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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ___________ to ___________
Commission file number 001-07260
NORTEL NETWORKS CORPORATION
(Exact name of registrant as specified in its charter)
CANADA NOT APPLICABLE
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
8200 DIXIE ROAD, SUITE 100
BRAMPTON, ONTARIO, CANADA L6T 5P6
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code (905) 863-0000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to filing requirements
for the past 90 days.
YES [x] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as at OCTOBER 31, 2002
3,839,553,654 WITHOUT NOMINAL OR PAR VALUE
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TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
PAGE
----
ITEM 1. Consolidated Financial Statements (unaudited)............................... 3
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................. 34
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk.......................................................... 68
ITEM 4. Controls and Procedures..................................................... 69
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings........................................................... 70
ITEM 2. Changes in Securities and Use of Proceeds................................... 70
ITEM 6. Exhibits and Reports on Form 8-K............................................ 70
SIGNATURES ............................................................................ 72
CERTIFICATIONS ............................................................................ 73
All dollar amounts in this document are in United States dollars unless
otherwise stated.
Alteon is a trademark of Alteon Websystems, Inc.
Bay Networks is a trademark of Nortel Networks.
Clarify is a trademark of Amdocs Software Systems Limited.
Moody's is a trademark of Moody's Investor Services, Inc.
Nortel Networks, NT are trademarks of Nortel Networks.
Standard & Poor's, S&P 100 and S&P 500 are trademarks of The McGraw-Hill
Companies, Inc.
2
PART I
FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (UNAUDITED)
Contents of Consolidated Financial Statements
PAGE
----
Consolidated Statements of Operations................................... 4
Consolidated Balance Sheets............................................. 5
Consolidated Statements of Cash Flows................................... 6
Notes to Consolidated Financial Statements.............................. 7
3
NORTEL NETWORKS CORPORATION
Consolidated Statements of Operations (unaudited)
(millions of U.S. dollars, except per share amounts)
- -------------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Revenues $ 2,355 $ 3,694 $ 8,040 $ 14,055
Cost of revenues 1,454 3,673 5,423 11,750
- -------------------------------------------------------------------------------------------------------------------------
Gross profit 901 21 2,617 2,305
Selling, general and administrative expense (excluding
stock option compensation) 682 1,919 2,193 4,902
Research and development expense 565 808 1,739 2,661
In-process research and development expense - - - 15
Amortization of intangibles
Acquired technology 38 185 122 744
Goodwill - 454 - 3,685
Stock option compensation 22 32 68 91
Special charges 1,194 1,024 2,084 14,949
Gain on sale of businesses - (45) (14) (45)
- -------------------------------------------------------------------------------------------------------------------------
Operating loss (1,600) (4,356) (3,575) (24,697)
Equity in net loss of associated companies (5) (6) (19) (138)
Other expense - net (2) (318) (20) (268)
Interest expense
Long-term debt (55) (54) (168) (138)
Other (12) (23) (33) (82)
- -------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations before income taxes (1,674) (4,757) (3,815) (25,323)
Income tax benefit (provision) (125) 1,289 478 2,842
- -------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (1,799) (3,468) (3,337) (22,481)
Net loss from discontinued operations - net of tax - - - (3,010)
- -------------------------------------------------------------------------------------------------------------------------
Net loss before cumulative effect of accounting change (1,799) (3,468) (3,337) (25,491)
Cumulative effect of accounting change - net of tax of $9 - - - 15
- -------------------------------------------------------------------------------------------------------------------------
Net loss $ (1,799) $ (3,468) $ (3,337) $(25,476)
=========================================================================================================================
Basic and diluted loss per common share
- from continuing operations $ (0.42) $ (1.08) $ (0.91) $ (7.07)
- from discontinued operations - - - (0.94)
- -------------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per common share $ (0.42) $ (1.08) $ (0.91) $ (8.01)
=========================================================================================================================
Dividends declared per common share $ - $ - $ - $0.03750
See notes to unaudited consolidated financial statements.
4
NORTEL NETWORKS CORPORATION
Consolidated Balance Sheets (unaudited)
(millions of U.S. dollars)
- --------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and cash equivalents $ 4,170 $ 3,513
Restricted cash and cash equivalents 420 -
Accounts receivable (less provisions of $528 at September 30, 2002; $655 at December 31, 2001) 2,007 2,923
Inventories - net 1,132 1,579
Income taxes recoverable 58 796
Deferred income taxes - net 1,162 1,386
Other current assets 673 857
Current assets of discontinued operations 293 708
- --------------------------------------------------------------------------------------------------------------------------------
Total current assets 9,915 11,762
Long-term receivables (less provisions of $877 at September 30, 2002; $828 at December 31, 2001) 79 203
Investments at cost and associated companies at equity 176 253
Plant and equipment - net 1,670 2,571
Goodwill 2,200 2,810
Intangible assets - net 133 285
Deferred income taxes - net 2,333 2,077
Other assets 868 893
Long-term assets of discontinued operations 66 283
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $ 17,440 $ 21,137
================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Notes payable $ 128 $ 426
Trade and other accounts payable 1,286 1,988
Payroll and benefit-related liabilities 646 636
Other accrued liabilities 4,689 5,459
Income taxes payable 116 143
Long-term debt due within one year 516 384
Current liabilities of discontinued operations 137 421
- --------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 7,518 9,457
Deferred income 99 154
Long-term debt 4,111 4,094
Deferred income taxes - net 499 518
Other liabilities 1,588 1,453
Minority interest in subsidiary companies 611 637
- --------------------------------------------------------------------------------------------------------------------------------
14,426 16,313
- --------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (notes 13 and 15)
SHAREHOLDERS' EQUITY
Common shares, without par value - Authorized shares: unlimited; Issued and outstanding
shares: 3,849,891,442 at September 30, 2002 and 3,213,742,169 at December 31, 2001 33,872 32,899
Additional paid-in capital 3,753 3,257
Deferred stock option compensation (118) (205)
Deficit (33,488) (30,151)
Accumulated other comprehensive loss (1,005) (976)
- --------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 3,014 4,824
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 17,440 $ 21,137
================================================================================================================================
See notes to unaudited consolidated financial statements.
5
NORTEL NETWORKS CORPORATION
Consolidated Statements of Cash Flows (unaudited)
(millions of U.S. dollars)
- --------------------------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) operating activities
Net loss from continuing operations $ (3,337) $(22,481)
Adjustments to reconcile net loss from continuing operations to net cash from (used in)
operating activities, net of effects from acquisitions and divestitures of businesses:
Amortization and depreciation 542 4,977
In-process research and development expense - 15
Non-cash portion of special charges and related asset write downs 1,292 13,334
Equity in net loss of associated companies 19 138
Stock option compensation 68 91
Deferred income taxes (45) (2,153)
Other liabilities (14) 62
Gain on sale of investments and businesses (28) (71)
Other - net 355 309
Change in operating assets and liabilities:
Accounts receivable 893 4,435
Inventories 407 1,738
Income taxes 711 (973)
Accounts payable and accrued liabilities (1,428) 645
Other operating assets and liabilities (33) 359
- --------------------------------------------------------------------------------------------------------------------------
Net cash from (used in) operating activities of continuing operations (598) 425
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) investing activities
Expenditures for plant and equipment (289) (1,113)
Proceeds on disposals of plant and equipment 186 151
Increase in restricted cash and cash equivalents (420) -
Increase in long-term receivables (247) (677)
Decrease in long-term receivables 253 192
Acquisitions of investments and businesses - net of cash acquired (29) (87)
Proceeds on sale of investments and businesses 79 232
- --------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities of continuing operations (467) (1,302)
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from (used in) financing activities
Dividends on common shares - (123)
Increase (decrease) in notes payable - net (289) 355
Proceeds from long-term debt 32 3,278
Repayments of long-term debt (22) (463)
Increase (decrease) in capital leases payable 162 (21)
Issuance of common shares 863 136
Issuance of prepaid forward purchase contracts 623 -
- --------------------------------------------------------------------------------------------------------------------------
Net cash from financing activities of continuing operations 1,369 3,162
- --------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash and cash equivalents 16 (5)
- --------------------------------------------------------------------------------------------------------------------------
Net cash from continuing operations 320 2,280
Net cash from (used in) discontinued operations 337 (569)
- --------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 657 1,711
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period - net 3,513 1,644
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period - net $ 4,170 $ 3,355
==========================================================================================================================
See notes to unaudited consolidated financial statements.
6
NORTEL NETWORKS CORPORATION
Notes to Consolidated Financial Statements (unaudited)
(millions of U.S. dollars, except per share amounts, unless otherwise stated)
1. Nortel Networks Corporation
Effective May 1, 2000, a newly formed Canadian corporation ("New Nortel")
and the corporation previously known as Nortel Networks Corporation ("Old
Nortel") participated in a Canadian court-approved plan of arrangement (the
"Arrangement") with BCE Inc. As a result of the Arrangement: Old Nortel and
its subsidiaries became direct and indirect subsidiaries, respectively, of
New Nortel; New Nortel assumed the name "Nortel Networks Corporation"; New
Nortel's common shares began to trade publicly on the New York and Toronto
stock exchanges under the symbol "NT"; Old Nortel was renamed "Nortel
Networks Limited" ("NNL"); and 100 percent of Old Nortel's common shares
were acquired by New Nortel and ceased to be publicly traded. The preferred
shares and debt securities of Old Nortel outstanding immediately prior to
the Arrangement remained outstanding and continued to be obligations of Old
Nortel immediately after the Arrangement. All of the business and operations
conducted by Old Nortel and its subsidiaries immediately prior to the
effective date of the Arrangement continued to be conducted by Old Nortel
and its subsidiaries as subsidiaries of New Nortel immediately after the
Arrangement.
2. Basis of presentation
The accompanying unaudited Consolidated Financial Statements of Nortel
Networks Corporation ("Nortel Networks") include all majority owned
subsidiaries over which Nortel Networks exercises control, and have been
prepared in accordance with the rules and regulations of the United States
Securities and Exchange Commission (the "SEC") for the preparation of
interim financial information. Accordingly, they do not include all
information and notes as required by United States generally accepted
accounting principles ("GAAP") in the preparation of annual consolidated
financial statements. The accounting policies used in the preparation of the
accompanying unaudited Consolidated Financial Statements are the same as
those described in Nortel Networks audited Consolidated Financial Statements
prepared in accordance with GAAP for the three years ended December 31,
2001, except as described in note 3. Although Nortel Networks is
headquartered in Canada, the accompanying unaudited Consolidated Financial
Statements are expressed in United States dollars as the greater part of
Nortel Networks financial results and net assets are denominated in United
States dollars.
In the opinion of management, all adjustments necessary to effect a fair
statement of the results for the periods presented have been made and all
such adjustments are of a normal recurring nature. The financial results for
the three months and nine months ended September 30, 2002, are not
necessarily indicative of financial results for the full year. The
accompanying unaudited Consolidated Financial Statements should be read in
conjunction with Nortel Networks Annual Report on Form 10-K for the year
ended December 31, 2001 (the "2001 10-K") and Current Report on Form 8-K
dated May 13, 2002, which includes certain supplemental financial disclosure
and disclosure related to certain events that occurred subsequent to the
filing of the original historical audited consolidated financial statements.
The preparation of Nortel Networks Consolidated Financial Statements
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Estimates are used when
accounting for items and matters such as long-term contracts, allowance for
uncollectible accounts receivable and customer financings, inventory
obsolescence, product warranty, amortization, asset valuations, employee
benefits, taxes, restructuring and other provisions, in-process research and
development ("IPR&D"), and contingencies.
Certain 2001 figures in the accompanying unaudited Consolidated Financial
Statements have been reclassified to conform to the 2002 presentation.
7
3. Accounting changes
(a) Accounting for goodwill and other intangible assets
In July 2001, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), effective for
fiscal years beginning after December 15, 2001. SFAS 142 changed the
accounting for goodwill from an amortization method to an
impairment-only approach. Thus, amortization of goodwill, including
goodwill recorded in past business combinations, and amortization of
intangibles with an indefinite life, ceased upon adoption of this
Statement. For any acquisitions completed after June 30, 2001, goodwill
and intangible assets with an indefinite life are not amortized. Nortel
Networks adopted the provisions of SFAS 142 effective January 1, 2002.
Nortel Networks completed the first of the required SFAS 142
transitional impairment tests during the second quarter of 2002 and
concluded that there was no impairment of recorded goodwill, as the fair
value of its reporting units exceeded their carrying amount as of
January 1, 2002. Therefore, the second step of the transitional
impairment test under SFAS 142 was not required to be performed.
As a result of the continued decline in both Nortel Networks overall
market value generally and within the Optical Networks segment
specifically, Nortel Networks as part of its review of financial results
during the three months ended September 30, 2002 evaluated the goodwill
associated with the businesses within the Optical Networks segment for
potential impairment. The conclusion of those evaluations was that the
fair value associated with the businesses within the Optical Networks
segment could no longer support the carrying value of the goodwill
associated with them. As a result, Nortel Networks recorded a goodwill
write down of $595. See note 6 for further information regarding this
goodwill write down. There can be no assurance that future goodwill
impairment tests will not result in a charge to net earnings (loss).
Acquired technology continues to be amortized and carried at cost less
accumulated amortization. Amortization is computed over the estimated
useful lives of the respective assets, generally two to three years.
8
The following table presents the impact on net loss and on basic and diluted
loss per common share from both continuing and discontinued operations for the
three months and nine months ended September 30, 2002 and 2001, of the SFAS 142
requirement to cease the amortization of goodwill as if the standard had been in
effect beginning January 1, 2001:
- -----------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Reported results:
Net loss from continuing operations $ (1,799) $ (3,468) $ (3,337) $(22,481)
Net loss from discontinued operations - net of tax - - - (3,010)
Cumulative effect of accounting change - net of tax of $9 - - - 15
- -----------------------------------------------------------------------------------------------------------------------
Net loss - reported $ (1,799) $ (3,468) $ (3,337) $(25,476)
=======================================================================================================================
Adjustments:
Amortization of goodwill from continuing
operations - net of tax (a) $ - $ 454 $ - $ 3,694
Amortization of goodwill from discontinued operations - - - 190
- -----------------------------------------------------------------------------------------------------------------------
Total net adjustments $ - $ 454 $ - $ 3,884
- -----------------------------------------------------------------------------------------------------------------------
Adjusted results:
Net loss from continuing operations $ (1,799) $ (3,014) $ (3,337) $(18,787)
Net loss from discontinued operations - net of tax - - - (2,820)
Cumulative effect of accounting change - net of tax of $9 - - - 15
- -----------------------------------------------------------------------------------------------------------------------
Net loss - adjusted $ (1,799) $ (3,014) $ (3,337) $(21,592)
=======================================================================================================================
Reported basic and diluted loss per common share:
- from continuing operations $ (0.42) $ (1.08) $ (0.91) $ (7.07)
- from discontinued operations - - - (0.94)
- -----------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per common share - reported $ (0.42) $ (1.08) $ (0.91) $ (8.01)
=======================================================================================================================
Adjusted basic and diluted loss per common share:
- from continuing operations $ (0.42) $ (0.94) $ (0.91) $ (5.90)
- from discontinued operations - - - (0.89)
- -----------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per common share - adjusted $ (0.42) $ (0.94) $ (0.91) $ (6.79)
=======================================================================================================================
(a) Includes goodwill amortization of equity accounted investments, net of
tax of nil and $5 for the three months and nine months ended September
30, 2001, respectively.
(b) Impairment or disposal of long-lived assets
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets. SFAS 144 applies to certain long-lived assets, including
discontinued operations, and develops one accounting model for long-lived
assets to be disposed of by sale. This Statement supersedes SFAS No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed Of", and the accounting and reporting provisions of
Accounting Principles Board Opinion ("APB") No. 30, "Reporting the Results
of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" ("APB 30"), for the disposal of a segment of a business.
Nortel Networks adopted the provisions of SFAS 144 effective January 1,
2002.
SFAS 144 requires that long-lived assets to be disposed of by sale be
measured at the lower of carrying amount or fair value less cost to sell,
whether reported in continuing operations or in discontinued operations.
Discontinued operations will no longer be measured at net realizable value
or include amounts for operating losses that have not yet been incurred.
SFAS 144 also broadens the reporting of discontinued operations to include
the disposal of a component of an entity provided that the operations and
cash flows of the component will be eliminated from the ongoing operations
of the entity and the entity will not have any significant continuing
involvement in the operations of the component. During the three months
ended September 30, 2002, Nortel Networks recorded a write down for plant
and equipment and inventory assets of $123 pursuant to SFAS 144. See note 6
for further information regarding this write down.
9
4. Discontinued operations
On June 14, 2001, Nortel Networks Board of Directors approved a plan to
discontinue Nortel Networks access solutions operations consisting of all of
Nortel Networks narrowband and broadband solutions, including copper, cable,
and fixed wireless solutions, as well as Nortel Networks then current
consolidated membership interest in Arris Interactive LLC ("Arris") and
equity investment in Elastic Networks Inc. ("Elastic Networks"). Also
affected by the decision were Nortel Networks prior acquisitions of Sonoma
Systems ("Sonoma"), Promatory Communications, Inc. ("Promatory"), Aptis
Communications, Inc. ("Aptis"), and Broadband Networks Inc.
Pursuant to APB 30, the revenues, costs and expenses, assets and
liabilities, and cash flows of Nortel Networks access solutions operations
have been segregated in the accompanying unaudited Consolidated Statements
of Operations, unaudited Consolidated Balance Sheets, and unaudited
Consolidated Statements of Cash Flows, and are reported as "discontinued
operations".
The results of discontinued operations for the three months and nine months
ended September 30, presented in the accompanying unaudited Consolidated
Statements of Operations, were as follows:
--------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
--------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 151 $ 138 $ 864
--------------------------------------------------------------------------------------------------------------------
Net loss from discontinued operations - net of tax of $119 $ - $ - $ - $ (442)
Net loss on disposal of operations - net of tax of $604 - - - (2,568)
--------------------------------------------------------------------------------------------------------------------
Net loss from discontinued operations - net of tax $ - $ - $ - $(3,010)
====================================================================================================================
During the three months ended June 30, 2002, Arris Group Inc. ("Arris
Group") completed a secondary public offering of 15 million common shares
held by Nortel Networks. Following the closing of the offering on June 25,
2002, Nortel Networks owned 22 million shares, or approximately 27 percent
of Arris Group's common shares. The cash proceeds received were $67 and a
gain of approximately $15 was recorded as a result of this transaction,
which is included in the estimated remaining provisions required for
discontinued operations. During the three months ended March 31, 2002,
Nortel Networks recorded a gain of approximately $13 due to the reduction of
Nortel Networks ownership interest in Arris Group, received for Nortel
Networks original interest in Arris, from approximately 49 percent to
approximately 46 percent as a result of Arris Group's issuance of common
shares in connection with its acquisition of another company, which is
included in the estimated remaining provisions required for discontinued
operations.
On April 21, 2002, Nortel Networks entered into an agreement with Aastra
Technologies Limited to sell certain assets, which were included in
discontinued operations, associated with Nortel Networks prior acquisition
of Aptis. The transaction was completed during the three months ended June
30, 2002. The consideration primarily consisted of approximately $16 in
cash, as well as contingent cash consideration of up to $60 over four years
based on the achievement of certain revenue targets by the business. Nortel
Networks recorded a loss of approximately $43 on the transaction, which
reduced the estimated remaining provisions for discontinued operations.
On March 5, 2002, Nortel Networks divested its approximately 46 percent
ownership interest in Elastic Networks to Paradyne Networks, Inc.
("Paradyne") in exchange for an approximately 8 percent ownership interest
in Paradyne. Nortel Networks recorded a gain of approximately $7 on the
transaction, which is included in the estimated remaining provisions
required for discontinued operations.
In connection with the decision to discontinue the access solutions
operations on June 14, 2001, Nortel Networks recorded a pre-tax loss on
disposal of the access solutions operations of $3,172 in the three months
ended June 30, 2001, which reflected the estimated costs directly associated
with Nortel Networks plan of disposition. The loss reflected: the write-off
of goodwill associated with the acquisitions of Sonoma and Promatory in the
amount of $755; provisions for both short-term and long-term receivables of
$601; a provision for inventories of $379; other asset write-offs totaling
$156; future contractual obligations and estimated liabilities of $1,104;
and estimated operating losses during the planned period of disposition of
$177.
10
During the nine months ended September 30, 2002, Nortel Networks has continued
to wind down the access solutions operations and there has been no change to the
initial disposal strategy or intent to exit the business since June 14, 2001.
However, the continued deterioration in industry and market conditions has
delayed certain disposal activities beyond the original planned timeframe of one
year. In particular, actions involving negotiations with customers, who have
also been affected by industry conditions, are taking longer than expected.
Therefore, although disposal activities continue beyond the one-year period
generally contemplated under APB 30, Nortel Networks continues to present the
access solutions operations as discontinued operations in the Consolidated
Financial Statements. Nortel Networks has disposed of or transitioned the
ownership of certain operations, and operations not disposed of or so
transitioned are expected to be closed. Nortel Networks now expects to complete
this plan by early 2003, subject to the closing of specific transactions, the
timing of which may continue to be impacted by customer issues, any applicable
regulatory requirements, and business issues.
At September 30, 2002, the remaining accruals of $134 related to the above-noted
future contractual obligations and estimated liabilities, and estimated
operating losses during the planned period of disposition, were included in
current liabilities of discontinued operations. The remaining accruals are
expected to be substantially drawn down by cash payments over the period of
disposition, the impact of which is expected to be partially offset by proceeds
from the sale of certain remaining assets to be disposed of.
The assets and liabilities of discontinued operations presented in the
accompanying unaudited Consolidated Balance Sheets were as follows:
- ------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2002 2001
- ------------------------------------------------------------------------------------------
Accounts receivable - net $ 20 $ 109
Inventories - net - 66
Deferred income taxes 192 358
Other current assets 81 175
- ------------------------------------------------------------------------------------------
Total current assets of discontinued operations 293 708
Intangible assets - net - 17
Other long-term assets 66 266
- ------------------------------------------------------------------------------------------
Total assets of discontinued operations $ 359 $ 991
==========================================================================================
Current liabilities $ 137 $ 421
Long-term liabilities (included in Other liabilities) 2 11
- ------------------------------------------------------------------------------------------
Total liabilities of discontinued operations $ 139 $ 432
==========================================================================================
The net cash from (used in) discontinued operations for the nine months ended
September 30, 2002 and 2001, presented in the accompanying unaudited
Consolidated Statements of Cash Flows, was as follows:
- --------------------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------------------
Cash flows from (used in) discontinued operations
Operating activities $ 240 $ (589)
Investing activities 97 20
- --------------------------------------------------------------------------------------------
Net cash from (used in) discontinued operations $ 337 $ (569)
============================================================================================
11
5. Consolidated Financial Statement Details
Consolidated balance sheets
Inventories - net:
---------------------------------------------------------------------------
September 30, December 31,
2002 2001
---------------------------------------------------------------------------
Raw materials $ 474 $ 759
Work in process 367 586
Finished goods 291 234
---------------------------------------------------------------------------
Inventories - net (a) $ 1,132 $ 1,579
===========================================================================
(a) Net of inventory provisions of $1,194 and $933 as at September 30,
2002 and December 31, 2001, respectively. Nortel Networks has also
accrued in other accrued liabilities $189 and $565 at September 30,
2002 and December 31, 2001, respectively, for cancellation charges,
for inventory in excess of future demand, and for the settlement of
certain other claims related to its contract manufacturers or
suppliers.
Goodwill:
The changes in the carrying amount of goodwill by reportable segment for
the nine months ended September 30, 2002 are as follows:
----------------------------------------------------------------------------------------------------------------------
Optical Wireless Wireline Enterprise
Networks Networks Networks Networks Other Total
----------------------------------------------------------------------------------------------------------------------
Balance as at January 1, 2002 $ 590 $ 21 $ 524 $ 1,660 $ 15 $ 2,810
Change:
Disposal - - - - (15) (15)
Write down (a) (595) - - - - (595)
Other 5 - (1) (4) - -
----------------------------------------------------------------------------------------------------------------------
Balance as at Sept 30, 2002 $ - $ 21 $ 523 $ 1,656 $ - $ 2,200
======================================================================================================================
(a) See note 6 for further information regarding this goodwill write down.
Intangible assets - net:
-----------------------------------------------------------------------------------------
September 30, December 31,
2002 2001
-----------------------------------------------------------------------------------------
Acquired technology $ 5,732 $ 5,762
Less: accumulated amortization (5,599) (5,477)
-----------------------------------------------------------------------------------------
Intangible assets - net $ 133 $ 285
=========================================================================================
The estimated future amortization expense of acquired technology is $35 for
the three months ending December 31, 2002, and $98 for the year ending
December 31, 2003.
12
Consolidated statements of cash flows
Interest and income taxes paid (received):
-------------------------------------------------------------------------------------------
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
-------------------------------------------------------------------------------------------
Interest paid $ 254 $ 195
Income taxes paid (received) $ (1,222) $ 196
===========================================================================================
6. Special charges
Special charges were as follows:
--------------------------------------------------------------------------------------------------------------------------------
CONTRACT
SETTLEMENT PLANT AND
WORKFORCE AND LEASE EQUIPMENT GOODWILL
REDUCTION COSTS WRITE DOWNS OTHER WRITE DOWN TOTAL
--------------------------------------------------------------------------------------------------------------------------------
Provision Balance as at December 31, 2001 $ 400 $ 773 $ - $ 31 $ - $ 1,204
Special Charges for the three months ended:
March 31, 2002 327 63 85 12 487
June 30, 2002 117 1 270 15 403
September 30, 2002 323 102 51 123 595 1,194
--------------------------------------------------------------------------------------------------------------------------------
Subtotal 1,167 939 406 181 595 3,288
--------------------------------------------------------------------------------------------------------------------------------
2002 Cumulative Drawdowns:
Cash (604) (255) - (11) - (870)
Non-Cash (107) - (406) (150) (595) (1,258)
--------------------------------------------------------------------------------------------------------------------------------
Provision Balance as at September 30, 2002 $ 456 $ 684 $ - $ 20 $ - $ 1,160
================================================================================================================================
Three months and nine months ended September 30, 2002
For the three months and nine months ended September 30, 2002, Nortel
Networks recorded special charges of $1,194 and $2,084, respectively,
related to restructuring activities, write downs of other assets and
goodwill. The special charges relating to restructuring are associated with
the work plan that Nortel Networks began implementing in 2001 and continued
into the third quarter of 2002, to streamline operations and activities
around core markets and leadership strategies.
Restructuring activities
Workforce reduction charges of $323 and $767 for the three months and nine
months ended September 30, 2002, respectively, were related to the cost of
severance and benefits associated with approximately 3,500 and 9,800
employees notified of termination, during the three months and nine months
ended September 30, 2002, respectively, across all of Nortel Networks
segments. Included in the workforce reduction charges for the three months
and nine months ended September 30, 2002, are $107 of non-cash pension
settlement and curtailment charges.
Contract settlement and lease costs included negotiated settlements of $102
and $166 for the three months and nine months ended September 30, 2002,
respectively, to either cancel contracts or renegotiate existing contracts
across all of Nortel Networks segments.
As part of its review of financial results during the three months and nine
months ended September 30, 2002, Nortel Networks performed assessments of
certain plant and equipment assets, primarily in the Optical Networks
segment, due to the current market conditions and the delay in the
anticipated recovery of that segment. The conclusion of these assessments
resulted in a write down of certain plant and equipment assets primarily
within the Optical Networks segment of approximately $31 and $386 during the
three months and nine months ended September 30, 2002 respectively. Also
included in plant and equipment write downs during the three months and nine
13
months ended September 30, 2002, was approximately $20 of leasehold
improvements and certain information technology equipment associated with
the exiting of leased and owned facilities.
Other
Assets held for sale
SFAS 144 requires assets held for sale to be measured at the lower of their
carrying amount or fair values less costs to sell. During the three months
ended September 30, 2002, certain plant and equipment and inventory of the
Optical Networks segment met the criteria of assets held for sale. Based on
the expected fair value of these assets to be realized on sale, Nortel
Networks recorded a charge of $123 against their carrying amounts during the
three months ended September 30, 2002. The remaining fair value of these
assets of $47 is included in inventory. See note 18 for additional
information regarding the asset sale transaction.
Other assets
Included in the nine months ended September 30, 2002, was a write off of $15
for certain acquired technology in the Optical Networks segment recorded
during the three months ended June 30, 2002, and a $12 write off of acquired
technology recorded in the three months ended March 31, 2002, associated
with the Xros, Inc. X-1000 IPR&D project.
Goodwill write down
As a result of the continued decline in both Nortel Networks overall market
value generally and within the Optical Networks segment specifically, Nortel
Networks as part of its review of financial results during the three months
ended September 30, 2002, evaluated the goodwill associated with the
businesses within the Optical Networks segment for potential impairment. The
conclusion of those evaluations was that the fair value associated with the
businesses within the Optical Networks segment could no longer support the
carrying value of the remaining goodwill associated with them. As a result,
Nortel Networks recorded a goodwill write down of $595.
Fair value was estimated using the expected present value of discounted
future cash flows of the businesses within the Optical Networks segment. The
assumptions supporting the estimated future cash flows, including the
discount rate and estimated terminal values, reflect management's best
estimates.
Year ended December 31, 2001
For the year ended December 31, 2001, Nortel Networks recorded restructuring
charges of $3,359, related to workforce reduction costs of $1,361, contract
settlement and lease costs of $883, plant and equipment write downs of $970,
and other costs of $145. During the year ended December 31, 2001, there were
cumulative cash and non-cash drawdowns against the provision of $1,093 and
$1,062, respectively, resulting in an ending provision balance at December
31, 2001 of $1,204. The cash drawdowns related primarily to workforce
reduction payments, and the non-cash drawdowns related primarily to the
plant and equipment write downs.
Period from January 1, 2001 to September 30, 2002
Of the approximately 45,900 employees notified during the period from
January 1, 2001 to September 30, 2002, approximately 16,500 were direct
employees performing manufacturing, assembly, test and inspection activities
associated with the production of Nortel Networks products, and
approximately 29,400 were indirect sales, marketing, research and
development, and administrative employees, and manufacturing managers. The
workforce reduction was primarily in North America and the United Kingdom
and extended across all of Nortel Networks segments. As at September 30,
2002, the workforce reduction provision balance has been drawn down by
cumulative cash payments of $1,579, plus $93 of non-cash pension settlement
and curtailment charges, resulting in an ending provision balance for
workforce reduction of $456. The remaining provision is expected to be
substantially drawn down by the end of 2003.
14
In connection with the above noted workforce reduction, Nortel Networks
identified a number of leased and owned facilities comprised of office,
warehouse and manufacturing space, as well as leased manufacturing
equipment, that were no longer required. As a result, Nortel Networks
recorded net lease costs of approximately $867. The costs primarily related
to Nortel Networks future contractual obligations under operating leases.
Offsetting the total lease charge is approximately $513 in expected sublease
revenue on leases that Nortel Networks cannot terminate. Nortel Networks
expects to have subleased substantially all of these properties by the end
of 2004. In addition, Nortel Networks wrote down the net carrying value of
specific owned facilities across all segments within North America and the
United Kingdom. The write down of approximately $112, which is included in
plant and equipment write downs, reflected the net realizable value based on
market assessments for general purpose facilities.
Contract settlement and lease costs included negotiated settlements of
approximately $182, to either cancel contracts or renegotiate existing
contracts across all of Nortel Networks segments. As at September 30, 2002,
the provision balance for contract settlement and lease costs was drawn down
by cumulative cash payments of $365, resulting in an ending provision
balance of $684. The remaining provision is expected to be substantially
drawn down by the end of 2006.
Plant and equipment write downs of approximately $462 consisted of the write
down of leasehold improvements and certain information technology equipment
associated with the exiting of the above noted leased and owned facilities.
In addition, as a result of the significant negative industry and economic
trends impacting Nortel Networks operations and expected future growth
rates, Nortel Networks has performed assessments of certain plant and
equipment assets as part of its review of financial results during 2001 and
the first nine months of 2002. The conclusion of these assessments resulted
in write downs of certain plant and equipment assets totaling approximately
$802, as summarized below.
Within the Optical Networks segment, it was determined that there was excess
manufacturing equipment at a number of facilities that would no longer be
required, or the carrying value of which was not recoverable from future
cash flows, as a result of the industry and economic environment. As a
result, Nortel Networks recorded charges totaling approximately $620 to
write down the value of this equipment to its net realizable value based on
the current fair value for this type of specialized equipment. Nortel
Networks expects to dispose of this equipment, other than equipment that it
continues to hold and use, by the second quarter of 2003. In 2001, Nortel
Networks also wrote down the net carrying value of a specialized
manufacturing facility within the Optical Networks segment for the
production of optical components within North America. The write down of
approximately $91 reflects the net realizable value based on market
assessments for a general purpose facility.
Within global operations, it was determined that there was excess test
equipment at a number of system houses that would no longer be required as a
result of the industry and economic environment. As a result, Nortel
Networks recorded charges totaling approximately $91 to write down the value
of this equipment to its net realizable value based on the current fair
value for this type of specialized equipment. Nortel Networks expects to
dispose of this equipment by the second quarter of 2003.
7. Income taxes
At September 30, 2002, Nortel Networks net deferred tax assets were $2,996,
reflecting temporary differences between the financial reporting and tax
treatment of certain current assets and liabilities, and non-current assets
and liabilities, plus the tax benefit of net operating and capital loss
carry forwards and tax credit carry forwards. These carry forwards expire at
various dates beginning in 2003.
During the three months ended September 30, 2002, Nortel Networks recorded
an income tax benefit of $325 on a pre-tax loss of $1,674, which was more
than offset by the recording of certain additional income tax valuation
allowances of $450. These additional valuation allowances were recorded in
accordance with SFAS No. 109 "Accounting for Income Taxes" ("SFAS 109"),
which requires that tax valuation allowances be established when it is more
likely than not that some portion or all of a company's deferred tax assets
will not be realized. The increase in the valuation allowances can be
attributed to further telecommunications market declines in the three months
ended September 30, 2002 and the resultant decline in forecasted taxable
income.
Nortel Networks assesses the realizability of its net deferred tax assets
quarterly, and based on all available evidence, both positive and negative,
concludes whether it is more likely than not that these deferred tax assets
15
will be realized. During the three months ended September 30, 2002, Nortel
Networks assessed positive evidence including forecasts of future taxable
income to support realization of the net deferred tax assets, and negative
evidence including Nortel Networks seven consecutive quarters of losses, and
concluded that it was more likely than not, that an additional $450 of the
net deferred tax assets as at September 30, 2002, were not realizable. If
market conditions deteriorate further or future results of operations are
less than expected, future assessments may result in a determination that
the remaining net deferred tax assets or some portion thereof are not
realizable. As a result, Nortel Networks may need to establish additional
tax valuation allowances for all or a portion of its deferred tax assets.
Nortel Networks effective tax benefit rate fluctuates from period to period
primarily as a result of the impact of certain non-tax deductible
restructuring charges, goodwill write downs, IPR&D expense, stock option
compensation, non-tax deductible goodwill amortization prior to January 1,
2002 and changes in the geographic earnings (loss) mix. Nortel Networks
effective tax benefit rate is not meaningful for the three months ended
September 30, 2002, as a result of recording the above noted income tax
valuation allowances. Excluding the additional income tax valuation
allowances and above noted impacts as applicable, the effective rate would
have been 31.0 percent for the three months and nine months ended September
30, 2002, respectively. For the three months and nine months ended September
30, 2001 the effective tax rate was 30.0 percent and 30.9 percent,
respectively.
Global investment tax credits of $21 and $63 for the three months ended
September 30, 2002 and 2001, respectively, and $75 and $110 for the nine
months ended September 30, 2002 and 2001, respectively, have been
incorporated into the income tax benefit (provision).
8. Common shares and prepaid forward purchase contracts
On June 12, 2002, Nortel Networks issued 632,500,000 common shares for net
proceeds of approximately $856. Concurrent with the common share offering,
28,750 equity units were offered, each initially evidencing its holder's
ownership of a prepaid forward purchase contract ("purchase contract"),
entitling the holder to receive Nortel Networks common shares and specified
zero-coupon U.S. treasury securities ("U.S. treasury strips"). Net proceeds
to Nortel Networks from the purchase contracts were $623. During the three
months ended September 30, 2002, 27 purchase contracts were settled early
resulting in 432,298 common shares being issued. As at September 30, 2002,
28,723 purchase contracts were outstanding. The purchase contracts are
classified in shareholders' equity as part of additional paid-in capital.
The settlement date for each remaining purchase contract is August 15, 2005,
subject to acceleration or early settlement in certain cases. The aggregate
number of Nortel Networks common shares issuable on the settlement date will
be between approximately 485 million and 583 million shares, subject to some
anti-dilution adjustments and adjustments for the proposed consolidation of
Nortel Networks common shares. On the settlement date (or earlier if an
acceleration event occurs prior to the settlement date or if the holder has
elected an early settlement option), Nortel Networks will issue and deliver
to the holder of each purchase contract after February 15, 2003 between
16,885.93 and 20,263.12 of its common shares (depending on the applicable
market value), subject to some anti-dilution adjustments. The applicable
market value will be the average of the closing prices of Nortel Networks
common shares on the New York Stock Exchange during a period shortly before
the settlement date. If the applicable market value of Nortel Networks
common shares is:
- greater than $1.692 per share, 16,885.93 common shares will be
issued and delivered for each purchase contract;
- less than or equal to $1.692 per share but greater than $1.410 per
share, the number of common shares to be issued and delivered for
each purchase contract will be equal to $28,571.00 divided by the
applicable market value; and
- less than or equal to $1.410 per share, 20,263.12 common shares will
be issued and delivered for each purchase contract.
A holder of purchase contracts may elect to accelerate the settlement date
in respect of some or all of its purchase contracts. Upon an early
settlement on or after August 15, 2002 and prior to February 15, 2003, the
holder will receive 16,011.04 Nortel Networks common shares per purchase
contract (regardless of the market price of Nortel Networks common shares at
that time), subject to some anti-dilution adjustments. Upon an early
settlement on or after February 15, 2003, the holder will receive 16,885.93
Nortel Networks common shares per purchase contract (regardless of the
market price of Nortel Networks common shares at that time), subject to some
anti-dilution adjustments.
16
If Nortel Networks Corporation is involved in a merger, amalgamation,
arrangement, consolidation or other reorganization event (other than with or
into Nortel Networks Limited or certain other subsidiaries) in which all of
its common shares are exchanged for consideration of at least 30 percent of
the value of which consists of cash or cash equivalents, then a holder of
purchase contracts may elect to accelerate and settle some or all of its
purchase contracts, for Nortel Networks common shares.
The settlement date under each purchase contract will automatically
accelerate upon occurrence of specified events of bankruptcy, insolvency or
reorganization with respect to Nortel Networks Corporation. Upon
acceleration of the settlement date, holders will be entitled to receive
20,263.12 Nortel Networks common shares per purchase contract (regardless of
the market price of Nortel Networks common shares at that time), subject to
some anti-dilution adjustments.
The U.S. treasury strips were purchased directly by a representative of the
underwriters from the gross proceeds of the equity unit offering and were
delivered to a third party acting as a custodian on behalf of the equity
unit holders. Nortel Networks has no obligations with respect to or interest
in the U.S. treasury strips.
9. Loss per common share
Basic earnings (loss) per common share is calculated by dividing the net
earnings (loss) by the weighted average number of common shares outstanding
during the period. Diluted earnings (loss) per common share is calculated by
dividing the applicable net earnings (loss) by the sum of the weighted
average number of common shares outstanding and all additional common shares
that would have been outstanding if potentially dilutive common shares had
been issued during the period.
The following table details the weighted average number of common shares
outstanding:
----------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in millions of shares) 2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------
Weighted average number of common shares
outstanding - basic and diluted (a) 4,335 3,203 3,671 3,181
==========================================================================================================
(a) The basic weighted average number of common shares outstanding
includes the minimum number of common shares to be issued upon
settlement of the purchase contracts of 485, and includes the effect
of early settlement by holders to September 30, 2002 (see note 8). The
impact of these 485 shares on a weighted basis is 197 for the nine
months ended September 30, 2002.
As a result of the net losses for the three months and nine months ended
September 30, 2002 and 2001, the following potentially dilutive securities
have not been included in the calculation of diluted loss per common share
because to do so would have been anti-dilutive:
----------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in millions of shares) 2002 2001 2002 2001
----------------------------------------------------------------------------------------------
Stock options 1 11 2 41
4.25 percent convertible senior notes
due on September 1, 2008 180 90 180 30
Purchase contracts (see note 8) 97 - 39 -
----------------------------------------------------------------------------------------------
Total 278 101 221 71
==============================================================================================
17
Nortel Networks announced on September 25, 2002 that it plans to present a
proposal to its shareholders for a consolidation of its outstanding common
shares (also known as a "reverse stock split") at its annual shareholders'
meeting planned for spring 2003. Prior to that meeting, the consolidation
ratio will be set by the Nortel Networks Board of Directors at a level which
would be expected at that time to result in an initial post-consolidation
common share price in the range of $10.00 to $20.00 per share, assuming
receipt of shareholder approval and regulatory approval. The planned share
consolidation proposal is intended to satisfy the minimum average share
price continued listing requirements of the New York Stock Exchange to
maintain Nortel Networks common share listing on that exchange.
10. Comprehensive loss
The components of comprehensive loss, net of tax, were as follows:
------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
------------------------------------------------------------------------------------------------------------------------------
Net loss $ (1,799) $ (3,468) $ (3,337) $(25,476)
Other comprehensive income (loss):
Change in foreign currency translation adjustment (a) (103) (88) (26) (334)
Unrealized gain (loss) on investments - net (b) (7) 30 (10) (43)
Unrealized derivative gains (losses) on cash flow hedges - net (c) (8) (14) 7 (20)
------------------------------------------------------------------------------------------------------------------------------
Comprehensive loss $ (1,917) $ (3,540) $ (3,366) $(25,873)
==============================================================================================================================
(a) The change in the foreign currency translation adjustment is not
adjusted for income taxes as it relates to indefinite investments in
non-United States subsidiaries.
(b) Certain securities deemed available-for-sale by Nortel Networks are
measured at fair value. Unrealized holding gains and losses related to
these securities are excluded from net loss and are included in
comprehensive loss until they are realized.
(c) Nortel Networks estimates that $9 of net derivative losses included
in other comprehensive loss will be reclassified into net earnings
(loss) within the next twelve months.
11. Stock-based compensation plans
On June 20, 2001, Nortel Networks commenced a voluntary stock option
exchange program (the "Exchange Program") for Nortel Networks employees,
whereby employees could exchange certain then outstanding stock options for
new stock options, based on a prescribed formula. Terms of the Exchange
Program were such that new grants would take place at least six months and a
day from the stock option cancellation date, which was July 27, 2001.
Approximately 93,416,000 stock options were accepted and cancelled. Nortel
Networks then Board of Directors and its then board appointed officers were
not eligible to participate in the Exchange Program.
On January 29, 2002, Nortel Networks granted approximately 52,700,000 new
stock options in connection with the Exchange Program with exercise prices
of $7.16 in United States dollars and $11.39 in Canadian dollars per common
share, which was the fair market value of Nortel Networks common shares on
the date of the grant.
18
Nortel Networks, as permitted under SFAS No. 123, "Accounting for Stock-based
Compensation" ("SFAS 123"), applies APB No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its plans. SFAS 123
requires disclosure of pro forma amounts to reflect the impact if Nortel
Networks had elected to adopt the optional recognition provisions of SFAS 123
for its stock option plans and employee stock purchase plans. Accordingly,
Nortel Networks net loss and loss per common share would have been increased to
the pro forma amounts as indicated below for the three months and nine months
ended September 30:
- ----------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Net loss:
- reported (a) $ (1,799) $ (3,014) $ (3,337) $ (21,592)
- pro forma $ (2,128) $ (3,385) $ (4,324) $ (22,792)
Basic and diluted loss per common share:
- reported (a) $ (0.42) $ (0.94) $ (0.91) $ (6.79)
- pro forma $ (0.49) $ (1.06) $ (1.18) $ (7.17)
======================================================================================================================
(a) The reported amounts for the three months and nine months ended September
30, 2001, have been adjusted to reflect the impact of the SFAS 142
requirement to cease the amortization of goodwill on net loss and basic and
diluted loss per common share as if the standard had been in effect
beginning January 1, 1999 (see note 3).
The fair value of stock options used to compute pro forma net earnings (loss)
and earnings (loss) per common share disclosures is the estimated fair value at
grant date using the Black-Scholes option-pricing model with the following
weighted average assumptions:
- ----------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
WEIGHTED-AVERAGE ASSUMPTIONS 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------
Expected dividend 0.00% 0.00% 0.00% 0.00%
Expected volatility 79.14% 68.74% 71.25% 70.68%
Risk-free interest rate 3.37% 4.20% 4.49% 4.76%
Expected option life in years 4 4 4 4
====================================================================================================
The weighted average fair values of Nortel Networks stock options, calculated
using the Black-Scholes option-pricing model, granted during the three months
ended September 30, 2002 and 2001 were $0.60 and $3.21 per share, respectively,
during the nine months ended September 30, 2002 and 2001 were $3.50 and $15.75
per share, respectively.
The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
subjective assumptions including the expected price volatility. Nortel Networks
uses expected volatility rates, which are based on historical volatility rates
trended into future years. Changes in the subjective input assumptions can
materially affect the fair value estimate, and therefore the existing models do
not necessarily provide a reliable single measure of the fair value of Nortel
Networks stock options.
19
12. Segmented information
General description
Nortel Networks operations are organized around four reportable segments;
Wireless Networks ("Wireless"), Enterprise Networks ("Enterprise"), Wireline
Networks ("Wireline"), and Optical Networks ("Optical", formerly named
Optical Long-Haul Networks). Enterprise and Wireline were previously
included together as the Metro and Enterprise Networks segment. Nortel
Networks reportable segments are focused on providing seamless networking
products and service capabilities across Wireless, Enterprise, Wireline and
Optical. These product and service solutions are used by service provider
and enterprise customers, including incumbent and competitive local exchange
carriers, interexchange carriers, service providers with global businesses,
wireless service providers, Internet service providers, application service
providers, hosting service providers, resellers, cable television companies,
other communication service providers, large businesses and their branch
offices, small businesses, and home offices, as well as government,
education, and utility organizations. Wireless includes wireless mobility
switching and access products for voice and data communications that span
most major global mobility standards. Enterprise includes a range of
Ethernet and application switching solutions, security solutions, virtual
private networks and routers, enterprise telephony solutions, digital
switching systems, business solutions and applications, and network
management software, along with related professional services used by our
enterprise customers. Wireline includes a range of Optical Ethernet
solutions, packet switching and routing solutions, such as data switching
systems, aggregation products, virtual private network gateways, and
routers, and circuit to packet solutions, such as digital switching systems,
and network management software, together with related professional services
used by our service provider customers. Optical includes long-haul optical
transmission products designed to provide long-distance, high capacity dense
wavelength division multiplexing transport, metro optical transmission
products, traditional optical transmission systems that support most global
transmission standards, optical switch platforms, and optical components for
long distance optical networks.
"Other" represents miscellaneous business activities and corporate
functions. None of these activities meet the quantitative criteria to be
disclosed as reportable segments.
As described in note 4, Nortel Networks access solutions operations were
discontinued during the year ended December 31, 2001. These operations were
previously included as a separate segment within Other. The data included
below excludes amounts related to the operations of the access solutions
segment.
Nortel Networks President and Chief Executive Officer ("CEO") has been
identified as the chief operating decision maker in assessing the
performance of the segments and the allocation of resources to the segments.
Each reportable segment is managed separately with each segment manager
reporting directly to the CEO. The CEO relies on the information derived
directly from Nortel Networks management reporting system. Contribution
margin represents the primary financial measure used by the CEO in assessing
performance and allocating resources, and includes the cost of revenues, and
selling, general and administrative expense, for which the segment managers
are held accountable. Costs associated with shared services, and other
corporate costs, are allocated to the segments based on usage determined by
headcount. Costs not allocated are primarily related to Nortel Networks
corporate compliance and other non-operational activities and are included
in Other. In addition, the CEO does not review asset information on a
segmented basis. The accounting policies of the reportable segments are the
same as those described in Nortel Networks audited Consolidated Financial
Statements for the year ended December 31, 2001.
Segments
During the three months ended September 30 2002, Nortel Networks changed the
way it managed its business to streamline and focus more directly on its
customers in four key businesses. Consequently, the former Metro and
Enterprise Networks segment was split into two new segments Enterprise and
Wireline, each with its own segment manager reporting directly to the CEO.
During the three months ended June 30, 2002, management shifted the
accountability for the metro optical portion of the former Metro and
Enterprise segment to Optical. As a result, financial information for these
two segments is reported on the new basis commencing in the three months
ended September 30, 2002 and historical comparative financial information
has been restated.
20
The following tables set forth information by segments:
-------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------------
REVENUES
Wireless $ 940 $ 1,349 $ 3,199 $ 4,510
Enterprise 617 729 1,928 2,521
Wireline 482 896 1,748 3,526
Optical 309 579 1,121 2,905
Other 7 141 44 593
-------------------------------------------------------------------------------------------------------------------
Total $ 2,355 $ 3,694 $ 8,040 $ 14,055
-------------------------------------------------------------------------------------------------------------------
CONTRIBUTION MARGIN
Wireless $ 276 $ 68 $ 761 $ 215
Enterprise 94 33 272 151
Wireline 82 (249) 255 243
Optical (82) (1,510) (578) (2,549)
Other (151) (240) (286) (657)
-------------------------------------------------------------------------------------------------------------------
Total 219 (1,898) 424 (2,597)
Research and development expense (565) (808) (1,739) (2,661)
In-process research and development expense - - - (15)
Amortization of acquired technology (38) (185) (122) (744)
Amortization of goodwill - (454) - (3,685)
Stock option compensation (22) (32) (68) (91)
Special charges (1,194) (1,024) (2,084) (14,949)
Gain on sale of businesses - 45 14 45
-------------------------------------------------------------------------------------------------------------------
Consolidated operating loss $ (1,600) $ (4,356) $ (3,575) $(24,697)
===================================================================================================================
13. Commitments
Nortel Networks enters into bid and performance bonds related to various
contracts, which generally have terms ranging from two to five years.
Potential payments due under these bonds are related to performance under
the applicable contract. The total amount of bid and performance bonds that
were available and undrawn was $576 excluding restricted cash and cash
equivalents at September 30, 2002.
During the nine months ended September 30, 2002, Nortel Networks entered
into a sale leaseback transaction for one of its properties which did not
qualify for off-balance sheet treatment. As a result, Nortel Networks
continues to include approximately $170 as plant and equipment for this
property and has recorded a capital lease obligation of $170.
14. Restricted cash and cash equivalents
Due to the current general economic and industry environment, and NNL's
current credit ratings, the basis under which customer performance bonds and
contracts can be obtained has changed, resulting in (but not limited to)
increased cash collateral requirements and/or increased fees in connection
with obtaining new customer performance bonds and contracts. As at September
30, 2002, approximately $420 of cash and cash equivalents was restricted as
cash collateral for certain customer performance bonds and contracts.
21
15. Contingencies
Subsequent to the February 15, 2001 announcement in which Nortel Networks
provided revised guidance for financial performance for the 2001 fiscal year
and the first quarter of 2001, Nortel Networks and certain of its then
current officers and directors were named as defendants in more than
twenty-five purported class action lawsuits. These lawsuits in the United
States District Courts for the Eastern District of New York, for the
Southern District of New York and for the District of New Jersey, and in the
provinces of Ontario, Quebec, and British Columbia in Canada, on behalf of
shareholders who acquired Nortel Networks securities as early as October 24,
2000 and as late as February 15, 2001, allege, among other things,
violations of United States federal and Canadian provincial securities laws.
Securities regulatory authorities in Canada and the United States are also
reviewing these matters. On May 11, 2001, Nortel Networks filed motions to
dismiss and/or stay in connection with the three proceedings in Quebec
primarily based on the factual allegations lacking substantial connection to
Quebec and the inclusion of shareholders resident in Quebec in the class
claimed in the Ontario lawsuit. The plaintiffs in two of these proceedings
in Quebec obtained court approval for discontinuances of their proceedings
on January 17, 2002. The motion to dismiss and/or stay the third proceeding
was heard on November 6, 2001 and the court deferred any determination on
the motion to the judge who will hear the application for authorization to
commence a class proceeding. On December 6, 2001, Nortel Networks filed a
motion seeking leave to appeal that decision. The motion for leave to appeal
was dismissed on March 11, 2002. On October 16, 2001, an order in the
Southern District of New York was filed consolidating twenty-five of the
related United States class action lawsuits into a single case, appointing
class plaintiffs and counsel for such plaintiffs. The plaintiffs served a
consolidated amended complaint on January 18, 2002. On December 17, 2001,
the defendants in the British Columbia action served notice of a motion
requesting the court to decline jurisdiction and to stay all proceedings on
the ground that British Columbia is an inappropriate forum.
A class action lawsuit against Nortel Networks was also filed in the United
States District Court for the Southern District of New York on behalf of
shareholders who acquired the securities of JDS Uniphase Corporation ("JDS")
between January 18, 2001 and February 15, 2001, alleging violations of the
same United States federal securities laws as the above-noted lawsuits.
On July 17, 2002, a new purported class action lawsuit (the "Ontario Claim")
was filed in the Ontario Superior Court of Justice, Commercial List, naming
Nortel Networks, certain of its current and former officers and directors,
and its auditor as defendants. The factual allegations in the Ontario Claim
are substantially similar to the allegations in the consolidated amended
complaint filed in the United States District Court described above. The
Ontario Claim is on behalf of all Canadian residents who purchased Nortel
Networks securities (including options on Nortel Networks securities)
between October 24, 2000 and February 15, 2001. The plaintiffs claim damages
of Cdn.$5,000, plus punitive damages in the amount of Cdn.$1,000,
prejudgment and postjudgment interest, and costs of the action.
On April 1, 2002, Nortel Networks filed a motion to dismiss both the above
consolidated United States shareholder class action and the above JDS
shareholder class action complaints on the grounds that they failed to state
a cause of action under United States federal securities laws. With respect
to the JDS shareholder class action complaint, Nortel Networks also moved to
dismiss on the separate basis that JDS shareholders lacked standing to sue
Nortel Networks.
A purported class action lawsuit was filed in the United States District
Court for the Middle District of Tennessee on December 21, 2001, on behalf
of participants and beneficiaries of the Nortel Networks Long-Term
Investment Plan (the "Plan") at any time during the period of March 7, 2000
through the filing date and who made or maintained Plan investments in
Nortel Networks common shares, under the Employee Retirement Income Security
Act for Plan-wide relief and alleging, among other things, material
misrepresentations and omissions to induce Plan participants to continue to
invest in and maintain investments in Nortel Networks common shares in the
Plan. A second purported class action lawsuit, on behalf of the Plan and
Plan participants for whose individual accounts the Plan purchased Nortel
Networks common shares during the period from October 27, 2000 to February
15, 2001, and making similar allegations, was filed in the same court on
March 12, 2002. A third purported class action lawsuit, on behalf of persons
who are or were Plan participants or beneficiaries at any time since March
1, 1999 to the filing date, and making similar allegations, was filed in the
same court on March 21, 2002. The first and second purported class action
lawsuits were consolidated by a new purported class action complaint, filed
on May 15, 2002 in the same court and making similar allegations, on behalf
of Plan participants and beneficiaries who directed the Plan to purchase or
hold shares of certain funds, which held primarily Nortel Networks common
shares, during the period of March 7, 2000 through December 21, 2000. On
September 24, 2002, plaintiffs in the consolidated action filed a motion to
22
consolidate all the actions and to transfer them to the United States
District Court for the Southern District of New York.
On February 12, 2001, Nortel Networks Inc. ("NNI"), an indirect subsidiary
of Nortel Networks, was served with a consolidated amended class action
complaint (the "First Complaint") that purported to add Nortel Networks as a
defendant to a lawsuit commenced in July 2000 against Entrust, Inc.
(formerly Entrust Technologies, Inc.) ("Entrust") and two of its then
current officers in the United States District Court for the Eastern
District of Texas (Marshall Division) (the "District Court"). The First
Complaint alleges that Entrust, two officers of Entrust, and Nortel Networks
violated the Securities Exchange Act of 1934 with respect to certain
statements made by Entrust. Nortel Networks is alleged to be a controlling
person of Entrust. On April 6, 2001, Nortel Networks filed a motion to
dismiss the First Complaint. On July 31, 2001, the First Complaint was
dismissed without prejudice. On August 31, 2001, the plaintiffs filed a
second amended class action complaint (the "Second Complaint") against the
same defendants asserting claims substantively similar to those in the First
Complaint. On September 21, 2001, Nortel Networks filed a motion to dismiss
the Second Complaint. The motion was granted by the District Court on
September 30, 2002, and the Second Complaint was dismissed without leave to
amend. Plaintiff's time to appeal the decision of the District Court has not
yet expired.
On March 4, 1997, Bay Networks, Inc. ("Bay Networks"), a company acquired on
August 31, 1998, announced that shareholders had filed two separate lawsuits
in the United States District Court for the Northern District of California
(the "Federal Court") and the California Superior Court, County of Santa
Clara (the "California Court"), against Bay Networks and ten of Bay
Networks' then current and former officers and directors, purportedly on
behalf of a class of shareholders who purchased Bay Networks' common shares
during the period of May 1, 1995 through October 14, 1996. On August 17,
2000, the Federal Court granted the defendants' motion to dismiss the
federal complaint. On August 1, 2001, the United States Court of Appeals for
the Ninth Circuit denied the plaintiffs' appeal of that decision. On April
18, 1997, a second lawsuit was filed in the California Court, purportedly on
behalf of a class of shareholders who acquired Bay Networks' common shares
pursuant to the registration statement and prospectus that became effective
on November 15, 1995. The two actions in the California Court were
consolidated in April 1998; however, the California Court denied the
plaintiffs' motion for class certification. In January 2000, the California
Court of Appeal rejected the plaintiffs' appeal of the decision. A petition
for review was filed with the California Supreme Court by the plaintiffs and
was denied. In February 2000, new plaintiffs who allege to have been
shareholders of Bay Networks during the relevant periods, filed a motion for
intervention in the California Court seeking to become the representatives
of a class of shareholders. The motion was granted on June 8, 2001 and the
new plaintiffs filed their complaint-in-intervention on an individual and
purported class representative basis alleging misrepresentations made in
connection with the purchase and sale of securities of Bay Networks in
violation of California statutory and common law. On March 11, 2002, the
California Court granted the defendants' motion to strike the class
allegations. The plaintiffs were permitted to proceed on their individual
claims. The plaintiffs are appealing the dismissal of their class
allegations.
Except as otherwise described herein, in each of the matters described
above, plaintiffs are seeking an unspecified amount of money damages.
Nortel Networks is also a defendant in various other suits, claims,
proceedings and investigations which arise in the normal course of business.
Nortel Networks is unable to ascertain the ultimate aggregate amount of
monetary liability or financial impact of the above matters which, unless
otherwise specified, seek damages of material or indeterminate amounts.
Nortel Networks cannot determine whether these actions, suits, claims,
proceedings and investigations will, individually or collectively, have a
material adverse effect on the business, results of operations, and
financial condition of Nortel Networks. Nortel Networks and any named
directors and officers of Nortel Networks intend to vigorously defend these
actions, suits, claims, proceedings and investigations.
23
16. Credit facilities
Effective April 8, 2002, NNL and NNI amended and extended the 364-day
revolving syndicated credit agreements originally entered into on April 12,
2000 and subsequently amended on April 11, 2001. The April 8, 2002
amendments reduced the size of the 364-day committed revolving facilities to
$1,175 from $1,750, extended the term to April 7, 2003 with no additional
term-out period thereafter, maintained the financial covenant in the April
2001 facilities requiring NNL's minimum consolidated tangible net worth to
be not less than $1,888, and included higher pricing reflecting the then
current credit and bank environment.
During the nine months ended September 30, 2002, Nortel Networks sold
certain real estate in the United Kingdom, which resulted in reductions in
the available commitments under NNL's and NNI's December 20, 2001 credit
facilities by approximately $65 to $1,510.
17. Recent pronouncements
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"), which is effective for exit
or disposal activities initiated after December 31, 2002. SFAS 146
supercedes Emerging Issues Task Force ("EITF") Issue No. 94-3 "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in Restructuring)" ("EITF
94-3"). SFAS 146 requires that costs associated with an exit or disposal
activity be recognized when the liability is incurred, whereas EITF 94-3
required recognition of a liability when an entity committed to an exit
plan.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"), which is effective for financial
statements issued for fiscal years beginning after June 15, 2002. SFAS 143
addresses the recognition and remeasurement of obligations associated with
the retirement of a tangible long-lived asset.
Nortel Networks has not yet determined the effect that the adoption of SFAS
146 and 143 will have on its business, results of operations, and financial
condition.
18. Subsequent events
On October 17, 2002 Nortel Networks announced that it expects the $1,510
December 20, 2001 credit facilities, that mature December 13, 2002 and which
are currently undrawn, will not be amended or extended.
On October 17, 2002, Nortel Networks announced that the decline in world
capital markets and global interest rates over the past year have had a
significant negative impact on the investment assets and liabilities of
Nortel Networks registered pension plans which are managed by third parties.
As a result, Nortel Networks expects to record at December 31, 2002, a
non-cash charge to shareholder's equity, currently expected to be between
$600 and $700, related to the increase in the minimum required recognizable
deficit associated with these registered pension plans.
On October 7, 2002, Nortel Networks announced an agreement whereby it will
sell certain assets relating to its optical components business to Bookham
Technology plc ("Bookham") for consideration of 61 million common shares of
Bookham, 9 million warrants with a strike price of one-third pence Sterling,
debt of $50, and cash of $10. Under the terms of the agreement, Nortel
Networks will sell the transmitter and receiver business located in
Paignton, U.K., Ottawa, Canada, and Harlow, U.K., and the pump laser and
amplifiers business located in Paignton, U.K., Zurich, Switzerland, and
Poughkeepsie, New York. The assets sold include plant and equipment,
inventory, patents, other intellectual property and trademarks. The
transaction includes a 3-year supply agreement with a minimum purchase
commitment of approximately $120 for the first 18 months. This transaction
closed on November 8, 2002.
24
19. Supplemental consolidating financial information
As a result of NNL's current credit ratings, various liens, pledges, and
guarantees are effective under certain credit and security agreements
entered into by NNL and various of its subsidiaries and will remain
effective notwithstanding Nortel Networks announcement on October 17, 2002
that it expects its $1,510 December 20, 2001 credit facilities, that mature
December 13, 2002, to expire without extension or amendment. In addition, in
accordance with the covenants in the trust indentures for all of Nortel
Networks current consolidated public debt securities, which represent
primarily all of Nortel Networks consolidated long-term debt at September
30, 2002, all such public debt securities are also secured equally and
ratably with the obligations under all of NNL and NNI's credit agreements by
liens on substantially all of the assets of NNL and those of most of its
United States and Canadian subsidiaries, and by pledges of shares in certain
of NNL's other subsidiaries. In addition, certain of NNL's wholly owned
subsidiaries have guaranteed NNL's obligations under the credit agreements
and outstanding public debt securities (the "Guarantor Subsidiaries").
Non-guarantor subsidiaries (the "Non-Guarantor Subsidiaries") represent
either wholly owned subsidiaries of Nortel Networks whose shares have been
pledged, or are the remaining subsidiaries of Nortel Networks which are not
providing liens, pledges, or guarantees.
The following supplemental consolidating financial data illustrates, in
separate columns, the composition of Nortel Networks Corporation, NNL, the
Guarantor Subsidiaries, the Non-Guarantor Subsidiaries, eliminations, and
the consolidated total as at September 30, 2002 and December 31, 2001, and
for the three months and nine months ended September 30, 2002 and 2001.
Investments in subsidiaries are accounted for by the equity method for
purposes of the supplemental consolidating financial data. Net earnings
(loss) of subsidiaries are, therefore, reflected in the investment accounts
and net loss. The principal elimination entries eliminate investments in
subsidiaries and intercompany balances and transactions. The financial data
may not necessarily be indicative of the results of operations or financial
position had the subsidiaries been operated as independent entities.
25
Supplemental Consolidating Statements of Operations for the three months ended
September 30, 2002:
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NORTEL NORTEL NON-
NETWORKS NETWORKS GUARANTOR GUARANTOR
CORPORATION LIMITED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 604 $ 1,780 $ 665 $ (694) $ 2,355
Cost of revenues - 527 1,143 478 (694) 1,454
- --------------------------------------------------------------------------------------------------------------------------------
Gross profit - 77 637 187 - 901
Selling, general and administrative expense
(excluding stock option compensation) - 245 394 43 - 682
Research and development expense - 235 251 79 - 565
Amortization of acquired technology - - 6 32 - 38
Stock option compensation - - - 22 - 22
Special charges - 194 591 409 - 1,194
- --------------------------------------------------------------------------------------------------------------------------------
Operating loss - (597) (605) (398) - (1,600)
Equity in net loss of associated companies (2,306) (1,210) (79) (2) 3,592 (5)
Other income (expense) - net 528 (46) 71 (24) (531) (2)
Interest expense
Long-term debt (21) (28) - (6) - (55)
Other - - (6) (6) - (12)
- --------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations
before income taxes (1,799) (1,881) (619) (436) 3,061 (1,674)
Income tax benefit (provision) - (75) (62) 12 - (125)
- --------------------------------------------------------------------------------------------------------------------------------
Net loss from continuing operations (1,799) (1,956) (681) (424) 3,061 (1,799)
Net loss from disc