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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 000-30758
NORTEL NETWORKS LIMITED
(Exact name of registrant as specified in its charter)
CANADA 62-12-62580
(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
1,460,978,637 WITHOUT NOMINAL OR PAR VALUE
===============================================================================
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
PAGE
----
ITEM 1. Consolidated Financial Statements (unaudited)......................................... 3
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................ 30
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................................... 64
ITEM 4. Controls and Procedures............................................................... 64
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings..................................................................... 65
ITEM 2. Changes in Securities and Use of Proceeds............................................. 65
ITEM 4. Submissions of Matters to a Vote of Security Holders.................................. 65
ITEM 6. Exhibits and Reports on Form 8-K...................................................... 66
SIGNATURES ...................................................................................... 67
CERTIFICATIONS ...................................................................................... 68
All dollar amounts in this document are in united states dollars unless
otherwise stated.
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 LIMITED
Consolidated Statements of Operations (unaudited)
(millions of U.S. dollars)
- ----------------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------
Revenues $ 2,353 $ 3,673 $ 8,033 $ 13,933
Cost of revenues 1,513 3,683 5,612 11,764
- ----------------------------------------------------------------------------------------------------------------------------
Gross profit (loss) 840 (10) 2,421 2,169
Selling, general and administrative expense 678 1,897 2,182 4,808
Research and development expense 553 771 1,697 2,547
Amortization of intangibles
Acquired technology 6 145 17 551
Goodwill - 357 - 1,718
Special charges 849 1,000 1,599 4,630
Gain on sale of businesses - (45) (3) (45)
- ----------------------------------------------------------------------------------------------------------------------------
Operating loss (1,246) (4,135) (3,071) (12,040)
Equity in net loss of associated companies (5) (6) (19) (138)
Other income (expense) - net 3 (313) (5) (252)
Interest expense
Long-term debt (34) (43) (104) (127)
Other (12) (28) (33) (90)
- ----------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations before income taxes (1,294) (4,525) (3,232) (12,647)
Income tax benefit (provision) (137) 1,255 447 2,645
- ----------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (1,431) (3,270) (2,785) (10,002)
Net loss from discontinued operations - net of tax - - - (2,538)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss before cumulative effect of accounting change (1,431) (3,270) (2,785) (12,540)
Cumulative effect of accounting change - net of tax of $9 - - - 15
- ----------------------------------------------------------------------------------------------------------------------------
Net loss (1,431) (3,270) (2,785) (12,525)
Dividends on preferred shares (6) (6) (16) (21)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss applicable to common shares $ (1,437) $ (3,276) $ (2,801) $ (12,546)
============================================================================================================================
See notes to unaudited consolidated financial statements.
4
NORTEL NETWORKS LIMITED
Consolidated Balance Sheets (unaudited)
(millions of U.S. dollars)
- ----------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents $ 4,089 $ 3,457
Restricted cash and cash equivalents 420 -
Accounts receivable (less provisions of $528 at September 30, 2002; $655 at December 31, 2001) 2,015 2,923
Inventories - net 1,131 1,563
Income taxes recoverable 58 790
Deferred income taxes - net 1,164 1,401
Other current assets 670 847
Current assets of discontinued operations 286 698
- ----------------------------------------------------------------------------------------------------------------------------------
Total current assets 9,833 11,679
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 176 263
Plant and equipment - net 1,666 2,459
Goodwill - net 2,020 2,283
Intangible assets - net 3 20
Deferred income taxes - net 2,393 2,106
Other assets 558 697
Long-term assets of discontinued operations 66 283
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 16,794 $ 19,993
==================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Notes payable $ 128 $ 426
Trade and other accounts payable 1,487 2,248
Payroll and benefit-related liabilities 637 613
Other accrued liabilities 4,611 5,347
Income taxes payable 110 143
Long-term debt due within one year 516 384
Current liabilities of discontinued operations 101 384
- ----------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 7,590 9,545
Deferred income 99 153
Long-term debt 2,310 2,293
Deferred income taxes - net 504 477
Other liabilities 1,570 1,452
Minority interest in subsidiary companies 74 100
- ----------------------------------------------------------------------------------------------------------------------------------
12,147 14,020
- ----------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (notes 12 and 14)
SHAREHOLDERS' EQUITY
Preferred shares, without par value - Authorized shares: unlimited; Issued and
outstanding shares: 30,000,000 at September 30, 2002 and December 31, 2001, respectively 536 536
Common shares, without par value - Authorized shares: unlimited; Issued and outstanding
shares: 1,460,978,637 at September 30, 2002 and 1,460,978,634 at December 31, 2001 2,111 2,111
Additional paid-in capital 20,803 18,797
Deficit (17,833) (14,507)
Accumulated other comprehensive loss (970) (964)
- ----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 4,647 5,973
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 16,794 $ 19,993
==================================================================================================================================
See notes to unaudited consolidated financial statements.
5
NORTEL NETWORKS LIMITED
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 $ (2,785) $ (10,002)
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 429 2,796
Non-cash portion of special charges and related asset write downs 842 3,021
Equity in net loss of associated companies 19 138
Deferred income taxes (14) (1,949)
Other liabilities (29) 62
Gain on sale of investments and businesses (17) (71)
Other - net 427 411
Change in operating assets and liabilities:
Accounts receivable 887 4,404
Inventories 392 1,753
Income taxes 699 (968)
Accounts payable and accrued liabilities (1,437) 434
Other operating assets and liabilities 30 359
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) operating activities of continuing operations (557) 388
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) investing activities
Expenditures for plant and equipment (289) (1,074)
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) (88)
Proceeds on sale of investments and businesses 44 232
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) investing activities of continuing operations (502) (1,264)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) financing activities
Dividends on preferred shares (16) (21)
Increase (decrease) in notes payable - net (289) 355
Proceeds from long-term debt 32 1,522
Repayments of long-term debt (22) (463)
Increase (decrease) in capital leases payable 163 (21)
Issuance of common shares 1,997 1,800
Stock option fair value increment (525) -
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) financing activities of continuing operations 1,340 3,172
- ---------------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash and cash equivalents 16 (5)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) continuing operations 297 2,291
Net cash from (used in) discontinued operations 335 (559)
- ---------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 632 1,732
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period - net 3,457 1,567
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period - net $ 4,089 $ 3,299
=================================================================================================================================
See notes to unaudited consolidated financial statements.
6
NORTEL NETWORKS LIMITED
Notes to Consolidated Financial Statements (unaudited)
(millions of U.S. dollars, unless otherwise stated)
1. Nortel Networks Limited
Effective May 1, 2000, Nortel Networks Limited ("Old Nortel") and a newly
formed Canadian corporation ("New 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"; 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. All acquisitions completed prior to May 1, 2000
were consummated by Old Nortel or its subsidiaries. Since May 1, 2000,
acquisitions involving any share consideration have been consummated by
New Nortel, while acquisitions not involving share consideration have
continued to be consummated by Old Nortel or its subsidiaries.
2. Basis of Presentation
The accompanying unaudited Consolidated Financial Statements of Nortel
Networks Limited ("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 $264.
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.
The following table presents the impact on net loss 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 $ (1,431) $ (3,270) $ (2,785) $(10,002)
Net loss from discontinued operations - net of tax - - - (2,538)
Cumulative effect of accounting change - net of tax of $9 - - - 15
----------------------------------------------------------------------------------------------------------------
Net loss - reported $ (1,431) $ (3,270) $ (2,785) $(12,525)
================================================================================================================
Adjustments:
Amortization of goodwill from continuing
operations - net of tax (a) $ - $ 357 $ - $ 1,727
Amortization of goodwill from discontinued operations - - - 121
----------------------------------------------------------------------------------------------------------------
Total net adjustments $ - $ 357 $ - $ 1,848
----------------------------------------------------------------------------------------------------------------
Adjusted results:
Net loss from continuing operations $ (1,431) $ (2,913) $ (2,785) $ (8,275)
Net loss from discontinued operations - net of tax - - - (2,417)
Cumulative effect of accounting change - net of tax of $9 - - - 15
----------------------------------------------------------------------------------------------------------------
Net loss - adjusted $ (1,431) $ (2,913) $ (2,785) $(10,677)
================================================================================================================
(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.
8
(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 $122 pursuant
to SFAS 144. See note 6 for further information regarding this write
down.
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 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 $ 862
---------------------------------------------------------------------------------------------------------------------
Net loss from discontinued operations - net of tax of $122 $ - $ - $ - $ (354)
Net loss on disposal of operations - net of tax of $596 - - - (2,184)
---------------------------------------------------------------------------------------------------------------------
Net loss from discontinued operations - net of tax $ - $ - $ - $ (2,538)
=====================================================================================================================
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.
9
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 $2,780 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 acquisition of Promatory in
the amount of $417; provisions for both short-term and long-term
receivables of $600; a provision for inventories of $381; other asset
write-offs totaling $151; future contractual obligations and estimated
liabilities of $1,059; and estimated operating losses during the planned
period of disposition of $172.
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 $98 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 185 348
Other current assets 81 175
----------------------------------------------------------------------------------------------------------------------
Total current assets of discontinued operations 286 698
Intangible assets - net - 17
Other long-term assets 66 266
----------------------------------------------------------------------------------------------------------------------
Total assets of discontinued operations $ 352 $ 981
======================================================================================================================
Current liabilities $ 101 $ 384
Long-term liabilities (included in Other liabilities) 2 11
----------------------------------------------------------------------------------------------------------------------
Total liabilities of discontinued operations $ 103 $ 395
======================================================================================================================
10
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 $ 238 $ (577)
Investing activities 97 18
----------------------------------------------------------------------------------------------------------------------
Net cash from (used in) discontinued operations $ 335 $ (559)
======================================================================================================================
5. Consolidated financial statement details
Consolidated balance sheets
Inventories - net:
---------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2002 2001
---------------------------------------------------------------------------------------------------------------------
Raw materials $ 474 $ 744
Work in process 367 576
Finished goods 290 243
---------------------------------------------------------------------------------------------------------------------
Inventories - net (a) $ 1,131 $ 1,563
=====================================================================================================================
(a) Net of inventory provisions of $1,184 and $911 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 TOTAL
----------------------------------------------------------------------------------------------------------------------
Balance as at January 1, 2002 $ 258 $ 21 $ 481 $ 1,523 $ 2,283
Change:
Write down (a) (264) - - - (264)
Other 6 - (1) (4) 1
----------------------------------------------------------------------------------------------------------------------
Balance as at September 30, 2002 $ - $ 21 $ 480 $ 1,519 $ 2,020
======================================================================================================================
(a) See note 6 for further information regarding this goodwill write
down.
INTANGIBLE ASSETS - NET:
---------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2002 2001
---------------------------------------------------------------------------------------------------------------------
Acquired technology $ 5,201 $ 5,201
Less: accumulated amortization (5,198) (5,181)
---------------------------------------------------------------------------------------------------------------------
Intangible assets - net $ 3 $ 20
=====================================================================================================================
11
Consolidated statements of cash flows
Interest and income taxes paid (received):
---------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
---------------------------------------------------------------------------------------------------------------------
Interest paid $ 168 $ 195
Income taxes paid (received) $ (1,223) $ 195
=====================================================================================================================
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 $ 393 $ 773 $ - $ 31 $ - $ 1,197
Special Charges for the three months ended:
March 31, 2002 312 56 75 - - 443
June 30, 2002 117 1 189 - - 307
September 30, 2002 317 95 51 122 264 849
---------------------------------------------------------------------------------------------------------------------
Subtotal 1,139 925 315 153 264 2,796
---------------------------------------------------------------------------------------------------------------------
2002 Cumulative Drawdowns:
Cash (595) (253) - (11) - (859)
Non-Cash (107) - (315) (122) (264) (808)
---------------------------------------------------------------------------------------------------------------------
Provision Balance as at September 30, 2002 $ 437 $ 672 $ - $ 20 $ - $ 1,129
=====================================================================================================================
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 $849 and $1,599, 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 $317 and $746 for the three months and
nine months ended September 30, 2002, respectively, were related to the
cost of severance and benefits associated with approximately 3,400 and
9,300 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
$95 and $152 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.
12
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 $295 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.
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 $122 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 17
for additional information regarding the asset sale transaction.
Goodwill write down
As a result of the continued decline in both Nortel Networks overall
market value generally and in 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
$264.
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 $3,310, related to workforce reduction costs of
$1,343, contract settlement and lease costs of $883, plant and equipment
write downs of $939, and other costs of $145. During the year ended
December 31, 2001, there were cumulative cash and non-cash drawdowns
against the provision of $1,082 and $1,031, respectively, resulting in an
ending provision balance at December 31, 2001 of $1,197. 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 44,800 employees notified during the period from
January 1, 2001 to September 30, 2002, approximately 16,300 were direct
employees performing manufacturing, assembly, test and inspection
activities associated with the production of Nortel Networks products,
and approximately 28,500 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 $1,559, plus $93 of non-cash
pension settlement and curtailment charges, resulting in an ending
provision balance for workforce reduction of $437. The remaining
provision is expected to be substantially drawn down by the end of 2003.
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
13
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 $169, 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 $363, resulting in an ending
provision balance of $672. 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 $680, 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 $498 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
$3,053, 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 $314 on a pre-tax loss of $1,294, 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 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
14
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 $109 for the nine
months ended September 30, 2002 and 2001, respectively, have been
incorporated into the income tax benefit (provision).
8. Related party transactions
Nortel Networks engages in certain transactions with Nortel Networks
Corporation and directly owned subsidiaries of Nortel Networks
Corporation. These transactions include cash borrowings between the
parties in addition to funding activities pursuant to reciprocal credit
agreements. As at September 30, 2002 and December 31, 2001, the balance
included in trade and other accounts payable owing to Nortel Networks
Corporation was $11 and $134, respectively, and to directly owned
subsidiaries of Nortel Networks Corporation was $164 and $116,
respectively.
On August 29, 2002, a payment was made by a subsidiary of Nortel Networks
to Nortel Networks Corporation equal to $525 representing the difference
between the market value of Nortel Networks Corporation common shares and
the exercise price of Nortel Networks Corporation stock options held and
exercised by employees of the subsidiary. This payment is referred to as
stock option fair value increment in the consolidated statement of cash
flows.
9. Common shares
On September 27, 2002, Nortel Networks issued 1 common share to Nortel
Networks Corporation in exchange for cash consideration of $672. Nortel
Networks Corporation, as the holder of all of Nortel Networks issued and
outstanding common shares, approved a reduction in Nortel Networks legal
stated capital for its common shares in the amount of $672.
On August 29, 2002, Nortel Networks issued 1 common share to Nortel
Networks Corporation in exchange for cash consideration of $525. Nortel
Networks Corporation, as the holder of all Nortel Networks issued and
outstanding common shares, approved a reduction in Nortel Networks legal
stated capital for its common shares in the amount of $525.
On June 28, 2002, Nortel Networks issued 1 common share to Nortel
Networks Corporation in exchange for cash consideration of $800. Nortel
Networks Corporation, as the holder of all of Nortel Networks issued and
outstanding common shares, approved a reduction in Nortel Networks legal
stated capital for its common shares in the amount of $800.
15
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 $ (1,431) $ (3,270) $ (2,785) $(12,525)
Other comprehensive income (loss):
Change in foreign currency translation adjustment (a) (94) (92) (3) (310)
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 $ (1,540) $ (3,346) $ (2,791) $(12,898)
=====================================================================================================================
(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. 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.
16
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. 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 617 719 1,927 2,450
Wireline 482 896 1,748 3,526
Optical 308 575 1,117 2,873
Other 6 134 42 574
-----------------------------------------------------------------------------------------------------------------
Total $ 2,353 $ 3,673 $ 8,033 $ 13,933
-----------------------------------------------------------------------------------------------------------------
Contribution margin
Wireless $ 276 $ 68 $ 761 $ 215
Enterprise 95 51 272 170
Wireline 83 (242) 259 250
Optical (117) (1,533) (715) (2,621)
Other (175) (251) (338) (653)
-----------------------------------------------------------------------------------------------------------------
Total 162 (1,907) 239 (2,639)
Research and development expense (553) (771) (1,697) (2,547)
Amortization of acquired technology (6) (145) (17) (551)
Amortization of goodwill - (357) - (1,718)
Special charges (849) (1,000) (1,599) (4,630)
Gain on sale of businesses - 45 3 45
-----------------------------------------------------------------------------------------------------------------
Consolidated operating loss $ (1,246) $ (4,135) $ (3,071) $ (12,040)
=================================================================================================================
12. 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.
17
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.
13. Restricted cash and cash equivalents
Due to the current general economic and industry environment, and Nortel
Networks 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.
14. Contingencies
Subsequent to the February 15, 2001 announcement in which Nortel Networks
Corporation provided revised guidance for financial performance for the
2001 fiscal year and the first quarter of 2001, Nortel Networks
Corporation and certain of its then current officers and directors were
named as defendants in more than twenty-five purported class action
lawsuits. These lawsuits in the United States District Courts for the
Eastern District of New York, for the Southern District of New York and
for the District of New Jersey, and in the provinces of Ontario, Quebec,
and British Columbia in Canada, on behalf of shareholders who acquired
Nortel Networks Corporation 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 against Nortel Networks Corporation 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 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 above. The Ontario Claim is on behalf of
all Canadian residents who purchased Nortel Networks Corporation
securities (including options on Nortel Networks Corporation 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 Corporation 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 Corporation also moved to dismiss on the
separate basis that JDS shareholders lacked standing to sue Nortel
Networks Corporation.
18
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
Corporation 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 Corporation 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 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 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 21, 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. ("NNI"), an indirect
subsidiary of Nortel Networks Corporation, was served with a consolidated
amended class action complaint (the "First 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.)
("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 Corporation violated the Securities
Exchange Act of 1934 with respect to certain statements made by Entrust.
Nortel Networks Corporation is alleged to be a controlling person of
Entrust. On April 6, 2001, Nortel Networks Corporation filed a motion to
dismiss the First Complaint. On July 31, 2001, the First Complaint was
dismissed without prejudice. On August 31, 2001, the plaintiffs filed a
second amended class action complaint (the "Second 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 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.
19
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.
15. Credit facilities
Effective April 8, 2002, Nortel Networks 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 Nortel Networks 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 Nortel Networks and NNI's December 20,
2001 credit facilities by approximately $65 to $1,510.
16. 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.
17. Subsequent events
On October 17, 2002 Nortel Networks Corporation 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 Corporation 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, we expect 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.
20
On October 7, 2002, Nortel Networks Corporation 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 Corporation 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.
18. Supplemental consolidating financial information
As a result of Nortel Networks current credit ratings, various liens,
pledges, and guarantees are effective under certain credit and security
agreements entered into by Nortel Networks 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 Nortel Networks and NNI's credit agreements by liens on
substantially all of the assets of Nortel Networks and those of most of
its United States and Canadian subsidiaries, and by pledges of shares in
certain of Nortel Networks other subsidiaries. In addition, certain of
Nortel Networks wholly owned subsidiaries have guaranteed Nortel Networks
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 liens, pledges, and guarantees described above also apply equally and
ratably to the obligations under Nortel Networks Corporation's $1,800
4.25 percent convertible senior notes due September 1, 2008.
The following supplemental consolidating financial data illustrates, in
separate columns, the composition of Nortel Networks Limited, 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.
21
Supplemental Consolidating Statements of Operations for the three months ended
September 30, 2002:
- ----------------------------------------------------------------------------------------------------------------------
NORTEL NON-
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ----------------------------------------------------------------------------------------------------------------------
Revenues $ 604 $ 1,780 $ 655 $ (686) $ 2,353
Cost of revenues 527 1,143 529 (686) 1,513
- ----------------------------------------------------------------------------------------------------------------------
Gross profit 77 637 126 - 840
Selling, general and administrative expense 245 394 39 - 678
Research and development expense 235 251 67 - 553
Amortization of acquired technology - 6 - - 6
Special charges 194 591 64 - 849
- ----------------------------------------------------------------------------------------------------------------------
Operating loss (597) (605) (44) - (1,246)
Equity in net loss of associated companies (1,210) (79) (2) 1,286 (5)
Other income (expense) - net (46) 71 (22) - 3
Interest expense
Long-term debt (28) - (6) - (34)
Other - (6) (6) - (12)
- ----------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (1,881) (619) (80) 1,286 (1,294)
Income tax provision (75) (62) - - (137)
- ----------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (1,956) (681) (80) 1,286 (1,431)
Net loss from discontinued operations
- net of tax - - - - -
- ----------------------------------------------------------------------------------------------------------------------
Net loss (1,956) (681) (80) 1,286 (1,431)
Dividends on preferred shares (6) - - - (6)
- ----------------------------------------------------------------------------------------------------------------------
Net loss applicable to common shares $ (1,962) $ (681) $ (80) $ 1,286 $ (1,437)
======================================================================================================================
22
Supplemental Consolidating Statements of Operations for the three months ended
September 30, 2001:
- ---------------------------------------------------------------------------------------------------------------
NORTEL NON-
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ---------------------------------------------------------------------------------------------------------------
Revenues $ 963 $ 2,496 $ 1,046 $ (832) $ 3,673
Cost of revenues 1,319 2,294 902 (832) 3,683
- ---------------------------------------------------------------------------------------------------------------
Gross profit (loss) (356) 202 144 - (10)
Selling, general and administrative expense 301 1,396 200 - 1,897
Research and development expense 193 460 118 - 771
Amortization of intangibles
Acquired technology - 145 - - 145
Goodwill 4 327 26 - 357
Special charges 164 593 243 - 1,000
Gain on sale of businesses (10) (16) (19) - (45)
- ---------------------------------------------------------------------------------------------------------------
Operating loss (1,008) (2,703) (424) - (4,135)
Equity in net loss of
associated companies (2,222) (430) - 2,646 (6)
Other income (expense) - net (45) (197) (71) - (313)
Interest expense
Long-term debt (37) 1 (7) - (43)
Other (11) (12) (5) - (28)
- ---------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (3,323) (3,341) (507) 2,646 (4,525)
Income tax benefit 53 1,052 150 - 1,255
- ---------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (3,270) (2,289) (357) 2,646 (3,270)
Net loss from discontinued operations
- net of tax - - - - -
- ---------------------------------------------------------------------------------------------------------------
Net loss (3,270) (2,289) (357) 2,646 (3,270)
Dividends on preferred shares (6) - - - (6)
- ---------------------------------------------------------------------------------------------------------------
Net loss applicable to common shares $ (3,276) $ (2,289) $ (357) $ 2,646 $ (3,276)
===============================================================================================================
23
Supplemental Consolidating Statements of Operations for the nine months ended
September 30, 2002:
- ---------------------------------------------------------------------------------------------------------------------
NORTEL NON-
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ---------------------------------------------------------------------------------------------------------------------
Revenues $ 2,208 $ 5,971 $ 2,116 $ (2,262) $ 8,033
Cost of revenues 1,989 4,078 1,807 (2,262) 5,612
- ---------------------------------------------------------------------------------------------------------------------
Gross profit 219 1,893 309 - 2,421
Selling, general and administrative expense 480 1,436 266 - 2,182
Research and development expense 673 802 222 - 1,697
Amortization of acquired technology - 17 - - 17
Special charges 457 925 217 - 1,599
Loss (gain) on sale of businesses (1) (3) 1 - (3)
- ---------------------------------------------------------------------------------------------------------------------
Operating loss (1,390) (1,284) (397) - (3,071)
Equity in net loss of associated companies (2,097) (327) (8) 2,413 (19)
Other income (expense) - net (12) 14 (7) - (5)
Interest expense
Long-term debt (84) - (20) - (104)
Other (3) (22) (8) - (33)
- ---------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (3,586) (1,619) (440) 2,413 (3,232)
Income tax benefit 276 73 98 - 447
- ---------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (3,310) (1,546) (342) 2,413 (2,785)
Net loss from discontinued operations
- net of tax - - - - -
- ---------------------------------------------------------------------------------------------------------------------
Net loss (3,310) (1,546) (342) 2,413 (2,785)
Dividends on preferred shares (16) - - - (16)
- ---------------------------------------------------------------------------------------------------------------------
Net loss applicable to common shares $ (3,326) $ (1,546) $ (342) $ 2,413 $ (2,801)
=====================================================================================================================
24
Supplemental Consolidating Statements of Operations for the nine months ended
September 30, 2001:
- ---------------------------------------------------------------------------------------------------------------
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ---------------------------------------------------------------------------------------------------------------
Revenues $ 3,738 $ 10,279 $ 3,885 $ (3,969) $ 13,933
Cost of revenues 3,905 8,251 3,577 (3,969) 11,764
- ---------------------------------------------------------------------------------------------------------------
Gross profit (loss) (167) 2,028 308 - 2,169
Selling, general and administrative expense 726 3,462 620 - 4,808
Research and development expense 100 2,152 295 - 2,547
Amortization of intangibles
Acquired technology - 551 - - 551
Goodwill 13 1,244 461 - 1,718
Special charges 409 2,440 1,781 - 4,630
Gain on sale of businesses (10) (29) (6) - (45)
- ---------------------------------------------------------------------------------------------------------------
Operating loss (1,405) (7,792) (2,843) - (12,040)
Equity in net earnings (loss) of
associated companies (8,915) (1,720) 1 10,496 (138)
Other income (expense) - net (5) (228) (19) - (252)
Interest expense
Long-term debt (107) 2 (22) - (127)
Other (30) (48) (12) - (90)
- ---------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (10,462) (9,786) (2,895) 10,496 (12,647)
Income tax benefit 460 1,740 445 - 2,645
- ---------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (10,002) (8,046) (2,450) 10,496 (10,002)
Net loss from discontinued operations
- net of tax (2,538) (1,650) - 1,650 (2,538)
- ---------------------------------------------------------------------------------------------------------------
Net loss before cumulative effect of
accounting change (12,540) (9,696) (2,450) 12,146 (12,540)
Cumulative effect of accounting change
- net of tax of $9 15 - - - 15
- ---------------------------------------------------------------------------------------------------------------
Net loss (12,525) (9,696) (2,450) 12,146 (12,525)
Dividends on preferred shares (21) - - - (21)
- ---------------------------------------------------------------------------------------------------------------
Net loss applicable to common shares $(12,546) $ (9,696) $ (2,450) $ 12,146 $ (12,546)
===============================================================================================================
25
Supplemental Consolidating Balance Sheets as at September 30, 2002:
- ----------------------------------------------------------------------------------------------------------------------
NORTEL NON-
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents $ 412 $ 2,724 $ 953 $ - $ 4,089
Restricted cash and cash equivalents 47 352 21 - 420
Accounts receivable - net 307 1,247 459 - 2,013
Intercompany accounts receivable 4,945 693 332 (5,968) 2
Inventories - net 666 210 255 - 1,131
Income taxes recoverable - 58 - - 58
Deferred income taxes - net 529 486 149 - 1,164
Other current assets 76 433 161 - 670
Current assets of discontinued operations 100 186 - - 286
- ----------------------------------------------------------------------------------------------------------------------
Total current assets 7,082 6,389 2,330 (5,968) 9,833
Long-term receivables - net 126 900 589 (1,536) 79
Investments at cost and associated
companies at equity 858 (8,355) 123 7,550 176
Plant and equipment - net 419 942 305 - 1,666
Goodwill - net - 1,948 72 - 2,020
Intangible assets - net - 3 - - 3
Deferred income taxes - net 607 1,662 124 - 2,393
Other assets 188 129 241 - 558
Long-term assets of discontinued operations 23 43 - - 66
- ----------------------------------------------------------------------------------------------------------------------
Total assets $ 9,303 $ 3,661 $ 3,784 $ 46 $ 16,794
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current liabilities
Notes payable $ 2 $ 3 $ 123 $ - $ 128
Trade and other accounts payable 334 818 152 - 1,304
Intercompany accounts payable 24 3,347 2,780 (5,968) 183
Payroll and benefit-related liabilities 53 489 95 - 637
Other accrued liabilities 929 2,795 887 - 4,611
Income taxes payable 20 4 86 - 110
Long-term debt due within one year 504 11 1 - 516
Current liabilities of discontinued operations 35 66 - - 101
- ----------------------------------------------------------------------------------------------------------------------
Total current liabilities 1,901 7,533 4,124 (5,968) 7,590
Deferred income 2 96 1 - 99
Long-term debt 1,775 173 362 - 2,310
Deferred income taxes - net 345 151 8 - 504
Other liabilities 633 1,200 1,273 (1,536) 1,570
Minority interest in subsidiary companies - - 74 - 74
- ----------------------------------------------------------------------------------------------------------------------
4,656 9,153 5,842 (7,504) 12,147
- ----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred shares 536 365 - (365) 536
Common shares 2,111 5,405 773 (6,178) 2,111
Additional paid-in capital 20,803 1,546 3,927 (5,473) 20,803
Deficit (17,833) (13,721) (6,625) 20,346 (17,833)
Accumulated other comprehensive income (loss) (970) 913 (133) (780) (970)
- ----------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 4,647 (5,492) (2,058) 7,550 4,647
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 9,303 $ 3,661 $ 3,784 $ 46 $ 16,794
======================================================================================================================
26
Supplemental Consolidating Balance Sheets as at December 31, 2001:
- ----------------------------------------------------------------------------------------------------------------------
NORTEL NON-
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents $ (41) $ 2,340 $ 1,158 $ - $ 3,457
Accounts receivable - net 409 2,032 480 - 2,921
Intercompany accounts receivable 4,952 1,054 588 (6,592) 2
Inventories - net 810 511 242 - 1,563
Income taxes recoverable 343 442 5 - 790
Deferred income taxes - net 287 1,080 34 - 1,401
Other current assets 107 563 177 - 847
Current assets of discontinued operations 244 454 - - 698
- ----------------------------------------------------------------------------------------------------------------------
Total current assets 7,111 8,476 2,684 (6,592) 11,679
Long-term receivables - net 225 1,078 547 (1,647) 203
Investments at cost and associated
companies at equity 2,543 (8,097) 516 5,301 263
Plant and equipment - net 705 1,353 401 - 2,459
Goodwill - net 31 2,117 135 - 2,283
Intangible assets - net - 20 - - 20
Deferred income taxes - net 436 1,578 92 - 2,106
Other assets 132 313 252 - 697
Long-term assets of discontinued operations 99 184 - - 283
- ----------------------------------------------------------------------------------------------------------------------
Total assets $ 11,282 $ 7,022 $ 4,627 $ (2,938) $ 19,993
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current liabilities
Notes payable $ 2 $ 168 $ 256 $ - $ 426
Trade and other accounts payable 372 1,288 338 - 1,998
Intercompany accounts payable 163 3,471 3,208 (6,592) 250
Payroll and benefit-related liabilities 63 449 101 - 613
Other accrued liabilities 1,355 3,240 752 - 5,347
Income taxes payable - 45 98 - 143
Long-term debt due within one year 313 63 8 - 384
Current liabilities of discontinued operations 134 250 - - 384
- ----------------------------------------------------------------------------------------------------------------------
Total current liabilities 2,402 8,974 4,761 (6,592) 9,545
Deferred income 3 143 7 - 153
Long-term debt 1,928 8 357 - 2,293
Deferred income taxes - net 360 100 17 - 477
Other liabilities 616 1,092 1,391 (1,647) 1,452
Minority interest in subsidiary companies - - 100 - 100
- ----------------------------------------------------------------------------------------------------------------------
5,309 10,317 6,633 (8,239) 14,020
- ----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred shares 536 365 - (365) 536
Common shares 2,111 950 386 (1,336) 2,111
Additional paid-in capital 18,797 6,043 4,204 (10,247) 18,797
Deficit (14,507) (11,605) (6,509) 18,114 (14,507)
Accumulated other comprehensive income (loss) (964) 952 (87) (865) (964)
- ----------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 5,973 (3,295) (2,006) 5,301 5,973
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 11,282 $ 7,022 $ 4,627 $ (2,938) $ 19,993
======================================================================================================================
27
Supplemental Consolidating Statements of Cash Flows for the nine months ended
September 30, 2002:
- ---------------------------------------------------------------------------------------------------------------------------------
NORTEL NON-
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) operating activities
Net loss from continuing operations $ (3,310) $ (1,546) $ (342) $ 2,413 $ (2,785)
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 29 - 429
Non-cash portion of special charges and related
asset write downs 221 551 70 - 842
Equity in net loss of associated companies 2,097 327 8 (2,413) 19
Deferred income taxes (423) 565 (156) - (14)
Other liabilities (16) 1 (14) - (29)
Gain on sale of investments and businesses (10) (7) - - (17)
Other - net 233 51 143 - 427
Change in operating assets and liabilities:
Accounts receivable 58 731 98 - 887
Inventories 135 271 (14) - 392
Income taxes 363 343 (7) - 699
Accounts payable and accrued liabilities (500) (873) (64) - (1,437)
Other operating assets and liabilities 42 - (12) - 30
Intercompany activities (610) 350 260 - -
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) operating activities (1,654) 1,098 (1) - (557)
- ---------------------------------------------------------------------------------------------------------------------------------
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)
Proceeds on sale of investments and businesses 20 24 - - 44
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) investing activities 14 (421) (95) - (502)
- ---------------------------------------------------------------------------------------------------------------------------------
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 - - 163
Issuance of common shares 1,997 - - - 1,997
Stock option fair value increment - (525) - - (525)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) financing activities 1,973 (521) (112) - 1,340
- ---------------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash
and cash equivalents 3 10 3 - 16
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) continuing operations 336 166 (205) - 297
Net cash from discontinued operations 117 218 - - 335
- ---------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 453 384 (205) - 632
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period - net (41) 2,340 1,158 - 3,457
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period - net $ 412 $ 2,724 $ 953 $ - $ 4,089
=================================================================================================================================
28
Supplemental Consolidating Statements of Cash Flows for the nine months ended
September 30, 2001:
- ---------------------------------------------------------------------------------------------------------------------------------
NORTEL NON-
NETWORKS GUARANTOR GUARANTOR
LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) operating activities
Net loss from continuing operations $ (10,002) $ (8,046) $ (2,450) $ 10,496 $ (10,002)
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 2,144 506 - 2,796
Non-cash portion of special charges and related
asset write downs 84 1,351 1,586 - 3,021
Equity in net loss of associated companies 8,915 1,720 (1) (10,496) 138
Deferred income taxes (952) (967) (30) - (1,949)
Other liabilities 10 75 (23) - 62
Gain on sale of investments and businesses - (26) (45) - (71)
Other - net 227 555 (371) - 411
Change in operating assets and liabilities:
Accounts receivable 614 2,853 937 - 4,404
Inventories 387 1,237 129 - 1,753
Income taxes (410) (523) (35) - (968)
Accounts payable and accrued liabilities (945) 1,299 80 - 434
Other operating assets and liabilities (122) 392 89 - 359
Intercompany activities 306 (536) 230 - -
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) operating activities (1,742) 1,528 602 - 388
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) investing activities
Expenditures for plant and equipment (304) (686) (84) - (1,074)
Proceeds on disposals 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) - - (88)
Proceeds on sale of investments and businesses 1 37 194 - 232
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (374) (673) (217) - (1,264)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) financing activities
Dividends on preferred shares (21) - - - (21)
Increase in notes payable - net 55 190 110 - 355
Proceeds from long-term debt 1,500 6 16 - 1,522
Repayments of long-term debt (250) (10) (203) - (463)
Decrease in capital leases payable (2) (13) (6) - (21)
Issuance of common shares 1,800 - - - 1,800
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) financing activities 3,082 173 (83) - 3,172
- ---------------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash
and cash equivalents (1) (2) (2) - (5)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash from continuing operations 965 1,026 300 - 2,291
Net cash used in discontinued operations (196) (363) - - (559)
- ---------------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 769 663 300 - 1,732
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period - net (73) 1,020 620 - 1,567
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period - net $ 696 $ 1,683 $ 920 $ - $ 3,299
=================================================================================================================================
29
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 Limited 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.
30
Nortel Networks Corporation's common shares are publicly-traded on the
New York and Toronto stock exchanges under the symbol "NT". Nortel Networks
Corporation holds all of Nortel Networks Limited's outstanding common shares but
none of its outstanding preferred shares. Acquisitions involving any share
consideration are completed by Nortel Networks Corporation, while acquisitions
involving only cash consideration are generally completed by Nortel Networks
Limited or one of its direct subsidiaries.
Developments in 2002
Optical Networks
On May 29, 2002, Nortel Networks Corporation announced plans to further
realign its Optical Networks business, including optical components, given that
it does not expect a meaningful recovery in the long-haul optical market before
early 2004. As part of this realignment, on October 7, 2002, Nortel Networks
Corporation 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 17 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 $463, primarily comprised of a $317
charge related to workforce reduction, a $95 charge related to contract
settlement and lease costs, and a $51 charge related to plant and equipment
write downs. The workforce reduction charge of $317 related to the cost of
severance and benefits associated with approximately 3,400 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 $95 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
$307, primarily comprised of a $189 charge related to plant and equipment write
downs and a $117 charge related to workforce reduction. The approximately $189
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 $443, primarily related to the cost of severance and benefits associated with
the approximately 4,000 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 $264.
31
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 $314 on a pre-tax
loss of $1,294, 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 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.
Credit facilities
On October 17, 2002 Nortel Networks Corporation announced that it
expects 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, Nortel Networks Corporation 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 our 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 our credit
rating 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
addition, certain of our 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.
The liens, pledges, and guarantees described above also apply equally
and ratably to the obligations under Nortel Networks Corporation's $1,800 4.25
percent convertible senior notes due on September 1, 2008.
32
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 18 of the accompanying unaudited consolidated financial statements. For
additional financial information related to the three years ended December 31,
2001, see our Current Report on Form 8-K dated May 13, 2002.
Pensions
On October 17, 2002, Nortel Networks Corporation 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.
Filing of shelf registration statement and base shelf prospectus
In 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. On June 12, 2002, Nortel
Networks Corporation utilized approximately $1,700 of the $2,500 in connection
with two concurrent equity offerings. 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. In the nine months ended September 30, 2002, Nortel Networks
Corporation contributed approximately $1,472 of the proceeds from the equity
offerings to Nortel Networks Limited in return for two common shares.
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.
33
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 719 617 (102) (14) 2,450 1,927 (523) (21)
Wireline 896 482 (414) (46) 3,526 1,748 (1,778) (50)
Optical 575 308 (267) (46) 2,873 1,117 (1,756) (61)
Other (a) 134 6 (128) (96) 574 42 (532) (93)
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 3,673 $ 2,353 $ (1,320) (36) $13,933 $ 8,033 $ (5,900) (42)
============================================================================================================================
(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 $ 1,756 $ 1,223 $ (533) (30) $ 6,787 $ 4,166 $ (2,621) (39)
Canada 182 89 (93) (51) 700 457 (243) (35)
Other countries 1,735 1,041 (694) (40) 6,446 3,410 (3,036) (47)
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 3,673 $ 2,353 $ (1,320) (36) $13,933 $ 8,033 $ (5,900) (42)
============================================================================================================================
(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
34
primarily due to a 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]
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.
35
Enterprise Networks
The following chart sets forth quarterly revenues for the Enterprise
Networks segment:
[BAR CHART]
Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002
- ------- ------- ------- ------- -------
$719 $791 $675 $635 $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, a significant decline
in Europe and the United States, and a moderate decline in the 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, a significant decline in the United
States, and a moderate decline in the 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,
and essentially flat revenues in the United States and Europe.
36
Wireline Networks
The following chart sets forth quarterly revenues for the Wireline
Networks segment:
[BAR CHART]
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 Asia Pacific region, a significant decline in Europe, and essentially flat
revenues in Canada and the Caribbean and Latin America region.
37
Optical Networks
The following chart sets forth quarterly revenues for the Optical
Networks segment:
[BAR CHART]
Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002
- ------- ------- ------- ------- -------
$575 $462 $405 $404 $308
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, a moderate decline 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.
38
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
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 $ (10) $ 840 $ 850 N/A $ 2,169 $ 2,421 $ 252 11.6
Gross margin (0.3)% 35.7% 36.0 N/A 15.6% 30.1% 14.5 93.0
- -----------------------------------------------------------------------------------------------------------------
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 $ 1,897 $ 678 $ (1,219) (64.3) $ 4,808 $ 2,182 $ (2,626) (54.6)
As a % of revenue 51.6% 28.8% N/A N/A 34.5% 27.2% 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
39
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
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 $ 771 $ 553 $ (218) (28.3) $ 2,547 $ 1,697 $ (850) (33.4)
As a % of revenues 21.0% 23.5% N/A N/A 18.3% 21.1% 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.
Amortization of intangibles
The following table sets forth the 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
- ------------------------------------------------------------------------------------------------------------------------
Amortization of intangibles
Acquired technology $ 145 $ 6 $ (139) (95.9) $ 551 $ 17 $ (534) (96.9)
Goodwill $ 357 $ - $ (357) (100.0) $ 1,718 $ - $ (1,718) (100.0)
- ------------------------------------------------------------------------------------------------------------------------
Amortization of intangibles
Acquired technology
The amortization of acquired technology for the three months and nine
months ended September 30, 2001 primarily reflected the charge related to the
acquisition of Bay Networks, Inc. The substantial decline in the three months
and nine months ended September 30, 2002 compared to the same period in 2001, is
primarily due to the completion of amortization associated with Bay Networks. As
at September 30, 2002 and December 31, 2001, the remaining carrying value of
acquired technology - net was $3 and $20, 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,
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
40
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 $264.
The amortization of goodwill for the three months and nine months ended
September 30, 2001 primarily reflected the charges related to the acquisitions
of Bay Networks, Qtera Corporation, and Clarify Inc.
As at September 30, 2002 and December 31, 2001, the carrying value of
goodwill was $2,020 and $2,283, 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 $849 and $1,599, 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 $317 and $746 for the three months and
nine months ended September 30, 2002, respectively, were related to the cost of
severance and benefits associated with approximately 3,400 and 9,300 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
$95 and $152 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 $295 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 $122 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 17 to the
accompanying unaudited consolidated financial statements.
41
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
$264.
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 $3,310, related to workforce reduction costs of $1,343, contract settlement
and lease costs of $883, plant and equipment write downs of $939, and other
costs of $145. During the year ended December 31, 2001, there were cumulative
cash and non-cash drawdowns against the provision of $1,082 and $1,031,
respectively, resulting in an ending provision balance at December 31, 2001 of
$1,197. 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 44,800 employees notified during the period from
January 1, 2001 to September 30, 2002, approximately 16,300 were direct
employees performing manufacturing, assembly, test and inspection activities
associated with the production of our products, and approximately 28,500 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 $1,559 plus $93 of non-cash pension
settlement and curtailment charges, resulting in an ending provision balance for
workforce reduction of $437. 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 and lease costs included negotiated settlements of
approximately $169, 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 $363, resulting in an ending provision balance of $672. 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 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 $680, 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
42
recorded charges totaling approximately $498 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 $25 and $80 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.
Income tax benefit
During the three months ended September 30, 2002, we recorded an income
tax benefit of $314 on a pre-tax loss of $1,294, 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, 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.
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.
43
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 $ (3,270) $ (1,431) $ 1,839 $ (10,002) $ (2,785) $ 7,217
- -------------------------------------------------------------------------------------------------------------------------
ADJUSTED RESULTS: (a)
Net loss from continuing operations $ (2,913) $ (1,431) $ 1,482 $ (8,275) $ (2,785) $ 5,490
- -------------------------------------------------------------------------------------------------------------------------
(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 $1,839 and $7,217 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 $862, respectively, for the same periods in 2001.
Access solutions operations also generated net cash of $48 and $335 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
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.
44
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.
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.
45
Liquidity and capital resources
Cash flows
Cash and cash equivalents, or cash, were $4,089, excluding $420 of
restricted cash and cash equivalents described below, at September 30, 2002, an
increase of $632 (including net cash from the access solutions operations of
$335) from December 31, 2001. This increase in cash was primarily due to $1,472
received from Nortel Networks Corporation from the proceeds of the June 12, 2002
equity offerings.
Cash flows used in operating activities were $557 for the nine months
ended September 30, 2002, due to a net loss of $1,128, 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 $502 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 $44, primarily
related to the sale of certain assets of our service commerce operation support
system business.
Cash flows generated from financing activities were $1,340 for the nine
months ended September 30, 2002, primarily due to $1,997 received from Nortel
Networks Corporation during the nine months ended September 30, 2002 in return
for 3 common shares and an increase in capital leases payable of $163, partially
offset by a stock option fair value increment of $525, which was a payment made
by one of our subsidiaries to Nortel Networks Corporation representing the
difference between the market value of Nortel Networks Corporation common shares
and the exercise price of Nortel Networks Corporation stock options held and
exercised by employees of the subsidiary, and 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 $437 relating to workforce reduction
initiatives are expected to be substantially completed by the end of 2003, and
the remaining cash payments of $672 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.
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
46
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.
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 $875 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
47
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 $98 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 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 Corporation 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
48
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 our consolidated tangible net worth at any time be not less than
$1,888. We continue to monitor our financial position 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, our consolidated tangible net worth may be reduced below the
$1,888 threshold. If we are 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 18 of the accompanying unaudited consolidated financial statements.
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, Nortel Networks
Corporation utilized approximately $1,700 of the $2,500 available under the
shelf registration statement and the base shelf prospectus. Approximately $800
remains available for use by Nortel Networks Corporation and Nortel Networks
Limited under the shelf registration statement and the 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 39
percent at September, 2002, compared to 34 percent at December 31, 2001. The
ratio reflects the increase in our deficit as a result of the net losses for the
nine months ended September 30, 2002, offset by the $1,472 from the equity
offerings received from Nortel Networks Corporation on June 12, 2002.
49
Credit ratings
- --------------------------------------------------------------------------------------------------------------------------------
RATING ON LONG-TERM DEBT ISSUED RATING ON PREFERRED SHARES
OR GUARANTEED BY NORTEL NETWORKS ISSUED BY NORTEL NETWORKS
RATING AGENCY LIMITED LIMITED LAST UPDATE
- --------------------------------------------------------------------------------------------------------------------------------
Standard & Poor's Ratings Service B CCC September 18, 2002
Moody's Investor Services, Inc. Ba3 B3 April 4, 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 $4,089, 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, 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
50
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., a direct subsidiary of
Nortel Networks Limited, was served with a consolidated amended class action
complaint that purported to add Nortel Networks Corporation as a defendant to a
lawsuit commenced in July 2000 against Entrust, Inc. (formerly Entrust
Technologies, Inc.) and two of its then current officers in the United States
District Court for the Eastern District of Texas (Marshall Division), or the
District Court. This complaint alleges that Entrust, two officers of Entrust,
and Nortel Networks Corporation violated the Securities Exchange Act of 1934
with respect to certain statements made by Entrust. Nortel Networks Corporation
is alleged to be a controlling person of Entrust. On April 6, 2001, Nortel
Networks Corporation filed a motion to dismiss the first complaint. On July 31,
2001, the first complaint was dismissed without prejudice. On August 31, 2001,
the plaintiffs filed a second amended class action complaint against the same
defendants asserting claims substantively similar to those in the first
complaint. On September 21, 2001, Nortel Networks Corporation filed a motion to
dismiss this second complaint. The motion 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
51
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 17 to Nortel Networks Limited'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
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
52
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
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:
o 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;
o 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;
53
o 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;
o increased price and product competition in the networking industry;
o 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;
o the impact of a continued decline in world capital markets and global
interest rates on investment assets and liabilities on our registered
pension plans;
o 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;
o fluctuations in our gross margins;
o the development, introduction and market acceptance of new
technologies, and integrated networking solutions, as well as the
adoption of new networking standards;
o variations in sales channels, product costs, and the mix of products
sold;
o the size and timing of customer orders and shipments;
o our ability to continue to obtain customer performance bonds and
contracts;
o our ability to maintain appropriate inventory levels;
o the impact of acquired businesses and technologies; and
o the impact of our product development schedules, manufacturing
capacity, and lead times required to produce our products; and
o 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).
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:
o 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;
o adverse changes in our current credit condition, or the credit quality
of our customers and suppliers;
o adverse changes in the market conditions in our industry and the
specific markets for our products;
54
o the trend towards the sale of integrated networking solutions;
o visibility to, and the actual size and timing of, capital expenditures
by our customers;
o inventory practices, including the timing of product and service
deployment, of our customers;
o 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;
o policies of our customers regarding utilization of single or multiple
vendors for the products they purchase;
o the overall trend toward industry consolidation and rationalization
among our customers, competitors, and suppliers;
o conditions in the broader market for communications products, including
data networking products and computerized information access equipment
and services;
o governmental regulation or intervention affecting communications or
data networking; and
o 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.
Our gross margins may be negatively affected as a result of a number of
factors, including:
o increased price competition;
o excess capacity;
o customer and contract settlements;
o higher material or labour costs;
o warranty costs;
o obsolescence charges;
o loss of cost savings on future inventory purchases as a result of high
inventory levels;
o introductions of new products and costs of entering new markets;
o increased levels of customer services;
o changes in distribution channels; and
o changes in product and geographic mix.
Lower than expected gross margins would negatively affect our operating
results.
55
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 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.
56
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:
o we may have difficulty borrowing money in the future, or accessing
sources of funding, including our credit facilities;
o 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;
o 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
o 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.
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 Nortel
Networks Corporation 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 our financial position 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 we are 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, Nortel Networks Corporation announced that it
expects 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
57
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
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:
o 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;
o the risk that future valuations of acquired businesses may decrease
from the market price we paid for these acquisitions;
58
o the generation of insufficient revenues by acquired businesses to
offset increased operating expenses associated with these acquisitions;
o the potential difficulties in completing in-process research and
development projects and delivering high quality products to our
customers;
o the potential difficulties in integrating new products, businesses and
operations in an efficient and effective manner;
o 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;
o the potential loss of key employees of the acquired businesses;
o the risk that acquired businesses will divert the attention of our
senior management from the operation of our business; and
o the risks of entering new markets in which we have limited experience
and where competitors may have a stronger market presence.
Our inability to successfully operate and integrate newly-acquired
businesses appropriately, effectively and in a timely manner could have a
material adverse effect on our ability to take advantage of further growth in
demand for IP-optimized network solutions and other advances in technology, as
well as on our revenues, gross margins, and expenses.
We operate in highly dynamic and volatile industries characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions, and short product life cycles.
The markets for our products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. We expect our success to depend, in substantial
part, on the timely and successful introduction of high quality, new products
and upgrades, as well as cost reductions on current products to address the
operational speed, bandwidth, efficiency, and cost requirements of our
customers. Our success will also depend on our ability to comply with emerging
industry standards, to operate with products of other suppliers, to address
emerging market trends, to provide our customers with new revenue-generating
opportunities and to compete with technological and product developments carried
out by others. The development of new, technologically advanced products,
including IP-optimized networking solutions and 3G wireless networks, is a
complex and uncertain process requiring high levels of innovation, as well as
the accurate anticipation of technological and market trends. Investments in
such development may result in expenses growing at a faster rate than revenues,
particularly since the initial investment to bring a product to market may be
high. We may not be successful in targeting new market opportunities, in
developing and commercializing new products in a timely manner, or in achieving
market acceptance for our new products.
The success of new or enhanced products, including IP-optimized
networking solutions and 3G wireless networks, depends on a number of other
factors, including the timely introduction of such products, market acceptance
of new technologies and industry standards, the quality and robustness of new or
enhanced products, competing product offerings, the pricing and marketing of
such products, and the availability of funding for such networks. Products and
technologies developed by our competitors may render our products obsolete.
Hackers may attempt to disrupt or exploit our customers' use of our
technologies. If we fail to respond in a timely and effective manner to
unanticipated changes in one or more of the technologies affecting
telecommunications and data networking or our new products or product
enhancements fail to achieve market acceptance, our ability to compete
effectively in our industry, and our sales, market share, and customer
relationships could be materially and adversely affected.
In addition, unanticipated changes in market demand for products based
on a specific technology, particularly lower than anticipated, or delays in,
demand for IP-optimized networking solutions, particularly long-haul and metro
optical networking solutions, or 3G wireless networks, could have a material
adverse effect on our business, results of operations, and financial condition
if we fail to respond to such changes in a timely and effective manner.
We face significant competition and may not be able to maintain our market share
and may suffer from competitive pricing practices.
We operate in a highly volatile industry that is characterized by
vigorous competition for market share and rapid technological development.
Competition is heightened in periods of slow overall market growth. These
59
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.
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:
o reversals or delays in the opening of foreign markets to new
competitors;
o trade protection measures;
o exchange controls;
o currency fluctuations;
o investment policies;
o restrictions on repatriation of cash;
o nationalization of local industry;
o economic, social and political risks;
60
o taxation;
o interest rates; and
o 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.
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.
61
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.
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
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
62
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 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.
63
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.
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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 nine months ended September 30, 2002, Nortel Networks
Corporation subscribed for one common share of Nortel Networks Limited, and
Nortel Networks Limited issued one of its common shares to Nortel Networks
Corporation, as of each of the following dates, in each case in exchange for
cash consideration in the following approximate amounts on such dates:
Amount of Consideration
Effective Date ($millions)
-------------- ----------
June 28, 2002 800
August 29, 2002 525
September 27, 2002 672
-------
Total 1,997
Each such issuance of common shares by Nortel Networks Limited to
Nortel Networks Corporation was exempt from registration under the Securities
Act on the basis that it occurred outside the United States, within the meaning
of Regulation S under the Securities Act.
ITEM 4. Submissions of Matters to a Vote of Security Holders
During the nine months ended September 30, 2002, Nortel Networks
Corporation, as the sole holder of the common shares of Nortel Networks Limited,
approved reductions in the legal stated capital of the common shares of Nortel
Networks Limited, pursuant to unanimous written resolutions and in accordance
with applicable Canadian corporate laws, as of the following dates and in the
following approximate amounts:
Amount of Reduction
Effective Date ($millions)
-------------- ----------
June 28, 2002 800
August 29, 2002 525
September 27, 2002 672
-------
Total 1,997
The reductions in the legal stated capital of the common shares of
Nortel Networks Limited, among other things, improve the ability to declare and
pay dividends on the outstanding preferred shares of Nortel Networks Limited
under applicable Canadian corporate laws.
65
ITEM 6. Exhibits and Reports on Form 8-K
a) Exhibits:
10.1 Resolution of the Board of Directors of Nortel Networks Limited dated
July 25, 2002, related to the payment of audit committee chairman fees.
10.2 Nortel Networks Limited SUCCESS Plan effective July 25, 2002.
10.3 General description of cash bonus for employees and executives of
Nortel Networks Corporation and Nortel Networks Limited.
b) Reports on Form 8-K:
Nortel Networks Limited 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 Limited, and (ii) Nortel Networks
Corporation's financial results for the second quarter of 2002.
Nortel Networks Limited 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 Limited's
Quarterly Report on Form 10-Q filed with the Securities and Exchange
Commission on August 13, 2002.
Nortel Networks Limited filed a Current Report on Form 8-K dated August
28, 2002 related to a press release announcing that Nortel Networks
Corporation expects its revenue from continuing operations for the
third quarter to be lower than second quarter 2002 revenues for
continuing operations by up to approximately 10%.
Nortel Networks Limited filed a Current Report on Form 8-K dated
September 26, 2002 related to a press release announcing that Nortel
Networks Corporation expects its revenues from continuing operations in
the third quarter to be lower than second quarter 2002 revenues for
continuing operations by approximately 15%.
Nortel Networks Limited filed a Current Report on Form 8-K dated
October 3, 2002 related to a press release announcing changes to Nortel
Networks Corporation's organization reflecting a more streamlined
structure focused more directly around its customers in four key
businesses: Wireless Networks, Wireline Networks, Enterprise Networks,
and Optical Networks.
Nortel Networks Limited filed a Current Report on Form 8-K dated
October 11, 2002 related to a press release stating that, in a letter
from Nortel Networks Corporation's President and Chief Executive
Officer to employees subsequently issued on the same date, Nortel
Networks Corporation updated employees on its third quarter 2002
revenues and its progress on its drive to achieve profitability.
Nortel Networks Limited filed a Current Report on Form 8-K dated
October 22, 2002 related to Nortel Networks Corporation's financial
results for the third quarter of 2002.
Nortel Networks Limited filed a Current Report on Form 8-K/A dated
November 7, 2002 related to Nortel Networks Corporation's press release
revising the breakdown of its Enterprise Networks and Wireline Networks
historical segment revenues.
66
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 LIMITED
(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
67
CERTIFICATION
I, FRANK A. DUNN, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Nortel Networks
Limited;
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
68
CERTIFICATION
I, DOUGLAS C. BEATTY, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Nortel Networks
Limited;
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
69