<PAGE> 1
================================================================================
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 1-7260
NORTEL NETWORKS CORPORATION
(Exact name of registrant as specified in its charter)
CANADA NOT APPLICABLE
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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
3,006,967,918 WITHOUT NOMINAL OR PAR VALUE
================================================================================
<PAGE> 2
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.......................... 23
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................. 46
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings............................................... 47
ITEM 2. Changes in Securities and Use of Proceeds....................... 47
ITEM 6. Exhibits and Reports on Form 8-K................................ 48
SIGNATURES ................................................................ 49
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
<PAGE> 3
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
<PAGE> 4
NORTEL NETWORKS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 7,314 $ 5,147 $ 21,457 $ 14,714
Cost of revenues 4,096 2,985 12,299 8,401
-----------------------------------------------------------------------------------------------------
Gross profit 3,218 2,162 9,158 6,313
Selling, general and administrative expense (excluding
stock option compensation) 1,380 952 4,053 2,789
Research and development expense 1,016 767 2,878 2,178
In-process research and development expense 22 -- 1,062 184
Amortization of intangibles
Acquired technology 222 171 612 513
Goodwill 1,089 306 2,378 893
Stock option compensation 31 -- 98 --
Special charges -- 63 195 116
Gain on sale of businesses -- (110) (174) (110)
-----------------------------------------------------------------------------------------------------
(542) 13 (1,944) (250)
Equity in net earnings (loss) of associated companies (16) 29 (22) --
Other income -- net 236 27 830 103
Interest expense
Long-term debt (22) (27) (69) (74)
Other (17) (11) (49) (40)
-----------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (361) 31 (1,254) (261)
Income tax provision 225 110 807 262
-----------------------------------------------------------------------------------------------------
Net loss applicable to common shares $ (586) $ (79) $ (2,061) $ (523)
=====================================================================================================
Loss per common share
-- basic $ (.20) $ (.03) $ (.71) $ (.19)
-- diluted $ (.20) $ (.03) $ (.71) $ (.19)
Dividends declared per common share $ .0188 $ .0188 $ .0563 $ .0563
</TABLE>
4
<PAGE> 5
NORTEL NETWORKS CORPORATION
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 $ 1,758 $ 2,153
Accounts receivable (less provision for uncollectibles -
$400 at September 30, 2000; $319 at December 31, 1999) 7,337 5,815
Inventories 4,059 2,823
Prepaid expenses and other assets 1,066 559
Deferred income taxes - net 991 826
--------------------------------------------------------------------------------------
15,211 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 848 1,072
--------------------------------------------------------------------------------------
PLANT AND EQUIPMENT (net of accumulated amortization -
$2,800 at September 30, 2000; $2,857 at December 31, 1999) 2,928 2,333
--------------------------------------------------------------------------------------
LONG-TERM DEFERRED INCOME TAXES - NET 115 362
--------------------------------------------------------------------------------------
INTANGIBLE ASSETS
Acquired technology - net 1,034 1,202
Goodwill - net 12,045 5,093
--------------------------------------------------------------------------------------
13,079 6,295
--------------------------------------------------------------------------------------
OTHER ASSETS 494 413
--------------------------------------------------------------------------------------
TOTAL ASSETS $33,903 $24,007
======================================================================================
</TABLE>
5
<PAGE> 6
NORTEL NETWORKS CORPORATION
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 2,547 2,360
Payroll and benefit-related liabilities 941 818
Other accrued liabilities 3,367 3,191
Income taxes payable 299 488
Long-term debt due within one year 300 35
--------------------------------------------------------------------------------
7,727 7,101
LONG-TERM LIABILITIES
Deferred income 69 53
Long-term debt 1,243 1,391
Deferred income taxes - net 712 767
Other liabilities 1,023 966
--------------------------------------------------------------------------------
10,774 10,278
--------------------------------------------------------------------------------
MINORITY INTEREST IN SUBSIDIARY COMPANIES 797 657
--------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (note 15)
SHAREHOLDERS' EQUITY
Common shares, without par value - Authorized
shares: unlimited; Issued and outstanding
shares: 3,001,519,454 at September 30, 2000
and 2,754,309,396 at December 31, 1999 22,152 11,745
Additional paid-in capital 2,014 794
Deferred stock option compensation (5) --
Retained earnings (deficit) (1,259) 967
Accumulated other comprehensive loss (570) (434)
--------------------------------------------------------------------------------
22,332 13,072
--------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 33,903 $ 24,007
================================================================================
</TABLE>
6
<PAGE> 7
NORTEL NETWORKS CORPORATION
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 $ (2,061) $ (523)
Adjustments to reconcile net loss to net cash
used in operating activities, net of effects
from acquisitions and divestitures of
businesses:
Amortization 3,477 1,857
In-process research and development 1,062 184
Equity in net loss of associated companies 22 --
Stock option compensation 98 --
Tax benefit from stock options 408 116
Increase (decrease) in deferred incomes taxes 41 (123)
Increase in other liabilities 85 69
Gain on sale of businesses and investments (791) (162)
Other - net 87 (96)
Change in operating assets and liabilities:
Accounts receivable (309) (1,321)
Inventories (1,467) (885)
Income taxes payable (187) 16
Accounts payable and accrued liabilities (747) 712
Other operating assets and liabilities (639) (101)
--------------------------------------------------------------------------------
Net cash used in operating activities (921) (257)
--------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Expenditures for plant and equipment (1,160) (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 (297) (722)
Proceeds on sale of businesses and investments 1,735 532
--------------------------------------------------------------------------------
Net cash from (used in) investing activities 263 (943)
--------------------------------------------------------------------------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Dividends on common shares (165) (154)
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 409 439
Common shares purchased for cancellation -- (11)
--------------------------------------------------------------------------------
Net cash from financing activities 298 156
--------------------------------------------------------------------------------
Effect of exchange rate changes on cash and
cash equivalents (35) 3
--------------------------------------------------------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (395) (1,041)
--------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF
PERIOD - NET 2,153 2,230
--------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD - NET $ 1,758 $ 1,189
================================================================================
</TABLE>
7
<PAGE> 8
NORTEL NETWORKS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(MILLIONS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE STATED)
1. NORTEL NETWORKS CORPORATION
Effective May 1, 2000, a newly formed Canadian corporation ("New Nortel";
also referred to herein as the "Corporation") and the corporation
previously known as Nortel Networks Corporation ("Old Nortel") participated
in a Canadian court-approved plan of arrangement (the "Arrangement") with
BCE Inc. ("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 Old
Nortel.
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"). The record date for determining Old Nortel and BCE
shareholders entitled to receive certificates representing New Nortel
common shares issuable in the Arrangement, on a post-split basis, was May
5, 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.
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.
8
<PAGE> 9
Except as noted below, Old Nortel's comparative consolidated interim and
annual financial statements, and its financial results for the period
January 1, 2000 to May 1, 2000, represent the financial position, results
of operations and cash flows of New Nortel as if Old Nortel and New Nortel
had historically been the same entity.
The preferred shares and debt securities of Old Nortel outstanding
immediately prior to the Arrangement remain outstanding and continue to be
obligations of Old Nortel. As a result, certain of New Nortel's
consolidated financial statements items, including comparative figures,
have been reclassified to reflect the impact of the Arrangement on New
Nortel and the ongoing equity interest of the Old Nortel preferred
shareholders. The impact of the Arrangement on the consolidated balance
sheets of New Nortel was the reclassification of the outstanding Class A
Series 4, 5 and 7 preferred shares of Old Nortel from shareholders' equity
to minority interest in subsidiary companies. The impact of the Arrangement
on the consolidated statements of operations of New Nortel was the
reclassification of the dividends on preferred shares to other income - net
to reflect the dividend distribution on the outstanding preferred shares to
the Old Nortel preferred shareholders.
All references to loss per common share, dividends declared per common
share, weighted average number of common shares outstanding, and common
shares issued and outstanding, have been restated to reflect the impact of
the New Nortel Stock Split.
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 Old Nortel 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 from operations 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 $ 6,000 $1,313 $ 1 (a) $ 7,314
Earnings (loss) before income taxes
from operations 780 49 (1)(b) 828(c)
SEPTEMBER 30, 2000
-----------------------------------------
Total assets $14,813 $2,099 $16,991 $33,903
</TABLE>
9
<PAGE> 10
<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 from operations 440 108 (64)(b) 484(c)
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 2000
---------------------------------------------
CORPORATE
SP&C ENTERPRISE & OTHER TOTAL
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
External revenues $17,608 $ 3,844 $ 5(a) $21,457
Earnings (loss) before income
taxes from operations 2,368 57 (235)(b) 2,190(c)
</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 from operations 1,250 324 (299)(b) 1,275(c)
</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. Excludes 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 certain of the one-time gains and
charges.
(c) Reconciliation of segment earnings before income taxes from operations
to earnings (loss) before income taxes reported in the consolidated
financial statements:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-----------------------------------------
2000 1999 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total earnings before income taxes
from operations for reportable
segments $ 828 $ 484 $ 2,190 $ 1,275
Acquisition Related Costs (1,327) (460) (4,005) (1,538)
Stock option compensation (31) -- (98) --
Special charges and one-time costs -- (103) (197) (165)
Gain on sale of businesses -- 110 174 110
One-time gains 169 -- 682 57
--------------------------------------------------------------------------------
Earnings (loss) before income taxes $ (361) $ 31 $(1,254) $ (261)
================================================================================
</TABLE>
10
<PAGE> 11
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 Old Nortel. The number of common
shares issued as consideration and the number of stock options assumed in
those acquisitions have been restated to reflect the impact of the
Arrangement, including the exchange of Old Nortel's common shares for New
Nortel's common shares and the New Nortel Stock Split. Since May 1, 2000,
acquisitions involving any share consideration have been consummated by New
Nortel, while acquisitions not involving share consideration have continued
to be consummated by Old Nortel or its subsidiaries.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 2000
--------------------------------------------------------------------------------
PURCHASE ACQUIRED
ACQUISITION DATE PRICE TECHNOLOGY IPR&D GOODWILL
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
EPiCON (i) September 5 $ 284 $ 13 $ 6 $ 262
Architel (ii) July 1 $ 472 $ 17 $ 16 $ 420
CoreTek (iii) June 23 $1,047 $ 115 $ 176 $ 790
Xros (iv) June 2 $3,227 $ 29 $ 191 $3,004
Photonic (v) May 12 $ 32 $ -- $ -- $ 29
Promatory (vi) March 23 $ 741 $ 60 $ 50 $ 641
Clarify (vii) March 16 $2,114 $ 210 $ 64 $1,814
Qtera (viii) January 28 $3,004 $ -- $ 559 $2,424
Dimension (ix) January 24 $ 37 $ -- $ -- $ 30
Other (x)
</TABLE>
Form of consideration and other
(i) EPiCON, Inc. ("EPiCON") was a provider of a software platform that
enables application service providers to deliver and manage
applications as services over the Internet. In November 1999, Nortel
Networks made an initial investment in EPiCON, representing an
approximate 9 percent ownership interest. On September 5, 2000, the
Corporation issued approximately 4.3 million common shares and assumed
the equivalent of approximately 1.0 million stock options to purchase
common shares of the Corporation to acquire the remaining approximate
91 percent ownership interest. The fair value of the assumed EPiCON
stock options, using the Black-Scholes valuation model, was $38. The
allocation of the purchase price included assumed net tangible
liabilities of $1 and deferred stock option compensation of $4. The
acquired technology assets are being charged to earnings on a
straight-line basis over three years and the in-process research and
development ("IPR&D") assets were charged to earnings in the period.
Goodwill is being amortized on a straight-line basis over three years.
11
<PAGE> 12
(ii) Architel Systems Corporation ("Architel") was a provider of software
systems that allow service providers to provide Internet and other
next-generation Internet Protocol ("IP") services. In connection with
the acquisition, the Corporation issued approximately 6.0 million
common shares and assumed the equivalent of approximately 0.8 million
stock options to purchase common shares of the Corporation. The fair
value of the assumed Architel stock options, using the Black-Scholes
valuation model, was $40. The allocation of the purchase price
included net tangible assets of $17 and deferred stock option
compensation of $2. 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 four years.
(iii) CoreTek, Inc. ("CoreTek") was a developer of strategic optical
components. In connection with the acquisition, the Corporation issued
approximately 14.5 million common shares and assumed the equivalent of
approximately 3.4 million stock options to purchase common shares of
the Corporation. The fair value of the assumed CoreTek stock options,
using the Black-Scholes valuation model, was $175. The maximum
contingent consideration is approximately $364, payable in common
shares of the Corporation upon CoreTek achieving certain business
performance objectives in 2000 and the first quarter of 2001. The
allocation of the purchase price included assumed net tangible
liabilities of $34. 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.
(iv) Xros, Inc. ("Xros") was a developer of second-generation, large-scale,
fully photonic switching. In connection with the acquisition, the
Corporation issued approximately 52.9 million common shares and
assumed the equivalent of approximately 2.1 million stock options to
purchase common shares of the Corporation. The fair value of the
assumed Xros stock options, using the Black-Scholes valuation model,
was $76. The allocation of the purchase price included net tangible
assets of $3. 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.
(v) 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.
(vi) Promatory Communications, Inc. ("Promatory") was a developer of
Digital Subscriber Line ("DSL") platforms for high-speed Internet
access. In connection with the acquisition, approximately 13.9 million
common shares of the Corporation were issued, of which approximately
1.3 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 equivalent of approximately 0.3 million stock
options to purchase common shares of the Corporation were also
assumed. 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 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.
12
<PAGE> 13
(vii) Clarify Inc. ("Clarify") was a provider of eBusiness front office
solutions. In connection with the acquisition, approximately 63.4
million common shares of the Corporation were issued and the
equivalent of approximately 17.6 million stock options to purchase
common shares of the Corporation were assumed. 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.
(viii) Qtera Corporation ("Qtera") was a producer of ultra-long-reach
optical networking systems. In connection with the acquisition,
approximately 56.4 million common shares of the Corporation were
issued, of which approximately 10.4 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 equivalent of
approximately 7.4 million stock options to purchase common shares of
the Corporation and 1.9 million warrants convertible into common
shares of the Corporation were assumed. 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.
(ix) 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.
(x) 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.
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.
13
<PAGE> 14
The acquisitions of EPiCON and Architel are collectively referred to herein as
the "Third Quarter 2000 Acquisitions," the acquisitions of CoreTek, Xros and
Photonic are collectively referred to herein as the "Second Quarter 2000
Acquisitions," and the acquisitions of Promatory, Clarify, Qtera, and Dimension
are collectively referred to herein as the "First Quarter 2000 Acquisitions."
The First Quarter 2000 Acquisitions, the Second Quarter 2000 Acquisitions and
the Third Quarter 2000 Acquisitions are collectively referred to herein as the
"First, Second and Third Quarter 2000 Acquisitions."
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 for the First, Second and Third
Quarter 2000 Acquisitions was an aggregate amount of IPR&D of $1,062.
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.
A brief description of the IPR&D projects related to the Third Quarter 2000
Acquisitions is set forth below, including an estimated percentage-of-completion
of products within each project at their respective acquisition dates.
14
<PAGE> 15
EPiCON
ALTIS VERSION 4.X. ALTiS is a software management and deployment platform that
can be used by both application service providers and enterprise information
technology departments to manage the deployment, installation and management
applications and remote applications on remote Windows PCs. Nortel Networks
estimated that the project was 45 percent complete at the time of acquisition,
that it would require approximately $1.5 to complete the project, and that the
completed project would begin to contribute to Nortel Networks' revenues by the
end of the first quarter of 2002. A discount rate of 35 percent was employed in
the analysis.
Architel
AUTOMATED SERVICE ACTIVATION PROGRAM ("ASAP") VERSION 4.3. ASAP is a software
system that allows communication providers to activate services instantly for
their customers and quickly realize revenues, while improving customer service
and reducing costs. Nortel Networks estimated that ASAP version 4.3 was 78
percent complete at the time of acquisition, and that it would require
approximately $0.1 to complete the project. The completed project began to
contribute to Nortel Networks' revenues in the third quarter of 2000. A discount
rate of 19 percent was employed in the analysis.
OBJECTEL VERSION 2.4. Objectel is a software system that provides accurate
inventory management, which enables real-time, flow-through network and service
provisioning. Nortel Networks estimated that Objectel version 2.4 was 60 percent
complete at the time of acquisition, that it would require approximately $0.4 to
complete the project, and that the completed project would begin to contribute
to Nortel Networks' revenues by the end of the fourth quarter of 2000. A
discount rate of 19 percent was employed in the analysis.
ORDER MANAGEMENT SYSTEM ("OMS") VERSION 1.7. OMS is a software system that
reduces service delivery times, operating costs and time to market for new
services by automating the network and service provisioning processes. Nortel
Networks estimated that OMS version 1.7 was 7 percent complete at the time of
acquisition, that it would require approximately $0.5 to complete the project
and that the completed project would begin to contribute to Nortel Networks'
revenues by the end of the fourth quarter of 2000. A discount rate of 19 percent
was employed in the analysis.
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:
CoreTek
GAIN TILT MONITOR ("GTM"). The GTM is a low-end wavelength monitor solution that
provides a measure of relative power accuracy per channel in Dense Wavelength
Division Multiplexing systems. The GTM was specifically designed to be used in
every long-haul line amplifier. Nortel Networks has revised its original
estimate and now expects that the completed project will begin to contribute to
Nortel Networks' revenues in the second quarter of 2001.
OPTICAL PERFORMANCE MONITOR ("OPM"). The OPM is a high-end wavelength monitor.
The OPM is geared to meet specifications provided by certain key
telecommunication service providers. Nortel Networks has revised its original
estimate and now expects that the completed project will begin to contribute to
Nortel Networks' revenues in the first quarter of 2001.
LASER LOCKER CARD ("LLC"). The LLC is a tunable laser configuration with an
optical feedback loop for wavelength locking. The LLC uses a differential etalon
approach that outputs a comparative signal into a closed feedback loop for
tuning and locking the laser. Nortel Networks estimated that the completed
project would begin to contribute to Nortel Networks' revenues by the end of the
fourth quarter of 2000.
15
<PAGE> 16
Xros
X-1000. The X-1000 is an all-optical cross-connect system for fiber-optic
networks. Nortel Networks has revised its original estimates and now expects
that the completed project will begin to contribute to Nortel Networks'
revenues in the second half of 2001.
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.
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.
16
<PAGE> 17
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 $1,016 $ 767 $2,878 $2,178
R&D costs incurred on
behalf of others* 14 45 49 94
--------------------------------------------------------------------------------
Total $1,030 $ 812 $2,927 $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.
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.
17
<PAGE> 18
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.
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.
18
<PAGE> 19
8. OTHER INCOME -- NET
Other income -- net for the third quarter and first nine months of 2000
totalled $236 and $830, respectively, and for the third quarter and first
nine months of 1999 totalled $27 and $103, 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.
10. LOSS PER COMMON SHARE
Basic loss per common share was calculated by dividing the net loss
applicable to common shares by the weighted average number of common shares
outstanding during the period. Diluted loss per common share was calculated
by dividing net loss applicable to common shares by the sum of the weighted
average number of common shares outstanding plus all additional common
shares that would have been outstanding if potentially dilutive common
shares had been issued. For the third quarter and first nine months of 2000
and 1999, respectively, the effect of converting options and Old Nortel's
redeemable preferred shares was antidilutive.
The following table details the weighted average number of common shares
outstanding for the third quarter and first nine months of 2000 and 1999,
respectively:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------
2000 1999 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average number of common
shares outstanding (millions)
-- basic 2,991 2,718 2,907 2,694
-- diluted 3,172 2,820 3,069 2,796
</TABLE>
19
<PAGE> 20
11. 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 $ (586) $ (79) $(2,061) $ (523)
Other comprehensive income
(loss):
Change in foreign currency
translation adjustment* (29) (11) (150) (90)
Change in unrealized gain
on investments -- net** (25) -- 14 (10)
--------------------------------------------------------------------------------
Comprehensive loss $ (640) $ (90) $(2,197) $ (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.
12. 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 nil 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 Old Nortel's common
shares immediately prior to the Arrangement to a nominal ownership interest
in the Corporation. As a result, BCE and entities that are owned by BCE are
no longer considered related parties after the Arrangement.
20
<PAGE> 21
13. INVENTORIES
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 661 $ 696
Work in process 955 819
Finished goods 2,443 1,308
--------------------------------------------------------------------------------
$ 4,059 $ 2,823
================================================================================
</TABLE>
14. 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>
15. 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 Old Nortel's securities commenced a class
action in the United States District Court for the Southern District of New
York alleging that Old Nortel 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 Old Nortel. In
January 2000, the court heard arguments on Old Nortel'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.
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 of the Corporation and/or its subsidiaries intend to
vigorously defend these actions.
21
<PAGE> 22
16. 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.
17. SUBSEQUENT EVENTS
On October 19, 2000, the Corporation acquired Sonoma Systems ("Sonoma"), a
developer of high-speed integrated video, data and voice communications
delivery simultaneously over a single connection. The acquisition was
completed by way of a merger of Sonoma with and into a wholly owned
subsidiary of the Corporation. In connection with the acquisition, the
Corporation issued approximately 4.8 million common shares and assumed the
equivalent of approximately 1.3 million stock options to purchase common
shares of the Corporation. Up to an additional $72 will be payable in
common shares of the Corporation upon Sonoma achieving certain business
performance objectives in the first twelve months after closing. The
acquisition will be accounted for using the purchase method.
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.
On October 5, 2000, the Corporation acquired Alteon WebSystems, Inc.
("Alteon"), a provider of next generation Internet infrastructure
solutions. The acquisition was completed by way of a merger of Alteon with
and into a wholly owned subsidiary of the Corporation. In connection with
the acquisition, the Corporation issued approximately 82.0 million common
shares and assumed the equivalent of approximately 29.0 million stock
options to purchase common shares of the Corporation. The acquisition will
be accounted for using the purchase method.
18. COMPARATIVE FIGURES
Certain comparative figures in the consolidated financial statements have
been reclassified to conform with the current period's presentation.
22
<PAGE> 23
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, a newly formed Canadian corporation ("New Nortel";
also referred to herein as the "Corporation") and the corporation previously
known as Nortel Networks Corporation ("Old Nortel") participated in a Canadian
court-approved plan of arrangement (the "Arrangement") with BCE Inc. ("BCE").
For details, see "Highlights - BCE Plan of Arrangement" below. Except as noted
below, Old Nortel's comparative consolidated interim and annual financial
statements, and the financial results for the period January 1, 2000 to May 1,
2000, represent the financial position, results of operations and cash flows of
New Nortel as if Old Nortel and New Nortel had historically been the same
entity. Unless the context indicates otherwise, the Corporation and its
subsidiaries are collectively referred to as "Nortel Networks."
The preferred shares and debt securities of Old Nortel outstanding
immediately prior to the Arrangement remain outstanding and continue to be
obligations of Old Nortel. As a result, certain of New Nortel's consolidated
financial statements items, including comparative figures, have been
reclassified to reflect the impact of the Arrangement on New Nortel and the
ongoing equity interest of Old Nortel's preferred shareholders. The impact of
the Arrangement on the consolidated balance sheets of New Nortel was the
reclassification of the outstanding Class A Series 4, 5 and 7 preferred shares
of Old Nortel from shareholders' equity to minority interest in subsidiary
companies. The impact of the Arrangement on the consolidated statements of
operations of New Nortel was the reclassification of the dividends on preferred
shares to other income - net to reflect the dividend distribution on the
outstanding preferred shares to Old Nortel's preferred shareholders.
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 Old Nortel.
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
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and its subsidiaries as subsidiaries of New Nortel after the Arrangement.
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"). The record date for determining Old Nortel and BCE shareholders
entitled to receive certificates representing New Nortel common shares issuable
in the Arrangement, on a post-split basis, was May 5, 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.
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<PAGE> 25
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:
September 5, 2000 Acquisition of EPiCON, Inc. ("EPiCON"), a provider of a
software platform that enables application service providers
("ASPs") to deliver and manage applications as services over
the Internet.
July 1, 2000 Acquisition of Architel Systems Corporation ("Architel"), a
provider of software systems that allow service providers to
provide Internet and other next-generation IP services.
June 23, 2000 Acquisition of CoreTek, Inc. ("CoreTek"), a developer of
strategic optical components.
June 2, 2000 Acquisition of Xros, Inc. ("Xros"), a developer of second-
generation, large-scale, fully photonic switching.
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.
The acquisitions of EPiCON and Architel are collectively referred to herein
as the "Third Quarter 2000 Acquisitions," the acquisitions of CoreTek, Xros and
Photonic are collectively referred to herein as the "Second Quarter 2000
Acquisitions" and the acquisitions of Promatory, Clarify, Qtera and Dimension
are collectively referred to herein as the "First Quarter 2000 Acquisitions."
The First Quarter 2000 Acquisitions, the Second Quarter 2000 Acquisitions and
the Third Quarter 2000 Acquisitions are collectively referred to herein as the
"First, Second, and Third Quarter 2000 Acquisitions." All acquisitions completed
prior to May 1, 2000 were consummated by Old Nortel. Since May 1, 2000,
acquisitions involving any share consideration have been consummated by New
Nortel, while acquisitions not involving share consideration have continued to
be consummated by Old Nortel or its subsidiaries.
In addition, the Corporation announced the following transactions:
o On October 19, 2000, the Corporation acquired Sonoma Systems ("Sonoma"), a
developer of high-speed integrated video, data and voice communications
delivery simultaneously over a single connection. The acquisition was
completed by way of a merger of Sonoma with and into a wholly owned
subsidiary of the Corporation. In connection with the acquisition, the
Corporation issued approximately 4.8 million common shares and assumed the
equivalent of approximately 1.3 million stock options to purchase common
shares of the Corporation. Up to an additional $72 million will be payable
in common shares of the Corporation upon
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<PAGE> 26
Sonoma achieving certain business performance objectives in the first
twelve months after closing. The acquisition will be accounted for using
the purchase method.
o 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, 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.
o On October 5, 2000, the Corporation acquired Alteon WebSystems, Inc.
("Alteon"), a provider of next generation Internet infrastructure
solutions. The acquisition was completed by way of a merger of Alteon with
and into a wholly owned subsidiary of the Corporation. In connection with
the acquisition, the Corporation issued approximately 82.0 million common
shares and assumed the equivalent of approximately 29.0 million stock
options to purchase common shares of the Corporation. The acquisition will
be accounted for using the purchase method.
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.
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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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-----------------------------------------------
(MILLIONS OF U.S. DOLLARS, EXCEPT PER
SHARE AMOUNTS)
--------------------------------------------------------------------------------
2000 1999 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Consolidated revenues $ 7,314 $ 5,147 $21,457 $14,714
SP&C revenues(1) $ 6,000 $ 3,885 $17,608 $10,985
Enterprise revenues(1) $ 1,313 $ 1,241 $ 3,844 $ 3,663
Earnings (loss) before
income taxes $ (361) $ 31 $(1,254) $ (261)
Net loss applicable to
common shares $ (586)(2) $ (79)(3) $(2,061)(2) $ (523)(3)
Loss per common share(4) $ (.20)(2) $ (.03)(3) $ (.71)(2) $ (.19)(3)
</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.
(2) Net loss applicable to common shares and loss per common share for the
third quarter and first nine months of 2000 included the impact of
after-tax charges 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. ("Bay
Networks") and all subsequent acquisitions), stock option compensation from
acquisitions and divestitures and, where applicable, certain of the
one-time gains and charges. Acquisition Related Costs for the third quarter
of 2000 totalled $1,327 million pre-tax ($1,245 million after-tax)
primarily associated with the acquisitions of Bay Networks, Xros, Qtera,
and Clarify. Acquisition Related Costs for the first nine months of 2000
totalled $4,005 million pre-tax ($3,780 million after-tax) primarily
associated with the acquisitions of Bay Networks, Qtera, Xros, and Clarify.
Stock option compensation from acquisitions and divestitures for the third
quarter of 2000 totalled $31 million pre-tax and after-tax. In addition,
the net loss applicable to common shares and loss per common share for the
third quarter of 2000 included a $169 million pre-tax ($116 million
after-tax) one-time gain due to a reduction in Nortel Networks' investment
in Entrust Technologies, Inc. ("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"). One-time charges were nil for the third quarter of 2000. For
the first nine months of 2000, the net loss applicable to common shares and
loss per common share included one-time gains of $856 million pre-tax ($511
million after-tax) primarily related to a gain from the Entrust
Technologies Transaction and the sale by Nortel Networks of a portion of
its share ownership in Entrust Technologies. For the first nine months of
2000, the net loss applicable to common shares and loss per common share
included total one-time charges of $197 million pre-tax ($176 million
after-tax) related to restructuring and $98 million pre-tax and after-tax
stock option compensation from acquisitions and divestitures.
(3) Net loss applicable to common shares and loss per common share for the
third quarter and the first nine months of 1999 included the impact of
after-tax charges of Acquisition Related Costs and one-time gains and
charges which totalled $453 million pre-tax ($393 million after-tax) and
$1,536 million pre-tax ($1,350 million after-tax), respectively.
(4) References to loss per common share amounts have been restated to reflect
the impact of the New Nortel Stock Split on May 5, 2000.
EARNINGS (LOSS) BEFORE INCOME TAXES
The loss before income taxes for the third quarter of 2000, compared to the
earnings for the same period in 1999, was primarily the result 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. ("Bay
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Networks") and all subsequent acquisitions) of $1,327 million pre-tax ($1,245
million after-tax), which was partially offset by revenue growth and higher
gross profits. These Acquisition Related Costs related primarily to the
acquisitions of Bay Networks, Xros, Qtera, and Clarify. By comparison, the
Acquisition Related Costs for the third quarter of 1999 were $460 million
pre-tax ($398 million after-tax), 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 loss before income taxes for the third quarter of 2000 also
included $31 million pre-tax and after-tax stock option compensation and a $169
million pre-tax ($116 million after-tax) one-time gain due to a reduction in
Nortel Networks' investment in Entrust Technologies, Inc. ("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"). One-time charges were nil for the third quarter of
2000. Earnings before income taxes for the third quarter of 1999 included a
one-time net gain of $110 million pre-tax ($74 million after-tax), related to
the divestiture and outsourcing of certain of Nortel Networks' manufacturing and
repair operations and assets, which was partially offset by one-time charges of
$103 million pre-tax ($69 million after-tax), primarily related to
restructuring.
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 $4,005 million pre-tax ($3,780 million after-tax), which was partially offset
by revenue growth and higher gross profits. These Acquisition Related Costs
related primarily to the acquisitions of Bay Networks, Qtera, Xros, and Clarify.
By comparison, Acquisition Related Costs for the first nine months of 1999 were
$1,538 million pre-tax ($1,350 million after-tax), primarily related to the
August 1998 acquisition of Bay Networks. The loss before income taxes for the
first nine months of 2000 also included $98 million pre-tax and after-tax stock
option compensation and one-time gains of $856 million pre-tax ($511 million
after-tax) primarily related to a gain from the Entrust Technologies Transaction
and the sale by Nortel Networks of a portion of its share ownership in Entrust
Technologies. These one-time gains were partially offset by one-time charges of
$197 million pre-tax ($176 million after-tax) related to restructuring. The loss
before income taxes for the first nine months of 1999 included one-time gains of
$167 million pre-tax ($110 million after-tax), primarily related to the
divestiture of certain of Nortel Networks' manufacturing and repair operations
and assets. These one-time gains were offset by one-time charges of $165 million
pre-tax ($111 million after-tax), primarily related to restructuring activities.
On a segmented basis, earnings before income taxes from operations for SP&C
for the third quarter of 2000 was $780 million, an increase of $340 million over
the same period in 1999. Earnings before income taxes from operations 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 from
operations for Other for the third quarter of 2000 was $1 million, compared to a
loss before income taxes from operations of $64 million for the same period in
1999. Earnings before income taxes for SP&C for the first nine months of 2000
was $2,368 million, an increase of $1,118 million over the same period in 1999.
Earnings before income taxes from operations 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 from operations for Other for the first
nine months of 2000 was $235 million, compared to a loss before income taxes
from operations of $299 million for the same period in 1999.
NET LOSS APPLICABLE TO COMMON SHARES
The net loss applicable to common shares for the third quarter and first
nine months of 2000 was $586 million and $2,061 million, respectively, or a loss
of $0.20 and $0.71 per common share, 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, or a loss of $0.03 and $0.19 per
common share, respectively, reflecting year-over-year increases in Acquisition
Related Costs and stock option compensation for the third quarter and first nine
months of 2000 of $878 million and $2,527 million, respectively. Excluding the
impact of Acquisition Related Costs, stock option compensation, and one-time
gains and charges for the third quarter and first nine months of 2000 the
Corporation recorded net earnings applicable to common shares of $574 million
and $1,482 million, respectively, or earnings of $0.18 and $0.48 per common
share on a diluted basis, respectively, compared to $314 million and $827
million, respectively, or earnings of $0.11 and $0.30 per common share on a
diluted basis, respectively, for the third quarter and first nine months of
1999. The increase in this measure of net earnings applicable to common shares
for the third quarter and first nine months of 2000, over the same periods in
1999, primarily reflected substantial
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<PAGE> 29
revenue growth and higher gross profits.
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) FOR THE THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------
2000 % OF TOTAL 1999 (1) % OF TOTAL % CHANGE
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SP&C $6,000 82 $3,885 76 54
Enterprise 1,313 18 1,241 24 6
Other 1 -- 21 -- (95)
--------------------------------------------------------------------------------
Total $7,314 100 $5,147 100 42
================================================================================
</TABLE>
<TABLE>
<CAPTION>
(MILLIONS OF U.S. DOLLARS) FOR THE NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------
2000 % OF TOTAL 1999 (1) % OF TOTAL % CHANGE
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SP&C $17,608 82 $10,985 75 60
Enterprise 3,844 18 3,663 25 5
Other 5 -- 66 -- (92)
--------------------------------------------------------------------------------
Total $21,457 100 $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 $2,167 million and $6,743 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.
SP&C
SP&C revenue growth of $2,115 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.
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<PAGE> 30
SP&C revenue growth of $6,623 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 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.
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<PAGE> 31
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 398 5 319 6 25
Other Countries 2,762 38 1,660 32 66
-------------------------------------------------------------------------------------------------------------
Total $ 7,314 100 $ 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 1,144 5 1,059 7 8
Other Countries 7,304 34 4,808 33 52
-------------------------------------------------------------------------------------------------------------
Total $ 21,457 100 $ 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.
Canada
The increase of $79 million, or 25 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 $85 million, or 8 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.
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<PAGE> 32
Other countries
Revenues for the third quarter of 2000 from Other Countries (countries
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 44.0% 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 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
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<PAGE> 33
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 $ 1,380 $ 952 $ 4,053 $ 2,789
As a percentage of revenues 18.9% 18.5% 18.9% 19.0%
</TABLE>
In the third quarter and first nine months of 2000, SG&A expense increased
by $428 million and $1,264 million, respectively, in absolute dollars, and as a
percentage of revenues increased by 0.4 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 $ 1,016 $ 767 $ 2,878 $ 2,178
As a percentage of revenues 13.9% 14.9% 13.4% 14.8%
</TABLE>
In absolute dollars, R&D expense increased in the third quarter and first
nine months of 2000 by $249 million and $700 million, respectively, or 32
percent in both periods, 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 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 1.0
percentage point and 1.4 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 for the First, Second and Third
Quarter 2000 Acquisitions was an aggregate amount of IPR&D of $1,062 million.
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
33
<PAGE> 34
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 products. Product-specific risk includes the stage of completion of each
project, 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.
A brief description of the IPR&D projects related to the Third Quarter 2000
Acquisitions is set forth below, including an estimated percentage-of-completion
of products within each project at their respective acquisition dates.
EPiCON
ALTIS VERSION 4.X. ALTiS is a software management and deployment platform
that can be used by both application service providers and enterprise
information technology departments to manage the deployment, installation and
management applications and remote applications on remote Windows PCs. Nortel
Networks estimated that the project was 45 percent complete at the time of
acquisition, that it would require approximately $1.5 million to complete the
project, and that the completed project would begin to contribute to Nortel
Networks' revenues by the end of the first quarter of 2002. A discount rate of
35 percent was employed in the analysis.
Architel
AUTOMATED SERVICE ACTIVATION PROGRAM ("ASAP") VERSION 4.3. ASAP is a
software system that allows communication providers to activate services
instantly for their customers and quickly realize revenues, while improving
customer service and reducing costs. Nortel Networks estimated that ASAP version
4.3 was 78 percent complete at the time of acquisition, and that it would
require approximately $0.1 million to complete the project. The completed
project began to contribute to Nortel Networks' revenues in the third quarter of
2000. A discount rate of 19 percent was employed in the analysis.
OBJECTEL VERSION 2.4. Objectel is a software system that provides accurate
inventory management, which enables real-time, flow-through network and service
provisioning. Nortel Networks estimated that Objectel version 2.4 was 60 percent
complete at the time of acquisition, that it would require approximately $0.4
million to complete the project, and that the completed project would begin to
contribute to Nortel Networks' revenues by the end of the fourth quarter of
2000. A discount rate of 19 percent was employed in the analysis.
ORDER MANAGEMENT SYSTEM ("OMS") VERSION 1.7. OMS is a software system that
reduces service delivery times, operating costs and time to market for new
services by automating the network and service provisioning processes. Nortel
Networks estimated that OMS version 1.7 was 7 percent complete at the time of
acquisition, that
34
<PAGE> 35
it would require approximately $0.5 million to complete the project and that the
completed project would begin to contribute to Nortel Networks' revenues by the
end of the fourth quarter of 2000. A discount rate of 19 percent was employed in
the analysis.
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:
CoreTek
GAIN TILT MONITOR ("GTM"). The GTM is a low-end wavelength monitor solution
that provides a measure of relative power accuracy per channel in Dense
Wavelength Division Multiplexing systems. The GTM was specifically designed to
be used in every long-haul line amplifier. Nortel Networks has revised its
original estimate and now expects that the completed project will begin to
contribute to Nortel Networks' revenues in the second quarter of 2001.
OPTICAL PERFORMANCE MONITOR ("OPM"). The OPM is a high-end wavelength
monitor. The OPM is geared to meet specifications provided by certain key
telecommunication service providers. Nortel Networks has revised its original
estimate and now expects that the completed project will begin to contribute to
Nortel Networks' revenues in the first quarter of 2001.
LASER LOCKER CARD ("LLC"). The LLC is a tunable laser configuration with an
optical feedback loop for wavelength locking. The LLC uses a differential etalon
approach that outputs a comparative signal into a closed feedback loop for
tuning and locking the laser. Nortel Networks estimated that the completed
project would begin to contribute to Nortel Networks' revenues by the end of the
fourth quarter of 2000.
Xros
X-1000. The X-1000 is an all-optical cross-connect system for fiber-optic
networks. Nortel Networks has revised its original estimates and now expects
that the completed project will begin to contribute to Nortel Networks'
revenues in the second half of 2001.
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.
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 its completion is expected to contribute to Nortel Networks'
revenues by the end of 2000.
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<PAGE> 36
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 $ 222 $ 171 $ 612 $ 513
Goodwill $ 1,089 $ 306 $ 2,378 $ 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 $1,034
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, Xros, and Clarify. As at September 30, 2000, the capitalized amount of
goodwill was $12,045 million.
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
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<PAGE> 37
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.
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.
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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 236 27 830 103
--------------------------------------------------------------------------------------------------
$ 220 $ 56 $ 808 $ 103
==================================================================================================
Interest expense $ 39 $ 38 $ 118 $ 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
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 $ 225 $ 110 $ 807 $ 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
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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 $ (921) $ (257) $ (664)
Cash flows from (used in) investing activities $ 263 $ (943) $ 1,206
Cash flows from financing activities $ 298 $ 156 $ 142
</TABLE>
Cash and cash equivalents ("cash") at September 30, 2000 of $1,758 million
decreased by $395 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 $921 million, compared to $257 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 $263 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 $297 million for the first nine months of
2000, 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 $1,160 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 $298 million, compared to $156 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 7 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.
Old Nortel 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) Old Nortel or (ii) NNCC and
guaranteed by Old Nortel, pursuant to a shelf registration statement filed with
the United States Securities and Exchange Commission. Old Nortel has also filed
in each of the provinces of Canada a short form prospectus under the Canadian
shelf prospectus program qualifying Old Nortel to issue up to C$500 million of
debt securities and warrants to purchase debt securities of Old Nortel. This
program will expire on February 23, 2002. On April 12, 2000, Nortel Networks
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<PAGE> 40
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 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
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<PAGE> 41
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 Old Nortel's securities commenced three
class actions in the United States District Court for the Southern District of
New York alleging that Old Nortel 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 Old Nortel. 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, Old Nortel 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.
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 of the Corporation and/or its subsidiaries 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
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<PAGE> 42
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 the 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.
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
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<PAGE> 43
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 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,
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<PAGE> 44
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. The Corporation 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.
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.
STOCK PRICE VOLATILITY. The common shares of the Corporation have
experienced, and may continue to experience, substantial price volatility,
particularly as a result of variations between the Corporation's actual or
anticipated financial results and the published expectations of analysts and as
a result of announcements by the Corporation and its competitors. In addition,
the stock market has experienced extreme price fluctuations that have affected
the market price of many technology companies in particular and that have often
been unrelated to the
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<PAGE> 45
operating performance of these companies. In addition, a major adjustment in the
capital markets may adversely impact Nortel Networks' ability to proceed with
future acquisitions. These factors, as well as general economic and political
conditions, may have a material adverse effect the market price of the
Corporation's common shares.
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; 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.
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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.
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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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Effective May 1, 2000, a newly formed Canadian corporation ("New Nortel";
also referred to herein as the "Corporation") and the corporation previously
known as Nortel Networks Corporation ("Old Nortel") participated in a Canadian
court-approved plan of arrangement (the "Arrangement") with BCE Inc. ("BCE"). 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 shareholders.
During the period covered by this report, the Corporation issued an
aggregate of 298,446 common shares upon the exercise of options under the Nortel
Networks/BCE 1985 Stock Option Plan and the Nortel Networks/BCE 1999 Stock
Option Plan (collectively, the "Nortel/BCE Plans") outside of the United States
to BCE employee optionholders under such plans that were not U.S. persons, as
more fully indicated in the table below. Such shares were deemed to be exempt
from registration under the United States Securities Act of 1933, as amended in
reliance upon the exemption provided by Regulation S thereunder.
<TABLE>
<CAPTION>
Number of Common Shares
Issued Without U.S.
Registration Upon Exercise Range of
of Stock Options Under Exercise Prices
Date of Exercise Nortel/BCE Plans US$
---------------- ---------------- ---------------
<S> <C> <C>
07/01/00 64,429 34.40 - 51.88
07/04/00 3,780 31.63 - 46.48
07/11/00 2,983 34.40 - 46.48
07/12/00 2,944 34.40 - 46.48
07/13/00 16,527 31.63 - 46.48
07/14/00 20,016 25.27 - 46.48
07/17/00 500 18.75
07/18/00 8,519 15.14 - 46.48
07/20/00 4,300 16.25
07/21/00 2,247 41.15
07/24/00 7,033 31.63 - 46.48
07/25/00 7,291 18.75 - 44.38
07/26/00 24,413 16.34 - 34.40
07/27/00 6,527 16.25 - 16.34
08/03/00 2,355 47.92
08/08/00 549 31.63
08/15/00 600 18.02
08/16/00 38,996 16.11 - 34.40
08/17/00 4,867 31.63 - 46.48
08/18/00 27,664 25.27 - 46.48
08/21/00 314 34.40
08/22/00 5,185 18.75 - 25.27
08/28/00 951 17.61
</TABLE>
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<TABLE>
<CAPTION>
Number of Common Shares
Issued Without U.S.
Registration Upon Exercise Range of
of Stock Options Under Exercise Prices
Date of Exercise Nortel/BCE Plans US$
---------------- ---------------- ---------------
<S> <C> <C>
08/30/00 19,197 31.63 - 46.48
09/01/00 22,851 34.40 - 51.88
09/05/00 980 31.63 - 34.40
09/11/00 800 45.56 - 45.59
09/12/00 598 42.65
09/19/00 1,030 16.25
</TABLE>
All monies received by the Corporation pursuant to the exercise of the stock
options under the Nortel/BCE Plans are transferred in full to BCE pursuant to
the terms of the Arrangement, except for nominal amounts paid in respect of the
rounding up of fractional entitlements into whole shares pursuant to the terms
of such plans, which amounts will be retained by the Corporation and used for
general corporate purposes.
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 July 26, 2000 announcing
its plans to invest approximately US$1.9 million in its global optical internet
business and also related to its financial outlook for 2000.
The Corporation filed a Report on Form 8-K dated August 7, 2000 and a 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 August 15, 2000, a Form
8-K/A dated August 25, 2000 and a Form 8-K/A dated October 20, 2000 related to
pro forma financial statements of the Corporation and the audited financial
statements of Alteon WebSystems, Inc. for the years ended June 30, 2000, 1999
and 1998.
The Corporation filed a Report on Form 8-K dated August 18, 2000 announcing
the signing of a definitive agreement to acquire Sonoma Systems.
The Corporation filed a Report on Form 8-K dated October 19, 2000 related
to its Restated Certificate and Articles of Incorporation.
The Corporation filed a Report on Form 8-K dated October 20, 2000
announcing the closing of the acquisition of Alteon WebSystems, Inc.
The Corporation filed a Report on Form 8-K dated October 27, 2000 related
to its financial outlook for 2000 and 2001.
The Corporation filed a Report on Form 8-K dated November 1, 2000
confirming its financial outlook for 2000 and 2001 and providing specific
guidance for the fourth quarter of 2000 and the first quarter of 2001.
48
<PAGE> 49
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
NORTEL NETWORKS CORPORATION
(REGISTRANT)
Chief Financial Officer Chief Accounting Officer
"F.A. DUNN" "D.C. BEATTY"
---------------------------- ----------------------------
F.A. DUNN D.C. BEATTY
Chief Financial Officer Controller
DATE: NOVEMBER 7, 2000
49
<PAGE> 50
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
