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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, 2000
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 0-30758
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 SEPTEMBER 30, 2000
1,456,889,062 COMMON SHARES WITHOUT NOMINAL OR PAR VALUE
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TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
PAGE
ITEM 1. Financial Statements (unaudited)........................ 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............20
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk......................................41
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings.......................................42
ITEM 6. Exhibits and Reports on Form 8-K........................42
SIGNATURES ........................................................43
ALL DOLLAR AMOUNTS IN THIS DOCUMENT ARE IN UNITED STATES DOLLARS
UNLESS OTHERWISE STATED.
Nortel Networks and Unified Networks are trademarks of Nortel Networks Limited.
Bay Networks is a trademark of Nortel Networks NA Inc.
FrontOffice is a trademark of Clarify Inc.
IMAS is a trademark of Promatory Communications, Inc.
2
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Contents of Consolidated Financial Statements
PAGE
Consolidated Statements of Operations....................... 4
Consolidated Balance Sheets................................. 5
Consolidated Statements of Cash Flows....................... 7
Notes to Consolidated Financial Statements.................. 8
3
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NORTEL NETWORKS LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(MILLIONS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 7,303 $ 5,147 $ 21,446 $ 14,714
Cost of revenues 4,085 2,985 12,288 8,401
------------------------------------------------------------------------------------
Gross profit 3,218 2,162 9,158 6,313
Selling, general and administrative
expense (excluding
stock option compensation) 1,372 952 4,045 2,789
Research and development expense 996 767 2,856 2,178
In-process research and development - - 673 184
expense
Amortization of intangibles
Acquired technology 207 171 596 513
Goodwill 739 306 1,939 893
Stock option compensation 29 - 96 -
Special charges - 63 195 116
Gain on sale of businesses - (110) (174) (110)
------------------------------------------------------------------------------------
(125) 13 (1,068) (250)
Equity in net earnings (loss) of (16) 29 (22) -
associated companies
Other income - net 242 34 852 124
Interest expense
Long-term debt (22) (27) (69) (74)
Other (16) (11) (48) (40)
------------------------------------------------------------------------------------
Earnings (loss) before income taxes 63 38 (355) (240)
Income tax provision 238 110 821 262
------------------------------------------------------------------------------------
Net loss (175) (72) (1,176) (502)
Dividends on preferred shares 7 7 23 21
------------------------------------------------------------------------------------
Net loss applicable to common shares $ (182) $ (79) $ (1,199) $ (523)
====================================================================================
</TABLE>
4
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NORTEL NETWORKS LIMITED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(MILLIONS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
-----------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,708 $ 2,153
Accounts receivable (less provision for uncollectibles -
$400 at September 30, 2000; $319 at December 31, 1999) 7,316 5,815
Inventories 4,060 2,823
Prepaid expenses and other assets 1,061 559
Deferred income taxes - net 993 826
-----------------------------------------------------------------------------------
15,138 12,176
-----------------------------------------------------------------------------------
LONG-TERM RECEIVABLES (less provision for uncollectibles -
$310 at September 30, 2000; $284 at December 31, 1999) 1,228 1,356
-----------------------------------------------------------------------------------
INVESTMENTS AT COST AND ASSOCIATED COMPANIES AT EQUITY 858 1,072
-----------------------------------------------------------------------------------
PLANT AND EQUIPMENT (net of accumulated amortization -
$2,796 at September 30, 2000; $2,857 at December 31, 1999) 2,896 2,333
-----------------------------------------------------------------------------------
LONG-TERM DEFERRED INCOME TAXES - NET 115 362
INTANGIBLE ASSETS
Acquired technology - net 876 1,202
Goodwill - net 8,011 5,093
-----------------------------------------------------------------------------------
8,887 6,295
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OTHER ASSETS 494 413
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TOTAL ASSETS $29,616 $24,007
===================================================================================
</TABLE>
5
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NORTEL NETWORKS LIMITED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(MILLIONS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------------------------------------------------------------------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 273 $ 209
Accounts payable and accrued liabilities
Trade and other payables 2,709 2,360
Payroll and benefit-related liabilities 938 818
Other accrued liabilities 3,306 3,191
Income taxes payable 299 488
Long-term debt due within one year 300 35
--------------------------------------------------------------------------------
7,825 7,101
LONG-TERM LIABILITIES
Deferred income 69 53
Long-term debt 1,242 1,391
Deferred income taxes - net 666 767
Other liabilities 1,023 966
--------------------------------------------------------------------------------
10,825 10,278
--------------------------------------------------------------------------------
MINORITY INTEREST IN SUBSIDIARY COMPANIES 188 48
--------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (note 14)
SHAREHOLDERS' EQUITY
Preferred shares, without par value - Authorized
shares: unlimited; Issued and outstanding
shares: 30,000,200 for 2000 and 1999 609 609
Common shares, without par value - Authorized
shares: unlimited; Issued and outstanding
shares: 1,453,333,924 at September 30, 2000
and 1,377,154,698 at December 31, 1999 17,012 11,745
Additional paid-in capital 1,832 794
Retained earnings (deficit) (285) 967
Accumulated other comprehensive loss (565) (434)
--------------------------------------------------------------------------------
18,603 13,681
--------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $29,616 $24,007
================================================================================
</TABLE>
6
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NORTEL NETWORKS LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(MILLIONS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
2000 1999
--------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net loss $(1,176) $ (502)
Adjustments to reconcile net loss to net cash used in operating
activities, net of effects from acquisitions and divestitures of businesses:
Amortization 3,014 1,857
In-process research and development 673 184
Equity in net loss of associated companies 22 -
Stock option compensation 96 -
Tax benefit from stock options 408 116
Increase (decrease) in deferred incomes taxes 63 (123)
Increase in other liabilities 56 69
Gain on sale of businesses and investments (791) (162)
Other - net (33) (96)
Change in operating assets and liabilities:
Accounts receivable (357) (1,321)
Inventories (1,469) (885)
Income taxes payable (187) 16
Accounts payable and accrued liabilities (542) 712
Other operating assets and liabilities (634) (101)
--------------------------------------------------------------------------------------------------
Net cash used in operating activities (857) (236)
--------------------------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Expenditures for plant and equipment (1,140) (543)
Proceeds on disposals of plant and equipment 33 14
Increase in long-term receivables (669) (367)
Decrease in long-term receivables 621 143
Acquisitions of investments and businesses - net of cash acquired (318) (722)
Proceeds on sale of businesses and investments 1,735 532
--------------------------------------------------------------------------------------------------
Net cash from (used in) investing activities 262 (943)
--------------------------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Dividends on common and preferred shares (76) (175)
Increase in notes payable 134 73
Decrease in notes payable (76) (67)
Additions to long-term debt 50 -
Reductions of long-term debt (62) (120)
Increase (decrease) in capital leases payable 8 (4)
Issuance of common shares 207 439
Common shares purchased for cancellation - (11)
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Net cash from financing activities 185 135
--------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (35) 3
--------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (445) (1,041)
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CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD - NET 2,153 2,230
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CASH AND CASH EQUIVALENTS AT END OF PERIOD - NET $ 1,708 $ 1,189
--------------------------------------------------------------------------------------------------
</TABLE>
7
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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 (the "Corporation"; also
referred to herein as "Old Nortel") and a newly formed Canadian
corporation ("New Nortel") participated in a Canadian court-approved plan
of arrangement (the "Arrangement") with BCE Inc. ("BCE"). 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 remain
outstanding and continue to be obligations of the Corporation.
As part of the Arrangement, the outstanding common shares of Old Nortel
were exchanged for common shares of New Nortel. Immediately prior to the
Arrangement, approximately 36 percent of the outstanding common shares of
Old Nortel were held by BCE. A substantial portion of the New Nortel
common shares issuable in respect of BCE's interest in Old Nortel was,
through the Arrangement, indirectly distributed to BCE common
shareholders. The aggregate number of New Nortel common shares issued in
the Arrangement was the same as the aggregate number of Old Nortel common
shares outstanding immediately prior to the Arrangement (excluding the
effects of the reservation of certain shares for issuance pursuant to
stock option plans). The consolidated assets and liabilities of New
Nortel and its subsidiaries immediately after the Arrangement were the
same as those of Old Nortel and its subsidiaries immediately prior to the
Arrangement (except for differences attributable to the accounting
treatment accorded to the outstanding preferred shares of Old Nortel).
All of the business and operations conducted by Old Nortel and its
subsidiaries prior to the effective date of the Arrangement continued to
be conducted by Old Nortel and its subsidiaries as subsidiaries of New
Nortel after the Arrangement.
In addition, as part of the Arrangement, New Nortel implemented a
two-for-one stock split with respect to its common shares (the "New
Nortel Stock Split"). In contrast, the Corporation's common shares did
not split as a result of the Arrangement.
Due to the fact that all of the Corporation's common shares are held by
New Nortel and are no longer publicly traded, information concerning the
Corporation's earnings (loss) per common share, and weighted average
number of common shares outstanding have not been presented in these
consolidated financial statements. For information regarding New Nortel's
loss per common share, and weighted average number of shares outstanding,
see the Nortel Networks Corporation Quarterly Report on Form 10-Q for the
period ended September 30, 2000.
These consolidated financial statements and the notes thereto relate to
the operations of the Corporation and its subsidiary companies
(collectively, "Nortel Networks").
2. ACCOUNTING POLICIES
The consolidated financial statements of the Corporation have been
prepared in accordance with accounting principles generally accepted in
the United States of America. Although the Corporation is headquartered
in Canada, the consolidated financial statements are expressed in United
States dollars as the greater part of the earnings and net assets of the
Corporation are denominated in United States dollars.
8
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Basis of presentation
The preparation of the Corporation's consolidated financial statements in
conformity with generally accepted accounting principles ("GAAP")
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, inventory obsolescence, product
warranty, amortization, employee benefits, taxes, provisions, in-process
research and development, and contingencies.
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 interim
consolidated financial statements are not necessarily indicative of
financial results for the full year. These Consolidated Financial
Statements (unaudited) should be read in conjunction with the audited
Consolidated Financial Statements and notes thereto for the year ended
December 31, 1999 prepared in accordance with United States GAAP and
included in the Current Report on Form 8-K of the Corporation dated
August 7, 2000 as amended by the Current Report on Form 8-K/A of the
Corporation dated August 18, 2000 (collectively referred to as the "U.S.
GAAP Form 8-K").
3. INFORMATION ON OPERATING SEGMENTS
General description
For a full description of Nortel Networks' operating segments, reference
should be made to the U.S. GAAP Form 8-K.
Operating segments
To reflect the evolution of certain businesses within the management
structure, revenues by segment for the third quarter and first nine
months of 1999 have been reclassified. Accordingly, the amounts for
earnings (loss) before income taxes for the third quarter and first nine
months of 1999 have also been reclassified. The primary effect of these
reclassifications was to move certain businesses among the segments to
more closely align the businesses with their primary customers. The
following tables set forth information by operating segments for the
third quarter of 2000 and 1999, and the first nine months of 2000 and
1999, respectively.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 2000
--------------------------------------------------------------------------------------
CORPORATE
SP&C ENTERPRISE & OTHER TOTAL
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
External revenues $5,989 $1,313 $ 1 (a) $ 7,303
Earnings (loss) before income taxes $ 803 $ 49 $ (789) (b) $ 63
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
---------------------------------------------
<S> <C> <C> <C> <C>
Total assets $14,732 $ 2,099 $12,785 $29,616
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 1999
---------------------------------------------------------------------------------------
CORPORATE
SP&C ENTERPRISE & OTHER TOTAL
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
External revenues $3,885 $1,241 $ 21 (a) $5,147
Earnings (loss) before income taxes 440 108 (510) (b) $ 38
</TABLE>
9
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<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 2000
-------------------------------------------------------------------------------------
CORPORATE
SP&C ENTERPRISE & OTHER TOTAL
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
External revenues $17,597 $ 3,844 $ 5 (a) $21,446
Earnings (loss) before income taxes $ 2,338 $ 57 $ (2,750) (b) $ (355)
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1999
---------------------------------------------------------------------------------------
CORPORATE
SP&C ENTERPRISE & OTHER TOTAL
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
External revenues $ 10,985 $ 3,663 $ 66 (a) $ 14,714
Earnings (loss) before income taxes $ 1,250 $ 324 $ (1,814) (b) $ (240)
</TABLE>
(a) Represents revenues from business units below the quantitative thresholds.
(b) Includes corporate services, the organization that manages the centralized
internal functions of the Corporation. Corporate services is managed on a
"fee for service" basis. The corporate services expenses are charged to the
operating segments either on a direct basis or through a matrix allocation.
Direct charges are based on actual usage of services while matrix
allocation is based on revenue, headcount or some other appropriate factor.
Costs not charged to the operating segments remain within Corporate &
Other. Includes the impact of "Acquisition Related Costs" (in-process
research and development expense, and the amortization of acquired
technology and goodwill from the August 1998 acquisition of Bay Networks,
Inc. and all subsequent acquisitions), stock option compensation from
acquisitions and divestitures, and one-time gains and charges, but excludes
the impact of dividends on preferred shares.
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4. ACQUISITIONS
The following table sets out certain information for acquisitions
completed by Nortel Networks in the first nine months of 2000. The
remainder of the purchase price information is outlined in the narrative
below the table. All of these acquisitions were accounted for using the
purchase method. The consolidated financial statements include the
operating results of each of these businesses from the date of
acquisition.
All acquisitions completed prior to May 1, 2000 were consummated by the
Corporation or its subsidiaries. Since May 1, 2000, acquisitions
involving any share consideration have been consummated by New Nortel and
are not reflected below, while acquisitions not involving share
consideration have continued to be consummated by the Corporation or its
subsidiaries and therefore are reflected below. The number of common
shares of the Corporation issued as consideration and the number of stock
options assumed on the closing of these acquisitions are stated below as
of the completion dates and, accordingly, have not been restated to
reflect the impact of the Arrangement including the exchange of the
Corporation's common shares for New Nortel's common shares and the New
Nortel Stock Split. For information regarding acquisitions consummated by
New Nortel since May 1, 2000, see the Nortel Networks Corporation
Quarterly Report on Form 10-Q for the period ended September 30, 2000.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 2000
-------------------------------------------------------------------------------------------------------
PURCHASE ACQUIRED
ACQUISITION DATE PRICE TECHNOLOGY IPR&D GOODWILL
----------- ---------- ---------- ---------- ------- ------------
<S> <C> <C> <C> <C> <C>
Photonic (i) May 12 $ 32 $ - $ - $ 29
Promatory (ii) March 23 $ 741 $ 60 $ 50 $ 641
Clarify (iii) March 16 $ 2,114 $ 210 $ 64 $ 1,814
Qtera (iv) January 28 $ 3,004 $ - $ 559 $ 2,424
Dimension (v) January 24 $ 37 $ - $ - $ 30
Other (vi)
</TABLE>
Form of consideration and other
(i) Photonic Technologies, Inc. ("Photonic") was a developer of optical
component technology for the manipulation and control of the
polarization of light. In connection with the acquisition, Nortel
Networks paid approximately $32 in cash to acquire the remaining
approximate two-thirds ownership interest in Photonic that it did
not previously own. The maximum contingent consideration is
approximately $5, payable in cash upon Photonic achieving certain
business performance objectives by the end of 2002. The allocation
of the purchase price included net tangible assets of $3. Goodwill
is being amortized on a straight-line basis over three years.
(ii) Promatory Communications, Inc. ("Promatory") was a developer of
Digital Subscriber Line ("DSL") platforms for high-speed Internet
access. In connection with the acquisition, approximately 6.9
million common shares of the Corporation were issued, of which
approximately 0.6 million common shares of the Corporation were
issued into escrow related to contingent consideration payable by
the Corporation upon the achievement by Promatory of certain
business performance objectives in 2000. The Corporation also
assumed the equivalent of approximately 0.1 million stock options
to purchase common shares of the Corporation. The fair value of the
assumed Promatory stock options, using the Black-Scholes valuation
model, was $14. These shares and stock options exclude the common
shares that are to be issued to the former holders of assumed stock
options on the achievement of certain business objectives. The
maximum contingent consideration is approximately $75, payable
11
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by the issuance of common shares of the Corporation upon Promatory
achieving certain business performance objectives. As at September 30,
2000, approximately $27 of the contingent consideration had been earned by
Promatory upon achievement of business performance objectives and has been
included in goodwill. The allocation of the purchase price included assumed
net tangible liabilities of $10. The acquired technology assets are being
charged to earnings on a straight-line basis over three years and the IPR&D
assets were charged to earnings in the period. Goodwill is being amortized
on a straight-line basis over three years.
(iii) Clarify Inc. ("Clarify") was a provider of eBusiness front office
solutions. In connection with the acquisition, the Corporation issued
approximately 31.7 million common shares of the Corporation and assumed the
equivalent of approximately 8.8 million stock options to purchase common
shares of the Corporation. The fair value of the assumed Clarify stock
options, using the Black-Scholes valuation model, was $363. The allocation
of the purchase price included net tangible assets of $26. The acquired
technology assets are being charged to earnings on a straight-line basis
over two years and the IPR&D assets were charged to earnings in the period.
Goodwill is being amortized on a straight-line basis over three years.
(iv) Qtera Corporation ("Qtera") was a producer of ultra-long-reach optical
networking systems. In connection with the acquisition, the Corporation
issued approximately 28.2 million common shares of the Corporation, of
which approximately 5.2 million common shares of the Corporation were
issued into escrow related to contingent consideration payable by the
Corporation upon the achievement by Qtera of certain business performance
objectives in 2000. The Corporation also assumed the equivalent of
approximately 3.7 million stock options to purchase common shares of the
Corporation and 0.9 million warrants convertible into common shares of the
Corporation. The fair values of the assumed Qtera stock options and
warrants, using the Black-Scholes valuation model were $385 and $78,
respectively. These shares, stock options, and warrants exclude the common
shares that are to be issued to the former holders of assumed stock options
and warrants on the achievement of certain business performance objectives.
The maximum contingent consideration is approximately $500, payable by the
issuance of common shares of the Corporation, upon Qtera achieving certain
business performance objectives. As at September 30, 2000, approximately
$300 of the contingent consideration had been earned by Qtera upon
achievement of business performance objectives and has been included in
goodwill. The allocation of the purchase price included net tangible assets
of $21. The IPR&D assets were charged to earnings in the period and
goodwill is being amortized on a straight-line basis over three years.
(v) Dimension Enterprises, Inc. ("Dimension") was an engineering and business
strategy consulting firm. In connection with the acquisition, Nortel
Networks paid approximately $37 in cash for Dimension. The maximum
contingent consideration is approximately $34, payable in cash upon
Dimension achieving certain business performance objectives by the end of
2002. The allocation of the purchase price included net tangible assets of
$7. Goodwill is being amortized on a straight-line basis over four years.
(vi) Other
Nortel Dasa
Effective January 1, 2000, Nortel Networks increased its ownership interest
in Nortel Dasa Network Systems GmbH and Co. KG ("Nortel Dasa"), previously
a joint venture with DaimlerChrysler Aerospace AG in Germany, from a 50
percent joint control interest to a 58 percent controlling interest.
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MNC
Effective January 1, 2000, Nortel Networks increased its
ownership interest in Matra Nortel Communications SAS ("MNC"),
previously a joint venture with Aerospatiale Matra in France,
from a 50 percent joint control interest to a 55 percent
controlling interest.
In-process research and development
In-process research and development ("IPR&D") charges represent the value
on completion of a business combination of the acquired research and
development which was not technologically feasible as of the acquisition
date and, other than its intended use, had no alternative future use.
Included in the purchase price allocations was an aggregate amount of
IPR&D of $673 for the nine months ended September 30, 2000. Independent
valuations were performed to assess and allocate a value to IPR&D. The
value allocated to IPR&D represented the estimated fair value based on
risk-adjusted future cash flows generated from the products that would
result from each of the in-process projects. Estimated future after-tax
cash flows of each project, on a product by product basis, were based on
Nortel Networks' estimates of revenues less operating expenses, cash flow
adjustments, income taxes, and charges for the use of contributory
assets. Future cash flows were also adjusted for the value contributed by
any core technology and development efforts that were completed
post-acquisition.
Revenues were estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles, the estimated
life of each product's underlying technology, and historical pricing.
Estimated operating expenses include cost of goods sold, selling, general
and administrative, and research and development ("R&D") expenses. The
estimated R&D expenses include costs to maintain the products once they
have been introduced into the market and are generating revenues, and
costs to complete the IPR&D. Operating expense estimates were consistent
with historical margins and expense levels for similar products.
The discount rates used to discount the projected net returns were based
on a weighted average cost of capital relative to Nortel Networks and the
high technology industry, as well as the product-specific risk associated
with the IPR&D projects. Product-specific risk includes the stage of
completion of each product, the complexity of the development work
completed to date, the likelihood of achieving technological feasibility,
and market acceptance.
The forecast data employed in the analyses was based upon both forecast
information maintained by the acquired companies and Nortel Networks'
estimate of future performance of the business. The inputs used by Nortel
Networks in analyzing IPR&D were based upon assumptions that Nortel
Networks believes to be reasonable but which are inherently uncertain and
unpredictable. These assumptions may be incomplete or inaccurate, and no
assurance can be given that unanticipated events and circumstances will
not occur. Accordingly, actual results may vary from the forecasted
results. While Nortel Networks believes that all of the development
projects will be successfully completed, failure of any of these projects
to achieve technological feasibility, and/or any variance from forecasted
results, may result in a material adverse effect on the business, results
of operations and financial condition of Nortel Networks.
The following updates projects that were in-process during the third
quarter of 2000 and related to acquisitions completed prior to the third
quarter of 2000:
Promatory
THE INTELLIGENT MULTISERVICE ACCESS SYSTEM ("IMAS") - THE 5.0 SERIES OF
RELEASES. IMAS is a broadband access platform that delivers business and
residential-class DSL services and accommodates all varieties of DSL with
direct integration into the optical Internet backbone. The initial 5.0
release was completed and began to contribute to Nortel Networks'
revenues in the third quarter of 2000.
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Clarify
FRONTOFFICE - RELEASE 9.0. FrontOffice is a fully scalable Customer
Relationship Management software product that allows companies to
effectively manage all aspects of the customer relationship throughout
the customer lifecycle. FrontOffice allows companies to automate and
integrate the collection and utilization of customer information obtained
from each point of contact, including sales staff, call center
representatives, field staff, and technical personnel. FrontOffice -
Release 9.0 is intended to provide new eBusiness initiatives that are
fully integrated with the existing set of application modules. This
project was completed and began to contribute to Nortel Networks'
revenues in the second quarter of 2000. A subsequent release is currently
in process and on schedule, with the completed project expected to begin
to contribute to Nortel Networks' revenues in the fourth quarter of 2000.
Qtera
PHOTONIC NETWORKING SYSTEMS. Photonic Networking Systems are
ultra-long-reach optical networking systems. These systems allow for
scalable optical Internet capabilities, which enable high performance,
rapid wavelength provisioning and restoration, and low cost survivable
bandwidth. This project is on schedule and the completed project is
expected to contribute to Nortel Networks' revenues by the end of 2000.
Periphonics
VPS/IS VERSION 6.X. The Voice Processing Services Information Server
("VPS/is") is a scalable transaction processing system that can be
configured for both small and very large installations. The system allows
a caller to access information in an organization's computer database
through a touch-tone telephone, speech input or the Internet, and to
receive the information from that database in the form of a
computer-generated voice response. Version 6.x represents a redesign of
the existing VPS/is product, which would include reduced system cost,
higher density, more features, greater reliability, and increased
scalability. This project was completed in the third quarter of 2000, and
is expected to begin to contribute to Nortel Networks' revenues in the
fourth quarter of 2000.
In order for Nortel Networks to succeed in the highly competitive and
rapidly changing marketplace in which it operates, acquired assets must
be integrated quickly into its Unified Networks solutions as enhancements
of existing technology or as part of a larger platform. It is Nortel
Networks' normal practice to begin the integration of all acquired
businesses (including management responsibilities, financial reporting
and human resources) immediately following the closing of the
transaction. As such, Nortel Networks does not specifically track
revenues generated from completed IPR&D projects of acquired businesses
subsequent to the closing and integration of acquisitions.
5. RESEARCH AND DEVELOPMENT
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
R&D expense $ 996 $ 767 $ 2,856 $ 2,178
R&D costs incurred on behalf of others* 14 45 49 94
---------------------------------------------------------------------------------------------------------------
Total $ 1,010 $ 812 $ 2,905 $ 2,272
===============================================================================================================
</TABLE>
* These costs include R&D charged to customers of Nortel Networks
pursuant to contracts that provide for full recovery for the
estimated cost of development, material, engineering,
installation, and all other attracted costs, which are accounted
for as contract costs.
14
<PAGE> 15
6. OTHER COSTS
2000
For the third quarter and first nine months of 2000, Nortel Networks
recorded special charges of nil and $195, respectively, relating to
restructuring and other charges, and one-time costs totalling nil and $2
for the same periods, respectively. In addition, Nortel Networks recorded
stock option compensation of $31 and $98 for the third quarter and first
nine months of 2000, respectively, primarily related to the impact of the
Arrangement on stock options held by former Nortel Networks employees who
had transferred to BCE or a BCE affiliated company. The related charge of
$67 for the first six months of 2000 has been reclassified to stock
option compensation from special charges to conform to the current
period's presentation.
Special charges
Restructuring activities involved the continued implementation of Nortel
Networks' strategic resource realignment initiative, which was approved
and began in the fourth quarter of 1999. An additional restructuring
activity involved the termination of employees in MNC, a subsidiary of
the Corporation located in France, as a result of technological shifts
within the industry.
Workforce reduction charges of $73 represented the cost of severance and
related benefits for the termination of approximately 1,600 employees in
the above noted restructuring activities. Workforce reduction costs of
approximately $66 were principally related to approximately 1,500
employees, primarily located in North America within SP&C and Enterprise.
The remaining $7 of the workforce reduction charge related to
approximately 100 employees in MNC within Enterprise.
A contract settlement charge of $4 reflects costs for computer equipment
for the 1,600 employees impacted in the workforce reduction, and
penalties for Nortel Networks' withdrawal from certain trade events.
Other charges primarily represented a reduction of the goodwill related
to MNC. Nortel Networks changed its business mandate for MNC from the
product focus for which it was acquired, and restructured the business to
a focus on distribution channels.
The provision balance has been drawn down by $147 resulting in a
provision balance of $48 as at September 30, 2000. The remaining
provision is expected to be substantially drawn down by December 31,
2000.
One-time costs
One-time costs of $2 related to inventory provisions associated with
restructuring and were recorded in cost of revenues.
1999
In the year ended December 31, 1999, Nortel Networks recorded special
charges aggregating to $160 relating to restructuring costs and one-time
costs of $49.
Special charges
Restructuring activities involved Nortel Networks' exit of the Satellite
and Time Division Multiple Access small switch operations within SP&C,
and the Consumer Products and Open Speech operations within Enterprise.
The restructuring activities also involved the consolidation of the
Broadband Wireless Access operations, as well as the streamlining of SP&C
manufacturing operations related to Nortel Networks' operations strategy
announced in January 1999.
15
<PAGE> 16
Also reflected in the 1999 restructuring costs were charges associated
with Nortel Networks' initiative to realign its resource investment into
growth areas in response to industry shifts as well as to create
efficiencies within Nortel Networks' existing organizations. This
initiative impacted various organizations within SP&C and Enterprise,
largely within North America, including the Mobility, Marketing and
Communications, Global Service, and Portfolio Networks organizations.
Nortel Networks also restructured, for purposes of outsourcing, certain
of its corporate processes including payroll, accounts payable, training
and resourcing functions.
The provision balance has been drawn down by $129 resulting in a
provision balance of $31 as at September 30, 2000. The remaining
provision is expected to be substantially drawn down by December 31,
2000.
One-time costs
One-time costs included a charge of $16 for the write-off of the
remaining book value of redundant raw materials inventory related to the
Consumer Products operations and the SP&C operations and were recorded in
cost of revenues. One-time costs also included a charge of $33, which was
recorded in selling, general and administrative expenses and related to
Nortel Networks' coverage of an obligation by a customer to a third party
and the settlement of a patent infringement lawsuit.
7. GAIN ON SALE OF BUSINESSES
Gain on sale of businesses for the third quarter and first nine months of
2000 totalled nil and $174, respectively, and $110 for each of the third
quarter and first nine months of 1999. The gain for the first nine months
of 2000, and the third quarter and first nine months of 1999 related to
the divestiture of certain manufacturing operations and tangible and
intangible assets in connection with Nortel Networks' operations
strategy.
8. OTHER INCOME - NET
Other income - net for the third quarter and first nine months of 2000
totalled $242 and $852, respectively, and for the third quarter and first
nine months of 1999 totalled $34 and $124, respectively. Other income -
net for the third quarter of 2000 primarily related to a $169 pre-tax
($116 after-tax) gain due to a reduction in Nortel Networks' investment
in Entrust Technologies, Inc. ("Entrust Technologies") from 33.5 percent
to 27.0 percent, primarily as a result of Entrust Technologies' issuance
of common shares in connection with its acquisition of enCommerce, Inc.
(the "Entrust Technologies Transaction"). Other income - net for the
first nine months of 2000 primarily related to the Entrust Technologies
Transaction and a $513 pre-tax ($344 after-tax) gain from the sale by
Nortel Networks of a portion of its share ownership in Entrust
Technologies in the first quarter of 2000.
9. INCOME TAXES
Excluding the impact of after-tax charges of Acquisition Related Costs,
stock option compensation and, where applicable, certain of the one-time
gains and charges, Nortel Networks' effective income tax rate was 29.9
percent and 32.0 percent for the third quarter and first nine months of
2000, respectively, compared with 34.6 percent for each of the same
periods in 1999. The decrease in Nortel Networks' effective tax rate was
primarily due to changes in its geographic mix of earnings.
Global investment tax credits of $52 and $134 for the third quarter and
first nine months of 2000, respectively, and $33 and $104 for the third
quarter and first nine months of 1999, respectively, have been applied
against the income tax provision.
16
<PAGE> 17
10. COMPREHENSIVE LOSS
Comprehensive loss represents the change, during the period, in net
assets of Nortel Networks from transactions and other events and
circumstances from non-owner sources. The components of comprehensive
loss, net of tax, for the third quarter and first nine months of 2000 and
1999, respectively, were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net loss applicable to common shares $ (182) $ (79) $ (1,199) $ (523)
Other comprehensive income (loss):
Change in foreign currency translation adjustment* (26) (11) (145) (90)
Change in unrealized gain on investments -- net** (25) -- 14 (10)
----------------------------------------------------------------------------------------------------------
Comprehensive loss $ (233) $ (90) $ (1,330) $ (623)
==========================================================================================================
</TABLE>
* 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.
** 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 earnings and are
included in comprehensive loss until they are realized.
11. RELATED PARTY TRANSACTIONS
In the ordinary course of business, Nortel Networks engages in
transactions with certain of its equity-owned investees that are under or
are subject to Nortel Networks' significant influence and with joint
ventures of Nortel Networks. These transactions are sales and purchases
of goods and services under usual trade terms and are measured at their
exchange amounts.
Receivables with related parties included in accounts receivable totalled
nil and $318 as at September 30, 2000 and December 31, 1999,
respectively. Accounts payable with related parties included in trade and
other payables totalled $150 and $1 as at September 30, 2000 and December
31, 1999, respectively. Revenue and purchase transactions with related
parties for the third quarter and first nine months of 2000 and 1999,
respectively, are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 93 $ 420 $ 603 $ 1,151
Purchases $ 99 $ 78 $ 303 $ 138
</TABLE>
Effective May 1, 2000, in conjunction with the Arrangement, BCE's
ownership interest was reduced from approximately 36 percent of the
Corporation's common shares immediately prior to the Arrangement to a
nominal ownership interest in New Nortel. As a result, BCE and entities
that are owned by BCE are no longer considered related parties after the
Arrangement.
17
<PAGE> 18
12. INVENTORIES
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 661 $ 696
Work in process 954 819
Finished goods 2,445 1,308
------------------------------------------------------------------------------------
$ 4,060 $ 2,823
</TABLE>
13. CONSOLIDATED STATEMENTS OF CASH FLOWS
Interest and income taxes paid
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------------------------------------------------
2000 1999 2000 1999
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest paid $ 28 $ 25 $ 99 $ 109
Income taxes paid $ 289 $ 77 $ 732 $ 349
</TABLE>
14. COMMITMENTS AND CONTINGENCIES
Contingencies
On March 4, 1997, Bay Networks 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 case and on September 8, 2000, a notice
of appeal was filed by the plaintiffs. 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 on February 28, 2000 and is under submission.
In June 1993, certain holders of the Corporation's securities commenced a
class action in the United States District Court for the Southern
District of New York alleging that the Corporation and certain of its
officers violated the Securities Exchange Act of 1934 and common law by
making material misstatements of, or omitting to state, material facts
relating to the business operations and prospects and financial condition
of the Corporation. In January 2000, the court heard arguments on the
Corporation's motion for summary judgment with respect to all claims in
the case. On September 28, 2000, the court granted summary judgment and
dismissed the consolidated action. Any appeal by the plaintiffs of this
decision must be filed with the court on or before November 2, 2000.
Nortel Networks is also a defendant in various other suits, claims and
investigations which arise in the normal course of business.
18
<PAGE> 19
Nortel Networks is unable to ascertain the ultimate aggregate amount of
monetary liability or financial impact of these matters and therefore
cannot determine whether these actions will, individually or
collectively, have a material adverse effect on the business, results of
operations and financial condition of Nortel Networks. The Corporation
and any named directors and officers intend to vigorously defend these
actions.
15. RECENT PRONOUNCEMENTS
In December 1999, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"), which provides guidance related to revenue
recognition. SAB 101 allows companies to report any changes in revenue
recognition related to the adoption of its provisions as an accounting
change at the time of implementation. Nortel Networks must adopt SAB 101
no later than December 31, 2000, effective as of January 1, 2000. Nortel
Networks is currently determining the impact that this statement will
have on its business, results of operations and financial condition.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS 133"). In June
2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities - an amendment of SFAS No.
133" ("SFAS 138"), which amends certain provisions of SFAS 133 to clarify
four areas. The amendment included expanding the normal purchase and sale
exemption for supply contracts, permitting the offsetting of certain
intercompany foreign currency derivatives and thus reducing the number of
third party derivatives, permitting hedge accounting for foreign-currency
denominated assets and liabilities, and redefining interest rate risk to
reduce sources of ineffectiveness. Nortel Networks has appointed a team
to implement SFAS 133 on a global basis. This team has been implementing
an SFAS 133 compliant risk management information system, globally
educating both financial and non-financial personnel, taking an inventory
of embedded derivatives and addressing various other SFAS 133 related
issues. Nortel Networks will adopt SFAS 133 and the corresponding
amendments under SFAS 138 on January 1, 2001, and is currently
determining the impact of SFAS 133 on its business, results of operations
and financial condition.
16. SUBSEQUENT EVENTS
On October 18, 2000, Nortel Networks and Antec Corporation ("Antec")
announced an agreement to create a new company, Arris, Inc. ("Arris").
Under the terms of the agreement, Nortel Networks will effectively
transfer its 81.25 percent ownership interest in Arris Interactive LLC
("Arris Interactive") to Arris in exchange for 33 million common shares
of Arris and approximately $325 in cash (which includes the payment of
approximately $112 of debt owing by Arris Interactive to Nortel
Networks), giving Nortel Networks an approximate 46.5 percent ownership
interest in Arris. Antec, which currently owns the remaining 18.75
percent of Arris Interactive, will become a subsidiary of Arris. The
current Antec shareholders will receive the remaining approximate 53.5
percent ownership interest in Arris. The transaction is expected to close
in the first quarter of 2001.
17. COMPARATIVE FIGURES
Certain comparative figures in the consolidated financial statements have
been reclassified to conform with the current period's presentation.
19
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following provides additional analysis as to the operations and
current financial position of Nortel Networks (as defined below). This
commentary is supplementary to and should be read in conjunction with the
Consolidated Financial Statements (unaudited) and notes thereto which begin on
page 4 and the audited Consolidated Financial Statements and notes thereto,
prepared in accordance with United States generally accepted accounting
principles ("GAAP"), and Management's Discussion and Analysis of Financial
Condition and Results of Operations for the year ended December 31, 1999 for Old
Nortel (as defined below) prepared in accordance with United States GAAP and
included in the Current Report on Form 8-K of the Corporation (as defined below)
dated August 7, 2000 as amended by the Current Report on Form 8-K/A of the
Corporation (as defined below) dated August 18, 2000 (collectively referred to
herein as the "U.S. GAAP Form 8-K"). The following also contains forward-looking
statements and should be read in conjunction with the factors set forth below
under "Forward-looking statements."
Effective May 1, 2000, Nortel Networks Limited (the "Corporation"; also
referred to herein as "Old Nortel") and a newly formed Canadian corporation
("New Nortel") participated in a Canadian court-approved plan of arrangement
(the "Arrangement") with BCE Inc. ("BCE"). For details, see "Highlights - BCE
Plan of Arrangement" below. Unless the context indicates otherwise, the
Corporation and its subsidiaries are collectively referred to as "Nortel
Networks."
HIGHLIGHTS
BCE Plan of Arrangement
Effective May 1, 2000, New Nortel and Old Nortel participated in the
Arrangement with BCE. 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 remain
outstanding and continue to be obligations of the Corporation.
As part of the Arrangement, the outstanding common shares of Old Nortel
were exchanged for common shares of New Nortel. Immediately prior to the
Arrangement, approximately 36 percent of the outstanding common shares of Old
Nortel were held by BCE. A substantial portion of the New Nortel common shares
issuable in respect of BCE's interest in Old Nortel was, through the
Arrangement, indirectly distributed to BCE common shareholders. The aggregate
number of New Nortel common shares issued in the Arrangement was the same as the
aggregate number of Old Nortel common shares outstanding immediately prior to
the Arrangement (excluding the effects of the reservation of certain shares for
issuance pursuant to stock option plans). The consolidated assets and
liabilities of New Nortel and its subsidiaries immediately after the Arrangement
were the same as those of Old Nortel and its subsidiaries immediately prior to
the Arrangement (except for differences attributable to the accounting treatment
accorded to the outstanding preferred shares of Old Nortel). All of the business
and operations conducted by Old Nortel and its subsidiaries prior to the
effective date of the Arrangement continued to be conducted by Old Nortel and
its subsidiaries as subsidiaries of New Nortel after the Arrangement.
20
<PAGE> 21
The following charts illustrate the Nortel Networks corporate structure before
and after the Arrangement:
[Graphic of Nortel Networks corporate structure
before and after the Arrangement]
In addition, as part of the Arrangement, New Nortel implemented a
two-for-one stock split with respect to its common shares (the "New Nortel Stock
Split"). In contrast, the Corporation's common shares did not split as a result
of the Arrangement.
Due to the fact that all of the Corporation's common shares are held by
New Nortel and are no longer publicly traded, information concerning the
Corporation's earnings (loss) per common share, and weighted average number of
common shares outstanding have not been presented in these consolidated
financial statements. For information regarding New Nortel's loss per common
share, and weighted average number of shares outstanding, see the Nortel
Networks Corporation Quarterly Report on Form 10-Q for the period ended
September 30, 2000.
New Nortel is the successor to Old Nortel for various purposes under the
Securities Exchange Act of 1934 (the "Exchange Act"), and has assumed Old
Nortel's Commission File Number (1-7260). New Nortel began filing reports under
the Exchange Act with the filing of its Quarterly Report on Form 10-Q for the
period ended March 31, 2000. Old Nortel is also a reporting company under the
Exchange Act, and filed a registration statement on Form 10 in order to obtain a
new Commission File Number. Old Nortel began filing reports under its new
Commission File Number (3-0758) with the filing of its Quarterly Report on Form
10-Q for the period ended March 31, 2000.
21
<PAGE> 22
Acquisitions and dispositions
In pursuing its vision for eBusiness, the high-performance Internet and
Unified Networks (integrated networks blending routing, optical, wireless,
wireline, switching, and Internet Protocol ("IP") technologies in a seamless
manner), and to strengthen its core business, Nortel Networks completed the
following acquisitions in the nine months ended September 30, 2000:
May 12, 2000 Acquisition of Photonic Technologies, Inc. ("Photonic"), a
developer of optical component technology for the
manipulation and control of the polarization of light.
March 23, 2000 Acquisition of Promatory Communications, Inc. ("Promatory"),
a developer of Digital Subscriber Line platforms for
high-speed Internet access.
March 16, 2000 Acquisition of Clarify Inc. ("Clarify"), a provider of
eBusiness front office solutions.
January 28, 2000 Acquisition of Qtera Corporation ("Qtera"), a producer of
ultra-long-reach optical networking systems.
January 24, 2000 Acquisition of Dimension Enterprises, Inc. ("Dimension"), an
engineering and business strategy consulting firm.
January 1, 2000 Increase of Nortel Networks' ownership interest in Nortel
Dasa Network Systems GmbH and Co. KG ("Nortel Dasa"),
previously a joint venture with DaimlerChrysler Aerospace AG
in Germany, from a 50 percent joint control interest to a 58
percent controlling interest.
January 1, 2000 Increase of Nortel Networks' ownership interest in Matra
Nortel Communications SAS ("MNC"), previously a joint
venture with Aerospatiale Matra in France, from a 50 percent
joint control interest to a 55 percent controlling interest.
All acquisitions completed prior to May 1, 2000 were consummated by the
Corporation or its subsidiaries. Since May 1, 2000, acquisitions involving any
share consideration have been consummated by New Nortel and are not reflected
below, while acquisitions not involving share consideration have continued to be
consummated by the Corporation or its subsidiaries. For information regarding
acquisitions consummated by New Nortel since May 1, 2000, see the Nortel
Networks Corporation Quarterly Report on Form 10-Q for the period ended
September 30, 2000. In addition, the Corporation announced the following
transaction:
On October 18, 2000, Nortel Networks and Antec Corporation ("Antec")
announced an agreement to create a new company, Arris, Inc. ("Arris"). Under the
terms of the agreement, Nortel Networks will effectively transfer its 81.25
percent ownership interest in Arris Interactive LLC ("Arris Interactive") to
Arris in exchange for 33 million common shares of Arris and approximately $325
million in cash (which includes the payment of approximately $112 million of
debt owing by Arris Interactive to Nortel Networks), giving Nortel Networks an
approximate 46.5 percent ownership interest in Arris. Antec, which currently
owns the remaining 18.75 percent of Arris Interactive, will become a subsidiary
of Arris. The current Antec shareholders will receive the remaining approximate
53.5 percent ownership interest in Arris. The transaction is expected to close
in the first quarter of 2001.
22
<PAGE> 23
Streamlining of business processes
On June 3, 2000, and September 1, 2000, Nortel Networks completed the
divestiture and outsourcing of specific operations in North America and Europe,
and in Turkey, respectively, to Solectron Corporation, an electronics
manufacturing services company offering a full range of integrated supply-chain
solutions. The conclusion of all of the proposed North American and European
transactions represents the fulfillment of substantially all of Nortel Networks'
operations strategy, originally announced in January 1999, to simplify and
streamline the Corporation's businesses and operations processes to better meet
the rapidly changing needs and values of its customers worldwide, and to move
from a vertically integrated company to a virtually integrated company.
On August 2, 2000, Nortel Networks announced an agreement with Computer
Sciences Corporation ("CSC") to outsource certain information services ("IS")
functions globally. Through this agreement, estimated to cost Nortel Networks
$3,000 million over seven years, CSC will directly support the Nortel Networks
IS organization by delivering global desktop and help support, computer
infrastructure management, legacy application development, and support and data
center management to Nortel Networks employees.
For information regarding Nortel Networks' restructuring activities in
the first nine months of 2000, see "Other costs" below. Additional disclosure of
the Corporation's restructuring activities is also contained on pages M-19 to
M-23 of the U.S. GAAP Form 8-K.
Other
Nortel Networks continues to focus on ensuring that processes and systems
reflect the strategic direction and evolution of certain businesses within the
management structure as well as the evolution of certain industry segments in
which Nortel Networks operates.
RESULTS OF OPERATIONS
CONSOLIDATED - Nortel Networks' consolidated results.
SERVICE PROVIDER AND CARRIER SEGMENT ("SP&C") - Nortel Networks' SP&C operating
segment delivers network solutions that are used by telecommunications operating
companies and other service providers to interconnect access lines and
transmission facilities to provide local or long-distance services, wireless
communications systems and products to transport voice, data and video
communications between locations within a city or between cities, countries or
continents.
ENTERPRISE SEGMENT ("ENTERPRISE") - Nortel Networks' Enterprise operating
segment delivers solutions consisting of eBusiness systems, including call
center, voice messaging and interactive response systems; Internet and data
networking solutions; Open IP systems; and Enterprise telephony solutions.
Enterprise customers include large and small businesses, governments,
educational institutions, utilities, and other public and private organizations.
CORPORATE AND OTHER SEGMENT ("OTHER") - Nortel Networks' non-operating segment
represents revenues from business units below the quantitative thresholds,
primarily divested businesses. Other also includes corporate services, the
organization that manages the centralized internal functions of the Corporation.
Costs not charged to the operating segments remain within Other.
23
<PAGE> 24
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(MILLIONS OF U.S. DOLLARS) SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Consolidated revenues $7,303 $5,147 $21,446 $14,714
SP&C revenues (1) $5,989 $3,885 $17,597 $10,985
Enterprise revenues (1) $1,313 $1,241 $ 3,844 $ 3,663
Earnings (loss) before income taxes $ 63 $ 38 $ (355) $ (240)
Net loss applicable to common shares $ (182) $ (79) $(1,199) $ (523)
</TABLE>
(1) Revenues by segment have been reclassified to reflect the evolution of
certain businesses within the management structure. The primary effect of
this reclassification was to move certain businesses among the segments to
more closely align the businesses with their primary customers.
EARNINGS (LOSS) BEFORE INCOME TAXES
The increase in earnings before income taxes for the third quarter of
2000, compared to the same period in 1999, was primarily the result of revenue
growth and higher gross profits, which was partially offset by "Acquisition
Related Costs" (in-process research and development expense, the amortization of
acquired technology and goodwill from the August 1998 acquisition of Bay
Networks, Inc. ("Bay Networks") and all subsequent acquisitions). These
Acquisition Related Costs were $941 million for the third quarter of 2000 and
related primarily to the acquisitions of Bay Networks, Qtera and Clarify. By
comparison, the Acquisition Related Costs for the third quarter of 1999 were
$460 million, primarily related to the August 1998 acquisition of Bay Networks.
Acquisition Related Costs are expected to continue to negatively impact Nortel
Networks' earnings before income taxes over the next several years.
The increase in the loss before income taxes for the first nine months of
2000, compared to the same period in 1999, was primarily the result of
Acquisition Related Costs of $3,147 million, which was partially offset by
revenue growth, higher gross profits and certain one-time gains. These
Acquisition Related Costs related primarily to the acquisitions of Bay Networks,
Qtera and Clarify. By comparison, Acquisition Related Costs for the first nine
months of 1999 were $1,538 million, primarily related to the August 1998
acquisition of Bay Networks. The loss before income taxes for the first nine
months of 2000, included one-time gains of $856 million primarily related to a
gain from the sale by Nortel Networks of a portion of its ownership in Entrust
Technologies, Inc. ("Entrust Technologies") and a gain due to a reduction in
Nortel Networks investment in Entrust Technologies, primarily as a result of
Entrust Technologies issuance of common shares in connection with its
acquisition of enCommerce, Inc. (the "Entrust Technologies Transaction").
On a segmented basis, earnings before income taxes for SP&C for the third
quarter of 2000 was $803 million, an increase of $363 million over the same
period in 1999. Earnings before income taxes for Enterprise for the third
quarter of 2000 was $49 million, a decrease of $59 million over the same period
in 1999. The loss before income taxes for Corporate & Other for the third
quarter of 2000 was $789 million, compared to a loss before income taxes of $510
million for the same period in 1999. Earnings before income taxes for SP&C for
the first nine months of 2000 was $2,338 million, an increase of $1,088 million
over the same period in 1999. Earnings before income taxes for Enterprise for
the first nine months of 2000 was $57 million, a decrease of $267 million over
the same period in 1999. The loss before income taxes for Corporate & Other for
the first nine months of 2000 was $2,750 million, compared to a loss before
income taxes of $1,814 million for the same period in 1999.
24
<PAGE> 25
NET LOSS APPLICABLE TO COMMON SHARES
The net loss applicable to common shares for the third quarter and first
nine months of 2000 was $182 million and $1,199 million, respectively, compared
to a net loss applicable to common shares for the third quarter and first nine
months of 1999 of $79 million and $523 million, respectively, reflecting
year-over-year increases in Acquisition Related Costs for the third quarter and
first nine months of 2000 of $495 million and $1,687 million, respectively.
REVENUES BY OPERATING SEGMENT
The following tables present revenues by segment for the third quarter
and first nine months of 2000 and 1999, respectively.
<TABLE>
<CAPTION>
(MILLIONS OF U.S. DOLLARS) THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 % OF TOTAL 1999(1) % OF TOTAL % CHANGE
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SP&C $5,989 82 $3,885 75 54
Enterprise 1,313 18 1,241 24 6
Other 1 - 21 1 (95)
-------------------------------------------------------------------------------------------------------------------
Total $7,303 100 $5,147 100 42
===================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
(MILLIONS OF U.S. DOLLARS) NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 % OF TOTAL 1999(1) % OF TOTAL % CHANGE
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SP&C $17,597 82 $10,985 75 60
Enterprise 3,844 18 3,663 25 5
Other 5 - 66 - (92)
-------------------------------------------------------------------------------------------------------------------
Total $21,446 100 $14,714 100 46
===================================================================================================================
</TABLE>
(1) Revenues by segment for the third quarter and first nine months of 1999
have been reclassified to reflect the evolution of certain businesses
within the management structure. The primary effect of this
reclassification was to move certain businesses among the segments to more
closely align the businesses with their primary customers.
The $2,156 million and $6,732 million, or 42 percent and 46 percent
increases in consolidated revenues in the third quarter and first nine months of
2000, respectively, compared to the same periods in 1999, were attributable to a
substantial increase in SP&C revenues and an increase in Enterprise revenues,
marginally offset by a sharp decrease in Other revenues. Consolidated revenues
increased due to new product introductions and increases in sales volume,
marginally offset by price reductions.
25
<PAGE> 26
SP&C SP&C revenue growth of $2,104 million, or 54 percent, in the third
quarter of 2000, compared to the same period in 1999, was largely driven by
substantial growth in sales of optical networking systems, mobility systems and
core switching. Although there was substantial growth in sales of optical
networking systems in the third quarter of 2000 over the same period in 1999,
the timing of customers' orders were affected by their current inventory levels
and deployment schedules and had a negative impact on sales increases reported
in the third quarter of 2000. The considerable increase in sales of optical
networking systems was driven by substantial growth in the United States, Europe
and the Caribbean and Latin America ("CALA"). The substantial increase in
mobility systems sales was driven by considerable growth across all regions,
particularly in the United States, the Asia Pacific region and CALA. The
substantial increase in core switching sales was primarily driven by
considerable growth in the United States, Europe and CALA, slightly offset by a
significant decline in the Asia Pacific region. In addition, in the third
quarter of 2000 high-speed Internet access solutions sales increased
considerably compared to the third quarter of 1999. The considerable increase in
sales of high-speed Internet access solutions was primarily due to a substantial
increase in sales in the Asia Pacific region, Europe, and CALA, more than
offsetting a modest decline in the United States. Overall, SP&C sales were
substantially higher across all regions, particularly in the United States,
Europe, the Asia Pacific region, and CALA in the third quarter of 2000 compared
to the same period in 1999.
SP&C revenue growth of $6,612 million, or 60 percent, in the first nine
months of 2000, compared to the same period in 1999, was largely driven by
substantial growth in sales of optical networking systems, mobility systems and
core switching. The considerable increase in sales of optical networking systems
was driven by substantial growth across all regions, particularly in the United
States, Europe and CALA. The considerable increase in sales of mobility systems
was driven by substantial growth in the United States, CALA and Europe. The
substantial increase in core switching sales was primarily driven by
considerable growth in the United States, Europe, and CALA. Overall, SP&C sales
were substantially higher in the United States, Europe and CALA in the first
nine months of 2000 compared to the same period in 1999.
Sales of optical networking systems are expected to exceed $10 billion
for the full year 2000. In the past, customer demand for optical networking
systems exceeded Nortel Networks' ability to supply these systems within
customary delivery periods, creating a backlog of orders for Nortel Networks'
optical networking systems. Nortel Networks has been addressing this situation
by increasing internal manufacturing capacity and expanding the use of contract
manufacturers. On February 14, 2000, the Corporation announced that it would
invest an additional $260 million in optical networking and components, in
addition to the $400 million investment announced in November 1999, to, among
other things, build new facilities in Canada, expand existing facilities in
Europe and increase its supply chain and customer service capabilities in the
United States. Furthermore, on July 24, 2000, the Corporation announced a $1,900
million investment to, among other things, expand optical production capacity
and capability in North America, the United Kingdom and Australia. Nortel
Networks is also continuing to work with its suppliers to increase capacity to
meet forecasted customer demand. By the end of the second quarter of 2000, the
prior backlog for optical networking systems was substantially reduced and
delivery periods returned to more traditional levels and remained unchanged at
the end of the third quarter of 2000. The timing of customers' orders, which may
be impacted by factors such as customers' inventory levels and deployment
schedules, may have an adverse effect on the business, results of operations and
financial condition of Nortel Networks.
Enterprise
Enterprise revenue growth of $72 million, or 6 percent, for the third
quarter of 2000, compared to the same period in 1999, was primarily due to the
consolidation of certain joint venture revenues effective January 1, 2000. In
the third quarter of 2000, sales of eBusiness application solutions increased
substantially due to the momentum related to the business activities of
acquisitions compared to the same period in 1999, and were primarily driven by
considerable growth in the United States, Europe and the Asia Pacific region. In
the third quarter of 2000, voice and data networking infrastructure solutions
sales were essentially flat compared to the same period in 1999, reflecting a
significant decline in the United States, and lower sales in the Asia Pacific
region, offset by a substantial increase in Europe. Overall, Enterprise revenues
were considerably higher in Europe due to the joint venture consolidations more
than offsetting a small decline in the United States and lower sales in Canada
in the third quarter of 2000, compared to the same period in 1999.
Enterprise revenue growth of $181 million, or 5 percent, for the first
nine months of 2000, compared to the
26
<PAGE> 27
same period in 1999, was due to the consolidation of certain joint venture
revenues effective January 1, 2000. In the first nine months of 2000, sales of
eBusiness application solutions increased substantially, compared to the same
period in 1999, primarily driven by considerable growth in the United States,
Europe and the Asia Pacific region. In the first nine months of 2000, voice and
data networking infrastructure solutions sales decreased slightly, compared to
the same period in 1999, primarily due to significant declines in the United
States and Canada, and lower sales in the Asia Pacific region, partially offset
by substantial growth in Europe. Overall, Enterprise revenues were considerably
higher in Europe due to the joint venture consolidations, more than offsetting a
slight decline in sales in the United States and lower sales in the Asia Pacific
region in the first nine months of 2000 compared to the same period in 1999.
Enterprise revenues are expected to continue to grow at a slower rate in 2000
compared to 1999.
Other
Other revenues decreased substantially in the third quarter and first
nine months of 2000, compared to the same period in 1999, primarily as a result
of the divestiture of certain investments in 1999.
REVENUES BY GEOGRAPHIC AREAS
(Based on the location of the customer)
<TABLE>
<CAPTION>
(MILLIONS OF U.S. DOLLARS) THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 % OF TOTAL 1999 % OF TOTAL % CHANGE
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
United States $4,154 57 $3,168 62 31
Canada 387 5 319 6 21
Other Countries 2,762 38 1,660 32 66
-------------------------------------------------------------------------------------------------------------------
Total $7,303 100 $5,147 100 42
===================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
(MILLIONS OF U.S. DOLLARS) NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------------------------------------------
2000 % OF TOTAL 1999 % OF TOTAL % CHANGE
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
United States $13,009 61 $8,847 60 47
Canada 1,133 5 1,059 7 7
Other Countries 7,304 34 4,808 33 52
--------------------------------------------------------------------------------------------------------------------
Total $21,446 100 $14,714 100 46
===================================================================================================================
</TABLE>
United States
The increase of $986 million, or 31 percent, in revenues from the United
States in the third quarter of 2000, compared to the same period in 1999, was
the result of substantially increased revenues in SP&C, partially offset by a
modest decline in sales in Enterprise. The increase in United States revenues in
the third quarter of 2000, over the same period in 1999, primarily resulted from
substantially higher sales to interexchange carriers ("IXCs") and independent
telephone operating carriers ("IOCs"). Considerable growth in sales to
purchasers of mobility systems also contributed to the growth in this region.
The increase of $4,162 million, or 47 percent, in revenues from the
United States in the first nine months of 2000, compared to the same period in
1999, was due to a substantial increase in revenues in SP&C, partially offset by
a modest decline in sales in Enterprise. The increase in United States revenues
in the first nine months of 2000, over the same period in 1999, primarily
resulted from substantially higher sales to IXCs, IOCs, regional Bell operating
companies, and purchasers of mobility systems.
27
<PAGE> 28
Canada
The increase of $68 million, or 21 percent, in revenues in the third
quarter of 2000, compared to the same period in 1999, was due to a substantial
increase in sales in SP&C, partially offset by lower sales in Enterprise. In
addition to substantially higher sales to Canadian customers other than Bell
Canada and other related companies of BCE (the "BCE Group"), sales to the BCE
Group were significantly higher in the third quarter of 2000, compared to the
same period in 1999.
The increase of $74 million, or 7 percent, in revenues in the first nine
months of 2000, compared to the same period in 1999, was primarily due to a
significant increase in sales in SP&C, partially offset by a small decline in
sales in Enterprise. Substantially higher sales to Canadian customers other than
the BCE Group more than offset considerably lower sales to the BCE Group in the
first nine months of 2000, compared to the same period in 1999.
Other countries
Revenues for the third quarter of 2000 from Other Countries (i.e. sales
to customers located outside of the United States and Canada) grew by $1,102
million, or 66 percent, over the same period in 1999. This growth was
attributable to substantial increases in sales in Europe, CALA and the Asia
Pacific region. The overall growth in revenues for Other Countries in the third
quarter of 2000, compared to the same period in 1999, was driven by considerably
higher sales in SP&C and substantially higher revenues in Enterprise in Europe
due to the joint venture consolidations.
The increase of $2,496 million, or 52 percent, in revenues in Other
Countries for the first nine months of 2000, compared to the same period in
1999, was primarily due to considerable increases in sales in Europe and CALA,
and significant growth in the Asia Pacific region. The overall growth in
revenues for Other Countries in the first nine months of 2000, compared to the
same period in 1999, was driven by considerably higher sales in SP&C and
substantially higher revenues in Enterprise in Europe due to the joint venture
consolidations.
See also "Forward-looking statements -- International growth and interest
rates" and "Forward-looking statements -- Foreign exchange" below.
GROSS PROFIT
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(MILLIONS OF U.S. DOLLARS) SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross profit $3,218 $2,162 $9,158 $6,313
Gross margin 44.1% 42.0% 42.7% 42.9%
</TABLE>
The increase in gross profit of $1,056 million, or 49 percent, in the
third quarter of 2000, compared to the same period in 1999, was primarily the
result of a substantial gross profit increase in SP&C and a significant gross
profit increase in Enterprise. Optical networking, mobility systems and core
switching largely drove the considerable increase in gross profit in the third
quarter of 2000 in SP&C. The significant increase in gross profit in Enterprise
was primarily attributed to a substantial increase in gross profit of eBusiness
application solutions, partially offset by significantly lower gross profit from
sales of voice and data networking infrastructure solutions. Weakening gross
margins for the third quarter of 2000 were realized in sales of voice and data
networking infrastructure solutions in Enterprise as a result of competitive
pricing pressures and less favourable product mix as compared to the same period
in 1999. Overall, gross margin increased in the third quarter of 2000 by 2
percentage points over the same period in 1999, primarily reflecting a change in
product mix.
The increase in gross profit of $2,845 million, or 45 percent, in the
first nine months of 2000, compared to the same period in 1999, was primarily
the result of a substantial gross profit increase in SP&C and essentially flat
gross profit in Enterprise. The substantial increase in gross profit in SP&C in
the first nine months of 2000 was largely due to optical networking, core
switching and mobility systems. The flat gross profit in Enterprise was
primarily attributed to a substantial increase in gross profit of eBusiness
application solutions, which was largely offset by a
28
<PAGE> 29
significant decline in gross profit from sales of voice and data networking
infrastructure solutions. Weakening gross margins for the first nine months of
2000 were realized in sales of voice and data networking infrastructure
solutions in Enterprise as a result of competitive pricing pressures and less
favourable product mix as compared to the same period in 1999. Overall, gross
margin decreased in the first nine months of 2000 by 0.2 percentage points over
the same period in 1999, reflecting competitive pricing pressures in certain of
the Nortel Networks' products and a change in product mix.
Although competitive pricing pressures continue, particularly with
respect to sales of voice and data networking infrastructure solutions, overall
Nortel Networks continues to focus on alleviating the impact of such pricing
pressures with manufacturing and other cost-reduction programs and by increasing
efficiencies. Gross margin can be negatively affected by changes in the mix of
products sold, the introduction of new products and technologies, continued
expansion into new high-growth markets, and fluctuations in the availability of,
and cost increases for, products manufactured by suppliers in networking
solutions offered by Nortel Networks. Given current competitive pricing
pressures, increased competition for customers due to new entrants into the
markets within which Nortel Networks operates, and changes in the mix of
products sold by Nortel Networks, gross margins could be adversely impacted in
future periods.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSE
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(MILLIONS OF U.S. DOLLARS) SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SG&A expense $1,372 $ 952 $4,045 $2,789
As a percentage of revenues 18.8% 18.5% 18.9% 19.0%
</TABLE>
In the third quarter and first nine months of 2000, SG&A expense
increased by $420 million and $1,256 million, respectively, in absolute dollars,
and as a percentage of revenues increased by 0.3 percentage points and decreased
0.1 percentage point, respectively, compared to the same periods in 1999. The
increased SG&A expense as a percentage of revenues for the third quarter of 2000
primarily reflected a higher percentage of SG&A expense in Enterprise, largely
due to acquisitions. The decreased SG&A expense as a percentage of revenues for
the first nine months of 2000 primarily reflected the lower percentage of SG&A
expense in SP&C, largely as a result of the increased growth in SP&C revenues,
more than offsetting the absolute dollar increase in SG&A expense within SP&C.
The decreased SG&A expense as a percentage of revenues for the first nine months
of 2000 was partially offset by a higher percentage of SG&A expense in
Enterprise. In absolute dollars, the increase in SG&A expense in the third
quarter and first nine months of 2000 reflected the continued funding of North
American and international market investments across SP&C and Enterprise,
strategic acquisitions, as well as increased investments supporting Nortel
Networks' global growth and to simplify and streamline business processes.
Although SG&A expense in absolute dollars is expected to continue to increase in
future periods, Nortel Networks intends to focus on reducing SG&A expense as a
percentage of revenues.
RESEARCH AND DEVELOPMENT ("R&D") EXPENSE
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(MILLIONS OF U.S. DOLLARS) SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
R&D expense $ 996 $ 767 $2,856 $2,178
As a percentage of revenues 13.6% 14.9% 13.3% 14.8%
</TABLE>
In absolute dollars, R&D expense increased in the third quarter and first
nine months of 2000 by $229 million and $678 million, respectively, or 30
percent and 31 percent, respectively, compared to the same periods in 1999. This
increased investment in R&D was primarily attributable to new equipment, process
development, advanced capabilities, and services for a broad array of
applications in SP&C including optical networking, core data networking and
other ongoing programs. In Enterprise, investment in R&D was primarily
attributable to data
29
<PAGE> 30
networks and IP technologies. R&D expense in absolute dollars is expected to
continue to increase. As a percentage of revenues, R&D expense for the third
quarter and first nine months of 2000 declined by 1.3 percentage points and 1.5
percentage points, respectively, primarily due to the significant growth in
consolidated revenues for the third quarter and first nine months of 2000,
compared to the same periods in 1999.
IN-PROCESS RESEARCH AND DEVELOPMENT ("IPR&D")
IPR&D charges represent the value on completion of a business combination
of the acquired R&D which was not technologically feasible as of the acquisition
date and, other than its intended use, had no alternative future use.
Included in the purchase price allocations was an aggregate amount of
IPR&D of $673 million for the nine months ended September 30, 2000. Independent
valuations were performed to assess and allocate a value to IPR&D. The value
allocated to IPR&D represented the estimated fair value based on risk-adjusted
future cash flows generated from the products that would result from each of the
in-process projects. Estimated future after-tax cash flows of each project, on a
product by product basis, were based on Nortel Networks' estimates of revenues
less operating expenses, cash flow adjustments, income taxes, and charges for
the use of contributory assets. Future cash flows were also adjusted for the
value contributed by any core technology and development efforts that were
completed post-acquisition.
Revenues were estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles, the estimated life of
each product's underlying technology, and historical pricing. Estimated
operating expenses include cost of goods sold, selling, general and
administrative, and R&D expenses. The estimated R&D expenses include costs to
maintain the products once they have been introduced into the market and are
generating revenues, and costs to complete the IPR&D. Operating expense
estimates were consistent with historical margins and expense levels for similar
products.
The discount rates used to discount the projected net returns were based
on a weighted average cost of capital relative to Nortel Networks and the high
technology industry, as well as the product-specific risk associated with the
IPR&D projects. Product-specific risk includes the stage of completion of each
product, the complexity of the development work completed to date, the
likelihood of achieving technological feasibility, and market acceptance.
The forecast data employed in the analyses was based upon both forecast
information maintained by the acquired companies and Nortel Networks' estimate
of future performance of the business. The inputs used by Nortel Networks in
analyzing IPR&D were based upon assumptions that Nortel Networks believes to be
reasonable but which are inherently uncertain and unpredictable. These
assumptions may be incomplete or inaccurate, and no assurance can be given that
unanticipated events and circumstances will not occur. Accordingly, actual
results may vary from the forecasted results. While Nortel Networks believes
that all of the development projects will be successfully completed, failure of
any of these projects to achieve technological feasibility, and/or any variance
from forecasted results, may result in a material adverse effect on the
business, results of operations and financial condition of Nortel Networks.
The following updates projects that were in-process during the third
quarter of 2000 and related to acquisitions completed prior to the third quarter
of 2000:
Promatory
THE INTELLIGENT MULTISERVICE ACCESS SYSTEM ("IMAS") - THE 5.0 SERIES OF
RELEASES. IMAS is a broadband access platform that delivers business and
residential-class DSL services and accommodates all varieties of DSL with direct
integration into the optical Internet backbone. The initial 5.0 release was
completed and began to contribute to Nortel Networks' revenues in the third
quarter of 2000.
30
<PAGE> 31
Clarify
FRONTOFFICE - RELEASE 9.0. FrontOffice is a fully scalable Customer
Relationship Management software product that allows companies to effectively
manage all aspects of the customer relationship throughout the customer
lifecycle. FrontOffice allows companies to automate and integrate the collection
and utilization of customer information obtained from each point of contact,
including sales staff, call center representatives, field staff, and technical
personnel. FrontOffice - Release 9.0 is intended to provide new eBusiness
initiatives that are fully integrated with the existing set of application
modules. This project was completed and began to contribute to Nortel Networks'
revenue in the second quarter of 2000. A subsequent release is currently in
process and on schedule, with the completed project expected to begin to
contribute to Nortel Networks' revenues in the fourth quarter of 2000.
Qtera
PHOTONIC NETWORKING SYSTEMS. Photonic Networking Systems are
ultra-long-reach optical networking systems. These systems allow for scalable
optical Internet capabilities, which enable high performance, rapid wavelength
provisioning and restoration, and low cost survivable bandwidth. This project is
on schedule and its completion is expected to contribute to Nortel Networks'
revenues by the end of 2000.
Periphonics
VPS/IS VERSION 6.X. The Voice Processing Services Information Server
("VPS/is") is a scalable transaction processing system that can be configured
for both small and very large installations. The system allows a caller to
access information in an organization's computer database through a touch-tone
telephone, speech input or the Internet, and to receive the information from
that database in the form of a computer-generated voice response. Version 6.x
represents a redesign of the existing VPS/is product, which would include
reduced system cost, higher density, more features, greater reliability, and
increased scalability. This project was completed in the third quarter of 2000,
and is expected to begin to contribute to Nortel Networks' revenues in the
fourth quarter of 2000.
In order for Nortel Networks to succeed in the highly competitive and
rapidly changing marketplace in which it operates, acquired assets must be
integrated quickly into its Unified Networks solutions as enhancements of
existing technology or as part of a larger platform. It is Nortel Networks'
normal practice to begin the integration of all acquired businesses (including
management responsibilities, financial reporting and human resources)
immediately following the closing of the transaction. As such, Nortel Networks
does not specifically track revenues generated from completed IPR&D projects of
acquired businesses subsequent to the closing and integration of acquisitions.
AMORTIZATION OF INTANGIBLES
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(MILLIONS OF U.S. DOLLARS) SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Acquired technology $ 207 $ 171 $ 596 $ 513
Goodwill $ 739 $ 306 $1,939 $ 893
</TABLE>
The amortization of acquired technology for the third quarter and first
nine months of 2000 primarily related to the acquisition of Bay Networks. As at
September 30, 2000, the capitalized amount of acquired technology was $876
million.
The amortization of goodwill for the third quarter and first nine months
of 2000 primarily reflects charges related to the acquisitions of Bay Networks,
Qtera and Clarify. As at September 30, 2000, the capitalized amount of goodwill
was $8,011 million.
31
<PAGE> 32
OTHER COSTS
2000
For the third quarter and first nine months of 2000, Nortel Networks
recorded special charges of nil and $195 million, respectively, relating to
restructuring and other charges, and one-time costs totalling nil and $2 million
for the same periods, respectively. In addition, Nortel Networks recorded stock
option compensation of $31 million and $98 million for the third quarter and
first nine months of 2000, respectively, primarily related to the impact of the
Arrangement on stock options held by former Nortel Networks employees who had
transferred to BCE or a BCE affiliated company. The related charge of $67
million for the first six months of 2000 has been reclassified to stock option
compensation from special charges to conform to the current period's
presentation.
Special charges
Restructuring activities involved the continued implementation of Nortel
Networks' strategic resource realignment initiative, which was approved and
began in the fourth quarter of 1999. An additional restructuring activity
involved the termination of employees in MNC, a subsidiary of the Corporation
located in France, as a result of technological shifts within the industry.
Workforce reduction charges of $73 million represented the cost of
severance and related benefits for the termination of approximately 1,600
employees in the above noted restructuring activities. Workforce reduction costs
of approximately $66 million were principally related to approximately 1,500
employees, primarily located in North America within SP&C and Enterprise. The
remaining $7 million of the workforce reduction charge related to approximately
100 employees in MNC within Enterprise.
A contract settlement charge of $4 million reflects costs for computer
equipment for the 1,600 employees impacted in the workforce reduction, and
penalties for Nortel Networks' withdrawal from certain trade events.
Other charges primarily represented a reduction of the goodwill related
to MNC. Nortel Networks changed its business mandate for MNC from the product
focus for which it was acquired, and restructured the business to a focus on
distribution channels.
The provision balance has been drawn down by $147 million resulting in a
provision balance of $48 million as at September 30, 2000. The remaining
provision is expected to be substantially drawn down by December 31, 2000.
One-time costs
One-time costs of $2 million related to inventory provisions associated
with restructuring and were recorded in cost of revenues.
1999
In the year ended December 31, 1999, Nortel Networks recorded special
charges aggregating to $160 million relating to restructuring costs and one-time
costs of $49 million.
Special charges
Restructuring activities involved Nortel Networks' exit of the Satellite
and Time Division Multiple Access small switch operations within SP&C, and the
Consumer Products and Open Speech operations within Enterprise. The
restructuring activities also involved the consolidation of the Broadband
Wireless Access operations, as well as the streamlining of SP&C manufacturing
operations related to Nortel Networks' operations strategy announced in January
1999.
32
<PAGE> 33
Also reflected in the 1999 restructuring costs were charges associated
with Nortel Networks' initiative to realign its resource investment into growth
areas in response to industry shifts as well as to create efficiencies within
Nortel Networks' existing organizations. This initiative impacted various
organizations within SP&C and Enterprise, largely within North America,
including the Mobility, Marketing and Communications, Global Service, and
Portfolio Networks organizations. Nortel Networks also restructured, for
purposes of outsourcing, certain of its corporate processes including payroll,
accounts payable, training and resourcing functions.
The provision balance has been drawn down by $129 million, resulting in a
provision balance of $31 million as at September 30, 2000. The remaining
provision is expected to be substantially drawn down by December 31, 2000.
One-time costs
One-time costs included a charge of $16 million for the write-off of the
remaining book value of redundant raw materials inventory related to the
Consumer Products operations and the SP&C operations and were recorded in cost
of revenues. One-time costs also included a charge of $33 million, which was
recorded in selling, general and administrative expenses and related to Nortel
Networks' coverage of an obligation by a customer to a third party and the
settlement of a patent infringement lawsuit.
EQUITY IN NET EARNINGS (LOSS) OF ASSOCIATED COMPANIES, OTHER INCOME - NET, AND
INTEREST EXPENSE
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(MILLIONS OF U.S. DOLLARS) SEPTEMBER 30, SEPTEMBER 30,
-----------------------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity in net earnings (loss) of associated companies $ (16) $ 29 $ (22) $ -
Other income - net 242 34 852 124
-----------------------------------------------------------------------------------------------------------------------------
$ 226 $ 63 $ 830 $ 124
=============================================================================================================================
Interest expense $ 38 $ 38 $ 117 $ 114
</TABLE>
The overall increase in equity in net earnings (loss) of associated
companies, and other income - net, for the third quarter of 2000, compared to
the same period in 1999, was primarily related to a $169 million pre-tax ($116
million after-tax) gain due to a reduction in Nortel Networks' investment in
Entrust Technologies from 33.5 percent to 27.0 percent primarily as a result of
the Entrust Technologies Transaction. The overall increase in equity in net
earnings (loss) of associated companies, and other income - net for the first
nine months of 2000 compared to the same period in 1999, was primarily a result
of the Entrust Technologies Transaction and a $513 million pre-tax ($344 million
after-tax) gain from the sale by Nortel Networks of a portion of its share
ownership in Entrust Technologies.
Foreign Exchange Risk
Nortel Networks continues to expand its business globally and, as such,
an increasing proportion of its business will be denominated in currencies other
than United States dollars. As a result, fluctuations in foreign currencies may
have an impact on Nortel Networks' business and financial results. Nortel
Networks endeavors to minimize the impact of such currency fluctuations through
its ongoing commercial practices and by attempting to hedge its exposures to
major currencies. In attempting to manage this foreign exchange risk, Nortel
Networks identifies operations and transactions that may have foreign exchange
exposure based upon, among other factors, the excess or deficiency of foreign
currency receipts over foreign currency expenditures in each of Nortel Networks'
significant foreign currencies. Nortel Networks' significant currency flows for
the third quarter and first nine months of 2000 were in United States dollars,
Canadian dollars, United Kingdom pounds, and the Euro. For the third quarter and
first nine months of 2000, the net impact of foreign exchange fluctuations was a
gain of $16 million and $6 million, respectively, as compared to nil and a loss
of $62 million for the same periods in 1999. Given the devaluation of the Euro,
and Nortel Networks' exposure to other international markets, Nortel Networks
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continuously monitors all of its foreign currency exposures. Nortel Networks
cannot predict whether it will incur foreign exchange losses in the future;
however, if significant foreign exchange losses are experienced, they could have
a material adverse effect on the business, results of operations and financial
condition of Nortel Networks.
INCOME TAXES
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(MILLIONS OF U.S. DOLLARS) SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income taxes $ 238 $ 110 $ 821 $ 262
Effective tax rate (1) 29.9% 34.6% 32.0% 34.6%
</TABLE>
(1) Excludes the impact of after-tax charges of Acquisition Related Costs,
stock option compensation from acquisitions/divestitures and, where
applicable, certain of the one-time gains and charges.
Nortel Networks' effective income tax rate was 29.9 percent and 32.0
percent for the third quarter and first nine months of 2000, respectively,
compared with 34.6 percent for each of the same periods in 1999. The decrease in
Nortel Networks' effective tax rate was primarily due to the change in Nortel
Networks' geographic earnings mix. Nortel Networks' earnings are subject to
different effective tax rates in each of the countries in which it operates. A
decrease in Nortel Networks' effective tax rate can result when the proportion
of revenues earned in low tax rate countries increases over the prior year.
LIQUIDITY AND CAPITAL RESOURCES
<TABLE>
<CAPTION>
(MILLIONS OF U.S. DOLLARS) NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------------------------------------
CHANGE FROM
2000 1999 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows (used in) operating activities $(857) $(236) $ (621)
Cash flows from (used in) investing activities $ 262 $(943) $1,205
Cash flows from financing activities $ 185 $ 135 $ 50
</TABLE>
Cash and cash equivalents ("cash") at September 30, 2000 of $1,708
million decreased by $445 million from $2,153 million at December 31, 1999,
primarily as a result of cash flows used in operating activities.
Cash flows used in operating activities for the first nine months of 2000
were $857 million, compared to $236 million during the same period in 1999. The
increase in use of cash flows for the first nine months of 2000 compared to the
first nine months of 1999 was primarily due to the net change in non-cash
operating assets and liabilities, partially offset by an increase in net
earnings, adjusted for non-cash items. The net change in non-cash operating
assets and liabilities was primarily due to decreases in accounts payable and
accrued liabilities, and an increase in inventories. The increase in inventory
was primarily due to measures taken to address the increased demand for optical
networking and mobility systems.
Cash flows generated from investing activities for the first nine months
of 2000 were $262 million, compared to $943 million used in investing activities
in the same period in 1999. The net change in cash flows was primarily due to an
increase in proceeds on sale of businesses and investments and a decrease in
cash used in the acquisition of investments and businesses - net of cash
acquired, partially offset by increased expenditures for plant and equipment.
Cash from proceeds on sale of businesses and investments was $1,735 million for
the first nine months of 2000, compared to $532 million during the same period
in 1999, and primarily related to a sale by Nortel Networks of a portion of its
share ownership in Entrust Technologies for aggregate proceeds of $527 million
and the divestiture of certain manufacturing operations and assets for aggregate
proceeds of $929 million. Cash used in acquisitions of investments and
businesses - net of cash acquired was $318 million for the first nine months of
2000,
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<PAGE> 35
compared to $722 million during the same period in 1999. Cash flows used in the
first nine months of 1999 primarily related to Nortel Networks purchase of
approximately $400 million of 12 percent Series A senior debentures from
VoiceStream Wireless Corporation, and the purchase of approximately $103 million
of 6.5 percent convertible unsecured subordinated debentures issued by a
subsidiary of BCE. Expenditures for plant and equipment were $1,140 million for
the first nine months of 2000, compared to $543 million during the same period
in 1999. This increase in cash flows used in plant and equipment expenditures
largely reflected capital investments to increase production capacity for
optical networking systems and components.
Cash flows from financing activities for the nine months ended September
30, 2000 were $185 million, compared to $135 million during the same period in
1999. The increase in cash flows was primarily due to a net increase in notes
payable and lower levels of long-term debt repayment.
The total debt to total capitalization ratio was 9 percent at September
30, 2000, compared to 10 percent at December 31, 1999 and 10 percent at
September 30, 1999. The decrease in the total debt to total capitalization ratio
at September 30, 2000, compared to September 30, 1999, was primarily due to the
issuance of common shares in connection with acquisitions and the exercise of
stock options.
The Corporation and Nortel Networks Capital Corporation ("NNCC"), an
indirect wholly owned subsidiary of the Corporation, have the ability to offer
from time to time up to an aggregate of $700 million of debt securities and
warrants to purchase debt securities, to be offered by (i) the Corporation or
(ii) NNCC and guaranteed by the Corporation, pursuant to a shelf registration
statement filed with the United States Securities and Exchange Commission. The
Corporation has also filed in each of the provinces of Canada a short form
prospectus under the Canadian shelf prospectus program qualifying the
Corporation to issue up to C$500 million of debt securities and warrants to
purchase debt securities of the Corporation. This program will expire on
February 23, 2002. On April 12, 2000, Nortel Networks entered into new 364-day
syndicated credit agreements, which permit borrowings in an aggregate amount not
to exceed $1,250 million, and new five-year syndicated credit agreements, which
permit borrowings in an aggregate amount not to exceed $750 million. The entire
amount of all of these committed facilities remains available. Nortel Networks
expects to meet its cash requirements from operations and conventional sources
of external financing.
The competitive environment requires Nortel Networks and many of its
principal competitors to provide significant amounts of medium-term and
long-term customer financing. Customer financing arrangements may include
financing in connection with the sale of Nortel Networks products and services,
as well as funding for certain non-product and service costs associated with
network installation and integration of Nortel Networks products and services,
working capital purposes and equity financing. While Nortel Networks has
generally been able to place a large portion of its customer financings with
third-party lenders, the Corporation anticipates that, due to the amount of
financing it expects to provide and the higher risks typically associated with
such financings (particularly when provided to start-up operations such as local
exchange carriers, to customers in developing countries or to customers in
specific financing-intensive areas of the industry such as third generation
wireless ("3-G wireless") operators which are in their early stages of
development), the amount of such financings required to be supported directly by
Nortel Networks for at least the initial portion of their term is expected to
continue to increase significantly in the future. At September 30, 2000, Nortel
Networks had entered into certain financing agreements for which the remaining
future provision of unfunded customer financing was up to approximately $3,100
million, not all of which is expected to be drawn upon. Nortel Networks expects
to continue to arrange for third-party lenders to assume customer financing
obligations agreed to by Nortel Networks and to fund other customer financings
directly supported by Nortel Networks from working capital and conventional
sources of external financing in the normal course. Due to recent economic
uncertainty in various countries and reduced demand for customer financings in
capital and bank markets, Nortel Networks may be required to continue to hold
certain customer financing obligations for longer periods prior to placement
with third-party lenders. Should customers fail to meet their obligations,
losses could be incurred and such losses may have a material adverse effect on
the business, results of operations and financial condition of Nortel Networks.
Nortel Networks has various programs in place to monitor and mitigate customer
credit risk; however, there can be no assurance that such measures will reduce
Nortel Networks' exposure to its customers' credit risk.
Nortel Networks has entered into supply contracts with customers for
products and services involving new
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<PAGE> 36
technologies currently being developed or which have not yet been commercially
deployed by Nortel Networks or require Nortel Networks to build and operate
networks on a turnkey basis. These supply contracts may contain delivery and
installation timetables and performance criteria which, if not met, could result
in the payment of substantial penalties or liquidated damages by Nortel
Networks, the termination of the related supply contract, and/or the reduction
of shared revenues under a turnkey arrangement, and could have a material
adverse effect on the business, results of operations and financial condition of
Nortel Networks.
LEGAL PROCEEDINGS
On March 4, 1997, Bay Networks announced that shareholders had filed two
separate lawsuits against Bay Networks and ten of Bay Networks' current and
former officers and directors. Both lawsuits purported to seek damages on behalf
of a class of shareholders who purchased Bay Networks' common shares during the
period of May 1, 1995 through October 14, 1996. One lawsuit was filed in the
United States District Court for the Northern District of California (the
"Federal Court") and alleges violations of the federal securities laws. In
September 1998, the Federal Court dismissed the plaintiffs' complaint in this
action, granting leave for the plaintiffs to amend the complaint. In November
1998, the Federal Court ordered a stay of the proceedings until a decision
regarding pleading standards in securities litigation was rendered by the United
States Ninth Circuit Court of Appeal in an unrelated case involving Silicon
Graphics, Inc. This decision was rendered on July 2, 1999 favorable to the
defense and the plaintiffs filed a Third Amended Complaint in December 1999. On
August 17, 2000, the defendants' Motion to Dismiss was granted and on September
8, 2000, a notice of appeal was filed by the plaintiffs. The other lawsuit
announced on March 4, 1997 was filed in the California Superior Court, County of
Santa Clara (the "California Court"), and alleges violations of the California
Corporations Code. On April 18, 1997, a shareholder (represented by some of the
same plaintiffs' law firms as in the aforementioned cases) filed a second
lawsuit in the California Court, alleging violations of the federal securities
laws and California Corporations Code by Bay Networks and nine of its current
and former officers and directors. This second action before the California
Court purported to seek damages 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. In April 1998, the
California Court granted the plaintiffs' motion to consolidate both actions
before the California Court (the "Consolidated California Action"), but denied
the plaintiffs' motion for class certification. The plaintiffs in the
Consolidated California Action have appealed this decision. Oral arguments in
this appeal were heard in November 1999. On January 19, 2000, the California
Court of Appeal affirmed the order denying the class certification. A petition
for review was filed with the California Supreme Court by the plaintiffs on
February 28, 2000 and is under submission. A new group of putative plaintiffs,
who allege to have been shareholders of Bay Networks during the relevant
periods, filed a motion for intervention in the California Court on February 22,
2000 seeking to become the representatives of a class of shareholders. This
motion is stayed pending determination of a request for reassignment of the
judge who will decide the motion for intervention.
In June 1993, certain holders of the Corporation's securities commenced
three class actions in the United States District Court for the Southern
District of New York alleging that the Corporation and certain of its officers
violated the Securities Exchange Act of 1934 and common law by making material
misstatements of, or omitting to state, material facts relating to the business
operations and prospects and financial condition of the Corporation.
Compensatory and punitive damages were sought in each of the class actions. All
three actions were subsequently consolidated and the plaintiffs were permitted
to file a Second Consolidated Amended Complaint after the first Consolidated
Amended Complaint had been dismissed without prejudice. A defense motion
challenging the sufficiency of the Second Consolidated Amended Complaint was
denied in part and granted in part on August 19, 1994. An Answer to this
Complaint was filed on September 22, 1994. On February 24, 1995, the
consolidated action was certified as a class action and on April 10, 1996, a
Stipulation and Order of Dismissal was granted permitting one of the named
officers to be dismissed from the suit. On May 2, 1996, the plaintiffs filed a
motion to file a Third Consolidated Amended Complaint. A defense motion
challenging the sufficiency of the Third Consolidated Amended Complaint was
denied in part and granted in part on March 24, 1999. On August 18, 1999 the
Corporation moved for summary judgment with respect to all claims in the case.
On September 28, 2000, the District Court granted summary judgment and dismissed
the consolidated actions. Any appeal of the District Court's opinion must be
filed with the court on or before November 2, 2000.
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<PAGE> 37
Nortel Networks is unable to ascertain the ultimate aggregate amount of
monetary liability or financial impact of these matters and therefore cannot
determine whether these actions will, individually or collectively, have a
material adverse effect on the business, results of operations and financial
condition of Nortel Networks. The Corporation and any named directors and
officers intend to vigorously defend these actions.
Additional disclosure of legal proceedings is contained on pages M-28 to
M-30 of the U.S. GAAP Form 8-K.
ENVIRONMENTAL MATTERS
Nortel Networks, primarily as a result of its manufacturing and research
operations, is subject to a wide range of environmental protection laws and
regulations in various jurisdictions around the world, and is exposed to
liabilities and compliance costs arising from past and current generation,
management and disposal of hazardous substances and wastes.
Nortel Networks has remedial activities under way at six of its
facilities and five previously occupied sites. An estimate of Nortel Networks'
anticipated remediation costs associated with all such facilities and sites, to
the extent probable and reasonably estimable, is included in the Corporation's
environmental accruals in an approximate amount of $29 million.
Additional disclosure of environmental matters is contained on pages F-35
to F-36 of the U.S. GAAP Form 8-K.
PENSIONS
Nortel Networks has non-contributory defined benefit pension plans
covering substantially all of its employees, the majority of whom are in Canada
and the United States. Pension benefits are based on length of service and rates
of compensation. In determining its pension obligations and expense, Nortel
Networks' weighted average discount rate used for 1999 pension calculations was
6.8 percent, which reflects the impact of economies with lower long-term
discount rates than would typically be found in the United States.
YEAR 2000 COMPLIANCE
Nortel Networks' information technology systems, facilities and
production infrastructure did not experience any material adverse impacts in the
first nine months of 2000 as a result of the Year 2000 date transition.
Similarly, no material Year 2000 impacts were reported in the first nine months
of 2000 with respect to Nortel Networks' products that were classified as Year
2000 ready. In addition, Nortel Networks experienced no material supply chain
problems in the first nine months of 2000 related to the date transition.
Additional disclosure of the Year 2000 date transition is contained on
pages M-31 to M-32 of the U.S. GAAP Form 8-K.
FORWARD-LOOKING STATEMENTS
Certain information and statements contained in this Management's
Discussion and Analysis of Financial Condition and Results of Operations and
other sections of this report, including statements containing words such as
"could," "expects," "may," "anticipates," "believes," "intends," "estimates,"
"plans," and similar expressions, constitute forward-looking statements with
respect to the financial condition, results of operations and business of Nortel
Networks, including statements that are based on current expectations,
estimates, forecasts, and projections about the markets in which Nortel Networks
operates and management's beliefs and assumptions regarding these markets. In
addition, other written or oral statements which constitute forward-looking
statements may be made by or on behalf of Nortel Networks. This information and
such statements are subject to important risks, uncertainties and assumptions
which are difficult to predict. The results or events predicted in these
statements may differ materially from actual results or events. Some of the
factors which could cause results or events to differ from current expectations
include, but are not limited to the factors set forth below. Nortel Networks
disclaims any intention or obligation to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
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ACQUISITIONS, RAPID TECHNOLOGICAL CHANGE AND VOICE AND DATA CONVERGENCE.
Nortel Networks expects that data communications traffic will grow substantially
in the future compared to the modest growth expected for voice traffic. The
growth of data traffic and the use of the Internet are expected to have a
significant impact on traditional voice networks and create market
discontinuities which will drive the convergence of data and telephony and give
rise to the demand for IP-optimized networking solutions. Many of Nortel
Networks' traditional customers have already begun to invest in data networking.
Given the dynamic and evolving nature of the communications business and the
technology involved, there can be no assurance as to the rate of such
convergence. Consequently, there is no assurance that the market discontinuities
and the resulting demand for IP-optimized networking solutions will continue to
develop. Certain events (including the evolution of other technologies) may
occur which would increase the demand for products based on other technologies
and reduce the demand for IP-optimized networking solutions. A lack of demand
for IP-optimized networking solutions in the future could have a material
adverse effect on the business, results of operations and financial condition of
Nortel Networks.
In order to position Nortel Networks to take advantage of the anticipated
growth in demand for IP-optimized networking solutions, Nortel Networks has
made, and may continue to make, strategic acquisitions which involve significant
risks and uncertainties. These risks and uncertainties include the risk that the
industry does not evolve as anticipated and that the technologies acquired do
not prove to be those needed to be successful in the industry, the difficulty in
integrating new businesses and operations in an efficient and effective manner,
the risks of customers of Nortel Networks or the acquired businesses deferring
purchase decisions as they evaluate the impact of the acquisition on Nortel
Networks' future product strategy, the potential loss of key employees of the
acquired businesses, the risk of diverting the attention of senior management
from the operation of the business, and the risks of entering new markets in
which Nortel Networks has limited experience. The inability to successfully
integrate significant acquisitions made by Nortel Networks could have a material
adverse effect on the business, results of operations and financial condition of
Nortel Networks.
The markets for Nortel Networks' products are characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions, and short product life cycles. Nortel Networks' success is
expected to depend, in substantial part, on the timely and successful
introduction of new products and upgrades of current products to comply with
emerging industry standards and to address competing technological and product
developments carried out by others. The development of new, technologically
advanced products, including IP-optimized networking solutions and 3-G wireless
networks, is a complex and uncertain process requiring high levels of
innovation, as well as the accurate anticipation of technological and market
trends. The success of new or enhanced products, including IP-optimized
networking solutions and 3-G wireless networks, is dependent on a number of
other factors including the timely introduction of such products, market
acceptance of new technologies and industry standards, and the pricing and
marketing of such products. An unanticipated change in one or more of the
technologies affecting telecommunications and data networking, or in market
demand for products based on a specific technology, particularly lower than
anticipated demand for IP-optimized networking solutions, could have a material
adverse effect on the business, results of operations and financial condition of
the Corporation if it fails to respond in a timely and effective manner to such
changes.
COMPETITION. Nortel Networks' principal competitors are large
telecommunications equipment suppliers, such as Alcatel, Lucent Technologies
Inc., Siemens AG, and Telefonaktiebolaget LM Ericsson, and data networking
companies such as Cisco Systems, Inc. and 3Com Corporation. Since some of the
markets in which Nortel Networks competes are characterized by rapid growth and,
in certain cases, low barriers to entry and rapid technological changes, smaller
niche market companies and start-up ventures may become principal competitors in
the future. One way to maximize market growth, enhance existing products and
introduce new products is through acquisitions of companies, where advisable.
These acquisitions may have the effect of inducing certain of Nortel Networks'
other competitors to enter into additional business combinations, to accelerate
product development, or to engage in aggressive price reductions or other
competitive practices, thereby creating even more powerful or aggressive
competitors.
Nortel Networks expects that it will face additional competition from
existing competitors and from a number of companies that have entered or may
enter Nortel Networks' existing and future markets. Some of Nortel Networks'
current and potential competitors have greater financial (which includes the
ability to provide customer
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<PAGE> 39
financing in connection with the sale of its products), marketing and technical
resources. Many of Nortel Networks' current and potential competitors have also
established relationships with Nortel Networks' current and potential customers.
Increased competition could result in price reductions, reduced profit margins
and loss of market share, each of which could have a material adverse effect on
the business, results of operations and financial condition of Nortel Networks.
INTERNATIONAL GROWTH AND INTEREST RATES. Nortel Networks intends to
continue to pursue growth opportunities in international markets. In many
international markets, long-standing relationships between Nortel Networks'
potential customers and their local providers and protective regulations,
including local content requirements and type approvals, create barriers to
entry. In addition, pursuit of such international growth opportunities may
require significant investments for an extended period before returns on such
investments, if any, are realized. Such projects and investments could be
adversely affected by reversals or delays in the opening of foreign markets to
new competitors, exchange controls, currency fluctuations, investment policies,
restrictions on repatriation of cash, nationalization of local industry, social
and political risks, taxation, and other factors, depending on the country in
which such opportunity arises. Difficulties in foreign financial markets and
economies, and of foreign financial institutions, could adversely affect demand
from customers in the affected countries. As a result of these risks, it is
uncertain whether the recent economic recoveries in certain foreign countries,
such as countries in CALA, and the Asia Pacific region will continue.
FOREIGN EXCHANGE. As Nortel Networks continues to expand its business
globally, an increasing proportion of its business may be denominated in
currencies other than United States dollars. As a result, Nortel Networks could
experience increased exposure to fluctuations in foreign currencies that may
have an impact on the Corporation's business and financial results. Nortel
Networks' primary exposures are related to United States dollars, Canadian
dollars, United Kingdom pounds, and the Euro. These exposures may change over
time as Nortel Networks changes the geographic mix of its global business and as
its business practices evolve.
Nortel Networks endeavors to minimize the impact of currency fluctuations
through its ongoing commercial practices and by attempting to hedge its
exposures to major currencies. In attempting to manage its foreign exchange
risk, Nortel Networks identifies operations and transactions that may have
foreign exchange exposure, based upon, among other factors, the excess or
deficiency of foreign currency receipts over foreign currency expenditures in
each of Nortel Networks' significant foreign currencies. Given the increasing
use of the Euro as a common currency for members of the European Union and its
devaluation, and Nortel Networks' exposure to other international markets,
Nortel Networks continuously monitors all of its foreign currency exposures.
Nortel Networks cannot predict whether foreign exchange losses will be incurred
in the future, and significant foreign exchange fluctuations may have a material
adverse effect on the business, results of operations and financial condition of
Nortel Networks.
FLUCTUATIONS IN OPERATING RESULTS, GENERAL INDUSTRY, MARKET CONDITIONS
AND GROWTH RATES. The results of operations for any quarter are not necessarily
indicative of results to be expected in future periods. Nortel Networks' future
operating results may be affected by various trends and factors which must be
managed in order to achieve favorable operating results. Nortel Networks'
operating results have historically been and are expected to continue to be
subject to quarterly fluctuations as a result of a number of factors. These
factors include: the impact of acquired businesses and technologies, the
introduction and market acceptance of new technologies and integrated networking
solutions, variations in the mix of products sold, and the timing of customer
orders and manufacturing capacity and lead times. In addition, there are trends
and factors beyond Nortel Networks' control which may affect its operations.
Such potential trends and factors include: adverse changes in the conditions in
the specific markets for Nortel Networks' products; capital expenditures by
Nortel Networks' customers generally; the conditions in the broader market for
communications, including data networking, computerized information access
equipment and services, and the conditions in the domestic or global economy
generally; governmental regulation or intervention affecting communications or
data networking; and other factors. Any of the above factors could have a
material adverse effect on the business, results of operations and financial
condition of Nortel Networks.
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Nortel Networks participates in a highly volatile and rapidly growing
industry that is characterized by vigorous competition for market share and
rapid technological development carried out amidst uncertainty over adoption of
industry standards and protection of intellectual property rights. These factors
could result in aggressive pricing practices and growing competition both from
start-up companies and from well-capitalized computer systems and communications
companies, which, in turn, could have a material adverse effect on the business,
results of operations and financial condition of Nortel Networks.
YEAR 2000 COMPLIANCE. Nortel Networks' information technology systems,
facilities and production infrastructure have not experienced any material
adverse impacts as a result of the Year 2000 date transition. Similarly, there
has been no material Year 2000 impacts reported with respect to Nortel Networks'
products that were classified as Year 2000 ready. In addition, Nortel Networks
experienced no material supply chain problems related to the transition date.
CONSOLIDATIONS IN TELECOMMUNICATIONS INDUSTRY. The telecommunications
industry has experienced the consolidation of industry participants and this
trend is expected to continue. Nortel Networks and one or more of its
competitors may each supply products to the corporations that have merged or
will merge. This consolidation could result in delays in purchasing decisions by
the merged corporations and/or Nortel Networks playing a lesser role in the
supply of communications products to the merged corporations, and could have a
material adverse effect on the business, results of operations and financial
condition of Nortel Networks.
UNCERTAINTIES OF THE INTERNET. There are currently few laws or
regulations that apply directly to access or commerce on the Internet. Nortel
Networks could be materially adversely affected by regulation in any country
where it operates relating to such technology as voice over the Internet,
encryption technology and access charges for Internet service providers, as well
as the continuing deregulation of the telecommunications industry. The adoption
of such measures could decrease demand for Nortel Networks' products and at the
same time increase the cost of selling such products. Changes in laws or
regulations governing the Internet and Internet commerce could have a material
adverse effect on the business, results of operations and financial condition of
Nortel Networks.
EMPLOYEES. Competition for technical personnel in the high-technology
industry is intense. Nortel Networks believes that its future success depends in
part on its continued ability to hire, assimilate and retain qualified personnel
particularly in high growth segments such as optical networking. To date, Nortel
Networks believes that it has been successful in recruiting and retaining
qualified employees, but there is no assurance that it will continue to be
successful in the future.
INCREASE IN CUSTOMER FINANCING, CUSTOMER CREDIT RISK, AND COMMITMENTS.
The competitive environment in which Nortel Networks operates requires Nortel
Networks and many of its principal competitors to provide significant amounts of
medium-term and long-term customer financing. Customer financing arrangements
may include financing in connection with the sale of Nortel Networks products
and services, as well as funding for certain non-product and service costs
associated with network installation and integration of Nortel Networks products
and services, working capital purposes and equity financing. While Nortel
Networks has generally been able to place a large amount of its customer
financings with third-party lenders, Nortel Networks anticipates that, due to
the amount of financing it expects to provide and the higher risks typically
associated with such financings (particularly when provided to start-up
operations such as local exchange carriers, to customers in developing countries
or to customers in specific financing-intensive areas of the industry such as
3-G wireless operators which are in their early stages of development), the
amount of such financings required to be supported directly by Nortel Networks
for at least the initial portion of their term, is expected to increase
significantly in the future. Nortel Networks expects to continue to arrange for
third-party lenders to assume customer financing obligations agreed to by Nortel
Networks and to fund other customer financings directly supported by Nortel
Networks from working capital and conventional sources of external financing in
the normal course. In the event of economic uncertainty in any given geographic
region and/or reduced demand for customer financings in capital and bank
markets, Nortel Networks may be required to continue to hold certain customer
financing obligations for longer periods prior to placement with third-party
lenders. Should customers fail to meet their obligations, losses could be
incurred and such losses may have a material adverse effect on the business,
results of operations and financial condition of Nortel Networks. Nortel
Networks has various programs in place to monitor and mitigate customer credit
risk;
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however, there can be no assurance that such measures will reduce Nortel
Networks exposure to its customers' credit risk.
Nortel Networks has entered into supply contracts with customers for
products and services involving new technologies currently being developed or
which have not yet been commercially deployed by Nortel Networks or require
Nortel Networks to build and operate networks on a turnkey basis. These supply
contracts may contain delivery and installation timetables and performance
criteria which, if not met, could result in the payment of substantial penalties
and/or liquidated damages by Nortel Networks, the termination of the related
supply contract, and/or the reduction of shared revenues under a turnkey
arrangement, and could have a material adverse effect on the business, results
of operations and financial condition of Nortel Networks.
COMPONENT SUPPLY AND MANUFACTURING CAPACITY. Nortel Networks' ability to
meet customer demand is, in part, dependent on Nortel Networks obtaining timely
and adequate component parts from suppliers and internal manufacturing capacity.
In the past, customer demand for optical networking systems exceeded Nortel
Networks' ability to supply these systems within customary delivery periods,
creating a large backlog of orders for Nortel Networks' optical networking
systems. By the end of the second quarter of 2000, the prior backlog for optical
networking systems was substantially reduced and delivery periods returned to
more traditional levels and remained unchanged at the end of the third quarter
of 2000. Nortel Networks works closely with its suppliers to ensure increased
capacity to meet increases in customer demand and also manages its internal
manufacturing capacity and inventory levels as required. However, as new markets
in which Nortel Networks participates grow quickly and competition for component
supplies and capacity increases, there can be no assurance that Nortel Networks
will not encounter component shortages in the future. In addition, Nortel
Networks' component suppliers may experience a consolidation in the industry,
which may result in fewer sources of components. A reduction or interruption in
component supply or a significant increase in the price of one or more
components could have a material adverse effect on the business, results of
operations and financial condition of Nortel Networks or customer relationships.
RECENT PRONOUNCEMENTS
In December 1999, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"), which provides guidance related to revenue recognition.
SAB 101 allows companies to report any changes in revenue recognition related to
the adoption of its provisions as an accounting change at the time of
implementation. Nortel Networks must adopt SAB 101 no later than December 31,
2000, effective as of January 1, 2000. Nortel Networks is currently determining
the impact that this statement will have on its business, results of operations
and financial condition.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). In June 2000, the
FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and
Certain Hedging Activities -- an amendment of SFAS No. 133" ("SFAS 138"), which
amends certain provisions of SFAS 133 to clarify four areas. The amendment
included expanding the normal purchase and sale exemption for supply contracts,
permitting the offsetting of certain intercompany foreign currency derivatives
and thus reducing the number of third party derivatives, permitting hedge
accounting for foreign-currency denominated assets and liabilities, and
redefining interest rate risk to reduce sources of ineffectiveness. Nortel
Networks has appointed a team to implement SFAS 133 on a global basis. This team
has been implementing an SFAS 133 compliant risk management information system,
globally educating both financial and non-financial personnel, taking an
inventory of embedded derivatives and addressing various other SFAS 133 related
issues. Nortel Networks will adopt SFAS 133 and the corresponding amendments
under SFAS 138 on January 1, 2001, and is currently determining the impact of
SFAS 133 on its business, results of operations and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the Consolidated
Financial Statements of the Corporation due to adverse changes in financial
market prices and rates. The Corporation's market risk exposure is primarily a
result of fluctuations in interest rates and foreign exchange rates. Disclosure
of market risk is contained on page M-27 of the U.S. GAAP Form 8-K.
41
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Disclosure of legal proceedings is contained in "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
3.1 Restated Certificate and Articles of Incorporation of the Corporation
effective October 1, 2000 (filed as Exhibit 3 to the Corporation's
Current Report on Form 8-K dated October 19, 2000 and incorporated
in its entirety herein by reference).
27 Financial Data Schedule
b) Reports on Form 8-K:
The Corporation filed a Report on Form 8-K dated August 7, 2000 and a
Report on Form 8-K/A dated August 18, 2000 related to its audited U.S. GAAP
financial statements as at December 31, 1999 and December 31, 1998.
The Corporation filed a Report on Form 8-K dated October 19, 2000 related
to its Restated Certificate and Articles of Incorporation.
42
<PAGE> 43
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
NORTEL NETWORKS LIMITED
(REGISTRANT)
Chief Financial Officer Chief Accounting Officer
"F.A. DUNN" "D.C. BEATTY"
-------------------------------- ---------------------------------
F.A. DUNN D.C. BEATTY
Chief Financial Officer Controller
Date: November 7, 2000
43
<PAGE> 44
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
3.1 Restated Certificate and Articles of Incorporation of the
Corporation effective October 1, 2000 (filed as Exhibit 3 to
the Corporation's Current Report on Form 8-K dated October 19,
2000 and incorporated in its entirety herein by reference).
27 Financial Data Schedule
