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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 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 NOT APPLICABLE
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
8200 DIXIE ROAD, SUITE 100
BRAMPTON, ONTARIO, CANADA L6T 5P6
(Address of principal executive offices) (Zip Code)
Registrant's 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 [x] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as at OCTOBER 31, 2002
3,839,553,654 WITHOUT NOMINAL OR PAR VALUE
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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.................................. 34
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk.......................................................... 68
ITEM 4. Controls and Procedures..................................................... 69
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings........................................................... 70
ITEM 2. Changes in Securities and Use of Proceeds................................... 70
ITEM 6. Exhibits and Reports on Form 8-K............................................ 70
SIGNATURES ............................................................................ 72
CERTIFICATIONS ............................................................................ 73
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.
Moody's is a trademark of Moody's Investor Services, Inc.
Nortel Networks, NT are trademarks of Nortel Networks.
Standard & Poor's, S&P 100 and S&P 500 are trademarks of The McGraw-Hill
Companies, 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 Nine months ended
September 30, September 30,
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Revenues $ 2,355 $ 3,694 $ 8,040 $ 14,055
Cost of revenues 1,454 3,673 5,423 11,750
- -------------------------------------------------------------------------------------------------------------------------
Gross profit 901 21 2,617 2,305
Selling, general and administrative expense (excluding
stock option compensation) 682 1,919 2,193 4,902
Research and development expense 565 808 1,739 2,661
In-process research and development expense - - - 15
Amortization of intangibles
Acquired technology 38 185 122 744
Goodwill - 454 - 3,685
Stock option compensation 22 32 68 91
Special charges 1,194 1,024 2,084 14,949
Gain on sale of businesses - (45) (14) (45)
- -------------------------------------------------------------------------------------------------------------------------
Operating loss (1,600) (4,356) (3,575) (24,697)
Equity in net loss of associated companies (5) (6) (19) (138)
Other expense - net (2) (318) (20) (268)
Interest expense
Long-term debt (55) (54) (168) (138)
Other (12) (23) (33) (82)
- -------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations before income taxes (1,674) (4,757) (3,815) (25,323)
Income tax benefit (provision) (125) 1,289 478 2,842
- -------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (1,799) (3,468) (3,337) (22,481)
Net loss from discontinued operations - net of tax - - - (3,010)
- -------------------------------------------------------------------------------------------------------------------------
Net loss before cumulative effect of accounting change (1,799) (3,468) (3,337) (25,491)
Cumulative effect of accounting change - net of tax of $9 - - - 15
- -------------------------------------------------------------------------------------------------------------------------
Net loss $ (1,799) $ (3,468) $ (3,337) $(25,476)
=========================================================================================================================
Basic and diluted loss per common share
- from continuing operations $ (0.42) $ (1.08) $ (0.91) $ (7.07)
- from discontinued operations - - - (0.94)
- -------------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per common share $ (0.42) $ (1.08) $ (0.91) $ (8.01)
=========================================================================================================================
Dividends declared per common share $ - $ - $ - $0.03750
See notes to unaudited consolidated financial statements.
4
NORTEL NETWORKS CORPORATION
Consolidated Balance Sheets (unaudited)
(millions of U.S. dollars)
- --------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents $ 4,170 $ 3,513
Restricted cash and cash equivalents 420 -
Accounts receivable (less provisions of $528 at September 30, 2002; $655 at December 31, 2001) 2,007 2,923
Inventories - net 1,132 1,579
Income taxes recoverable 58 796
Deferred income taxes - net 1,162 1,386
Other current assets 673 857
Current assets of discontinued operations 293 708
- --------------------------------------------------------------------------------------------------------------------------------
Total current assets 9,915 11,762
Long-term receivables (less provisions of $877 at September 30, 2002; $828 at December 31, 2001) 79 203
Investments at cost and associated companies at equity 176 253
Plant and equipment - net 1,670 2,571
Goodwill 2,200 2,810
Intangible assets - net 133 285
Deferred income taxes - net 2,333 2,077
Other assets 868 893
Long-term assets of discontinued operations 66 283
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $ 17,440 $ 21,137
================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Notes payable $ 128 $ 426
Trade and other accounts payable 1,286 1,988
Payroll and benefit-related liabilities 646 636
Other accrued liabilities 4,689 5,459
Income taxes payable 116 143
Long-term debt due within one year 516 384
Current liabilities of discontinued operations 137 421
- --------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 7,518 9,457
Deferred income 99 154
Long-term debt 4,111 4,094
Deferred income taxes - net 499 518
Other liabilities 1,588 1,453
Minority interest in subsidiary companies 611 637
- --------------------------------------------------------------------------------------------------------------------------------
14,426 16,313
- --------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (notes 13 and 15)
SHAREHOLDERS' EQUITY
Common shares, without par value - Authorized shares: unlimited; Issued and outstanding
shares: 3,849,891,442 at September 30, 2002 and 3,213,742,169 at December 31, 2001 33,872 32,899
Additional paid-in capital 3,753 3,257
Deferred stock option compensation (118) (205)
Deficit (33,488) (30,151)
Accumulated other comprehensive loss (1,005) (976)
- --------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 3,014 4,824
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 17,440 $ 21,137
================================================================================================================================
See notes to unaudited consolidated financial statements.
5
NORTEL NETWORKS CORPORATION
Consolidated Statements of Cash Flows (unaudited)
(millions of U.S. dollars)
- --------------------------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) operating activities
Net loss from continuing operations $ (3,337) $(22,481)
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 542 4,977
In-process research and development expense - 15
Non-cash portion of special charges and related asset write downs 1,292 13,334
Equity in net loss of associated companies 19 138
Stock option compensation 68 91
Deferred income taxes (45) (2,153)
Other liabilities (14) 62
Gain on sale of investments and businesses (28) (71)
Other - net 355 309
Change in operating assets and liabilities:
Accounts receivable 893 4,435
Inventories 407 1,738
Income taxes 711 (973)
Accounts payable and accrued liabilities (1,428) 645
Other operating assets and liabilities (33) 359
- --------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) operating activities of continuing operations (598) 425
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) investing activities
Expenditures for plant and equipment (289) (1,113)
Proceeds on disposals of plant and equipment 186 151
Increase in restricted cash and cash equivalents (420) -
Increase in long-term receivables (247) (677)
Decrease in long-term receivables 253 192
Acquisitions of investments and businesses - net of cash acquired (29) (87)
Proceeds on sale of investments and businesses 79 232
- --------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities of continuing operations (467) (1,302)
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) financing activities
Dividends on common shares - (123)
Increase (decrease) in notes payable - net (289) 355
Proceeds from long-term debt 32 3,278
Repayments of long-term debt (22) (463)
Increase (decrease) in capital leases payable 162 (21)
Issuance of common shares 863 136
Issuance of prepaid forward purchase contracts 623 -
- --------------------------------------------------------------------------------------------------------------------------
Net cash from financing activities of continuing operations 1,369 3,162
- --------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash and cash equivalents 16 (5)
- --------------------------------------------------------------------------------------------------------------------------
Net cash from continuing operations 320 2,280
Net cash from (used in) discontinued operations 337 (569)
- --------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 657 1,711
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period - net 3,513 1,644
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period - net $ 4,170 $ 3,355
==========================================================================================================================
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
Nortel's 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 Nortel's 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 nine months ended September 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.
As a result of the continued decline in both Nortel Networks overall
market value generally and within the Optical Networks segment
specifically, Nortel Networks as part of its review of financial results
during the three months ended September 30, 2002 evaluated the goodwill
associated with the businesses within the Optical Networks segment for
potential impairment. The conclusion of those evaluations was that the
fair value associated with the businesses within the Optical Networks
segment could no longer support the carrying value of the goodwill
associated with them. As a result, Nortel Networks recorded a goodwill
write down of $595. See note 6 for further information regarding this
goodwill write down. There can be no assurance that future goodwill
impairment tests will not result in a charge to net earnings (loss).
Acquired technology continues 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.
8
The following table presents 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 nine months ended September 30, 2002 and 2001, of the SFAS 142
requirement to cease the amortization of goodwill as if the standard had been in
effect beginning January 1, 2001:
- -----------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Reported results:
Net loss from continuing operations $ (1,799) $ (3,468) $ (3,337) $(22,481)
Net loss from discontinued operations - net of tax - - - (3,010)
Cumulative effect of accounting change - net of tax of $9 - - - 15
- -----------------------------------------------------------------------------------------------------------------------
Net loss - reported $ (1,799) $ (3,468) $ (3,337) $(25,476)
=======================================================================================================================
Adjustments:
Amortization of goodwill from continuing
operations - net of tax (a) $ - $ 454 $ - $ 3,694
Amortization of goodwill from discontinued operations - - - 190
- -----------------------------------------------------------------------------------------------------------------------
Total net adjustments $ - $ 454 $ - $ 3,884
- -----------------------------------------------------------------------------------------------------------------------
Adjusted results:
Net loss from continuing operations $ (1,799) $ (3,014) $ (3,337) $(18,787)
Net loss from discontinued operations - net of tax - - - (2,820)
Cumulative effect of accounting change - net of tax of $9 - - - 15
- -----------------------------------------------------------------------------------------------------------------------
Net loss - adjusted $ (1,799) $ (3,014) $ (3,337) $(21,592)
=======================================================================================================================
Reported basic and diluted loss per common share:
- from continuing operations $ (0.42) $ (1.08) $ (0.91) $ (7.07)
- from discontinued operations - - - (0.94)
- -----------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per common share - reported $ (0.42) $ (1.08) $ (0.91) $ (8.01)
=======================================================================================================================
Adjusted basic and diluted loss per common share:
- from continuing operations $ (0.42) $ (0.94) $ (0.91) $ (5.90)
- from discontinued operations - - - (0.89)
- -----------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per common share - adjusted $ (0.42) $ (0.94) $ (0.91) $ (6.79)
=======================================================================================================================
(a) Includes goodwill amortization of equity accounted investments, net of
tax of nil and $5 for the three months and nine months ended September
30, 2001, 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.
Nortel Networks adopted the provisions of SFAS 144 effective January 1,
2002.
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. During the three months
ended September 30, 2002, Nortel Networks recorded a write down for plant
and equipment and inventory assets of $123 pursuant to SFAS 144. See note 6
for further information regarding this write down.
9
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 nine months
ended September 30, presented in the accompanying unaudited Consolidated
Statements of Operations, were as follows:
--------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
--------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 151 $ 138 $ 864
--------------------------------------------------------------------------------------------------------------------
Net loss from discontinued operations - net of tax of $119 $ - $ - $ - $ (442)
Net loss on disposal of operations - net of tax of $604 - - - (2,568)
--------------------------------------------------------------------------------------------------------------------
Net loss from discontinued operations - net of tax $ - $ - $ - $(3,010)
====================================================================================================================
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 Group's 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 Group's 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 remaining provisions for discontinued operations.
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 three months
ended June 30, 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.
10
During the nine months ended September 30, 2002, Nortel Networks has continued
to 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 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 September 30, 2002, the remaining accruals of $134 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 partially 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:
- ------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2002 2001
- ------------------------------------------------------------------------------------------
Accounts receivable - net $ 20 $ 109
Inventories - net - 66
Deferred income taxes 192 358
Other current assets 81 175
- ------------------------------------------------------------------------------------------
Total current assets of discontinued operations 293 708
Intangible assets - net - 17
Other long-term assets 66 266
- ------------------------------------------------------------------------------------------
Total assets of discontinued operations $ 359 $ 991
==========================================================================================
Current liabilities $ 137 $ 421
Long-term liabilities (included in Other liabilities) 2 11
- ------------------------------------------------------------------------------------------
Total liabilities of discontinued operations $ 139 $ 432
==========================================================================================
The net cash from (used in) discontinued operations for the nine months ended
September 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 $ 240 $ (589)
Investing activities 97 20
- --------------------------------------------------------------------------------------------
Net cash from (used in) discontinued operations $ 337 $ (569)
============================================================================================
11
5. Consolidated Financial Statement Details
Consolidated balance sheets
Inventories - net:
---------------------------------------------------------------------------
September 30, December 31,
2002 2001
---------------------------------------------------------------------------
Raw materials $ 474 $ 759
Work in process 367 586
Finished goods 291 234
---------------------------------------------------------------------------
Inventories - net (a) $ 1,132 $ 1,579
===========================================================================
(a) Net of inventory provisions of $1,194 and $933 as at September 30,
2002 and December 31, 2001, respectively. Nortel Networks has also
accrued in other accrued liabilities $189 and $565 at September 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 nine months ended September 30, 2002 are as follows:
----------------------------------------------------------------------------------------------------------------------
Optical Wireless Wireline Enterprise
Networks Networks Networks Networks Other Total
----------------------------------------------------------------------------------------------------------------------
Balance as at January 1, 2002 $ 590 $ 21 $ 524 $ 1,660 $ 15 $ 2,810
Change:
Disposal - - - - (15) (15)
Write down (a) (595) - - - - (595)
Other 5 - (1) (4) - -
----------------------------------------------------------------------------------------------------------------------
Balance as at Sept 30, 2002 $ - $ 21 $ 523 $ 1,656 $ - $ 2,200
======================================================================================================================
(a) See note 6 for further information regarding this goodwill write down.
Intangible assets - net:
-----------------------------------------------------------------------------------------
September 30, December 31,
2002 2001
-----------------------------------------------------------------------------------------
Acquired technology $ 5,732 $ 5,762
Less: accumulated amortization (5,599) (5,477)
-----------------------------------------------------------------------------------------
Intangible assets - net $ 133 $ 285
=========================================================================================
The estimated future amortization expense of acquired technology is $35 for
the three months ending December 31, 2002, and $98 for the year ending
December 31, 2003.
12
Consolidated statements of cash flows
Interest and income taxes paid (received):
-------------------------------------------------------------------------------------------
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
-------------------------------------------------------------------------------------------
Interest paid $ 254 $ 195
Income taxes paid (received) $ (1,222) $ 196
===========================================================================================
6. Special charges
Special charges were as follows:
--------------------------------------------------------------------------------------------------------------------------------
CONTRACT
SETTLEMENT PLANT AND
WORKFORCE AND LEASE EQUIPMENT GOODWILL
REDUCTION COSTS WRITE DOWNS OTHER WRITE DOWN TOTAL
--------------------------------------------------------------------------------------------------------------------------------
Provision Balance as at December 31, 2001 $ 400 $ 773 $ - $ 31 $ - $ 1,204
Special Charges for the three months ended:
March 31, 2002 327 63 85 12 487
June 30, 2002 117 1 270 15 403
September 30, 2002 323 102 51 123 595 1,194
--------------------------------------------------------------------------------------------------------------------------------
Subtotal 1,167 939 406 181 595 3,288
--------------------------------------------------------------------------------------------------------------------------------
2002 Cumulative Drawdowns:
Cash (604) (255) - (11) - (870)
Non-Cash (107) - (406) (150) (595) (1,258)
--------------------------------------------------------------------------------------------------------------------------------
Provision Balance as at September 30, 2002 $ 456 $ 684 $ - $ 20 $ - $ 1,160
================================================================================================================================
Three months and nine months ended September 30, 2002
For the three months and nine months ended September 30, 2002, Nortel
Networks recorded special charges of $1,194 and $2,084, respectively,
related to restructuring activities, write downs of other assets and
goodwill. The special charges relating to restructuring are associated with
the work plan that Nortel Networks began implementing in 2001 and continued
into the third quarter of 2002, to streamline operations and activities
around core markets and leadership strategies.
Restructuring activities
Workforce reduction charges of $323 and $767 for the three months and nine
months ended September 30, 2002, respectively, were related to the cost of
severance and benefits associated with approximately 3,500 and 9,800
employees notified of termination, during the three months and nine months
ended September 30, 2002, respectively, across all of Nortel Networks
segments. Included in the workforce reduction charges for the three months
and nine months ended September 30, 2002, are $107 of non-cash pension
settlement and curtailment charges.
Contract settlement and lease costs included negotiated settlements of $102
and $166 for the three months and nine months ended September 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 three months and nine
months ended September 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 primarily
within the Optical Networks segment of approximately $31 and $386 during the
three months and nine months ended September 30, 2002 respectively. Also
included in plant and equipment write downs during the three months and nine
13
months ended September 30, 2002, was approximately $20 of leasehold
improvements and certain information technology equipment associated with
the exiting of leased and owned facilities.
Other
Assets held for sale
SFAS 144 requires assets held for sale to be measured at the lower of their
carrying amount or fair values less costs to sell. During the three months
ended September 30, 2002, certain plant and equipment and inventory of the
Optical Networks segment met the criteria of assets held for sale. Based on
the expected fair value of these assets to be realized on sale, Nortel
Networks recorded a charge of $123 against their carrying amounts during the
three months ended September 30, 2002. The remaining fair value of these
assets of $47 is included in inventory. See note 18 for additional
information regarding the asset sale transaction.
Other assets
Included in the nine months ended September 30, 2002, was a write off of $15
for certain acquired technology in the Optical Networks segment recorded
during the three months ended June 30, 2002, and a $12 write off of acquired
technology recorded in the three months ended March 31, 2002, associated
with the Xros, Inc. X-1000 IPR&D project.
Goodwill write down
As a result of the continued decline in both Nortel Networks overall market
value generally and within the Optical Networks segment specifically, Nortel
Networks as part of its review of financial results during the three months
ended September 30, 2002, evaluated the goodwill associated with the
businesses within the Optical Networks segment for potential impairment. The
conclusion of those evaluations was that the fair value associated with the
businesses within the Optical Networks segment could no longer support the
carrying value of the remaining goodwill associated with them. As a result,
Nortel Networks recorded a goodwill write down of $595.
Fair value was estimated using the expected present value of discounted
future cash flows of the businesses within the Optical Networks segment. The
assumptions supporting the estimated future cash flows, including the
discount rate and estimated terminal values, reflect management's best
estimates.
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 September 30, 2002
Of the approximately 45,900 employees notified during the period from
January 1, 2001 to September 30, 2002, approximately 16,500 were direct
employees performing manufacturing, assembly, test and inspection activities
associated with the production of Nortel Networks products, and
approximately 29,400 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 September 30,
2002, the workforce reduction provision balance has been drawn down by
cumulative cash payments of $1,579, plus $93 of non-cash pension settlement
and curtailment charges, resulting in an ending provision balance for
workforce reduction of $456. The remaining provision is expected to be
substantially drawn down by the end of 2003.
14
In connection 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 $867. The costs primarily related
to Nortel Networks future contractual obligations under operating leases.
Offsetting the total lease charge is approximately $513 in expected sublease
revenue on leases that Nortel Networks cannot terminate. 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 $112, which is included in
plant and equipment write downs, reflected the net realizable value based on
market assessments for general purpose facilities.
Contract settlement and lease costs included negotiated settlements of
approximately $182, to either cancel contracts or renegotiate existing
contracts across all of Nortel Networks segments. As at September 30, 2002,
the provision balance for contract settlement and lease costs was drawn down
by cumulative cash payments of $365, resulting in an ending provision
balance of $684. The remaining provision is expected to be substantially
drawn down by the end of 2006.
Plant and equipment write downs of approximately $462 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 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 nine months of 2002. The conclusion of these assessments resulted
in write downs of certain plant and equipment assets totaling approximately
$802, 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 $620 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, other than equipment that it
continues to hold and use, by the second quarter of 2003. 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 $91 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 second quarter of 2003.
7. Income taxes
At September 30, 2002, Nortel Networks net deferred tax assets were $2,996,
reflecting temporary differences between the financial reporting and tax
treatment of certain current assets and liabilities, and non-current assets
and liabilities, plus the tax benefit of net operating and capital loss
carry forwards and tax credit carry forwards. These carry forwards expire at
various dates beginning in 2003.
During the three months ended September 30, 2002, Nortel Networks recorded
an income tax benefit of $325 on a pre-tax loss of $1,674, which was more
than offset by the recording of certain additional income tax valuation
allowances of $450. These additional valuation allowances were recorded in
accordance with SFAS No. 109 "Accounting for Income Taxes" ("SFAS 109"),
which requires that tax valuation allowances be established when it is more
likely than not that some portion or all of a company's deferred tax assets
will not be realized. The increase in the valuation allowances can be
attributed to further telecommunications market declines in the three months
ended September 30, 2002 and the resultant decline in forecasted taxable
income.
Nortel Networks assesses the realizability of its net deferred tax assets
quarterly, and based on all available evidence, both positive and negative,
concludes whether it is more likely than not that these deferred tax assets
15
will be realized. During the three months ended September 30, 2002, Nortel
Networks assessed positive evidence including forecasts of future taxable
income to support realization of the net deferred tax assets, and negative
evidence including Nortel Networks seven consecutive quarters of losses, and
concluded that it was more likely than not, that an additional $450 of the
net deferred tax assets as at September 30, 2002, were not realizable. If
market conditions deteriorate further or future results of operations are
less than expected, future assessments may result in a determination that
the remaining net deferred tax assets or some portion thereof are not
realizable. As a result, Nortel Networks may need to establish additional
tax valuation allowances for all or a portion of its deferred tax assets.
Nortel Networks effective tax benefit rate fluctuates from period to period
primarily as a result of the impact of certain non-tax deductible
restructuring charges, goodwill write downs, IPR&D expense, stock option
compensation, non-tax deductible goodwill amortization prior to January 1,
2002 and changes in the geographic earnings (loss) mix. Nortel Networks
effective tax benefit rate is not meaningful for the three months ended
September 30, 2002, as a result of recording the above noted income tax
valuation allowances. Excluding the additional income tax valuation
allowances and above noted impacts as applicable, the effective rate would
have been 31.0 percent for the three months and nine months ended September
30, 2002, respectively. For the three months and nine months ended September
30, 2001 the effective tax rate was 30.0 percent and 30.9 percent,
respectively.
Global investment tax credits of $21 and $63 for the three months ended
September 30, 2002 and 2001, respectively, and $75 and $110 for the nine
months ended September 30, 2002 and 2001, respectively, have been
incorporated into the income tax benefit (provision).
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 holder's
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. During the three
months ended September 30, 2002, 27 purchase contracts were settled early
resulting in 432,298 common shares being issued. As at September 30, 2002,
28,723 purchase contracts were outstanding. The purchase contracts are
classified in shareholders' equity as part of additional paid-in capital.
The settlement date for each remaining purchase contract is 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 shares, subject to some
anti-dilution adjustments and adjustments for the proposed consolidation of
Nortel Networks common shares. 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.
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.
16
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.
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 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.
The following table details the weighted average number of common shares
outstanding:
----------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in millions of shares) 2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------
Weighted average number of common shares
outstanding - basic and diluted (a) 4,335 3,203 3,671 3,181
==========================================================================================================
(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, and includes the effect
of early settlement by holders to September 30, 2002 (see note 8). The
impact of these 485 shares on a weighted basis is 197 for the nine
months ended September 30, 2002.
As a result of the net losses for the three months and nine months ended
September 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in millions of shares) 2002 2001 2002 2001
----------------------------------------------------------------------------------------------
Stock options 1 11 2 41
4.25 percent convertible senior notes
due on September 1, 2008 180 90 180 30
Purchase contracts (see note 8) 97 - 39 -
----------------------------------------------------------------------------------------------
Total 278 101 221 71
==============================================================================================
17
Nortel Networks announced on September 25, 2002 that it plans to present a
proposal to its shareholders for a consolidation of its outstanding common
shares (also known as a "reverse stock split") at its annual shareholders'
meeting planned for spring 2003. Prior to that meeting, the consolidation
ratio will be set by the Nortel Networks Board of Directors at a level which
would be expected at that time to result in an initial post-consolidation
common share price in the range of $10.00 to $20.00 per share, assuming
receipt of shareholder approval and regulatory approval. The planned share
consolidation proposal is intended to satisfy the minimum average share
price continued listing requirements of the New York Stock Exchange to
maintain Nortel Networks common share listing on that exchange.
10. Comprehensive loss
The components of comprehensive loss, net of tax, were as follows:
------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
------------------------------------------------------------------------------------------------------------------------------
Net loss $ (1,799) $ (3,468) $ (3,337) $(25,476)
Other comprehensive income (loss):
Change in foreign currency translation adjustment (a) (103) (88) (26) (334)
Unrealized gain (loss) on investments - net (b) (7) 30 (10) (43)
Unrealized derivative gains (losses) on cash flow hedges - net (c) (8) (14) 7 (20)
------------------------------------------------------------------------------------------------------------------------------
Comprehensive loss $ (1,917) $ (3,540) $ (3,366) $(25,873)
==============================================================================================================================
(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) Nortel Networks estimates that $9 of net derivative losses included
in other comprehensive loss will be reclassified into net earnings
(loss) within the next twelve months.
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.
18
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 nine months
ended September 30:
- ----------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Net loss:
- reported (a) $ (1,799) $ (3,014) $ (3,337) $ (21,592)
- pro forma $ (2,128) $ (3,385) $ (4,324) $ (22,792)
Basic and diluted loss per common share:
- reported (a) $ (0.42) $ (0.94) $ (0.91) $ (6.79)
- pro forma $ (0.49) $ (1.06) $ (1.18) $ (7.17)
======================================================================================================================
(a) The reported amounts for the three months and nine months ended September
30, 2001, 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).
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
WEIGHTED-AVERAGE ASSUMPTIONS 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------
Expected dividend 0.00% 0.00% 0.00% 0.00%
Expected volatility 79.14% 68.74% 71.25% 70.68%
Risk-free interest rate 3.37% 4.20% 4.49% 4.76%
Expected option life in years 4 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 September 30, 2002 and 2001 were $0.60 and $3.21 per share, respectively,
during the nine months ended September 30, 2002 and 2001 were $3.50 and $15.75
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.
19
12. Segmented information
General description
Nortel Networks operations are organized around four reportable segments;
Wireless Networks ("Wireless"), Enterprise Networks ("Enterprise"), Wireline
Networks ("Wireline"), and Optical Networks ("Optical", formerly named
Optical Long-Haul Networks). Enterprise and Wireline were previously
included together as the Metro and Enterprise Networks segment. Nortel
Networks reportable segments are focused on providing seamless networking
products and service capabilities across Wireless, Enterprise, Wireline 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. Wireless includes wireless mobility
switching and access products for voice and data communications that span
most major global mobility standards. Enterprise includes a range of
Ethernet and application switching solutions, security solutions, virtual
private networks and routers, enterprise telephony solutions, digital
switching systems, business solutions and applications, and network
management software, along with related professional services used by our
enterprise customers. Wireline includes a range of Optical Ethernet
solutions, packet switching and routing solutions, such as data switching
systems, aggregation products, virtual private network gateways, and
routers, and circuit to packet solutions, such as digital switching systems,
and network management software, together with related professional services
used by our service provider customers. 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.
"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.
Segments
During the three months ended September 30 2002, Nortel Networks changed the
way it managed its business to streamline and focus more directly on its
customers in four key businesses. Consequently, the former Metro and
Enterprise Networks segment was split into two new segments Enterprise and
Wireline, each with its own segment manager reporting directly to the CEO.
During the three months ended June 30, 2002, management shifted the
accountability for the metro optical portion of the former Metro and
Enterprise segment to Optical. As a result, financial information for these
two segments is reported on the new basis commencing in the three months
ended September 30, 2002 and historical comparative financial information
has been restated.
20
The following tables set forth information by segments:
-------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------------
REVENUES
Wireless $ 940 $ 1,349 $ 3,199 $ 4,510
Enterprise 617 729 1,928 2,521
Wireline 482 896 1,748 3,526
Optical 309 579 1,121 2,905
Other 7 141 44 593
-------------------------------------------------------------------------------------------------------------------
Total $ 2,355 $ 3,694 $ 8,040 $ 14,055
-------------------------------------------------------------------------------------------------------------------
CONTRIBUTION MARGIN
Wireless $ 276 $ 68 $ 761 $ 215
Enterprise 94 33 272 151
Wireline 82 (249) 255 243
Optical (82) (1,510) (578) (2,549)
Other (151) (240) (286) (657)
-------------------------------------------------------------------------------------------------------------------
Total 219 (1,898) 424 (2,597)
Research and development expense (565) (808) (1,739) (2,661)
In-process research and development expense - - - (15)
Amortization of acquired technology (38) (185) (122) (744)
Amortization of goodwill - (454) - (3,685)
Stock option compensation (22) (32) (68) (91)
Special charges (1,194) (1,024) (2,084) (14,949)
Gain on sale of businesses - 45 14 45
-------------------------------------------------------------------------------------------------------------------
Consolidated operating loss $ (1,600) $ (4,356) $ (3,575) $(24,697)
===================================================================================================================
13. Commitments
Nortel Networks enters into bid and performance bonds related to various
contracts, which generally have terms ranging from two to five years.
Potential payments due under these bonds are related to performance under
the applicable contract. The total amount of bid and performance bonds that
were available and undrawn was $576 excluding restricted cash and cash
equivalents at September 30, 2002.
During the nine months ended September 30, 2002, Nortel Networks entered
into a sale leaseback transaction for one of its properties which did not
qualify for off-balance sheet treatment. As a result, Nortel Networks
continues to include approximately $170 as plant and equipment for this
property and has recorded a capital lease obligation of $170.
14. Restricted cash and cash equivalents
Due to the current general economic and industry environment, and NNL's
current credit ratings, the basis under which customer performance bonds and
contracts can be obtained has changed, resulting in (but not limited to)
increased cash collateral requirements and/or increased fees in connection
with obtaining new customer performance bonds and contracts. As at September
30, 2002, approximately $420 of cash and cash equivalents was restricted as
cash collateral for certain customer performance bonds and contracts.
21
15. 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. 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 against Nortel Networks 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 July 17, 2002, a new 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 above. 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.
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 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
September 24, 2002, plaintiffs in the consolidated action filed a motion to
22
consolidate all the actions and to transfer them to the United States
District Court for the Southern District of New York.
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 was granted by the District Court on
September 30, 2002, and the Second Complaint was dismissed without leave to
amend. Plaintiff's time to appeal the decision of the District Court has not
yet expired.
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, 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, unless
otherwise specified, seek damages of material or indeterminate amounts.
Nortel Networks 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.
23
16. 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 NNL's minimum consolidated tangible net worth to
be not less than $1,888, and included higher pricing reflecting the then
current credit and bank environment.
During the nine months ended September 30, 2002, Nortel Networks sold
certain real estate in the United Kingdom, which resulted in reductions in
the available commitments under NNL's and NNI's December 20, 2001 credit
facilities by approximately $65 to $1,510.
17. Recent pronouncements
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"), which is effective for exit
or disposal activities initiated after December 31, 2002. SFAS 146
supercedes Emerging Issues Task Force ("EITF") Issue No. 94-3 "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in Restructuring)" ("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.
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
146 and 143 will have on its business, results of operations, and financial
condition.
18. Subsequent events
On October 17, 2002 Nortel Networks announced that it expects the $1,510
December 20, 2001 credit facilities, that mature December 13, 2002 and which
are currently undrawn, will not be amended or extended.
On October 17, 2002, Nortel Networks announced that the decline in world
capital markets and global interest rates over the past year have had a
significant negative impact on the investment assets and liabilities of
Nortel Networks registered pension plans which are managed by third parties.
As a result, Nortel Networks expects to record at December 31, 2002, a
non-cash charge to shareholder's equity, currently expected to be between
$600 and $700, related to the increase in the minimum required recognizable
deficit associated with these registered pension plans.
On October 7, 2002, Nortel Networks announced an agreement whereby it will
sell certain assets relating to its optical components business to Bookham
Technology plc ("Bookham") for consideration of 61 million common shares of
Bookham, 9 million warrants with a strike price of one-third pence Sterling,
debt of $50, and cash of $10. Under the terms of the agreement, Nortel
Networks will sell the transmitter and receiver business located in
Paignton, U.K., Ottawa, Canada, and Harlow, U.K., and the pump laser and
amplifiers business located in Paignton, U.K., Zurich, Switzerland, and
Poughkeepsie, New York. The assets sold include plant and equipment,
inventory, patents, other intellectual property and trademarks. The
transaction includes a 3-year supply agreement with a minimum purchase
commitment of approximately $120 for the first 18 months. This transaction
closed on November 8, 2002.
24
19. Supplemental consolidating financial information
As a result of NNL's 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 and will remain
effective notwithstanding Nortel Networks announcement on October 17, 2002
that it expects its $1,510 December 20, 2001 credit facilities, that mature
December 13, 2002, to expire without extension or amendment. 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 September
30, 2002, all such public debt securities are also secured equally and
ratably with the obligations under all of NNL and NNI's 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 NNL's other subsidiaries. In addition, certain of NNL's wholly owned
subsidiaries have guaranteed NNL's 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 September 30, 2002 and December 31, 2001, and
for the three months and nine months ended September 30, 2002 and 2001.
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.
25
Supplemental Consolidating Statements of Operations for the three months ended
September 30, 2002:
- --------------------------------------------------------------------------------------------------------------------------------
NORTEL NORTEL NON-
NETWORKS NETWORKS GUARANTOR GUARANTOR
CORPORATION LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 604 $ 1,780 $ 665 $ (694) $ 2,355
Cost of revenues - 527 1,143 478 (694) 1,454
- --------------------------------------------------------------------------------------------------------------------------------
Gross profit - 77 637 187 - 901
Selling, general and administrative expense
(excluding stock option compensation) - 245 394 43 - 682
Research and development expense - 235 251 79 - 565
Amortization of acquired technology - - 6 32 - 38
Stock option compensation - - - 22 - 22
Special charges - 194 591 409 - 1,194
- --------------------------------------------------------------------------------------------------------------------------------
Operating loss - (597) (605) (398) - (1,600)
Equity in net loss of associated companies (2,306) (1,210) (79) (2) 3,592 (5)
Other income (expense) - net 528 (46) 71 (24) (531) (2)
Interest expense
Long-term debt (21) (28) - (6) - (55)
Other - - (6) (6) - (12)
- --------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (1,799) (1,881) (619) (436) 3,061 (1,674)
Income tax benefit (provision) - (75) (62) 12 - (125)
- --------------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (1,799) (1,956) (681) (424) 3,061 (1,799)
Net loss from discontinued operations
- net of tax - - - - - -
- --------------------------------------------------------------------------------------------------------------------------------
Net loss $(1,799) $(1,956) $ (681) $ (424) $ 3,061 $(1,799)
================================================================================================================================
26
Supplemental Consolidating Statements of Operations for the three months ended
September 30, 2001:
- --------------------------------------------------------------------------------------------------------------------------------
NORTEL NORTEL NON-
NETWORKS NETWORKS GUARANTOR GUARANTOR
CORPORATION LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 963 $ 2,496 $ 1,066 $ (831) $ 3,694
Cost of revenues - 1,319 2,294 891 (831) 3,673
- --------------------------------------------------------------------------------------------------------------------------------
Gross profit (loss) - (356) 202 175 - 21
Selling, general and administrative expense
(excluding stock option compensation) - 301 1,396 222 - 1,919
Research and development expense - 193 460 155 - 808
Amortization of intangibles
Acquired technology - - 145 40 - 185
Goodwill - 4 327 123 - 454
Stock option compensation - - - 32 - 32
Special charges - 164 593 267 - 1,024
Gain on sale of businesses - (10) (16) (19) - (45)
- --------------------------------------------------------------------------------------------------------------------------------
Operating loss - (1,008) (2,703) (645) - (4,356)
Equity in net earnings
(loss) of associated companies (3,473) (2,222) (430) 1 6,118 (6)
Other income (expense) - net - (45) (197) (70) (6) (318)
Interest expense
Long-term debt (11) (37) 1 (7) - (54)
Other 5 (11) (12) (5) - (23)
- --------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (3,479) (3,323) (3,341) (726) 6,112 (4,757)
Income tax benefit 11 53 1,052 173 - 1,289
- --------------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (3,468) (3,270) (2,289) (553) 6,112 (3,468)
Net loss from discontinued operations
- net of tax - - - - - -
- --------------------------------------------------------------------------------------------------------------------------------
Net loss $(3,468) $(3,270) $(2,289) $ (553) $ 6,112 $(3,468)
================================================================================================================================
27
Supplemental Consolidating Statements of Operations for the nine months ended
September 30, 2002:
- --------------------------------------------------------------------------------------------------------------------------------
NORTEL NORTEL NON-
NETWORKS NETWORKS GUARANTOR GUARANTOR
CORPORATION LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 2,208 $ 5,971 $ 2,123 $(2,262) $ 8,040
Cost of revenues - 1,989 4,078 1,618 (2,262) 5,423
- --------------------------------------------------------------------------------------------------------------------------------
Gross profit - 219 1,893 505 - 2,617
Selling, general and administrative expense
(excluding stock option compensation) - 480 1,436 277 - 2,193
Research and development expense - 673 802 264 - 1,739
Amortization of acquired technology - - 17 105 - 122
Stock option compensation - - - 68 - 68
Special charges - 457 925 702 - 2,084
Gain on sale of businesses - (1) (3) (10) - (14)
- --------------------------------------------------------------------------------------------------------------------------------
Operating loss - (1,390) (1,284) (901) - (3,575)
Equity in net loss of associated companies (3,801) (2,097) (327) (9) 6,215 (19)
Other income (expense) - net 521 (12) 14 (2) (541) (20)
Interest expense
Long-term debt (64) (84) - (20) - (168)
Other - (3) (22) (8) - (33)
- --------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (3,344) (3,586) (1,619) (940) 5,674 (3,815)
Income tax benefit 7 276 73 122 - 478
- --------------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (3,337) (3,310) (1,546) (818) 5,674 (3,337)
Net loss from discontinued operations
- net of tax - - - - - -
- --------------------------------------------------------------------------------------------------------------------------------
Net loss $(3,337) $(3,310) $(1,546) $ (818) $ 5,674 $(3,337)
================================================================================================================================
28
Supplemental Consolidating Statements of Operations for the nine months ended
September 30, 2001:
- ------------------------------------------------------------------------------------------------------------------------------------
NORTEL NORTEL NON-
NETWORKS NETWORKS GUARANTOR GUARANTOR
CORPORATION LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 3,738 $ 10,279 $ 4,003 $ (3,965) $ 14,055
Cost of revenues - 3,905 8,251 3,559 (3,965) 11,750
- ------------------------------------------------------------------------------------------------------------------------------------
Gross profit - (167) 2,028 444 - 2,305
Selling, general and administrative expense
(excluding stock option compensation) - 726 3,462 714 - 4,902
Research and development expense - 100 2,152 409 - 2,661
In-process research and development expense - - - 15 - 15
Amortization of intangibles
Acquired technology - - 551 193 - 744
Goodwill - 13 1,244 2,428 - 3,685
Stock option compensation - - - 91 - 91
Special charges - 409 2,440 12,100 - 14,949
Gain on sale of businesses - (10) (29) (6) - (45)
- ------------------------------------------------------------------------------------------------------------------------------------
Operating loss - (1,405) (7,792) (15,500) - (24,697)
Equity in net earnings (loss) of associated
companies (22,459) (8,915) (1,720) 2 32,954 (138)
Other income (expense) - net 2 (5) (228) (16) (21) (268)
Interest expense
Long-term debt (11) (107) 2 (22) - (138)
Other 5 (30) (48) (9) - (82)
- ------------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (22,463) (10,462) (9,786) (15,545) 32,933 (25,323)
Income tax benefit (provision) (3) 460 1,740 645 - 2,842
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (22,466) (10,002) (8,046) (14,900) 32,933 (22,481)
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 (25,476) (12,540) (9,696) (15,372) 37,593 (25,491)
Cumulative effect of accounting change
- net of tax of $9 - 15 - - - 15
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss $(25,476) $(12,525) $ (9,696) $(15,372) $ 37,593 $(25,476)
====================================================================================================================================
29
Supplemental Consolidating Balance Sheets as at September 30, 2002:
- ------------------------------------------------------------------------------------------------------------------------------------
NORTEL NORTEL NON-
NETWORKS NETWORKS GUARANTOR GUARANTOR
CORPORATION LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 69 $ 412 $ 2,724 $ 965 $ - $ 4,170
Restricted cash and cash equivalents - 47 352 21 - 420
Accounts receivable - net - 307 1,247 451 - 2,005
Intercompany accounts receivable - 4,945 693 359 (5,995) 2
Inventories - net - 666 210 256 - 1,132
Income taxes recoverable - - 58 - - 58
Deferred income taxes - net 12 529 486 135 - 1,162
Other current assets - 76 433 164 - 673
Current assets of discontinued operations - 100 186 7 - 293
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 81 7,082 6,389 2,358 (5,995) 9,915
Long-term receivables - net 24 126 900 492 (1,463) 79
Investments at cost and associated
companies at equity 4,754 858 (8,355) 123 2,796 176
Plant and equipment - net - 419 942 309 - 1,670
Goodwill - - 1,948 252 - 2,200
Intangible assets - net - - 3 130 - 133
Deferred income taxes - net (13) 607 1,662 77 - 2,333
Other assets 27 188 129 524 - 868
Long-term assets of discontinued operations - 23 43 - - 66
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 4,873 $ 9,303 $ 3,661 $ 4,265 $ (4,662) $ 17,440
====================================================================================================================================
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current liabilities
Notes payable $ - $ 2 $ 3 $ 123 $ - $ 128
Trade and other accounts payable 2 334 818 124 - 1,278
Intercompany accounts payable 51 24 3,347 2,581 (5,995) 8
Payroll and benefit-related liabilities - 53 489 104 - 646
Other accrued liabilities 11 929 2,795 954 - 4,689
Income taxes payable - 20 4 92 - 116
Long-term debt due within one year - 504 11 1 - 516
Current liabilities of discontinued operations - 35 66 36 - 137
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 64 1,901 7,533 4,015 (5,995) 7,518
Deferred income - 2 96 1 - 99
Long-term debt 1,800 1,775 173 363 - 4,111
Deferred income taxes - net (5) 345 151 8 - 499
Other liabilities - 633 1,200 1,218 (1,463) 1,588
Minority interest in subsidiary companies - - - 75 536 611
- ------------------------------------------------------------------------------------------------------------------------------------
1,859 4,656 9,153 5,680 (6,922) 14,426
- ------------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred shares - 536 365 46 (947) -
Common shares 33,872 2,111 5,405 1,535 (9,051) 33,872
Additional paid-in capital 3,753 20,803 1,546 19,880 (42,229) 3,753
Deferred stock option compensation (118) - - (127) 127 (118)
Deficit (33,488) (17,833) (13,721) (22,601) 54,155 (33,488)
Accumulated other comprehensive income (loss) (1,005) (970) 913 (148) 205 (1,005)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 3,014 4,647 (5,492) (1,415) 2,260 3,014
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,873 $ 9,303 $ 3,661 $ 4,265 $ (4,662) $ 17,440
====================================================================================================================================
30
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
====================================================================================================================================
31
Supplemental Consolidating Statements of Cash Flows for the nine months ended
September 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 $(3,337) $(3,310) $(1,546) $ (818) $ 5,674 $(3,337)
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 - 66 334 142 - 542
Non-cash portion of special charges
and related asset write downs - 221 551 520 - 1,292
Equity in net loss of associated companies 3,801 2,097 327 9 (6,215) 19
Stock option compensation - - - 68 - 68
Deferred income taxes 1 (423) 565 (188) - (45)
Other liabilities - (16) 1 1 - (14)
Gain on sale of investments and businesses - (10) (7) (11) - (28)
Other - net 59 233 51 12 - 355
Change in operating assets and liabilities:
Accounts receivable - 58 731 104 - 893
Inventories - 135 271 1 - 407
Income taxes - 363 343 5 - 711
Accounts payable and accrued liabilities (23) (500) (873) (32) - (1,428)
Other operating assets and liabilities (54) 42 - (21) - (33)
Intercompany activity 115 (610) 350 145 - -
- --------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) operating activities 562 (1,654) 1,098 (63) (541) (598)
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Expenditures for plant and equipment - (40) (214) (35) - (289)
Proceeds on disposals of plant and equipment - 5 181 - - 186
Increase in restricted cash and cash equivalents - (47) (352) (21) - (420)
Increase in long-term receivables - 62 (187) (122) - (247)
Decrease in long-term receivables - 19 151 83 - 253
Acquisitions of investments and
businesses - net of cash acquired - (5) (24) - - (29)
Investment in subsidiaries (1,997) - - - 1,997 -
Proceeds on sale of investments and businesses - 20 24 35 - 79
- --------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) investing activities (1,997) 14 (421) (60) 1,997 (467)
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Dividends on preferred shares - (16) - - 16 -
Decrease in notes payable - net - - (159) (130) - (289)
Proceeds from long-term debt - - 1 31 - 32
Repayments of long-term debt - (5) (4) (13) - (22)
Increase (decrease) in capital leases payable - (3) 166 (1) - 162
Issuance of common shares 863 1,997 - - (1,997) 863
Issuance of prepaid forward purchase contracts 623 - - - - 623
Stock option fair value increment - - (525) - 525 -
- --------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) financing activities 1,486 1,973 (521) (113) (1,456) 1,369
- --------------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash
and cash equivalents - 3 10 3 - 16
- --------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) continuing operations 51 336 166 (233) - 320
Net cash from discontinued operations - 117 218 2 - 337
- --------------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 51 453 384 (231) - 657
- --------------------------------------------------------------------------------------------------------------------------------
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 $ 69 $ 412 $ 2,724 $ 965 $ - $ 4,170
================================================================================================================================
32
Supplemental Consolidating Statements of Cash Flows for the nine months ended
September 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 $(22,466) $(10,002) $(8,046) $(14,900) $ 32,933 $(22,481)
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 - 146 2,144 2,687 - 4,977
In-process research and development expense - - - 15 - 15
Non-cash portion of special charges and
related asset write downs - 84 1,351 11,899 - 13,334
Equity in net earnings (loss) of
associated companies 22,459 8,915 1,720 (2) (32,954) 138
Stock option compensation - - - 91 - 91
Deferred income taxes - (952) (967) (234) - (2,153)
Other liabilities - 10 75 (23) - 62
Gain on sale of investments and businesses - - (26) (45) - (71)
Other - net - 227 555 (473) - 309
Change in operating assets and liabilities:
Accounts receivable - 614 2,853 968 - 4,435
Inventories - 387 1,237 114 - 1,738
Income taxes - (410) (523) (40) - (973)
Accounts payable and accrued liabilities (145) (945) 1,299 436 - 645
Other operating assets and liabilities - (122) 392 89 - 359
Intercompany activity 176 306 (536) 54 - -
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) operating activities 24 (1,742) 1,528 636 (21) 425
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Expenditures for plant and equipment - (304) (686) (123) - (1,113)
Proceeds on disposal of plant and equipment - 20 131 - - 151
Increase in long-term receivables - (161) (165) (351) - (677)
Decrease in long-term receivables - 82 86 24 - 192
Acquisitions of investments and businesses -
net of cash acquired - (12) (76) 1 - (87)
Investment in subsidiaries (1,800) - - - 1,800 -
Proceeds on sale of investments and businesses - 1 37 194 - 232
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) investing activities (1,800) (374) (673) (255) 1,800 (1,302)
- ------------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Dividends on common and preferred shares (123) (21) - - 21 (123)
Increase in notes payable - net - 55 190 110 - 355
Proceeds from long-term debt 1,756 1,500 6 16 - 3,278
Repayments of long-term debt - (250) (10) (203) - (463)
Decrease in capital leases payable - (2) (13) (6) - (21)
Issuance of common shares 136 1,800 - - (1,800) 136
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) financing activities 1,769 3,082 173 (83) (1,779) 3,162
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash
and cash equivalents - (1) (2) (2) - (5)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) continuing operations (7) 965 1,026 296 - 2,280
Net cash used in discontinued operations - (196) (363) (10) - (569)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (7) 769 663 286 - 1,711
- ------------------------------------------------------------------------------------------------------------------------------------
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 $ 13 $ 696 $ 1,683 $ 963 $ - $3,355
====================================================================================================================================
33
ITEM 2. MANAGEMENT'S 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 Management's 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.
During the three months ended September 30, 2002, we changed the way we
managed our business to streamline and focus more directly on our customers in
four key businesses: Wireless Networks, Enterprise Networks (formerly part of
Metro & Enterprise Networks), Wireline Networks (formerly part of Metro &
Enterprise Networks) and Optical Networks (formerly named Optical Long-Haul
Networks). Our operations are focused on providing seamless networking products
and service capabilities across these four core business areas. 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 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
Enterprise Networks segment includes a range of Ethernet and application
switching solutions, security solutions, virtual private networks and routers,
enterprise telephony solutions, digital switching systems, business solutions
and applications, and network management software, along with related
professional services used by our enterprise customers. Our Wireline Networks
segment includes a range of Optical Ethernet solutions, packet switching and
routing solutions, such as data switching systems, aggregation products, virtual
private network gateways, and routers, circuit to packet solutions, such as
digital switching systems, and network management software, together with
related professional services used by our service provider customers. 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, 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 Corporation's 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 Limited's outstanding common shares but
none of its outstanding preferred shares.
34
DEVELOPMENTS IN 2002
Optical Networks
On May 29, 2002, we announced plans to further realign our Optical
Networks business, including optical components, given that we do not expect a
meaningful recovery in the long-haul optical market before early 2004. As part
of this realignment, on October 7, 2002, we announced an agreement to sell
certain optical components assets to Bookham Technology plc for shares,
warrants, debt and cash consideration, and the transaction closed on November 8,
2002. The transaction includes a 3-year supply agreement with a minimum purchase
commitment of approximately $120 for the first 18 months.
For additional information, see "Subsequent events" in note 18 to the
accompanying unaudited consolidated financial statements.
Restructuring
In the three months ended September 30, 2002, we recorded as part of
special charges, restructuring charges of $476, primarily comprised of a $323
charge related to workforce reduction, a $102 charge related to contract
settlement and lease costs, and a $51 charge related to plant and equipment
write downs. The workforce reduction charge of $323 related to the cost of
severance and benefits associated with approximately 3,500 employees notified of
termination during the period and included $107 for non-cash pension settlement
and curtailment charges. The contract settlement and lease costs of $102 include
negotiated settlements to either cancel contracts or renegotiate existing
contracts across all of our segments. The plant and equipment write down of $51
primarily related to a write down of plant and equipment assets within our
Optical Networks segment and charges relating to leasehold improvements and
certain information technology equipment associated with the exiting of leased
and owned facilities.
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. The workforce
reduction charges of $117 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
approximately 4,400 employees notified of termination during the period.
As of September 30, 2002, our workforce numbered approximately 40,800.
Following the completion of remaining workforce reductions, primarily related to
recently announced reductions, the realignment of the Optical Networks segment,
and the previously announced European work council activities, we expect to have
a workforce of approximately 35,000. We will continue to actively review our
cost structure to reduce or redirect costs that are not warranted. Additional
charges will be required in the fourth quarter of 2002 and into 2003 related to
remaining announced workforce reductions and related charges, and the continued
restructuring of the Optical Networks segment.
See "Special charges" for additional information.
Goodwill write down
As a result of the continued decline in both our overall market value
generally and within the Optical Networks segment specifically, as part of our
review of financial results during the three months ended September 30, 2002, we
evaluated the goodwill associated with the businesses within the Optical
Networks segment for potential impairment. The conclusion of those evaluations
was that the fair value associated with the businesses within the Optical
Networks segment could no longer support the carrying value of the goodwill
associated with them. As a result, we recorded a goodwill write down of $595.
Deferred income taxes
As part of our quarterly review procedures we performed an evaluation of
the recoverability of our deferred income tax assets. During the three months
ended September 30, 2002, we recorded an income tax benefit of $325 on a pre-tax
loss of $1,674, which was more than offset by the recording of certain
additional income tax valuation allowances of $450. These additional valuation
allowances were recorded in accordance with the Statement of Financial
Accounting Standard No. 109, "Accounting for Income Taxes", or SFAS 109, which
requires that tax valuation allowances be established when it is more
35
likely than not that some portion or all of a company's deferred tax assets will
not be realized. The increase in the valuation allowances can be attributed to
further telecommunications market declines in the three months ended September
30, 2002 and the resultant decline in forecasted taxable income.
If market conditions deteriorate further or future results of operations
are less than expected, future assessments may result in a determination that
the remaining net deferred tax assets or some portion thereof are not
realizable. As a result, we may need to establish additional tax valuation
allowances for all or a portion of our deferred tax assets.
See "Income taxes" for additional information.
Common shares
On September 25, 2002, we announced that we plan to present a proposal
to our shareholders for a consolidation of our outstanding common shares, also
known as a reverse stock split, at our annual shareholders' meeting planned for
spring 2003. Prior to that meeting, the consolidation ratio will be set by the
Nortel Networks Corporation Board of Directors at a level which would be
expected at that time to result in an initial post-consolidation common share
price in the range of $10.00 to $20.00 per share, assuming receipt of
shareholder approval and regulatory approval. The planned share consolidation
proposal is intended to satisfy the minimum average share price listing
requirements of the New York Stock Exchange to maintain our common share listing
on that exchange.
At the close of trading on July 19, 2002, Standard & Poor's changed the
members of certain S&P indices, replacing the seven non-United States companies,
including Nortel Networks, in the S&P 500 index with seven United States
corporations. At the same time, we were also replaced in the S&P 100 index. Our
membership in the S&P/TSX 60 and the S&P Global 1200 indices were unaffected by
these changes.
Credit facilities
On October 17, 2002 we announced that we expect Nortel Networks
Limited's and Nortel Networks Inc's $1,510 December 20, 2001 credit facilities,
that mature December 13, 2002 and which are currently undrawn, will not be
amended or extended.
During the nine months ended September 30, 2002, we sold certain real
estate in the United Kingdom, which resulted in reductions in the available
commitments under the December 20, 2001 credit facilities. As at September 30,
2002 our available commitments have been reduced from $1,575 to $1,510.
On April 10, 2002, we 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 of the April 2001 facilities
requiring Nortel Networks Limited's 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.
See "Liquidity and capital resources" for additional details on our
credit agreements.
Debt rating downgrades
On April 4, 2002, Moody's Investor Services, Inc. lowered Nortel
Networks Limited's United States senior long-term debt rating below investment
grade to Ba3 and then, on November 1, 2002, lowered the rating from Ba3 to B3
with a negative outlook.
On April 9, 2002, Standard & Poor's Ratings Service lowered their credit
rating for Nortel Networks Limited below investment grade to BB- and then, on
September 18, 2002, lowered the credit rating from BB- to B with a negative
outlook.
As a result of the April 2002 debt rating downgrades, 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 September 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 Limited's other subsidiaries. In
36
addition, certain of Nortel Networks Limited's wholly owned subsidiaries have
guaranteed Nortel Networks Limited's obligations under the credit agreements and
outstanding public debt securities. The April 2002 364-day and April 2000 five
year credit agreements and such public debt will continue to benefit from such
liens, pledges, and guarantees, notwithstanding the expected expiration of the
$1,510 December 2001 facilities maturing in December 2002.
See "Liquidity and capital resources" for additional details on our
credit ratings and the granting of security under our credit agreements.
For additional financial information related to those subsidiaries
providing guarantees, see "Supplemental consolidating financial information" in
note 19 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.
Pensions
On October 17, 2002, we announced that the decline in world capital
markets and global interest rates over the past year have had a significant
negative impact on the investment assets and liabilities of our registered
pension plans which are managed by third parties. As a result, we expect to
record at December 31, 2002, a non-cash charge to shareholders' equity,
currently expected to be between $600 and $700, related to the increase in the
minimum required recognizable deficit associated with these registered pension
plans. In 2002, we have made all required cash contributions to our registered
pension plans as well as additional voluntary contributions, totaling
approximately $150.
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
holder's 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 is 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 adjustments for the proposed consolidation of our common shares,
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. During
the three months ended September 30, 2002, holders of 27 purchase contracts
exercised their early settlement rights and received 432,298 common shares. As
at September 30, 2002 there were 28,723 purchase contracts outstanding.
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. Approximately $800 remains available under the shelf
registration and base shelf prospectus, 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.
Results of operations - continuing operations
Revenues
Segment revenues
During the three months ended September 30, 2002, we changed the way we
managed our business to streamline and focus more directly on our customers in
four key businesses: Wireless Networks, Enterprise Networks (formerly part of
Metro & Enterprise Networks), Wireline Networks (formerly part of Metro &
Enterprise Networks) and Optical Networks (formerly named Optical Long-Haul
Networks). 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.
All reported and historical information has been restated to reflect
these realignments.
37
The following table sets forth revenues by segment for the three months
and nine months ended September 30:
- --------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2002 $ Change % Change 2001 2002 $ Change % Change
- --------------------------------------------------------------------------------------------------------
Wireless $ 1,349 $ 940 $ (409) (30) $ 4,510 $ 3,199 $ (1,311) (29)
Enterprise 729 617 (112) (15) 2,521 1,928 (593) (24)
Wireline 896 482 (414) (46) 3,526 1,748 (1,778) (50)
Optical 579 309 (270) (47) 2,905 1,121 (1,784) (61)
Other (a) 141 7 (134) (95) 593 44 (549) (93)
- --------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 3,694 $ 2,355 $ (1,339) (36) $14,055 $ 8,040 $ (6,015) (43)
========================================================================================================
(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 nine months ended September 30:
- ---------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2002 $ Change % Change 2001 2002 $ Change % Change
- ---------------------------------------------------------------------------------------------------------
EXTERNAL REVENUES (A)
United States $ 1,761 $ 1,224 $ (537) (31) $ 6,850 $ 4,173 $ (2,677) (39)
Canada 183 89 (94) (51) 699 456 (243) (35)
Other countries 1,750 1,042 (708) (41) 6,506 3,411 (3,095) (48)
- --------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 3,694 $ 2,355 $ (1,339) (36) $14,055 $ 8,040 $ (6,015) (43)
========================================================================================================
(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
customers focused on maximizing their return on invested capital and, as a
result, our revenues declined sequentially during 2001. In the first nine months
of 2002, we have continued to see constraints on capital expenditures by
industry participants. As a result, for the three months and nine months ended
September 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
September 30, 2002 were down significantly compared to the three months ended
June 30, 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 customers for the
remainder of 2002 and 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. 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 ended September
30, 2002 compared to the same period in 2001 was the result of considerable
declines across all segments with the exception of Enterprise Networks, which
decreased significantly compared to the same period in 2001. The substantial
decline in revenues for the nine months ended September 30, 2002 compared to the
same period in 2001 was the result of considerable declines across all segments.
The significant decline in revenues in the three months ended September 30, 2002
compared to the three months ended June 30, 2002 was primarily due to a
38
substantial decline in Optical Networks revenues, significant declines in
Wireless Networks and Wireline Networks revenues, and a modest decline in
revenue in our Enterprise Networks segment.
The substantial decline in revenues for the three months and nine months
ended September 30, 2002 compared to the same periods in 2001 was due to
considerable declines in all geographic regions. Compared to the three months
ended June 30, 2002, revenues for the three months ended September 2002 declined
significantly in the United States and Caribbean and Latin America region,
declined substantially in Canada, and declined in Europe, partially offset by a
significant increase in the Asia Pacific region.
Wireless Networks
The following chart sets forth quarterly revenues for the Wireless
Networks segment:
[BAR CHART]
Wireless Networks Revenues by Quarter
Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002
- ------- ------- ------- ------- -------
$1,349 $1,204 $1,136 $1,123 $940
The substantial decline in overall Wireless Networks segment revenues in
the three months and nine months ended September 30, 2002 compared to the same
period in 2001 was primarily due to a continued deterioration in wireless
service providers' financial condition and subscriber growth, and increased
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 September 30, 2002 compared to the same period in 2001 was primarily due
to substantial decreases in Canada, the Asia Pacific region, and the Caribbean
and Latin America region, a significant decline in the United States, and a
decline in Europe. The substantial decrease in overall segment revenues during
the nine months ended September 30, 2002 compared to the same period in 2001 was
due to substantial decreases in all geographic regions, partially offset by an
increase in Canada.
Overall Wireless Networks segment revenues for the three months ended
September 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. CDMA and Universal Mobile Telecommunications Systems, or UMTS,
technology sales are expected to represent a larger proportion of our total
Wireless Networks segment revenues as third generation, or 3G, technologies are
expected to gain a greater foothold in the market due to increased wireless data
traffic and requirements for greater wireless spectrum efficiency. GSM sales are
expected to decline as technology transitions to General Packet Radio Standard,
or GPRS, and Enhanced Data for Global Evolution, or EDGE, 2.5G technologies.
Time Division Multiple Access, or TDMA, sales are also 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 due to the lack of financing and the overall industry
decline. We anticipate a reduction in global capital expenditures for wireless
operators in 2003 and 2004, 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 anticipated 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
September 30, 2002 declined significantly compared to the three months ended
June 30, 2002, due to substantial declines in the United States, Canada, and the
Caribbean and Latin America region, and essentially flat revenues in Europe,
partially offset by a substantial increase in the Asia Pacific region.
39
Enterprise Networks
The following chart sets forth quarterly revenues for the Enterprise
Networks segment:
[BAR CHART]
Enterprise Networks Revenues by Quarter
Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002
- ------- ------- ------- ------- -------
$729 $799 $675 $636 $617
The Enterprise Networks segment services enterprise customers which
include large businesses and their branch offices, small businesses, and home
offices, as well as government, education, and utility organizations.
The significant decline in overall Enterprise Networks segment revenues
in the three months ended September 30, 2002 and the substantial decline in the
nine months ended September 30, 2002 compared to the same periods in 2001 was
primarily due to enterprise customers continuing to delay investment decisions
surrounding next generation products due to overall economic conditions and
technology evolution uncertainties. The significant decline in overall segment
revenues in the three months ended September 30, 2002 compared to the same
period in 2001 was due to a substantial decline in Canada and Europe, and
significant declines in the United States and Asia Pacific region, partially
offset by a substantial increase in the Caribbean and Latin America region. The
substantial decline in overall segment revenues in the nine months ended
September 30, 2002 compared to the same period in 2001 was due to considerable
declines in Europe and Canada, significant declines in the United States and
Asia Pacific region, partially offset by a significant increase in the Caribbean
and Latin America region.
As data, voice, and multimedia communications technologies continue to
converge, and 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 increase the use of
packet-based technologies. However, the timing of this progression is unclear as
a result of the continuing industry adjustment which is expected to continue to
have a negative impact on the level of spending by enterprise customers.
Overall Enterprise Networks segment revenues for the three months ended
September 30, 2002 experienced a moderate decline compared to the three months
ended June 30, 2002, primarily due to a significant decrease in demand for the
more mature Ethernet switching technologies. The moderate decline in overall
segment revenues in the three months ended September 30, 2002 compared to the
three months ended June 30, 2002, was due to a substantial decline in Canada, a
decline in the Asia Pacific region and the Caribbean and Latin America region, a
moderate decline in the United States, and essentially flat revenues in Europe.
40
Wireline Networks
The following chart sets forth quarterly revenues for the Wireline
Networks segment:
[BAR CHART]
Wireless Networks Revenues by Quarter
Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002
- ------- ------- ------- ------- -------
$896 $921 $679 $587 $482
The Wireline Networks segment serves our service provider customers,
which include local and long-distance telephone companies, Internet service
providers, and other communications service providers.
The substantial decline in overall Wireline Networks segment revenues in
the three months and nine months ended September 30, 2002 compared to the same
periods in 2001 was primarily due to a substantial decrease in sales in the
circuit to packet and packet switching and routing technologies. The
considerable decline in the circuit to packet portion of this segment was a
result of continued reduced demand in the local exchange and interexchange
carrier markets due to the significant industry adjustment, including industry
consolidation and tightened capital markets, and the decline in demand for
traditional circuit switching products. 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, compounded by the ongoing industry
adjustment as our service provider customers continued to reduce capital
expenditures. The substantial decline in overall segment revenues in the three
months and nine months ended September 30, 2002 compared to the same periods in
2001 was due to considerable declines across all geographic regions.
As data, voice, and multimedia communications technologies continue to
converge, and service providers look for ways to maximize the effectiveness of
their existing networks while reducing ongoing capital expenditures and
operating costs, we anticipate that service providers will increasingly use
packet-based technologies in their communications networks. However, the timing
of this progression is unclear as a result of the continuing industry adjustment
which is expected to continue to have a negative impact on the level of spending
by service provider customers and could affect Wireline Networks revenues.
Overall Wireline Networks segment revenues for the three months ended
September 30, 2002 declined significantly compared to the three months ended
June 30, 2002, primarily due to a substantial decrease in demand for traditional
circuit switching products and a decline in demand for the packet switching and
routing portion of this segment. The significant decline in overall segment
revenues in the three months ended September 30, 2002 compared to the three
months ended June 30, 2002 was due to a substantial decline in the United States
and the Asia Pacific region, a significant decline in Europe, and essentially
flat revenues in Canada and the Caribbean and Latin America region.
41
Optical Networks
The following chart sets forth quarterly revenues for the Optical
Networks segment:
[BAR CHART]
Optical Revenues by Quarter
Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002
- ------- ------- ------- ------- -------
$579 $465 $406 $406 $309
The substantial decline in overall Optical Networks segment revenues in
the three months and nine months ended September 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.
When the industry began experiencing the significant adjustment and the
capital markets tightened, our customers reduced their purchases sharply as they
focused on reducing inventory levels to complete existing network build-outs and
on improving the efficiency of their networks. Our major customers in the
optical long-haul portion of the segment remain focused on maximizing return on
invested capital by increasing the capacity utilization rates and efficiency of
existing networks. 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. Revenues 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 revenue 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
three quarters of 2002. The substantial decline in revenues in the optical
long-haul portion of the segment during the three months and nine months ended
September 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 occurred in this segment in 2001 and the first nine months of 2002,
primarily due to significant excess inventories, which resulted in significant
pricing pressures.
Revenues in the metro optical portion of the segment are primarily
driven by demand for enterprise connectivity and storage solutions. The decline
in revenue in the metro optical portion of the segment for the three months
ended September 30, 2002 and the substantial decline for the nine months ended
September 30, 2002, compared to the same periods in 2001, were primarily due to
a decline in demand for mature products, compounded by the ongoing industry
adjustment as customers continue to focus on optimizing existing networks, which
has delayed the deployment of next generation products. Revenue in the metro
optical portion of the segment increased as a percentage of total Optical
Networks segment revenue for the nine months ended September 30, 2002, compared
to the same period in 2001.
Due to the severe reduction, in number and size, of new optical
long-haul network build-outs during 2001 and the first three quarters of 2002
and due to the nature of the optical long-haul portion of this segment, we do
not expect a meaningful recovery in the optical long-haul market before early
2004 and we expect that this segment will be one of the last to recover from the
significant industry adjustment.
The substantial decline in overall Optical Networks segment revenues for
the three months ended September 30, 2002 compared to the same period in 2001
was due to substantial declines in Europe and the United States, a significant
decline in Canada, essentially flat revenues in the Asia Pacific region, and a
significant increase in the Caribbean and Latin America region. The substantial
decline in overall Optical Networks segment revenues for the nine months ended
September 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 declined substantially for the
three months ended September 30, 2002 compared to the three months ended June
30, 2002, primarily due to a considerable decline in demand for the optical
42
long-haul portion of the segment, and a decline in demand for the metro optical
portion of the segment. The substantial decline in Optical Networks revenues was
due to considerable decreases in the United States, Canada, and the Caribbean
and Latin America region, and a significant decline in Europe, partially offset
by a significant increase in revenues in the Asia Pacific region.
Gross profit and gross margin
The following table sets forth gross profit and gross margin for the
three months and nine months ended September 30:
- ----------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2002 Change % Change 2001 2002 Change % Change
- ----------------------------------------------------------------------------------------------------------
Gross profit $ 21 $ 901 $ 880 N/A $ 2,305 $ 2,617 $ 312 13.5
Gross margin 0.6% 38.3% 37.7 N/A 16.4% 32.5% 16.1 98.2
- ----------------------------------------------------------------------------------------------------------
The considerable increase in gross margin for the three months ended
September 30, 2002 compared to the same period in 2001 was primarily due to the
approximately $750 of incremental charges related to increased inventory
provisions and contract and customer settlements in the three months ended
September 30, 2001. Excluding these incremental charges, gross margin would have
been approximately 20.9 percent for the three months ended September 30, 2001,
which is also considerably lower than the gross margin for the three months
ended September 30, 2002, primarily due to our lower cost structure in relation
to our sales volume and more favourable supplier pricing in 2002.
The substantial increase in gross margin for the nine months ended
September 30, 2002 compared to the same period in 2001 was primarily due to
approximately $1,500 of incremental charges related to the increased inventory
provisions and contract and customer settlements in the nine months ended
September 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 30, 2002. Excluding these incremental charges, gross margin
for the nine months ended September 30, 2002 and 2001 would have been
approximately 35.0 percent and 27.1 percent, respectively, which represents a
substantial increase in gross margin for the period, and is primarily due to the
sequential improvements in our cost structure as we have reduced capacity in
relation to our sales volume during the nine months ended September 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 high thirty to low forty percent range for the
remainder of 2002 and into 2003.
See "Forward-looking statements" for factors that may affect our gross
margins.
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 nine months ended September 30:
- -----------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2002 $ Change % Change 2001 2002 $ Change % Change
- -----------------------------------------------------------------------------------------------------------
SG&A expense 1,919 $ 682 $ (1,237) (64.5) $ 4,902 $ 2,193 $ (2,709) (55.3)
As a % of revenues 51.9% 29.0% N/A N/A 34.9% 27.3% N/A N/A
- -----------------------------------------------------------------------------------------------------------
SG&A expense declined substantially in the three months and nine months
ended September 30, 2002 compared to the same periods in 2001 reflecting the
impact of our work plan which we began in 2001. SG&A expense decreased
significantly compared to the three months ended June 30, 2002. In the three
months ended September 30, 2002 and June 30, 2002, incremental charges of
approximately $120 related to increased provisioning for trade and customer
financed receivables, and $100 related to potentially uncollectible receivables,
were taken respectively. Excluding these incremental charges, SG&A expense for
the three months ended September 30, 2002 and June 30, 2002 would have been
approximately $562 and $667, respectively, which represents a significant
decrease in SG&A expense, primarily due to the impact of workforce reductions,
which in turn has also resulted in a reduction in other related costs such as
43
information services and real estate. We expect that the quarterly SG&A expense
will continue to decline over the next few quarters and will trend towards $500
a quarter.
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 nine months
ended September 30:
- ----------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2002 $ Change % Change 2001 2002 $ Change % Change
- ----------------------------------------------------------------------------------------------------------
R&D expense $ 808 $ 565 $ (243) (30.1) $ 2,661 $ 1,739 $ (922) (34.6)
As a % of revenues 21.9% 24.0% N/A N/A 18.9% 21.6% N/A N/A
- ----------------------------------------------------------------------------------------------------------
R&D expense decreased substantially in the three months and nine months
ended September 30, 2002 compared to the same periods in 2001, reflecting
focused investments to drive market leadership in our core businesses. R&D
expense represented our planned investment in our next generation core products
across all segments. R&D expense will decline substantially for the full year
2002, compared to the full year 2001, as we improve process efficiencies and
continue to focus our R&D spending on market and customer priorities. R&D
expense decreased slightly in the three months ended September 30, 2002 compared
to the three months ended June 30, 2002. We expect that quarterly R&D expense
will continue to decline over the next few quarters and will trend towards $500
a quarter. 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 nine
months ended September 30:
- -----------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2002 $ Change % Change 2001 2002 $ Change % Change
- -----------------------------------------------------------------------------------------------------------------
IPR&D expense $ - $ - $ - N/A $ 15 $ - $ (15) (100.0)
Amortization of intangibles
Acquired technology $ 185 $ 38 $ (147) (79.5) $ 744 $ 122 $ (622) (83.6)
Goodwill $ 454 $ - $ (454) (100.0) $ 3,685 $ - $ (3,685) (100.0)
- -----------------------------------------------------------------------------------------------------------------
IPR&D expense
In the nine months ended September 30, 2001, IPR&D expense reflected the
acquisition of JDS Uniphase Corporation's 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 nine
months ended September 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, and Clarify Inc. As at September 30,
2002 and December 31, 2001, the remaining carrying value of acquired technology
- - net was $133 and $285, respectively.
Goodwill
On January 1, 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,
44
2002 and concluded at that time 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.
As a result of the continued decline in both our overall market value
generally and within the Optical Networks segment specifically, as part of our
review of financial results during the three months ended September 30, 2002, we
evaluated the goodwill associated with the businesses within the Optical
Networks segment for potential impairment. The conclusion of those evaluations
was that the fair value associated with the businesses within the Optical
Networks segment could no longer support the carrying value of the goodwill
associated with them. As a result, we recorded a goodwill write down of $595.
The amortization of goodwill for the three months and nine months ended
September 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 September 30, 2002 and December 31, 2001, the carrying value of
goodwill was $2,200 and $2,810, respectively.
Special charges
Three months and nine months ended September 30, 2002
For the three months and nine months ended September 30, 2002, we
recorded special charges of $1,194 and $2,084, respectively, related to
restructuring activities, write downs of other assets and goodwill. The special
charges relating to restructuring are associated with the work plan that we
began implementing in 2001 and continued into the third quarter of 2002, to
streamline operations and activities around core markets and leadership
strategies.
Restructuring activities
Workforce reduction charges of $323 and $767 for the three months and
nine months ended September 30, 2002, respectively, were related to the cost of
severance and benefits associated with approximately 3,500 and 9,800 employees
notified of termination during the three months and nine months ended September
30, 2002, respectively, across all of our segments. Included in the workforce
reduction charges for the three months and nine months ended September 30, 2002,
are $107 of non-cash pension settlement and curtailment charges.
Contract settlement and lease costs included negotiated settlements of
$102 and $166 for the three months and nine months ended September 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 three months and
nine months ended September 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 primarily within the Optical Networks segment of
approximately $31 and $386 during the three months and nine months ended
September 30, 2002, respectively. Also included in plant and equipment write
downs during the three months and nine months ended September 30, 2002, was
approximately $20 of leasehold improvements and certain information technology
equipment associated with the exiting of leased and owned facilities.
Assets held for sale
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", or SFAS 144, requires assets held for sale to be measured at the lower
of their carrying amount or fair values less costs to sell. During the three
months ended September 30, 2002, certain plant and equipment and inventory of
the Optical Networks segment met the criteria of assets held for sale. Based on
the expected fair value of these assets to be realized on sale, we recorded a
charge of $123 against their carrying amounts during the three months ended
September 30, 2002. The remaining fair value of these assets of $47 is included
in inventory.
For additional information, see "Subsequent events" in note 18 to the
accompanying unaudited consolidated financial statements.
45
Other assets
Included in the nine months ended September 30, 2002, was a write off of
$15 for certain acquired technology in the Optical Networks segment recorded
during the three months ended June 30, 2002, and a $12 write off of acquired
technology recorded in the three months ended March 31, 2002, associated with
the Xros, Inc. X-1000 IPR&D project.
Goodwill write down
As a result of the continued decline in both our overall market value
generally and within the Optical Networks segment specifically, as part of our
review of financial results during the three months ended September 30, 2002, we
evaluated the goodwill associated with the businesses within the Optical
Networks segment for potential impairment. The conclusion of those evaluations
was that the fair value associated with the businesses within the Optical
Networks segment could no longer support the carrying value of the remaining
goodwill associated with them. As a result, we recorded a goodwill write down of
$595.
Fair value was estimated using the expected present value of discounted
future cash flows of the businesses within the Optical Networks segment. The
assumptions supporting the estimated future cash flows, including the discount
rate and estimated terminal values, reflect management's best estimates.
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 September 30, 2002
Of the approximately 45,900 employees notified during the period from
January 1, 2001 to September 30, 2002, approximately 16,500 were direct
employees performing manufacturing, assembly, test and inspection activities
associated with the production of our products, and approximately 29,400 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 September 30, 2002, the workforce reduction provision balance has been drawn
down by cumulative cash payments of $1,579 plus $93 of non-cash pension
settlement and curtailment charges, resulting in an ending provision balance for
workforce reduction of $456. The remaining provision is expected to be
substantially drawn down by the end of 2003.
In connection 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 $867.
The costs primarily related to our future contractual obligations under
operating leases. Offsetting the total lease charge is approximately $513 in
expected sublease revenue on leases that we cannot terminate. 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 $112, 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 and lease costs included negotiated
settlements of approximately $182, to either cancel contracts or renegotiate
existing contracts across all of our segments. As at September 30, 2002, the
provision balance for contract settlement and lease costs was drawn down by
cumulative cash payments of $365, resulting in an ending provision balance of
$684. The remaining provision is expected to be substantially drawn down by the
end of 2006.
46
Plant and equipment write downs of approximately $462 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 nine months of 2002. The
conclusion of these assessments resulted in write downs of certain plant and
equipment assets totaling approximately $802, 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 $620 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, other
than equipment that we continue to hold and use, by the second quarter of 2003.
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 $91 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 second
quarter of 2003.
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 $10 and $19 during the three months
and nine months ended September 30, 2002, respectively, 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
During the three months ended September 30, 2002, we recorded an income
tax benefit of $325 on a pre-tax loss of $1,674, which was more than offset by
the recording of certain additional income tax valuation allowances of $450.
These additional valuation allowances were recorded in accordance with Statement
of Financial Accounting Standard No. 109 "Accounting for Income Taxes", or SFAS
109, which requires that tax valuation allowances be established when it is more
likely than not that some portion or all of a company's deferred tax assets will
not be realized. The increase in the valuation allowances can be attributed to
further telecommunications market declines in the three months ended September
30, 2002 and the resultant decline in forecasted taxable income.
We assess the realizability of our net deferred tax assets quarterly,
and based on all available evidence, both positive and negative, conclude
whether it is more likely than not that these deferred tax assets will be
realized. During the three months ended September 30, 2002, we assessed positive
evidence including forecasts of future taxable income to support realization of
the net deferred tax assets, and negative evidence including our seven
consecutive quarters of losses, and concluded that it was more likely than not,
that an additional $450 of the net deferred tax assets as at September 30, 2002,
are not realizable. If market conditions deteriorate further or future results
of operations are less than expected, future assessments may result in a
determination that the remaining net deferred tax assets or some portion thereof
are not realizable. As a result, we may need to establish additional tax
valuation allowances for all or a portion of our deferred tax assets.
Our effective tax benefit rate fluctuates from period to period
primarily as a result of the impact of certain non-tax deductible restructuring
charges, goodwill write downs, IPR&D expense, stock option compensation, non-tax
deductible goodwill amortization prior to January 1, 2002 and changes in the
geographic earnings (loss) mix. Our effective tax benefit rate is not meaningful
for the three months ended September 30, 2002, as a result of recording the
above noted income tax valuation allowances. Excluding the additional income tax
valuation allowances and above noted impacts as applicable, the effective rate
would have been 31.0 percent for the three months and nine months ended
September 30, 2002, respectively. For the three months and nine months ended
September 30, 2001 the effective tax rate was 30.0 percent and 30.9 percent,
respectively.
47
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.
Net loss from continuing operations
- -----------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2002 $ Change 2001 2002 $ Change
- -----------------------------------------------------------------------------------------------------------------
Reported results:
Net loss from continuing operations $ (3,468) $ (1,799) $ 1,669 $ (22,481) $ (3,337) $ 19,144
Basic and diluted loss per common share
- - continuing operations $ (1.08) $ (0.42) $ 0.66 $ (7.07) $ (0.91) $ 6.16
- -----------------------------------------------------------------------------------------------------------------
ADJUSTED RESULTS: (a)
Net loss from continuing operations $ (3,014) $ (1,799) $ 1,215 $ (18,787) $ (3,337) $ 15,450
Basic and diluted loss per common share
- - continuing operations $ (0.94) $ (0.42) $ 0.52 $ (5.90) $ (0.91) $ 4.99
- -----------------------------------------------------------------------------------------------------------------
(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.
Principally as a result of the factors discussed above, our reported net
loss from continuing operations improved by $1,669 and $19,144 in the three
months and nine months ended September 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 nil for the three
months ended September 30, 2002 and $138 for the nine months ended September 30,
2002, compared to $151 and $864, respectively, for the same periods in 2001.
Access solutions operations also generated net cash of $48 and $337 during the
three months and nine months ended September 30, 2002, respectively.
During the nine months ended September 30, 2002, we have continued to
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, 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
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.
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 Group's 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 Group's 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
48
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.
For additional information, see "Discontinued operations" in note 4 to
the accompanying unaudited consolidated financial statements.
Critical accounting policies
Revenue recognition
Our 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 receivables
In establishing the appropriate provisions for receivables, management
must regularly review the financial stability of individual customers. This
analysis involves a judgment of a counterparty's ability to meet and sustain its
financial commitments, and takes into account a counterparty's 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 counterparty's projected financial condition, or uncertainty in the
future outlook of our industry or the economy could result in bad debts lower
than, or 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 lower than, or in excess of the
provisions determined to be appropriate as at the balance sheet date.
49
Tax asset valuation
In establishing the appropriate income tax valuation allowances, we
assess realization of our net deferred tax assets quarterly, and based on all
available evidence, both positive and negative, we determine whether it is more
likely than not that remaining net deferred tax assets or a portion thereof will
be realized. If market conditions deteriorate further or future results of
operations are less than expected, future assessments may result in a
determination that the remaining net deferred tax assets or some portion thereof
are not realizable. As a result, we may need to establish additional tax
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 $4,170, excluding $420 of
restricted cash and cash equivalents described below, at September 30, 2002, an
increase of $657 (including net cash from the access solutions operations of
$337) from December 31, 2001. This 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 $598 for the nine months
ended September 30, 2002, due to a net loss of $1,148, adjusted for non-cash
items, partially offset by a net change in operating assets and liabilities. The
net change in operating assets and liabilities was due to reductions in accounts
receivable, income tax, inventory balances, and changes in other operating
assets and liabilities, partially offset by a reduction in accounts payable and
accrued liabilities. The reduction in income tax is primarily due to the
collection of income tax refunds during the period. The reduction in the
remaining operating assets and liabilities is primarily due to the continued
decline in sales volumes and the associated size of the business, as well as the
utilization of certain contract manufacturer and supplier provisions and
restructuring provisions, during the nine months ended September 30, 2002.
During the nine months ended September 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 $467 for the nine months
ended September 30, 2002. These were primarily due to $420 of restricted cash
and cash equivalents held as cash collateral for certain customer performance
bonds and contracts, and expenditures for plant and equipment of $289, partially
offset by proceeds on disposal of certain plant and equipment of $186, mainly
related to the sale of certain real estate in the United Kingdom, and net
proceeds on the sale/acquisition of investments and businesses of $79, primarily
related to the sale of certain assets of our service commerce operation support
system business.
Cash flows generated from financing activities were $1,369 for the nine
months ended September 30, 2002, primarily due to approximately $1,479 of net
proceeds generated by the equity offerings and an increase in capital leases
payable of $162, partially offset by a net decrease in notes payable of $289.
Uses of liquidity
Our cash requirements for the next 12 months are primarily to fund
operations, research and development, capital expenditures, workforce reduction
and other restructuring activities, debt service, and customer financings. We
may from time to time purchase our outstanding debt securities in privately
negotiated or open market transactions, by tender offer or otherwise, in
compliance with applicable laws. The following provides additional information
related to our uses of liquidity.
Special charges
The remaining cash payments of $456 relating to workforce reduction
initiatives are expected to be substantially completed by the end of 2003, and
the remaining cash payments of $684 related to contract settlement and lease
costs are expected to be substantially completed by the end of 2006. Additional
charges will be required in the fourth quarter of 2002 and into 2003 related to
the remaining announced workforce reductions and related charges, and the
continued restructuring of the Optical Networks segment. We expect to fund
restructuring costs of approximately $900 in 2003.
50
See "Special charges" for additional information.
Cash obligations
Our contractual cash obligations for long-term debt, outsourcing
contracts and operating leases as at September 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. On October 1, 2002, as part of our
normal course debt repayments, we repaid the $300 6.88% Notes due October 1,
2002 and accrued interest.
In 2002, we have made all required cash contributions to our registered
pension plans as well as additional voluntary contributions, totaling
approximately $150.
Commitments and guarantees
We enter into bid and performance bonds related to various contracts,
which generally have terms ranging from two to five 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 amount of bid and
performance bonds that were available and undrawn was $576, excluding restricted
cash and cash equivalents of $420, and $1,177 at September 30, 2002 and December
31, 2001, respectively.
Due to the current general economic and industry environment, and our
current credit condition, the basis under which customer performance bonds and
contracts can be obtained has changed, resulting in (but not limited to)
increased cash collateral requirements and/or increased fees in connection with
obtaining new customer performance bonds and contracts. However, we currently do
not expect that the requirements and/or fees to obtain customer performance
bonds and contracts will have a material adverse effect on our ability to win
contracts from potential customers. As at September 30, 2002, approximately $420
of cash and cash equivalents was restricted as cash collateral for certain
customer performance bonds and contracts.
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. 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, in certain circumstances. As is customary for the
industry, these supply and networking outsourcing contracts are highly
customized to address each customer's 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.
51
Customer financing
The following table provides information related to customer financing
commitments as at:
- --------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2002 2001
- --------------------------------------------------------------------------------
Drawn and outstanding (a) $ 314 $ 464
Undrawn commitments 815 1,611
- --------------------------------------------------------------------------------
Total customer financing $ 1,129 $ 2,075
- --------------------------------------------------------------------------------
(a) Net of provisions of $895 and $887 as at September 30, 2002 and December
31, 2001, respectively.
We currently have customer financing commitments and/or balances
outstanding in connection with the construction of new networks, including third
generation, or 3G, wireless networks. Although we may commit to provide customer
financing to customers in areas that are strategic to our core business
activities, we remain focused on reducing our overall customer financing
exposures consistent with our financing agreements. 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 during the nine months ended September 30, 2002,
we have reduced undrawn commitments which reflect commitment expiration,
cancellations and changing customer business plans. 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 reducing that capacity as quickly and
efficiently as possible, and on minimizing the 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 current credit
condition, adverse changes in the credit quality of our customers, and economic
downturns in various countries. As a result, we are currently directly
supporting, and expect to be required to support in the future, most commitments
and outstanding balances of such customer financings. While we will continue to
seek to arrange for third-party lenders to assume our customer financing
obligations we expect to fund most customer financings from working capital and
conventional sources of external financing in the normal course.
See "Forward-looking statements" for additional factors that may impact
our customer financing arrangements.
Discontinued operations
At September 30, 2002, the remaining accruals of the discontinued access
solutions operations totaled $134 and were related to certain future contractual
obligations and estimated liabilities, 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 partially offset by proceeds from the sale of
certain remaining assets to be disposed of. During the nine months ended
September 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
We currently have a number of credit facilities (discussed in more
detail below), all of which contain financial covenants, and in the case of the
$1,510 December 2001 facilities, impose additional restrictive covenants. Except
for the $750 April 2000 five year credit facilities, all of our credit
facilities expire within the next six months. We continue to have
52
ongoing discussions with our banks regarding our existing credit facilities as
well as exploring additional financing opportunities and credit arrangements,
including bid and performance arrangements to support our expected business
needs. As we continue to assess our overall liquidity and business needs as well
as our expected financial performance, we may elect or it may be necessary to
reduce or terminate any or all of our credit facilities prior to their expiries.
Nortel Networks Limited and Nortel Networks Inc. amended their 364-day
credit facilities in December 2001 which expire on December 13, 2002. As
announced on October 17, 2002, we do not expect to amend or extend these
facilities. As noted above, these credit facilities contain financial covenants
that require (i) the maintenance of a minimum consolidated tangible net worth
(at the consolidated Nortel Networks Limited level) of not less than $1,880, and
(ii) the achievement (at the consolidated Nortel Networks level), of minimum
consolidated earnings before interest, taxes, depreciation and amortization, or
EBITDA, of negative $350 or better for the full year ended December 31, 2002.
Certain business restructuring charges and other incremental charges and gains
as publicly disclosed are excluded from the calculation of EBITDA. These credit
facilities also 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 facilities is maintained. The credit facilities also 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. These restrictions have not had, and are not expected, for the
period prior to the expected expiration of these facilities, to have an effect
on Nortel Networks Corporation's ability to meet its primary cash obligations
associated with making interest payments on the $1,800 4.25 percent convertible
senior notes due September 1, 2008.
On April 12, 2000, Nortel Networks Limited and Nortel Networks Inc.
entered into 364-day revolving syndicated credit facilities and five-year
syndicated credit facilities, which permit borrowings for general corporate
purposes in an aggregate amount of up to $1,750 and $750, respectively.
Effective April 8, 2002, Nortel Networks Limited and Nortel Networks Inc.
amended and extended the $1,750 364-day credit facilities which reduced the size
of the facilities to $1,175 from $1,750, included higher pricing, and extended
the term to April 7, 2003 with no additional term-out period thereafter. As a
result, total borrowings currently permitted under the April 2002 364-day and
April 2000 five-year credit facilities are $1,925. The April 2002 364-day and
April 2000 five-year credit facilities expire in April 2003 and April 2005,
respectively.
The April 2002 364-day and April 2000 five-year credit facilities
require that Nortel Networks Limited's consolidated tangible net worth at any
time be not less than $1,888. We continue to monitor the financial position of
Nortel Networks Limited in light of this covenant and we expect that if we
continue to incur net losses or record additional charges relating to our
restructuring work plan, the accounting of our registered pension plans, the
valuation of deferred income tax assets or for other events, Nortel Networks
Limited's consolidated tangible net worth may be reduced below the $1,888
threshold. If Nortel Networks Limited is unable to comply with the
consolidated tangible net worth covenant, we will be unable to access these
facilities.
Notwithstanding the expected expiration of the $1,510 December 2001
credit facilities, any amounts subsequently drawn under any of Nortel Networks
Limited's and Nortel Networks Inc.'s existing credit facilities will be secured
equally and ratably with all of our current outstanding public debt securities
pursuant to the security documents which became effective following Moody's
Investors Services, Inc.'s downgrade of Nortel Networks Limited's United States
senior long-term debt rating to 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 Limited's
other subsidiaries. In addition, certain of Nortel Networks Limited's wholly
owned subsidiaries have provided guarantees of Nortel Networks Limited's
obligations under these credit facilities. The security would be released, if
and when, Nortel Networks Limited's United States senior long-term debt ratings
return to Baa2 (with a stable outlook) and BBB (with a stable outlook), as
determined by Moody's Investors Services, Inc. and Standard & Poor's Ratings
Service, respectively, or when all of our existing credit facilities terminate
or expire.
As at September 30, 2002, we were in compliance with the covenants of
the above-noted credit facilities and had no amounts outstanding under any of
these credit facilities. 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 facilities in the
future.
For additional financial information related to those subsidiaries
providing guarantees, see "Supplemental consolidating financial information" in
note 19 of the accompanying unaudited consolidated financial statements.
53
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 September 30, 2002, we have utilized
approximately $1,700 of the $2,500 available under our shelf registration
statement and our base shelf prospectus. Approximately $800 remains available
for use 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.
The total debt to total capitalization ratio of Nortel Networks was 57
percent at September 30, 2002, compared to 47 percent at December 31, 2001. The
ratio reflects the increase in our deficit, partially offset by the equity
offerings on June 12, 2002.
Credit ratings
- -------------------------------------------------------------------------------------------------------------------------------
RATING ON LONG-TERM DEBT ISSUE OR
GUARANTEED BY NORTEL NETWORKS RATING ON PREFERRED
LIMITED/NORTEL NETWORKS SHARES ISSUED BY NORTEL
RATING AGENCY CORPORATION NETWORKS LIMITED LAST UPDATE
- -------------------------------------------------------------------------------------------------------------------------------
Standard & Poor's Ratings Service B CCC September 18, 2002
Moody's Investor Services, Inc. B3 Caa3 November 1, 2002
- -------------------------------------------------------------------------------------------------------------------------------
The ratings remain on negative outlook by Moody's and Standard & Poor's.
There can be no assurance that our credit ratings will not be lowered further or
that such ratings agencies will not issue adverse commentaries, potentially
resulting in higher financing costs and further reduced access to capital
markets or replacement credit facilities. Our credit ratings may also affect our
ability, and the cost, to securitize receivables, obtain customer performance
bonds and contracts, and enter into normal course derivative or hedging
transactions.
See "Forward-looking statements" for effects of changes in respect of
our debt ratings.
During 2001 and the first nine months of 2002, we took actions to
strengthen our cash and liquidity positions and as of September 30, 2002, our
primary source of liquidity is our current cash and cash equivalents. At
September 30, 2002 we had cash and cash equivalents of $4,170, excluding $420 of
restricted cash and cash equivalents. We believe this cash will be sufficient to
fund our current business model, manage our investments and meet our customer
commitments for at least the next 12 months. However, a continued slow down in
capital spending by service providers and other customers may require us to
adjust our current business model. As a result, our revenues and cash flows may
be materially lower than we expect and we may be required to further reduce our
capital expenditures and investments or take other measures 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,
54
on behalf of shareholders who acquired Nortel Networks Corporation's 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 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 between January 18, 2001 and
February 15, 2001, alleging violations of the same United States federal
securities laws as the above-noted lawsuits.
On July 17, 2002, a new purported class action lawsuit, or the Ontario
Claim, was filed in the Ontario Superior Court of Justice naming Nortel Networks
Corporation, 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 paragraph below. 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 Corporation and
the named directors and officers of Nortel Networks Corporation intend to
vigorously defend the Ontario Claim.
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
Corporation's 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 Corporation's 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 Corporation's 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
September 24, 2002, plaintiffs in the consolidated action filed a motion to
consolidate all the actions and to transfer them to the United States District
Court for the Southern District of New York.
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,
55
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 was granted on September 30, 2002, and
the Second Complaint was dismissed without leave to amend. Plaintiffs' time to
appeal the decision of the District Court has not yet expired.
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 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, unless otherwise
specified, seek damages of material or indeterminate amounts. We 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 $25.
For a discussion of Environmental matters, see "Environmental matters"
in note 19 to Nortel Networks Corporation's audited consolidated financial
statements and notes thereto for the year ended December 31, 2001.
FORWARD-LOOKING STATEMENTS
Certain information and statements contained in this Management's
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
56
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.
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 continue to
restructure our business 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 by management 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, which are based in part on
management forecasts of future business performance, 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, net
deferred taxes, pension assets, 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 a return to
profitability.
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 and other
customers may affect our revenues more than we currently expect. Moreover, the
significant slowdown in capital spending by our customers 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 significantly 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 or if we
are required to record additional charges relating to our restructuring work
plan, the accounting of our registered pension plans, the valuation of deferred
income tax assets or for other events, we may be unable to comply with certain
57
financial covenants under our current credit facilities. 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.
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 forecasts, estimates and assumptions
for asset valuations and in determining the amounts of accrued
liabilities and other items in our consolidated financial statements;
- the impact of a continued decline in world capital markets and global
interest rates on investment assets and liabilities on our registered
pension plans;
- 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 continue to obtain customer performance bonds and
contracts;
- 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; and
- changes in legislation, regulation, and/or accounting rules.
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).
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Significant fluctuations in our operating results could contribute to
volatility in the market price of Nortel Networks Corporation's common shares.
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 current credit condition, or the credit quality
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 increased 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 corporation's common shares.
Our gross margins may be negatively affected as a result of a number of
factors, including:
- increased price competition;
- excess capacity;
- customer and contract settlements;
- higher material or labour costs;
- warranty costs;
59
- obsolescence charges;
- 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 Corporation's 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 remains strong, 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 in key senior management positions and in our key
areas of potential growth. An important 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 scope of these programs
for employees and the value of these opportunities have been adversely affected
by the volatility or negative performance of the market price for Nortel
Networks Corporation's common shares (including the proposed consolidation of
Nortel Networks Corporation's 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 which has negatively impacted our
level of incentive programs and incentive compensation plans. 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. In addition, due to the current
general economic and industry environment, and our current credit condition, an
increased portion of our cash and cash equivalents may be restricted as cash
collateral for customer performance bonds and contracts. Also, except for the
$750 April 2000 five year credit facilities, all of our credit facilities expire
within the next six months. We continue to have ongoing discussions with our
banks regarding our existing credit facilities as well as exploring additional
financing opportunities and credit arrangements, including bid and performance
arrangements to support our expected business needs. As we continue to assess
our overall liquidity and business needs as well as our expected financial
performance, we may elect or it may be necessary to reduce or terminate any or
all of our credit facilities prior to their expiries. We believe our cash on
hand will be sufficient to fund our current business model, manage our
investments and meet our customer commitments for at least the next 12 months.
However, a continued slow down in capital spending by service providers and
other customers may require us to adjust our current business model. As a
result, our revenues and cash flows may be materially lower than we expect and
we may be required to further reduce our capital expenditures and investments or
take other measures 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. Our inability to manage cash flow fluctuations resulting from the above
factors and the potential reduction or termination of
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any or all of our credit facilities 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, and 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 facilities and any significant reduction in
our credit facilities, 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, our $1,510 December 364-day credit facilities, which
expire on December 13, 2002 and are not expected to be amended or renewed,
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 facilities is maintained. The credit facilities 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. These restrictions have not had, and are not expected, for the
period prior to expiration of these facilities, to have an effect on Nortel
Networks Corporation's ability to meet its primary cash obligations associated
with making interest payments on the $1,800 4.25 percent convertible senior
notes due September 1, 2008.
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.
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We currently have a number of credit facilities, all of which contain financial
covenants and in the case of the $1,510 December 2001 facilities impose
additional restrictive covenants that, if we are unable to comply with, may
adversely affect our ability to access these facilities.
Our $1,510 December 364-day credit facilities 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, or EBITDA, thresholds. The
consolidated tangible net worth of Nortel Networks Limited may not be less than
$1,880 at any time. The consolidated EBITDA covenant requires that we achieve a
cumulative EBITDA of negative $350 or better for the full year ended December
31, 2002. Certain business restructuring charges and other incremental charges
and gains as publicly disclosed are excluded from the calculation of EBITDA.
Our $1,175 April 2002 364-day credit facilities and the $750 April 2000
five-year credit facilities also include a financial covenant, which require
that Nortel Networks Limited consolidated tangible net worth at any time be not
less than $1,888. We continue to monitor the financial position of Nortel
Networks Limited in light of this covenant and we expect that if we continue to
incur net losses or record additional charges relating to our restructuring work
plan, the accounting of our registered pension plans, the valuation of deferred
income tax assets or for other events, Nortel Networks Limited's consolidated
tangible net worth may be reduced below the $1,888 threshold. If Nortel Networks
Limited is unable to comply with the consolidated tangible net worth covenant
under these credit facilities, we will be unable to access these facilities.
On October 17, 2002, we announced that we expect that the $1,510
December 2001 364-day credit facilities will not be amended or extended and will
expire on December 13, 2002. Our $1,175 April 2002 364-day credit facilities and
$750 April 2000 five-year credit facilities are scheduled to expire in April
2003 and April 2005.
Changes in respect of our public debt ratings or current credit condition may
materially and adversely affect the availability, the cost, and the terms and
conditions of our debt and alternative financing arrangements.
Certain of our outstanding debt instruments are publicly rated by
independent rating agencies, which ratings are below investment grade. These
public debt ratings and our current credit condition may affect our ability to
raise debt, our access to the commercial paper market (which is currently closed
to us), our ability to engage in alternative financing arrangements, our ability
to engage in normal course derivative or hedging transactions, and our ability
to obtain customer performance bonds and contracts. Our current credit condition
requires us to pay increased fees and/or post cash collateral to secure certain
customer performance bonds and contracts and may also negatively affect the cost
to us and terms and conditions of debt and alternative financing arrangements.
Additionally, any negative developments regarding our cash flow, public debt
ratings, current credit condition and/or our incurring significant levels of
debt, or our failure to meet certain covenants under our credit facilities,
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 alternative financing arrangements.
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 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 sender's unique IP address and the receiver's
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
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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 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;
- 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.
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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 Wireline 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 Redback
Networks Inc. Our principal competitors in the sale of our 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 Wireless Networks 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 Optical Networks 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.
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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.
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 country's currency. Also, availability to enter into normal
course derivative or hedging transactions in the future may be impacted by our
current credit condition. 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.
65
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 change in the regulation of the telecommunications industry. If a
jurisdiction in which we operate adopts measures which affect the regulation of
the Internet or 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 Corporation's stock price has historically been volatile and
further declines in the market price of Nortel Networks Corporation's 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 Corporation's common shares have experienced, and may
continue to experience, substantial price volatility, including considerable
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. Also, Nortel Networks
Corporation is no longer listed on the S&P 500 or S&P 100 indices which may also
affect the price volatility of Nortel Networks Corporation's common shares. Our
credit quality, any equity or equity-related offerings, operating results and
prospects, among other factors, including any exclusion of Nortel Networks
Corporation's common shares from any other widely followed stock market indices,
will also affect the market price of Nortel Networks Corporation common shares.
On September 25, 2002, we announced that we plan to present a proposal
to our shareholders for a consolidation of Nortel Networks Corporation's
outstanding common shares (also known as a reverse stock split) at our annual
shareholders' meeting planned for spring 2003 in order to satisfy listing
66
requirements of the New York Stock Exchange. There can be no assurance that our
shareholders will adopt the proposal, and rejection of the proposal by our
shareholders may result in the delisting of Nortel Networks Corporation's common
shares from the New York Stock Exchange. In addition, in the event that the
trading price or trading volume of Nortel Networks Corporation's common shares
on the New York Stock Exchange were to fall to an abnormally low level, the New
York Stock Exchange would have discretionary authority to begin delisting
proceedings prior to any vote by Nortel Networks Corporation's shareholders on
the proposed consolidation. The delisting of Nortel Networks Corporation's
common shares from the New York Stock Exchange could have a material adverse
effect on the market price and liquidity of Nortel Networks Corporation's common
shares.
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
Corporation's common shares or our other securities, may negatively impact our
ability to raise capital, issue debt, retain employees or make future strategic
acquisitions. 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
Corporation's 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, 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
expect we may continue in the future to provide customer financing to customers
in areas that are strategic to our core business activity. 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, our current credit
condition, adverse changes in the credit quality of our customers, 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.
Certain customers have been experiencing financial difficulties and have
failed to meet their financial obligations. As a result, we have incurred
charges for increased provision related to certain trade and customer financed
receivables. If there are further increases in the failure of our customers to
meet their customer financing and receivables obligations to us or if the
assumptions underlying the amount of provisions we have taken with respect to
customer financing and receivables obligations do not reflect actual future
financial conditions and customer payment levels, we could incur losses lower
than, or in excess of our provisions, which could have a material adverse effect
on our cash flow and operating results.
Negative developments associated with our supply and network outsourcing
contracts 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. 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, 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
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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
Corporation's 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.
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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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Within the 90-day period prior to the filing of this report, an
evaluation was carried out under the supervision and with the participation of
Nortel Networks management, including our President and Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures (as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934). Based upon that evaluation, the President and
Chief Executive Officer and Chief Financial Officer concluded that the design
and operation of these disclosure controls and procedures were effective.
Changes in Internal Control
There were no significant changes in our internal controls or in other
factors that could significantly affect these internal controls subsequent to
the date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
69
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings
For a discussion of our material legal proceedings, see "Legal
proceedings" in Management's Discussion and Analysis of Financial Condition and
Results of Operations.
ITEM 2. Changes in Securities and Use of Proceeds
During the third quarter of 2002, Nortel Networks Corporation issued an
aggregate of 151,945 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$
---------------- --------------------------------------- ---------
07/01/02 56,484 16.3417 - 51.8770
07/02/02 35,820 16.2474 - 25.2739
07/16/02 17,393 46.4847 - 51.8770
07/20/02 17,393 46.4847 - 51.8770
08/15/02 3,848 34.3992 - 46.4847
08/19/02 5,106 31.6277 - 46.4847
09/01/02 15,901 46.4847 - 51.8770
ITEM 6. Exhibits and Reports on Form 8-K
a) Exhibits:
10.1 Nortel Networks Corporation Executive Retention and Termination Plan, as
amended and restated effective June 26, 2002.
10.2 Resolution of the Board of Directors of Nortel Networks Corporation
dated July 25, 2002 related to payment of audit committee chairman fees.
10.3 Resolution of the Board of Directors of Nortel Networks Limited dated
July 25, 2002 related to payment of audit committee chairman fees.
10.4 Nortel Networks Limited SUCCESS Plan effective July 25, 2002.
10.5 General description of cash bonus for employees and executives of Nortel
Networks Corporation and Nortel Networks Limited.
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b) Reports on Form 8-K:
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 & Poor's 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.
Nortel Networks Corporation filed a Current Report on Form 8-K dated
August 13, 2002 related to the certification pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 accompanying Nortel Networks
Corporation's Quarterly Report on 10-Q filed with the Securities and
Exchange Commission on August 13, 2002.
Nortel Networks Corporation filed a Current Report on Form 8-K dated
August 28, 2002 related to a press release it issued announcing that it
expects revenue from continuing operations for the third quarter to be
lower than its previously stated guidance.
Nortel Networks Corporation filed a Current Report on Form 8-K dated
September 26, 2002 related to a press release it issued announcing that
it now expects revenues from continuing operations in the third quarter
to be lower than second quarter 2002 revenues for continuing operations
by approximately 15%.
Nortel Networks Corporation filed a Current Report on Form 8-K dated
October 3, 2002 related to a press release announcing changes to its
organization reflecting a more stream-lined structure focused more
directly around its customers in four key businesses: Wireless Networks;
Wireline Networks; Enterprise Networks; and Optical Networks.
Nortel Networks Corporation filed a Current Report on Form 8-K dated
October 11, 2002 related to a press release stating that in a letter
from the President and Chief Executive Officer to employees subsequently
issued on the same date updated employees on the Nortel Networks
Corporation third quarter 2002 revenues and its progress on driving to
achieve profitability.
Nortel Networks Corporation filed a Current Report on Form 8-K dated
October 22, 2002 related to its financial results for the third quarter
of 2002.
Nortel Networks Corporation filed a Current Report on Form 8-K/A dated
November 7, 2002 related to a press release revising the breakdown of
Enterprise Networks and Wireline Networks historical segment revenues.
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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 M.J. GOLLOGLY
Chief Financial Officer Controller
DATE: NOVEMBER 12, 2002
72
CERTIFICATION
I, FRANK A. DUNN, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Nortel Networks
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
"FRANK A. DUNN"
- -----------------------------------------
FRANK A. DUNN
President and Chief Executive Officer
73
CERTIFICATION
I, DOUGLAS C. BEATTY, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Nortel Networks
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
"DOUGLAS C. BEATTY"
- -----------------------------------------
DOUGLAS C. BEATTY
Chief Financial Officer
74