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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)