Marshall Division), or the District Court. This complaint alleges that Entrust, two officers of Entrust, and Nortel Networks Corporation violated the Securities Exchange Act of 1934 with respect to certain statements made by Entrust. Nortel Networks Corporation is alleged to be a controlling person of Entrust. On April 6, 2001, Nortel Networks Corporation filed a motion to dismiss the first complaint. On July 31, 2001, the first complaint was dismissed without prejudice. On August 31, 2001, the plaintiffs filed a second amended class action complaint against the same defendants asserting claims substantively similar to those in the first complaint. On September 21, 2001, Nortel Networks Corporation filed a motion to dismiss this second complaint. The motion is currently under consideration by the District Court.
On March 4, 1997, Bay Networks, Inc., a company acquired on August 31, 1998, announced that shareholders had filed two separate lawsuits in the United States District Court for the Northern District of California, or the Federal Court, and the California Superior Court, County of Santa Clara, or the California Court, against Bay Networks and ten of Bay Networks then current and former officers and directors, purportedly on behalf of a class of shareholders who purchased Bay Networks common shares during the period of May 1, 1995 through October 14, 1996. On August 17, 2000, the Federal Court granted the defendants motion to dismiss the federal complaint. On August 1, 2001, the United States Court of Appeals for the Ninth Circuit denied the plaintiffs appeal of that decision. On April 18, 1997, a second lawsuit was filed in the California Court, purportedly on behalf of a class of shareholders who acquired Bay Networks common shares pursuant
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to the registration statement and prospectus that became effective on November 15, 1995. The two actions in the California Court were consolidated in April 1998; however, the California Court denied the plaintiffs motion for class certification. In January 2000, the California Court of Appeal rejected the plaintiffs appeal of the decision. A petition for review was filed with the California Supreme Court by the plaintiffs and was denied. In February 2000, new plaintiffs who allege to have been shareholders of Bay Networks during the relevant periods, filed a motion for intervention in the California Court seeking to become the representatives of a class of shareholders. The motion was granted on June 8, 2001 and the new plaintiffs filed their complaint-in-intervention on an individual and purported class representative basis alleging misrepresentations made in connection with the purchase and sale of securities of Bay Networks in violation of California statutory and common law. On March 11, 2002, the California Court granted the defendants motion to strike the class allegations. The plaintiffs were permitted to proceed on their individual claims. The plaintiffs are appealing the dismissal of their class allegations.
Except as disclosed above, in each of the matters described above, plaintiffs are seeking an unspecified amount of money damages.
We are also a defendant in various other suits, claims, proceedings and investigations which arise in the normal course of business.
We are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact of the above matters which seek damages of material or indeterminate amounts, and therefore cannot determine whether these actions, suits, claims, proceedings and investigations will, individually or collectively, have a material adverse effect on our business, results of operations, and financial condition. We and any of our named directors and officers intend to vigorously defend these actions, suits, claims, proceedings and investigations.
Environmental matters
We, primarily as a result of our manufacturing operations, are subject to numerous environmental protection laws and regulations in various jurisdictions around the world, and are exposed to liabilities and compliance costs arising from our past and current generation, management and disposition of hazardous substances and wastes.
We have remedial activities under way at five of our facilities and seven previously occupied sites. An estimate of our anticipated remediation costs associated with all such facilities and sites, to the extent probable and reasonably estimable, is included in our environmental accruals in an approximate amount of $29.
For a discussion of Environmental matters, see Environmental matters in note 18 to Nortel Networks Corporations audited consolidated financial statements and notes thereto for the year ended December 31, 2001.
Forward-looking statements
Certain information and statements contained in this Managements Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report, including statements containing words such as could, expects, may, anticipates, believes, intends, estimates, plans, and similar expressions, are forward-looking statements. These address our business, results of operations, and financial condition, and include statements based on current expectations, estimates, forecasts, and projections about the operating environment, economies and markets in which we operate and our beliefs and assumptions regarding such operating environment, economies and markets. In addition, we or others on our behalf may make other written or oral statements which constitute forward-looking statements. This information and such statements are subject to important risks, uncertainties, and assumptions, which are difficult to predict. The results or events predicted in these statements may differ materially from actual results or events. Some of the factors which could cause results or events to differ from current expectations include, but are not limited to, the factors set forth below. Except as otherwise required by applicable securities laws, we disclaim any intention or obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
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We have restructured our business to respond to industry and market conditions. The assumptions underlying our restructuring efforts may prove to be inaccurate and we may have to restructure our business again in the future.
In response to changes in industry and market conditions, we have restructured our business in the past, are currently restructuring our business, and may again restructure our business in the future to achieve certain cost savings and to strategically realign our resources. We have based our work plan pertaining to the restructuring on certain assumptions regarding the cost structure of our business and the nature, severity, and duration of the current industry adjustment which may not prove to be accurate. We have stated that we will continue to assess our work plan based on an ongoing assessment of the industry adjustment.
While restructuring, we have assessed, and will continue to assess, whether we should dispose of or otherwise exit businesses or further reduce our workforce, as well as review the recoverability of our tangible and intangible assets associated with those businesses. Any decision to further limit investment or to dispose of or otherwise exit businesses may result in the recording of additional charges, such as workforce reduction costs, facilities reduction costs, asset write downs, and contractual settlements. Additionally, estimates and assumptions used in asset valuations are subject to uncertainties, as are accounting estimates with respect to the useful life and ultimate recoverability of our carrying basis of assets, including goodwill and other intangible assets. As a result, future market conditions may result in further charges for the write down of tangible and intangible assets.
We may not be able to successfully implement the initiatives we have undertaken in restructuring our business and, even if successfully implemented, these initiatives may not be sufficient to meet the changes in industry and market conditions and to achieve future profitability.
We must successfully implement our work plan if we are to adjust our cost structure to reflect current and expected future economic conditions, market demands and revenues, and to achieve future profitability. We must also manage the potentially higher growth areas of our business, as well as the non-core areas of our business, effectively in light of current and expected future market demands and trends.
Under our work plan, we have also implemented a number of initiatives, including exiting businesses and writing down our tangible and intangible assets, to streamline our business, and to focus our investments on delivering what we believe to be the key next-generation networking solutions. However, our work plan, including workforce reductions, may not be sufficient to meet the changes in industry and market conditions, and such conditions may continue to deteriorate or last longer than we expect. In addition, we may not be able to successfully implement our work plan and may be required to refine, expand or extend our work plan. Furthermore, our workforce reductions may impair our ability to realize our current or future business objectives. Lastly, costs actually incurred in connection with restructuring actions may be higher than the estimated costs of such actions and/or may not lead to the anticipated cost savings. As a result, our restructuring efforts may not result in our return to profitability within the currently expected timeframe.
We may be materially and adversely affected by continued reductions in spending on telecommunications infrastructure by our customers.
A continued slowdown in capital spending by service providers may affect our revenues more than we currently expect. Moreover, the significant slowdown in capital spending by service providers has created uncertainty as to market demand. As a result, revenues and operating results for a particular period can be difficult to predict. In addition, there can be no certainty as to the severity or duration of the current industry adjustment. Many of our traditional customers have already begun to invest in data networking and/or are in the process of transitioning from voice-only networks to networks which include data traffic. However, as a result of changes in industry and market conditions, many of our customers have reduced their capital spending on telecommunications infrastructure. Our revenues and operating results have been and may continue to be materially and adversely affected by the continued reductions in capital spending on telecommunications infrastructure by our customers. If the reduction of capital spending continues longer than we expect and we continue to incur net losses as a result, we may be unable to comply with certain covenants under our current credit agreements. As well, we have focused on the larger customers in our markets, which provide a substantial portion of our revenues. A reduction or delay in business from one or more of these customers, or a failure to achieve a significant market share with these customers, could have a material adverse effect on our business, results of operations, and financial condition.
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Our operating results have historically been subject to yearly and quarterly fluctuations and are expected to continue to fluctuate.
Our operating results have historically been and are expected to continue to be subject to quarterly and yearly fluctuations as a result of a number of factors. These factors include:
| our ability to successfully implement programs to stimulate customer spending by anticipating and offering the kinds of products and services customers will require in the future to increase the efficiency and profitability of their networks; | ||
| our ability to successfully complete programs on a timely basis to reduce our cost structure, including fixed costs, to streamline our operations, and to reduce product costs; | ||
| our ability to focus our business on what we believe to be potentially higher growth, higher margin businesses, and to dispose of or exit non-core businesses; | ||
| increased price and product competition in the networking industry; | ||
| the inherent uncertainties of using estimates and assumptions for asset valuations and in determining the amounts of accrued liabilities and other items in our consolidated financial statements; | ||
| our ability to implement our work plan without negatively impacting our relationships with our customers, the delivery of products based on new and developing technologies, the delivery of high quality robust products at competitive prices, the maintenance of technological leadership, the effectiveness of our internal processes and organizations, and the retention of qualified personnel; | ||
| fluctuations in our gross margins; | ||
| the development, introduction and market acceptance of new technologies, and integrated networking solutions, as well as the adoption of new networking standards; | ||
| variations in sales channels, product costs, and the mix of products sold; | ||
| the size and timing of customer orders and shipments; | ||
| our ability to maintain appropriate inventory levels; | ||
| the impact of acquired businesses and technologies; and | ||
| the impact of our product development schedules, manufacturing capacity, and lead times required to produce our products. |
Additionally, we are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances, which may result in a charge to net earnings (loss).
Significant fluctuations in our operating results could contribute to volatility in the market price of Nortel Networks Corporations common shares.
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Economic conditions in the United States, Canada, and globally, affecting the telecommunications industry, as well other trends and factors affecting the telecommunications industry, are beyond our control and may result in reduced demand and pricing pressure on our products.
There are trends and factors affecting the telecommunications industry, which are beyond our control and may affect our operations. Such trends and factors include:
| adverse changes in the public and private equity and debt markets and our ability, as well as the ability of our customers and suppliers, to obtain financing or to fund working capital and capital expenditures; | ||
| adverse changes in our credit rating, or the credit ratings of our customers and suppliers; | ||
| adverse changes in the market conditions in our industry and the specific markets for our products; | ||
| the trend towards the sale of integrated networking solutions; | ||
| visibility to, and the actual size and timing of, capital expenditures by our customers; | ||
| inventory practices, including the timing of product and service deployment, of our customers; | ||
| the amount of network capacity and the network capacity utilization rates of our customers, and the amount of sharing and/or acquisition of new and/or existing network capacity by our customers; | ||
| policies of our customers regarding utilization of single or multiple vendors for the products they purchase; | ||
| the overall trend toward industry consolidation and rationalization among our customers, competitors, and suppliers; | ||
| conditions in the broader market for communications products, including data networking products and computerized information access equipment and services; | ||
| governmental regulation or intervention affecting communications or data networking; and | ||
| the effects of war and acts of terrorism, such as disruptions in general global economic activity, changes in logistics and security arrangements, and reduced customer demand for our products and services. |
Economic conditions affecting the telecommunications industry, which affect market conditions in the telecommunications and networking industry, in the United States, Canada and globally, affect our business. Reduced capital spending and/or negative economic conditions in the United States, Canada, Europe, Asia, Latin America and/or other areas of the world could result in reduced demand for or pricing pressure on our products.
Our gross margins may be negatively affected, which in turn would negatively affect our operating results and could contribute to volatility in the market price of Nortel Networks Corporations common shares.
Our gross margins may be negatively affected as a result of a number of factors, including:
| increased price competition; | ||
| excess capacity; | ||
| higher material or labour costs; | ||
| warranty costs; | ||
| obsolescence charges; |
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| loss of cost savings on future inventory purchases as a result of high inventory levels; | ||
| introductions of new products and costs of entering new markets; | ||
| increased levels of customer services; | ||
| changes in distribution channels; and | ||
| changes in product and geographic mix. |
Lower than expected gross margins would negatively affect our operating results and could contribute to volatility in the market price of Nortel Networks Corporations common shares.
We may not be able to attract or retain the specialized technical and managerial personnel necessary to achieve our business objectives.
Competition for certain key positions and specialized technical personnel in the high-technology industry is intense, despite current economic conditions. We believe that our future success depends in part on our continued ability to hire, assimilate, and retain qualified personnel in a timely manner, particularly key members of senior management and in our key areas of potential growth. A key factor in attracting and retaining qualified employees is our ability to provide employees with the opportunity to participate in the potential growth of our business through programs such as stock option plans and employee investment plans. The value of these opportunities may be adversely affected by the volatility or negative performance of the market price for Nortel Networks Corporations common shares. We may also find it more difficult to attract or retain qualified employees because of our recent significant workforce reductions and business performance. In addition, if we have not properly sized our workforce and retained those employees with the appropriate skills, our ability to compete effectively may be adversely affected. We are also more dependent on those employees we have retained, as many have taken on increased responsibilities due to the workforce reductions. If we are not successful in attracting, retaining or recruiting qualified employees, including members of senior management, in the future, we may not have the necessary personnel to effectively compete in the highly dynamic, specialized and volatile industry in which we operate or to achieve our business objectives.
Future cash flow fluctuations may affect our ability to fund our working capital requirements or achieve our business objectives in a timely manner.
Our working capital requirements and cash flows historically have been, and are expected to continue to be, subject to quarterly and yearly fluctuations, depending on such factors as timing and size of capital expenditures, levels of sales, timing of deliveries and collection of receivables, inventory levels, customer payment terms, customer financing obligations, and supplier terms and conditions. Our inability to manage cash flow fluctuations resulting from such factors could have a material adverse effect on our ability to fund our working capital requirements from operating cash flows and other sources of liquidity or to achieve our business objectives in a timely manner.
Our business may be materially and adversely affected by our increased levels of debt.
In order to finance our business we have incurred, have entered into credit facilities allowing for drawdowns of, and filed a shelf registration statement and base shelf prospectus for potential offerings of, significant levels of debt compared to historical levels, and we may need to secure additional sources of funding, which may include debt or convertible debt financing, in the future. A high level of debt, arduous or restrictive terms and conditions relating to accessing certain sources of funding, failure to meet certain covenants under our credit agreements, poor business performance or lower than expected cash inflows could have adverse consequences on our ability to fund our business and the operation of our business.
In particular, certain of such credit agreements contain financial covenants that require the maintenance of a minimum consolidated tangible net worth and the achievement of certain minimum consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) thresholds. The consolidated tangible net worth of Nortel Networks Limited may not be less than $1,888 at any time. The consolidated EBITDA covenant requires that we achieve a cumulative EBITDA of negative $700 or better for the nine months ended September 30, 2002 and negative $350 or better for the full
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year ended December 31, 2002. In addition, there are minimum EBITDA covenants in place for the first three quarters of 2003, tested in quarterly increments during the period. Compliance with this covenant will require EBITDA improvements during the third and fourth quarters of 2002, and further improvements in the year thereafter. Certain business restructuring charges and other incremental charges and gains as publicly disclosed are excluded from the calculation of EBITDA. In addition, these credit agreements contain covenants restricting additional debt, the payment of dividends, corporate events, liens, sale and leasebacks, and investments, among others. Payments of dividends on the outstanding preferred shares of Nortel Networks Limited is permitted provided that compliance with certain covenants of the credit agreements is maintained. The credit agreements contain covenants restricting the transfer of funds by way of loans or dividends to Nortel Networks Corporation and its other wholly owned subsidiaries from Nortel Networks Limited, which as at June 30, 2002 had consolidated net assets of $5,521. These restrictions have not had, and are not expected to have an effect on Nortel Networks Corporations ability to meet its primary cash obligations associated with the $1,800 4.25 percent convertible senior notes due September 1, 2008. If we continue to incur net losses, we may be unable to comply with certain of our covenants under the credit agreements, which could adversely affect the liquidity available to us. Our principal credit facilities are scheduled to expire in December 2002 and April 2003. If we are unable to renew, extend, and/or replace such facilities, or to do so on terms or at commitment levels equivalent to our current facilities, the liquidity available to us could be reduced.
Other effects of a high level of debt include the following:
| we may have difficulty borrowing money in the future, or accessing sources of funding, including our credit facilities; | ||
| we may need to use a large portion of our cash flow from operations to pay principal and interest on our indebtedness, which would reduce the amount of cash available to finance our operations and other business activities; | ||
| a high debt level, arduous or restrictive terms and conditions, or lower than expected cash flows would make us more vulnerable to economic downturns and adverse developments in our business; and | ||
| if operating cash flows are not sufficient to meet our operating expenses, capital expenditures, and debt service requirements as they become due, we may be required, in order to meet our debt service obligations, to delay or reduce capital expenditures or the introduction of new products, sell assets, and/or forego business opportunities including acquisitions, research and development projects, or product design enhancements. |
Changes in respect of our public debt ratings may materially and adversely affect the availability, the cost, and the terms and conditions of our debt and asset-based financings.
Certain of our outstanding debt instruments are publicly rated by independent rating agencies, which ratings are now below investment grade. These public debt ratings affect our ability to raise debt, our access to the commercial paper market (which is currently closed to us), our ability to engage in asset-based financing, and our ability to obtain performance bonds. These public debt ratings also may negatively affect the cost to us and terms and conditions of debt and asset-based financings. Additionally, any negative developments regarding our cash flow, public debt ratings and/or our incurring significant levels of debt, or our failure to meet certain covenants under our credit agreements, could cause us to lose access to, and/or cause a default under certain of our credit facilities and adversely affect further the cost and terms and conditions of our debt and asset-based financings.
Our performance may be materially and adversely affected if our expectations regarding market demand for particular products prove to be wrong.
We expect that data communications traffic will grow at a faster rate than the growth expected for voice traffic, and that the use of the Internet will continue to increase. We expect the growth of data traffic and the use of the Internet will significantly impact traditional voice networks, both wireline and wireless. We believe that this will create market discontinuities. By market discontinuities, we mean opportunities for new technologies, applications, products and services that enable the secure, rapid, and efficient transport of large volumes of data traffic over networks and allow service providers and carriers to increase revenues and improve operating results. Market discontinuities will also make traditional voice network products and services less effective as they were not designed for data traffic. We believe that these market
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discontinuities in turn will lead to the convergence of data and voice through upgrades of traditional voice networks to transport large volumes of data traffic or through the construction of new networks designed to transport both voice and data traffic. Either approach would require significant capital expenditures by service providers and carriers. We also believe that such developments will give rise to the demand for Internet Protocol-, or IP-, optimized networking solutions, and third generation, or 3G, wireless networks. Internet Protocol is the predominant method by which data is sent from one computer to another on the Internet a data message is divided into smaller packets which contain both the senders unique IP address and the receivers unique IP address, and each packet is sent, potentially by different routes and as independent units, across the Internet. There is no continuing connection between the end points which are communicating versus traditional telephone communications which involve establishing a fixed circuit that is maintained for the duration of the voice or data communications call. 3G wireless networks are an evolution of communications networks from second generation wireless networks for voice and low speed data communications that are based on circuit switching when a call is dialed, a circuit is established between the mobile handset and the third party, and the connection lasts for the duration of the call. By comparison, 3G networks allow devices to be always on because the networks are packet-based. We expect 3G networks to include such features as voice, high speed data communications and high bandwidth multimedia capabilities, and usability on a variety of different communications devices, such as cellular telephones and pagers, with the user having accessibility anywhere and at any time to these features.
We cannot be sure what the rate of such convergence of voice and data networks will be, due to the dynamic and rapidly evolving nature of the communications business, the technology involved and the availability of capital. Consequently, market discontinuities and the resulting demand for IP-optimized networking solutions or 3G wireless networks may not materialize. Alternatively, the pace of that development may be slower than currently anticipated. It may also be the case that the market may develop in an unforeseen direction. Certain events, including the commercial availability and actual implementation of new technologies, including 3G networks, or the evolution of other technologies, may occur which would affect the extent or timing of anticipated market demand, or increase demand for products based on other technologies, or reduce the demand for IP-optimized networking solutions or 3G wireless networks, which in turn may reduce purchases of our networking solutions by our customers, require increased expenditures to develop and market different technologies, or provide market opportunities for our competitors. Our performance may also be materially and adversely affected by a lack of growth in the rate of data traffic, a reduction in the use of the Internet or a reduction in the demand for IP-optimized networking solutions or 3G wireless networks in the future.
We have made, and may continue to make, strategic acquisitions in order to enhance our business. If we are not successful in operating or integrating these acquisitions, our business, results of operation, and financial condition may be materially and adversely affected.
In the past, we acquired companies to enhance the expansion of our business and products. We may consider selective opportunistic acquisitions of companies or businesses with resources and product or service offerings capable of providing us with additional strengths to help fulfill our vision of building the new, high-performance Internet. Acquisitions involve significant risks and uncertainties. These risks and uncertainties include:
| the risk that the industry may develop in a different direction than anticipated and that the technologies we acquire do not prove to be those we need to be successful in the industry; | ||
| the risk that future valuations of acquired businesses may decrease from the market price we paid for these acquisitions; | ||
| the generation of insufficient revenues by acquired businesses to offset increased operating expenses associated with these acquisitions; | ||
| the potential difficulties in completing in-process research and development projects and delivering high quality robust products to our customers; | ||
| the potential difficulties in integrating new products, businesses and operations in an efficient and effective manner; | ||
| the risk that our customers or customers of the acquired businesses may defer purchase decisions as they evaluate the impact of the acquisitions on our future product strategy; |
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| the potential loss of key employees of the acquired businesses; | ||
| the risk that acquired businesses will divert the attention of our senior management from the operation of our business; and | ||
| the risks of entering new markets in which we have limited experience and where competitors may have a stronger market presence. |
Our inability to successfully operate and integrate newly-acquired businesses appropriately, effectively and in a timely manner could have a material adverse effect on our ability to take advantage of further growth in demand for IP-optimized network solutions and other advances in technology, as well as on our revenues, gross margins, and expenses.
We operate in highly dynamic and volatile industries characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions, and short product life cycles.
The markets for our products are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. We expect our success to depend, in substantial part, on the timely and successful introduction of high quality, new products and upgrades, as well as cost reductions on current products to address the operational speed, bandwidth, efficiency, and cost requirements of our customers. Our success will also depend on our ability to comply with emerging industry standards, to operate with products of other suppliers, to address emerging market trends, to provide our customers with new revenue-generating opportunities and to compete with technological and product developments carried out by others. The development of new, technologically advanced products, including IP-optimized networking solutions and 3G wireless networks, is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. Investments in such development may result in expenses growing at a faster rate than revenues, particularly since the initial investment to bring a product to market may be high. We may not be successful in targeting new market opportunities, in developing and commercializing new products in a timely manner, or in achieving market acceptance for our new products.
The success of new or enhanced products, including IP-optimized networking solutions and 3G wireless networks, depends on a number of other factors, including the timely introduction of such products, market acceptance of new technologies and industry standards, the quality and robustness of new or enhanced products, competing product offerings, the pricing and marketing of such products, and the availability of funding for such networks. Products and technologies developed by our competitors may render our products obsolete. Hackers may attempt to disrupt or exploit our customers use of our technologies. If we fail to respond in a timely and effective manner to unanticipated changes in one or more of the technologies affecting telecommunications and data networking or our new products or product enhancements fail to achieve market acceptance, our ability to compete effectively in our industry, and our sales, market share, and customer relationships could be materially and adversely affected.
In addition, unanticipated changes in market demand for products based on a specific technology, particularly lower than anticipated, or delays in, demand for IP-optimized networking solutions, particularly long-haul and metro optical networking solutions, or 3G wireless networks, could have a material adverse effect on our business, results of operations, and financial condition if we fail to respond to such changes in a timely and effective manner.
We face significant competition and may not be able to maintain our market share and may suffer from competitive pricing practices.
We operate in a highly volatile industry that is characterized by vigorous competition for market share and rapid technological development. Competition is heightened in periods of slow overall market growth. These factors could result in aggressive pricing practices and growing competition from smaller niche companies, established competitors, as well as well-capitalized computer systems and communications companies, which, in turn, could have a material adverse effect on our gross margins.
Our principal competitors in the sale of our Metro and Enterprise Networks products to service providers are large communications companies such as Alcatel S.A., Fujitsu Limited, Telefonaktiebolagat LM Ericsson, Lucent Technologies Inc., and Siemens Aktiengesellschaft. In addition, we compete with smaller companies that address specific niches within this market, such as Ciena Corporation (who recently combined with ONI Systems Corp), Sonus Systems Limited, and
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Redback Networks Inc. Our principal competitors in the sale of our Metro and Enterprise Networks solutions to enterprises are Alcatel, Avaya Inc., Cisco Systems, Inc., Ericsson, and Siemens. We also compete with smaller companies that address specific niches, such as Foundry Networks, Inc., Extreme Networks, Inc., Enterasys Networks, Inc., 3Com Corporation, and Genesys Telecommunications Laboratories, Inc. Our major competitors in the global wireless infrastructure business have traditionally included Ericsson, Lucent, Motorola, Inc., and Nokia Corporation. More recently, Siemens and Samsung Electronics Co., Ltd. have emerged as competitors. Our major competitors in the sale of long-distance optical networking equipment include Alcatel, Ciena, Fujitsu, Lucent, and Marconi plc. Since some of the markets in which we compete are characterized by the potential for rapid growth and, in certain cases, low barriers to entry and rapid technological changes, smaller, specialized companies and start-up ventures are now or may become principal competitors in the future. We may also face competition from the resale of used telecommunications equipment, including our own on occasion, by failed, downsized or consolidated high technology enterprises and telecommunications service providers. In addition, one way to maximize market growth, enhance existing products and introduce new products is through acquisitions of companies, where advisable. Our acquisitions of other companies may cause certain of our competitors to enter into additional business combinations, to accelerate product development, or to engage in aggressive price reductions or other competitive practices, creating even more powerful or aggressive competitors.
We expect that we will face additional competition from existing competitors and from a number of companies that have entered or may enter our existing and future markets. Some of our current and potential competitors have greater marketing, technical and financial resources, including access to capital markets and/or the ability to provide customer financing in connection with the sale of products. Many of our current and potential competitors have also established, or may in the future establish, relationships with our current and potential customers. Other competitive factors include the ability to provide new technologies and products, end-to-end networking solutions, and new product features, as well as conformance to industry standards. Increased competition could result in price reductions, negatively affecting our operating results, reducing profit margins and potentially leading to a loss of market share.
We face certain barriers in our efforts to expand internationally.
We intend to continue to pursue international and emerging market growth opportunities. In many international markets, long-standing relationships between potential customers and their local suppliers and protective regulations, including local content requirements and type approvals, create barriers to entry. In addition, pursuing international opportunities may require significant investments for an extended period before we realize returns on such investments, if any, and such investments may result in expenses growing at a faster rate than revenues. Furthermore, such projects and investments could be adversely affected by:
| reversals or delays in the opening of foreign markets to new competitors; | ||
| trade protection measures; | ||
| exchange controls; | ||
| currency fluctuations; | ||
| investment policies; | ||
| restrictions on repatriation of cash; | ||
| nationalization of local industry; | ||
| economic, social and political risks; | ||
| taxation; | ||
| interest rates; and | ||
| other factors, depending on the country involved. |
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Difficulties in foreign financial markets and economies and of foreign financial institutions, particularly in emerging markets, could adversely affect demand from customers in the affected countries. An inability to maintain or expand our business in international and emerging markets could have a material adverse effect on our business, results of operations, and financial condition.
Fluctuating foreign currencies may negatively impact our business, results of operations, and financial condition.
As an increasing proportion of our business may be denominated in currencies other than United States dollars, fluctuations in foreign currencies may have an impact on our business, results of operations, and financial condition. Our primary currency exposures are to Canadian dollars, United Kingdom pounds, and the Euro. These exposures may change over time as we change the geographic mix of our global business and as our business practices evolve. For instance, if we increase our presence in emerging markets, we may see an increase in our exposure to such emerging market currencies, such as, for example, the Chinese renminbi. These currencies may be affected by internal factors, and external developments in other countries, all of which can have an adverse impact on a countrys currency. We cannot predict whether foreign exchange losses will be incurred in the future, and significant foreign exchange fluctuations may have a material adverse effect on our results of operations.
We may become involved in disputes regarding intellectual property rights that could materially and adversely affect our business if we do not prevail.
Our industry is subject to uncertainty over adoption of industry standards and protection of intellectual property rights. Our success is dependent on our proprietary technology, which we rely on patent, copyright, trademark and trade secret laws to protect. While our business is global in nature, the level of protection of our proprietary technology provided by such laws varies by country. Our issued patents may be challenged, invalidated, or circumvented, and our rights under issued patents may not provide us with competitive advantages. Patents may not be issued from pending applications, and claims in patents issued in the future may not be sufficiently broad to protect our proprietary technology. In addition, claims of intellectual property infringement or trade secret misappropriation may be asserted against us or our customers in connection with their use of our products, and the outcome of any such claims are uncertain. A failure by us to react to changing industry standards, the lack of broadly-accepted industry standards, successful claims of intellectual property infringement or other intellectual property claims against us or our customers, or a failure by us to protect our proprietary technology, could have a material adverse effect on our business, results of operations, and financial condition. In addition, if others infringe on our intellectual property rights, we may not be able to successfully contest such challenges.
Rationalization and consolidation in the telecommunications industry may cause us to experience a loss of customers.
The telecommunications industry has experienced the consolidation and rationalization of industry participants and we expect this trend to continue. There have been adverse changes in the public and private equity and debt markets for telecommunications industry participants which have affected their ability to obtain financing or to fund capital expenditures. Some operators have experienced financial difficulty and have, or may, file for bankruptcy protection or be acquired by other operators. Other operators may merge and we and one or more of our competitors may each supply products to the companies that have merged or will merge. This rationalization/consolidation could result in our dependence on a smaller number of customers, purchasing decision delays by the merged companies and/or our playing a lesser role, or no longer playing a role, in the supply of communications products to the merged companies. In addition, telecommunications equipment suppliers may enter into business combinations, or may be acquired by or sell a substantial portion of their assets to other competitors, resulting in accelerated product development, increased financial strength, or a broader base of customers, creating even more powerful or aggressive competitors. We may also see rationalization among equipment/component suppliers. The business failures of operators, competitors or suppliers may cause uncertainty among investors and in the telecommunications market generally.
Changes in regulation of the Internet may affect the manner in which we conduct our business and may materially and adversely affect our business, results of operations, and financial condition.
There are currently few domestic or international laws or regulations that apply directly to access to or commerce on the Internet. We could be materially and adversely affected by regulation of the Internet in any country where we operate in respect of such technologies as voice over the Internet, encryption technology and access charges for Internet service providers. We could also be materially and adversely affected by increased competition as a result of the continuing
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deregulation of the telecommunications industry. If a jurisdiction in which we operate adopts measures which affect the regulation of the Internet or the deregulation of the telecommunications industry, we could experience both decreased demand for our products and increased costs of selling such products. Changes in laws or regulations governing the Internet and Internet commerce could have a material adverse effect on our business, results of operations, and financial condition.
Nortel Networks Corporations stock price has historically been volatile and a major decline in the market price of Nortel Networks Corporations common shares or our other securities may negatively impact our ability to make future strategic acquisitions, raise capital, issue debt, or retain employees.
Nortel Networks Corporations common shares have experienced, and may continue to experience, substantial price volatility, including decreases, particularly as a result of variations between our actual or anticipated financial results and the published expectations of analysts and as a result of announcements by our competitors and us. Our credit quality, any equity offerings, operating results and prospects, among other factors, including any exclusion of Nortel Networks Corporations common shares from any widely followed stock market indices, will also affect the market price of Nortel Networks Corporation common shares. In addition, the stock markets have experienced extreme price fluctuations that have affected the market price and trading volumes of many technology and telecommunications companies in particular, with potential consequential negative effects on the trading of securities of such companies. These price fluctuations have in some cases been unrelated to the operating performance of these companies. A major decline in the capital markets generally, or an adjustment in the market price or trading volumes of Nortel Networks Corporations common shares or our other securities, may negatively impact our ability to make future strategic acquisitions, raise capital, issue debt, or retain employees. These factors, as well as general economic and political conditions, and continued negative events within the technology sector, may in turn have a material adverse effect on the market price of Nortel Networks Corporations common shares.
We have provided and may continue to provide significant financing to our customers. The current downturn in the economy increases our exposure to our customers credit risk and the risk that our customers will not be able to fulfill their payment obligations.
The competitive environment in which we operate has required us in the past, and we expect may continue to require us in the future, to provide significant amounts of medium-term and long-term customer financing. Customer financing arrangements may include financing in connection with the sale of our products and services, funding for certain non-product and service costs associated with network installation and integration of our products and services, financing for working capital and equity financing. We may provide customer financing in the future for such customer requirements as turnkey construction of new networks, particularly for 3G wireless operators. If we do, we may be required to directly hold a significantly greater amount of such financings than in the past, when we were able to place a large amount of our customer financing obligations with third party lenders.
We expect to continue to hold certain current and future customer financing obligations for longer periods prior to any possible placement with third-party lenders, due to, among other factors, recent economic uncertainty in various countries, adverse capital market conditions, adverse changes in the credit ratings of our customers or ourselves, and reduced demand for telecommunications financing in capital and bank markets. In addition, risks generally associated with customer financing, including the risks associated with new technologies, new network construction, market demand and competition, customer business plan viability and funding risks, may require us to hold certain customer financing obligations over a longer term. We may not be able to place any of our current or future customer financing obligations with third-party lenders on acceptable terms.
Recently, certain of our customers, including a number of competitive local exchange carriers, have been experiencing financial difficulties, and during the third and fourth quarters of 2001, we noted the amount of customer financing with respect to which customers that have failed to meet their financing obligations had increased. If there is further increase in the failure of our customers to meet their customer financing obligations to us, we could incur losses in excess of our provisions, which could have a material adverse effect on our cash flow and operating results.
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Negative developments associated with our supply and outsourcing contracts, turnkey arrangements and contract manufacturing agreements may materially and adversely affect our business, results of operations, financial condition, and supply relationships.
We have entered into supply contracts with customers to provide products and services, which in some cases involve new technologies currently being developed, or which we have not yet commercially deployed, or which require us to build and operate networks on a turnkey basis. We have also entered into network outsourcing contracts with customers to operate their networks. Some of these supply and network outsourcing contracts contain delivery and installation timetables, performance criteria and other contractual obligations which, if not met, could result in our having to pay substantial penalties or liquidated damages, the termination of the related supply or network outsourcing contract, and/or the reduction of shared revenues under a turnkey arrangement, in certain circumstances. Unexpected developments in these supply and outsourcing contracts could have a material adverse effect on our revenues, cash flows, and relationships with our customers.
Our ability to meet customer demand is, in part, dependent on us obtaining timely and adequate component parts and products from suppliers, contract manufacturers, and internal manufacturing capacity. As part of the transformation of our supply chain from a vertically integrated manufacturing model to a virtually integrated model, we have outsourced a substantial portion of our manufacturing capacity to contract manufacturers. We work closely with our suppliers and contract manufacturers to address quality issues and to meet increases in customer demand, when needed, and we also manage our internal manufacturing capacity, quality, and inventory levels as required. However, we may encounter shortages of quality components and/or products in the future. In addition, our component suppliers and contract manufacturers have experienced, and may continue to experience, a consolidation in the industry, which may result in fewer sources of components or products and greater exposure to the financial stability of our suppliers. A reduction or interruption in component supply or external manufacturing capacity, a significant increase in the price of one or more components, or excessive inventory levels could materially and negatively affect our gross margins and our operating results and could materially damage customer relationships.
Further, certain of our supply arrangements with our contract manufacturers were negotiated prior to the current industry and economic downturn and, depending upon the extent and duration of this downturn, the terms of these arrangements may not be achievable. To the extent that we fail to meet any of these arrangements, and if we are unable to successfully renegotiate the applicable arrangement, we may be obligated to indemnify the contract manufacturer for certain direct costs attributable to our failure to so perform. The actual amount of any such indemnification, which could be substantial, would be based on a variety of complex, inter-related factors. The failure to reach a satisfactory resolution of any such matter could have a material adverse effect on our business, results of operations, financial condition, and supply relationships.
Our business may suffer if strategic alliances which we have entered into are not successful.
We have entered into a number of strategic alliances with suppliers, developers, and members in our industry to facilitate product compatibility, encourage adoption of industry standards, or to offer complementary product or service offerings to meet customer needs. In some cases, the companies with which we have strategic alliances also compete against us in some of our business areas. If a member of a strategic alliance fails to perform its obligations, if the relationship fails to develop as expected, or if the relationship is terminated, we could experience delays in product availability or impairment of our relationships with our customers.
The adverse resolution of litigation against us could negatively impact our business.
We are currently a defendant in numerous class actions and other lawsuits, including lawsuits initiated on behalf of holders of Nortel Networks Corporations common shares, which seek damages of material and indeterminate amounts, as well as lawsuits in the normal course of business. We are and may in the future be subject to other litigation arising in the normal course of our business. Litigation may be time consuming, expensive, and distracting from the conduct of our business, and the outcome of litigation is difficult to predict. The adverse resolution of any specific lawsuit could have a material adverse effect on our business, results of operations, and financial condition.
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Recent pronouncements
In July 2002, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 146, Accounting for Costs Associated with Exit or Disposal Activities, or SFAS 146, which is effective for exit or disposal activities initiated after December 31, 2002. SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring) or EITF 94-3. SFAS 146 requires that costs associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF 94-3 required recognition of a liability when an entity committed to an exit plan. We have not yet determined the effect that the adoption of SFAS 146 will have on our business, results of operations, and financial condition.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, or SFAS 143, which is effective for financial statements issued for fiscal years beginning after June 15, 2002. SFAS 143 addresses the recognition and remeasurement of obligations associated with the retirement of a tangible long-lived asset. We have not yet determined the effect that the adoption of SFAS 143 will have on our business, results of operations, and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the consolidated financial statements of Nortel Networks due to adverse changes in financial market prices and rates. Nortel Networks market risk exposure is primarily a result of fluctuations in interest rates and foreign exchange rates. Disclosure of market risk is contained in our Annual Report on Form 10-K for the year ended December 31, 2001.
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PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings
For a discussion of our material legal proceedings, see Legal proceedings in Managements Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 2. Changes in Securities and Use of Proceeds
During the second quarter of 2002, Nortel Networks Corporation issued an aggregate of 171,306 common shares upon the exercise of options granted under the Nortel Networks/BCE 1985 Stock Option Plan and the Nortel Networks/BCE 1999 Stock Option Plan. The common shares issued on the exercise of these options were issued outside of the United States to BCE Inc. employees who were not United States persons at the time of option exercise, or to BCE in connection with options that expired unexercised or were forfeited. The common shares issued are deemed to be exempt from registration pursuant to Regulation S under the United States Securities Act of 1933 (the Securities Act), as amended. All funds received by Nortel Networks Corporation in connection with the exercise of stock options granted under the two Nortel Networks/BCE stock option plans are transferred in full to BCE pursuant to the terms of the May 1, 2000 plan of arrangement, except for nominal amounts paid to Nortel Networks Corporation to round up fractional entitlements into whole shares. Nortel Networks Corporation keeps these nominal amounts and uses them for general corporate purposes.
Number of Common Shares Issued Without U.S. | Range of | |||||||
Registration Upon Exercise | Exercise Prices | |||||||
Date of Exercise | of Stock Options Under Nortel/BCE Plans | Canadian$ | ||||||
04/01/02 |
104,150 | 16.25 - 58.38 | ||||||
04/04/02 |
6,360 | 46.48 | ||||||
05/01/02 |
17,393 | 46.48 - 51.87 | ||||||
05/19/02 |
1,759 | 51.88 | ||||||
06/01/02 |
25,940 | 16.25 - 46.48 | ||||||
06/25/02 |
15,704 | 51.88 |
ITEM 4. Submissions of Matters to a Vote of Security Holders
The annual and special meeting of shareholders of Nortel Networks Corporation (the Meeting) was held on April 25, 2002.
Election of Directors
The shareholders elected each of the ten nominees for directors as listed in the Nortel Networks Corporations proxy circular and proxy statement dated March 11, 2002. The proxies received by Nortel Networks Corporation for the Meeting were voted as follows:
Director | Shares Voted For | Shares Withheld | Broker Non-Votes | |||||||||
Honourable J.J. Blanchard |
1,828,466,434 | 31,957,054 | 302 | |||||||||
R.E. Brown |
1,830,072,022 | 30,321,816 | 302 | |||||||||
J.E. Cleghorn |
1,829,596,274 | 30,828,539 | 302 | |||||||||
F.A. Dunn |
1,828,896,930 | 31,521,069 | 302 | |||||||||
L.Y. Fortier |
1,828,146,385 | 32,283,517 | 302 | |||||||||
R.A. Ingram |
1,829,126,899 | 31,303,303 | 302 |
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Director | Shares Voted For | Shares Withheld | Broker Non-Votes | |||||||||
W.A. Owens |
1,829,658,246 | 30,776,760 | 302 | |||||||||
G. Saucier |
1,829,377,017 | 31,059,235 | 302 | |||||||||
S.H. Smith, Jr. |
1,828,713,214 | 31,722,932 | 302 | |||||||||
L.R. Wilson |
1,828,533,417 | 31,902,454 | 302 |
Mr. A. Blinder was nominated from the floor. 37,464 shares were voted for the election of Mr. Blinder.
Appointment of Auditors
The shareholders ratified the appointment of Deloitte & Touche LLP as Nortel Networks Corporations independent auditors. The proxies received by Nortel Networks Corporation for the Meeting were voted as follows:
Shares Voted For | Shares Withheld | Broker Non-Votes | ||||||||||
1,777,721,053 | 59,848,310 | 1,399 |
Shareholder Proposal
The shareholders rejected the shareholder proposal that half of any shares acquired under options must be held for at least one year. The proxies received by Nortel Networks Corporation for the Meeting were voted as follows:
Shares Voted For | Shares Voted Against | Broker Non-Votes | ||||||||||
202,070,898 | 1,272,682,558 | 370,206,012 |
ITEM 6. Exhibits and Reports on Form 8-K
a) | Exhibits: |
10.1 | Purchase Contract and Unit Agreement dated as of June 12, 2002 among Nortel Networks Corporation, Computershare Trust Company of Canada, as purchase contract agent, and Holders (as defined therein) from time to time. | |
10.2 | Resolution of the Board of Directors of Nortel Networks Corporation dated January 24, 2002, related to the payment of directors fees. | |
10.3 | Resolution of the Board of Directors of Nortel Networks Limited dated January 24, 2002, related to the payment of directors fees. | |
10.4 | Nortel Networks Corporation Executive Retention and Termination Plan, as amended and restated effective June 26, 2002. | |
10.5 | Pledge Agreement Supplement dated as of May 20, 2002 between Nortel Networks Mauritius Ltd and JPMorgan Chase Bank, as Collateral Agent supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks International Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase Bank, as Collateral Agent. | |
10.6 | Pledge Agreement Supplement dated as of May 15, 2002 between Nortel Networks International Finance & Holding B.V. and JPMorgan Chase Bank, as Collateral Agent, supplementing the Foreign Pledge Agreement dated |
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as of April 4, 2002 among Nortel Networks International Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase Bank, as Collateral Agent. |
10.7 | Pledge Agreement Supplement dated as of June 4, 2002 between Nortel Networks Singapore Pte Ltd, and JPMorgan Chase Bank, as Collateral Agent, supplementing the Foreign Pledge Agreement dated as of April 10, 2002 among Nortel Networks International Finance & Holding B.V., Nortel Communications Holdings (1997) Limited, Nortel Networks AB and JPMorgan Chase Bank, as Collateral Agent. | |
10.8 | Pledge Agreement Supplement dated as of May 15, 2002 between Nortel Networks Limited and JPMorgan Chase Bank, as Collateral Agent, supplementing the Foreign Pledge Agreement dated as of April 4, 2002 among Nortel Networks Limited, the Subsidiary Guarantors party thereto and JPMorgan Chase Bank, as Collateral Agent. | |
b) | Reports on Form 8-K: | |
Nortel Networks Corporation filed a Current Report on Form 8-K dated April 4, 2002 related to a press release it issued in response to an announcement that Moodys Investors Service, Inc. lowered ratings on securities issued or guaranteed by it and its principal operating subsidiaries to below investment grade. | ||
Nortel Networks Corporation filed a Current Report on Form 8-K dated April 10, 2002 related to: (i) the announcement of the amendment and extension of the $1.75 billion April 2001 credit facilities, and reduction of the facilities to $1.175, of its principal operating subsidiaries, Nortel Networks Limited and Nortel Networks Inc.; and (ii) an update on its first quarter of 2002 performance. | ||
Nortel Networks Corporation filed a Current Report on Form 8-K dated April 22, 2002 related to its financial results for the first quarter of 2002. | ||
Nortel Networks Corporation filed a Current Report on Form 8-K dated May 13, 2002 related to: (i) the filing of audited consolidated financial statements for the three years ended December 31, 2001 of Nortel Networks Corporation and audited financial statements for the three years ended December 31, 2001 of Nortel Networks S.A. in accordance with Rule 3-10 and 3-16, respectively, of Regulation S-X under the Securities Act of 1933; (ii) the intended filing of a shelf registration statement on Form S-3 with the United States Securities and Exchange Commission and a preliminary base shelf prospectus with the Canadian securities regulatory authorities for the purpose of qualifying the potential sale by Nortel Networks Corporation or Nortel Networks Limited from time to time in the United States and/or Canada of up to an aggregate of $2.5 billion of various types of securities; (iii) the intended withdrawal by Nortel Networks Limited and Nortel Networks Capital Corporation, a wholly owned indirect finance subsidiary of Nortel Networks Limited, of their existing U.S. shelf registration statement currently pertaining to an aggregate of up to US$1.0 billion of debt securities and warrants to purchase debt securities; and (iv) the filing of certain information incorporated by reference into the Canadian preliminary base shelf prospectus, including historical consolidated financial statements of Nortel Networks Corporation prepared in accordance with Canadian generally accepted accounting principles. | ||
Nortel Networks Corporation filed a Current Report on Form 8-K dated May 28, 2002 related to the filing of unaudited interim Consolidated Financial Statements of Nortel Networks Corporation, prepared in accordance with Canadian generally accepted accounting principles, for the three month period ended March 31, 2002. | ||
Nortel Networks Corporation filed a Current Report on Form 8-K dated May 29, 2002 related to the announcement that (i) it expects revenues in the second quarter of 2002 to be flat to down 5 percent compared to the first quarter of 2002; (ii) it plans to further realign its Optical Long Haul business, including optical components; and (iii) its actions are aimed at reducing its overall break even cost structure. | ||
Nortel Networks Corporation filed a Current Report on Form 8-K dated June 3, 2002 related to the commencement pursuant to separate preliminary prospectus supplements and accompanying prospectuses of two concurrent offerings in the United States and Canada of common shares of Nortel Networks Corporation and equity units. | ||
Nortel Networks Corporation filed a Current Report on Form 8-K dated June 7, 2002 related to (i) two concurrent offerings in the United States and Canada of common shares of Nortel Networks Corporation and equity units |
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pursuant to separate prospectus supplements and accompanying prospectuses; and (ii) the filing of certain agreements with respect to the two concurrent offerings. | |
Nortel Networks Corporation filed a Current Report on Form 8-K dated June 11, 2002 related to exercise by the underwriters of the two concurrent public offerings of common shares of Nortel Networks Corporation and equity units of their respective over-allotment options to purchase additional prepaid forward purchase contracts of Nortel Networks Corporation and common shares of Nortel Networks Corporation. | |
Nortel Networks Corporation filed a Current Report on Form 8-K dated July 11, 2002 related to a press release it issued in response to an announcement that Standard & Poors will be replacing the seven non-U.S. companies, including Nortel Networks Corporation, currently in the S&P 500 index with seven U.S. corporations. | |
Nortel Networks Corporation filed a Current Report on Form 8-K dated July 22, 2002 related to (i) the appointment of the new Chief Financial Officer of Nortel Networks Corporation, and (ii) its financial results for the second quarter of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NORTEL NETWORKS CORPORATION
(Registrant)
Chief Financial Officer | Chief Accounting Officer | |
D.C. BEATTY | M.J. GOLLOGLY | |
|
||
D.C. BEATTY Chief Financial Officer |
M.J. GOLLOGLY Controller |
Date: August 13, 2002
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